Bond navigators: Unconstrained active management

Our Global Bond Opportunities fund is the global sibling of our Sterling Extra Yield fund, where both funds are united by the application of one core investment philosophy: we believe that there are fundamental inefficiencies in credit markets.

In our view, active credit management thrives on these inefficiencies and although these are not always evident, we believe that there are certain biases within debt markets that maintain them.

The funds have a common approach to value; Global Bond Opportunities started with an idea to complement the success of Sterling Extra Yield but with greater flexibility to invest in global credit markets. In concept, the funds are simple. We believe that credit markets offer investors long-established inefficiencies. Our emphasis on covenants (legal constraints), structure (position in the capital structure) and security (claim on specific assets) seeks to improve the balance of risk and return and we believe this contributes to performance over the medium term.

Royal London Global Bond Opportunities Fund

Royal London Sterling Extra Yield Bond Fund

No benchmark, no problem

While the two funds have a similar investment philosophy, the make-up of each fund is quite different. So why do funds see such similar returns over medium (and long) term?

Over the years, we have seen the opportunity set change, but our search for value has not. We adapt how we do this to reflect the way the market has shifted and the opportunity it provides. A key aspect underpinning this approach is the lack of constraint from a benchmark – meaning neither fund has been dragged into positions that the philosophy would see as ‘unvaluable’, just because this helps manage risk relative to a benchmark. This is a key difference in mindset between looking to ‘outperform’, and instead simply looking to produce solid absolute returns whatever the prevailing market conditions.

A good example of this was during the recent interest rate cycle. The funds were in a position to avoid having to invest in long-dated bonds at low yields, and instead stick to their bottom-up investing process. Reflecting this, the funds have increased exposure to floating rate notes, where interest payments are linked to cash rates, which can help reduce interest rate risk in the funds and continue to generate income. This approach mitigated the impact on the funds in 2022 following the rise of government bond yields as interest rates increased while the income from the floating rate notes was steady.

Our focus is always on returns, not relative performance. One example of this is how the funds shift between investment grade and high yield markets, increasing and decreasing exposure as market conditions change. We don’t look at whether a bond is investment grade or high yield, rather on whether or not we consider it an attractive investment. The funds are opportunistic.

Unrated, not unloved

Another key element to the funds’ performance is our exposure to unrated bonds. Some of the opportunities we find in securities that do not have a formal credit rating. Under our approach, the absence of a rating on its own is just one aspect of our assessment. This encompasses the sector, maturity or even the secured nature of a bond. Each of which in isolation, is unlikely to make us want to hold a security. The same applies to the rating (or lack of one).

Some of these non-rated bonds are from issuers that also have rated bonds in issue; it is the bond that is rated, not the issuer. However, many non-rated bonds have some enhanced protective features or offer ring-fenced collateral as compensation for the lack of rating. The choice of which to buy comes down to valuation.

The largest issued bond currently in the market, at a cool EUR7.8bn, is an unrated Rabobank bond which is not in benchmark indices due to that lack of rating. A benchmark-constrained fund may not be allowed to own such a bond, but both of our funds hold this issue. We always get back to our bottom-up approach, with sector and stock selection being our key drivers of performance.

With an ever-changing opportunity set, the funds can look to invest where we see value without compromising returns and income generation. In the current market, the composition of all-in yields is very different to what it has been in the past – but we believe that the funds can continue to excel in this yield environment.

Income: attractive but not the end goal

Income generation has been a consistent theme throughout the life of the funds. In our view, performance will always come from finding where the attractive balance of risk versus return lies, and we don’t chase where that might be. Instead, we monitor opportunities across a broad spectrum. We are not focused solely on income – the funds can hold zero coupon bonds or low income assets – so long as we believe these offer the prospect of attractive medium-term returns. We have to be aware of risk, but where we see attractive income we have the flexibility to lock that in. Income is a useful component towards achieving our goal, not a goal in itself. Higher yielding bonds generally reflect higher risk but we target bonds which offer an attractive yield with the aim of maximising income, without taking on the degree of risk associated with high yield bond funds.

The advantage of having no benchmark is that we are not pulled into areas of risk where we do not see value, especially in volatile markets. Benchmarks can become more volatile due to the nature of constituents and their indebtedness, but we can focus on the quantum of risk – we don’t buy what we don’t want to buy.

How do you achieve performance?

At present, financials continue to provide a key area of opportunity, as the regulatory backdrop has been very supportive for bank debt since the Great Financial Crisis. Floating rate notes play a big part in our flexible approach, but it’s also important to note that these funds are not made up of quirky names. Many of the names in the portfolios are very recognisable names.

Another major focus is diversification. No fund will see long-term success without diversification being part of the underlying investment philosophy. The funds aims to mitigate stock specific risk by holding a diversified portfolio of investments, so that no individual investment can, in isolation, have an excessive impact on overall fund performance.

Volatility in the first half of 2025, which has somehow ramped up from what has felt like constant volatility since the start of Covid, has been the perfect example of this philosophy can thrive.

Most of the volatility in fixed income markets has come from government bonds. The rhetoric coming from the new US administration is largely being taken in stride by corporate bond markets now. In our view, the best way to navigate volatile markets, is to focus on asset-rich sectors – and this has been a pillar for us since these funds launched.

The philosophy of our established and experienced investment grade sterling credit team is complementary to how these funds are run. There is consistency in how we see value, which is the foundation of the funds. We follow the model that has seen high levels of success over the decades, but we are afforded an extra layer of flexibility to find ‘yieldier’ opportunities and a wider opportunity investing universe.

For professional investors only.  This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. Reference to any security is for information purposes only and should not be considered a recommendation to buy or sell.

The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change. Forward looking statements are subject to certain risks and uncertainties,  Actual outcomes may be materially different from those expressed or implied.