A lower risk bond fund if rates stay higher for longer

The latest economic data suggests that inflation is proving stickier than expected and may not fall back to its 2% target as quickly as first thought. If this continues to be the case then the Bank of England may decide to keep interest rates higher for longer.

Cautious investors who are concerned about this sort of scenario might want to consider a high quality, short duration bond fund. These currently offer the prospect of a real return in excess of inflation and have very low risk.

Why short duration?

A short duration bond is one with relatively little time left to maturity. Securities that fall into this category are less sensitive to changes in interest rates, because the principal (the amount the issuer agrees to pay back the investor) is repaid more quickly and can be reinvested earlier. This means that if rates stay higher for longer than expected, the value of the bonds should be largely unaffected.

A member of the Select 50

One way to gain exposure would be AXA Sterling Credit Short Duration Bond, which is a member of Fidelity’s Select 50 list of handpicked funds. It aims to provide income combined with any capital growth over the short-term, which is defined as a period of three years or less.

The fund is actively managed without reference to any benchmark and over the year to the end of March generated a total return of 6.61%. This was an attractive result given the low-risk nature of the holdings. Please remember past performance is not a reliable indicator of future returns.

The underlying portfolio

It has a diversified portfolio of 194 separate securities spread across 142 different issuers. Almost three quarters of the assets are invested in corporate bonds from the financial and industrial sectors, with only around 12% in sovereign, quasi and foreign government debt.

The UK is the largest allocation at 36%, with the rest divided between other developed countries, principally Germany, the US and France. Despite this, just under 94% of the fund is denominated or hedged back to sterling, thereby eliminating most of the currency risk.

All the holdings are investment grade, which are considered to be the least likely to default, with the typical maturity being somewhere between one and five years. The modified duration of the portfolio as a whole is 2.45 years, which makes it relatively insensitive to changes in interest rate expectations.

What are the manager’s latest views?

In his March update, manager Nicholas Trindade expects market conditions to remain very volatile as the macroeconomic outlook continues to be uncertain given high interest rates, sticky inflation, slowing growth and tighter lending conditions.

"As a result, we have reduced the overall level of credit risk as valuations look fair to expensive. Still, we believe the yields available on sterling short-dated bonds remain attractive due to the inverted gilt yield and credit curves.” He said.

How much income does it pay?

AXA Sterling Credit Short Duration Bond pays quarterly dividends in January, April, July and October. These have increased steadily over the course of the last year, with the fund offering an historic yield of 3.5%. Please note this is not guaranteed.¹

How do the costs stack up?

The fund has relatively low ongoing charges of 0.41%, which is what you would expect from this sort of portfolio.

What other options are there?

If interest rates do remain higher for longer, the nearest equivalent would be a money market fund. Popular options on the Fidelity platform include the Fidelity Cash Fund and the Legal & General Cash Trust. Read more on the role of cash funds in a portfolio.

More on AXA Sterling Credit Short Duration Bond

Past performance is not a reliable indicator of future returns
Source: Morningstar from 31.3.19 to 31.3.24. Basis: bid to bid with income reinvested in GBP. Excludes initial charge. The fund’s primary share class according to the IA is shown.

Source:

¹ AXA Sterling Credit Short Duration Bond Fund factsheet, 28.3.24

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Select 50 is not a personal recommendation to buy or sell a fund. The AXA Sterling Credit Short Duration Bond Fund can invest in overseas markets so the value of investments could be affected by changes in currency exchange rates. The fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Due to the greater possibility of default an investment in a corporate bond is generally less secure than an investment in government bonds. Tax treatment depends on individual circumstances and all tax rules may change in the future. The Key Information Document (KID) for Fidelity and non-Fidelity funds is available in English and can be obtained from our website at www.fidelity.co.uk. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.