Fund Focus: how to navigate the bond turmoil

Those who have taken part in the UK government bond buying renaissance of recent years would do well not to look at the news, or any price charts, right now.

That’s because it has been another wild week or so for these investments. 

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The fragile state of Sir Keir Starmer’s premiership has put bond investors on edge and yields (which move inversely to prices) on 10 and 30-year UK government bonds (gilts) have reached multi-decade highs.

The pain hasn’t just been reserved for the UK, what with worries about inflation (and higher interest rates) unsettling government bonds around the world. But the bond exposure you take, and the way you are taking it, has had a big bearing on returns.

Funds vs direct?

Government bond yields, which move inversely to prices, have moved to more attractive levels in the last few years, offering you a good level of income as well as, in theory, a low valuation. 

But yields have continued to rise in recent years and fund performance figures tell us how painful that period has been. The average fund in the Investment Association’s (IA) UK Gilts sector has lost around 20% over five years, with the UK Index Linked Gilts sector down by 35%.

As mentioned, we also have the prospect of another tough time for the asset class, or at least for government bonds and higher-quality corporate debt. 

Such instruments are highly sensitive to interest rate rises and higher rates more generally, meaning any inflation brought about by conflict in the Middle East could cause them further problems.

With gilts specifically, how you have taken exposure will make a big difference to your experience. 

If you bought gilts directly, as many have done in recent years, then you can simply hold that instrument until it matures and guarantee a set return, based on the yield when you bought it. 

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It is worth noting that interactive investor has seen strong demand for gilts with low coupons, meaning most of the return comes from capital gains as opposed to income. 

With funds it gets trickier, as you are stuck with the returns you receive. So, if you hold a government bond fund you might be waiting for it to recover, or even deploying more cash to try and buy in low. 

Government bond exposure is a problem for some of the other defensive funds investors use, from the likes of Vanguard LifeStrategy 20% Eq A Grs Acc to wealth preservation trusts such as Ruffer Investment Company. 

In 2022, when interest rate rises upended markets, we saw the LifeStrategy fund sustain heavier losses than the other names in that range, which have higher exposure to stock markets. 

Meanwhile Ruffer has a variety of different bond exposures but around a fifth of the portfolio is in either long-dated bonds or inflation-linked bonds, both of which have a bad time when rates rise.

Those who have bond exposure via funds might therefore at least want to diversify by subsector but also possibly by region.

Bonds are different beasts

As a reminder, government bonds and investment-grade bonds (corporate debt with a higher credit rating) are viewed as defensive assets when equities fall. 

But they are very sensitive to interest rate moves. It’s also worth remembering that with government bonds in particular, the issues surrounding a particular country or government can affect performance.

We saw that in 2022 with the UK’s disastrous “mini-Budget”, with Treasuries as the US fell out of favour last year, and have seen that in recent times again with the UK.

The bonds commonly viewed as higher risk, such as high-yield corporate bonds, have done better in recent years. They are less sensitive to interest rate moves, and their fate is decided more by the state of the economy and of the companies that issue such debt.

This performance divide is apparent if we look at some of the top bond funds by five-year returns. 

Royal London Sterl Extra Yld Bd A, a flexible fund that tends to focus on high-yield bonds, tops the table with a roughly 33% return, while other high yield-focused names such as Royal London Global Bd Opps Z GBP, Schroder Strategic Credit L Acc and Artemis High Income I Inc have also done well. We also see some funds with a focus on short duration, or low sensitivity to interest rate moves, doing well over that period.

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It could be worth hedging out interest rate risk via funds with a focus on low duration or high-yield credit, although the latter in particular comes with its own potential problems. It’s also worth asking how the flexible bond funds out there are positioned.

To look at a few names, the Fidelity Strategic Bond W Acc fund headed up by former Allianz manager Mike Riddell tends to have more of a macro-economic approach and actively seeks to have low correlation to equity markets. The fund has done relatively well so far in 2026, making a return of around 2%.

A more sedate flexible name, Jupiter Strategic Bond I Acc, has also done “well” with a 1.5% return. 

It tends to have a very spread out portfolio, with corporate bonds accounting for 55.7% of the portfolio and government bonds making up roughly a third. Meanwhile, MI TwentyFour AM Dynamic Bond I Acc, a flexible name that backs various esoteric parts of the market, has made around 0.8%.

A key requirement here may again be patience. But as I discussed when building a hypothetical cautious portfolio back in March, it’s also worth asking what alternative diversifiers need considering too.