L&G Strategic Bond Fund: the importance of dynamism in difficult times

Our central investment thesis since the COVID-19 pandemic is that there has been a seismic global shift from monetary policy to fiscal policy. Governments that are currently sitting on large deficits will need to focus on growth – austerity is not an option.

As we settle into 2025, the key long-term risks markets face are:

• Domestic polarisation and inequality
• A worsening of US/China tensions
• Far-reaching ramifications of technological change, including artificial intelligence
• Climate change
• Government fiscal sustainability

We believe most of these threats come with the risk of higher interest rates caused by upward pressure on prices.

In our view, these factors are also likely to deliver shorter – and possibly sharper – economic and market cycles, which would create a very different backdrop for investors, particularly those in fixed income. If we are right, this will lead to more volatility and unpredictability.

To navigate the uncertainty, we rely on our global team of specialists spanning credit analysts, strategists and portfolio managers in London, Chicago, Singapore and Hong Kong.

We have identified US real interest rates, rate cut expectations and the US dollar as key market indicators to watch. The relationship between the new US government’s policy, interest rates and the US dollar is so strong that it’s almost impossible to disentangle them. A strong dollar and high real interest rates can have material impacts on emerging markets, particularly local currency emerging markets – which the fund does not actively invest in. We will also keep an eye on how countries react to any potential US tariffs imposed on them.

Another key factor we are monitoring is the strength of employment markets – which will determine the path of both interest rates and equity markets. Real wages are currently high across almost all developed market economies. But only the US consumer is using this boon to keep on spending to support the consumer-driven US economy, whereas the UK and European consumer don’t appear willing to spend – contributing to less than positive economic outlooks. Therefore, we are keeping an eye on company hiring intentions, how UK companies will change their pricing vs employment mix due to the national insurance hikes, and the impact of immigration curbs on the labour supply in the US economy.

The case for a fixed income all-rounder

While the role of fixed income assets during difficult times is well understood, this ever-evolving and unpredictable landscape is making it increasingly harder for financial advisers to select a number of separate fixed income funds to work together to provide a stable return for their clients. However, we believe a strategic bond fund can act as a ‘one stop shop’ for an investor’s fixed income allocation.

A wide investment universe

A strategic bond fund can invest across a broader range of fixed income assets, compared with traditional bond funds, providing the flexibility and diversification required to efficiently and effectively capture potential opportunities and aims to mitigate risks.

As the investment ‘looking glass’ for 2025 is unusually murky, we believe it is now more important than ever to maintain a wide range of investments across fixed income asset classes and to adapt quickly as market dynamics change.

Inflows to fixed income have been strong as investors are looking for a steady yield and, hopefully, returns that are uncorrelated with equity markets. So we’re seeking higher yields across global markets. We aim to  earn that yield over the course of the year in the belief that and it should  pay for most of the inevitable bumps in the road. For example, we’re currently looking for attractive yields in shorter maturities in selected emerging markets and in quality high yield companies, as well as subordinated debt of well-regulated banks that can provide investors higher yields than low-quality high yield companies. We increased our allocation to emerging markets and high yield in February 2024, which boosted returns as these were some of the stronger performers last year. We also have broad exposure to European real estate companies, which are in credit-repair mode and generated even stronger returns during the year.

Duration management

We believe the duration of fixed income portfolios should be managed in a more dynamic fashion in 2025. Over the last 40 years until 2021, duration had been something to ‘buy and hold’. However, a more volatile, shorter cycle backdrop will require not only a sharper focus on duration management of the entire portfolio, but also its interaction with risk assets. Our team includes interest rate experts who look at the dynamics between interest rates and credit spreads to actively manage duration. We actively position the fund’s duration with a view to the correlation of returns between government bonds and credit spreads. Without this, investors could face large capital losses.

Throughout 2021 and 2022, we maintained duration between 0 and 2.5 years as it became clearer that inflation would not be transitory.

Our duration management was also an important driver of fund performance and lower volatility over 2024. We successfully maintained a low duration exposure for the first half of the year, then increased this in July due to renewed recession fears in the market. As rates rallied amid the volatility at the start of August, we decided to take some profit from this position. We have also had several cross-market positions, such as Japanese government bonds versus US Treasuries, that would not be possible without the nimbleness and expertise of our rates team.

Risk management

The fund was constructed with a strong focus on risk management – which we believe will be an advantage in uncertain times. In our view, diversification of risk is the most important component of smoothing returns in fixed income investing. We seek to optimise risk-adjusted returns and have developed multiple sources of returns by diversifying across issues, issuers, sectors and regions. We also constantly monitor cross-correlations between these sources of returns to ensure there is no duplication of risk positions.

Our risk-management process also seeks to hedge against some of our bond exposures to mitigate potential downside risks or to reduce costs, for example through the use of derivatives, credit default indices or equity options. We increased our credit default swap index hedges in October 2024 as credit spreads, particularly in the US, reached decades-long tights: we didn’t want to reduce portfolio yield by reducing our physical corporate credit exposure, but wanted to add some protection against very tight areas of the market.

A fund for all seasons

The L&G Strategic Bond Fund offers a comprehensive solution for navigating fixed income markets and aims to smooth out investors’ journeys towards consistent, positive returns.

We diversify sources of alpha through credit selection, duration and risk management. We believe these three factors contribute differently to fund returns depending on market conditions.

L&G’s Asset Management division has over 50 years’ experience managing fixed income assets over many different market environments. The fund benefits from this experience and expertise by utilising a team-based approach; bringing together experts from across global fixed income, to understand the increasing complexity of credit markets and identify opportunities.

All these factors are crucial in helping the fund generate positive long-term returns, with top quartile returns over 2024 and over three and five year periods**. We believe we are well-equipped to navigate the challenges 2025 may bring in our aim to deliver consistent long-term returns for investors. 

Rolling 12-month performance to 31 December
2024	2023	2022	2021	2020
10.53	6.14	-4.13	2.52	12.52

**Source: Lipper, I Acc, GBP, net of fees as at 31 December 2024. Past performance is not a guide to the future.