In 2004, the top selling bond fund at Fundsupermart was the Shenton Income Fund (click here for factsheet). This global bond fund is an absolute return unit trust that can invest in almost any bond market. Unlike relative return bond funds, which are benchmarked against a global bond index, the Shenton Income Fund (SIF) is benchmarked against the 12-month Fixed Deposit (see chart below for fund performance against the benchmark). According to the fund house, this is because the objective of the fund is to provide positive returns to investors. As investors are familiar with the concept of receiving positive interest/returns from S$ fixed deposits, using the 12-mth SGD FD rate as the benchmark for SIF communicates the objective of the fund clearly.

Source: Fundsupermart

The fact that it can invest in Emerging Markets, has raised concerns about the volatility of the fund. The fund house says that while the fund can tactically invest in Emerging Markets, it invests in high quality credits with a rating of around single A, and in countries like Poland and Hungary. They add that risk controls are in place to ensure that the fund does not take excessive risk.

The fund size currently stands at S$775 million (as at 31 Jan 2005), which is large by Singapore standards. The fund returned an annualised 9.32%, 9.15% and 6.51% in the 3-year, 2-year 1-year period ending 31 December 2004 (figures calculated using offer-to-bid prices and in SGD, with income re-invested). This performance compares well with other global bond funds as shown in the first table below (the performance tables compare both absolute return and relative return global bond funds). On a risk adjusted basis for the same period, the fund also holds up well against its peers (see 2nd table below). This indicates the fund is not taking excessive risk for extra return, says Chan who has 11 years experience in the investment industry.

INVESTMENT STRATEGY

The fund is managed by Chan, who works with the fixed income investment team at DBS Asset Management. The team meets quarterly to discuss country views (see below). They also at this time decide the currency, duration and yield curve strategy, which are three key themes for this fund. Credit selection includes putting bonds through a 'credit scoring model', which reflects whether the bond should be bought. Failure to meet the requisite criteria means that the bond will not be selected for the portfolio.

Source: DBS Asset Management

As the lead manager for the fund, Chan says that he has the final say as to what goes into the fund. That said, he can't ignore the fixed income investment team's views. For example, if the consensus is that the team is bearish on the US bond maket and the US dollar, he can at best take a neutral position in that bond market.

While the fund does have the leeway to invest in corporate bonds, most of its bets are now in sovereign (or government) bonds. There are a few reasons for this. First, the environment now isn't favourable for global corporate bonds says Chan. Also, corporate bonds in emerging markets tend to be exposed to higher business risk, as corporate governance in these markets is much poorer than in developed bond markets. As such, liquidity tends to be much tighter for these bonds.

THE CURRENCY QUESTION

One common misconception about this fund is that it actively trades currencies. While the fund is exposed to currency risk, it does not buy and sell currencies per se. Rather the exposure to foreign currencies comes in the form of investments into locally denominated bonds. These are foreign bonds that are denominated in their home currencies (e.g. an Indonesian bond denominated in rupiah), rather than in US dollars. This allows the fund manager to capitalize from a currency gain, as well as from a potentially higher yield. The market for locally denominated debt is large, as many countries issue sovereign debt in their own currencies. According to a Merrill Lynch study, it's worth more than US$2 trillion dollars.

Chan says that as the US dollar has been falling against most other currencies and should continue to do so, investing in locally denominated debt is now a central strategy for the fund. "If I buy Indonesian debt in rupiah, they pay me around 12%, but when that bond is denominated in USD that drops to 7%. Anyway, the US dollar debt only takes up 16% of the fund, and my core currency exposure to the US dollar is 9%. About 44% of the fund is in Euro currency and this includes Eastern European currencies that are tied to the EUR, because they are pegged. But my base currency is still the Singapore dollar."

Chan adds that if he likes a foreign bond but feels that its currency will depreciate against the Singapore dollar, he has the option of hedging that bond back into SGD, which is the base currency for the fund. However he emphasises that he doesn't trade currencies. "If I don't have Philippine bonds in my portfolio, but I feel that the Philippine peso (PhP) will appreciate against the Singapore dollar, I won't go out and buy peso and sell SGD. We don't go into the currency market to play currencies. Our currency views are a result of the underlying bonds that we hold in the portfolio."

Currently the fund's exposure to SGD is about 30%. He says that he didn't hedge a number of the fund's holdings back into Singapore dollars because he isn't that positive on the Singapore dollar. As a result, the fund suffered a loss recently, when the Singapore dollar appreciated against several currencies. The fund manager believes that this appreciation is temporary.

RISK CONTROL THROUGH DIVERSIFICATION

At present, 90% of the fund is in investment grade debt (BBB credit rating and above), and the rest is in non-rated bonds. These non-rated bonds are mostly Singapore corporate bonds that have no risk classification. Chan says the fund can at most invest 10% of its holdings in sub-investment grade bonds (those with a rating below BBB by Standard & Poors). The duration of the fund is 3.7 years, and slightly under half the fund is in bonds with a BBB rating. Chan says the fund can trade to capitalize on price appreciation. He frequently sells bonds before the maturity date to lock in a profit.

He adds that risk is controlled through portfolio diversification. The fund has almost 200 bonds in its portfolio, and this is spread across a wide variety of countries and sectors. For example, the Top 10 holdings as at end December 2004, account for only 16% of the fund. Also, any country that forms less than 4% of the fund is classified under 'Others'. The fund has around 30% of its holdings in this category (see below). The fund also has around 8% in supranationals. These are bonds issued by entities such as the World Bank.

COUNTRY & SECTOR ALLOCATION OF THE FUND AS AT 31 DECEMBER 2004

Source: DBS Asset Management

The fund's volatility did increase last year. According to the fund house, annual volatility in 2003 was around 3.2%, and in 2004 it rose to 4.5%. The volatility of the fund over three year rolling periods (from the fund’s inception in Jan 1989 to Dec 2004) ranges from 3.2% to 4.5% per annum. The increase in volatility was a result of currency movements last year, as the fund increased its exposure to locally denominated debt. The fund manager says that the volatility of the fund is comparable to that of most global bond funds, and adds that by taking a bit more risk, he has the chance to improve returns.

"Take the 10-year Singapore Government Bond, which is rated AAA. each year if nothing happens I will get 3%, as well as my capital. Now I go into Indonesian 10-year government bond denominated in rupiah, and that gives me 12%. So nothing happens then I get 12%. What if the Indonesian currency weakens by 5%? (which is rather extreme) I still have a yield gain of 7%. I may have a loss on the currency but I have a gain on the yield. Whereas for my Singapore government bond, even though I don't have a currency loss, my yield is still lower. This is the reason that I don't want to park too much in SGD, because you really can't get too much out from here, and I avoid Singapore corporate bonds because of poor liquidity."

WHERE DOES THIS FUND BELONG IN AN INVESTMENT PORTFOLIO?

This fund is on our Fundsupermart Recommended list, and can be part of a core portfolio for the long term investor. That's because global bond funds are considered low risk (with a Fundsupermart risk rating of 2; click here to view our risk rating system) and have lower volatility than equity funds. Thus they provide much needed stability through various market conditions. Although bond markets can go through cycles, the fluctuation of bond funds is much lower when compared to equity funds. Historically, bond funds seldom go through years when the overall return is negative. Most times global bond funds can provide a consistent positive return, although this may be significantly lower than what an equity fund can achieve in a rising market.

Source: Fundsupermart

The pie chart above illustrates where global bond funds belong in an overall portfolio. The percentage which should be allocated to global bond funds is dependent on an individual's risk profile. The diagram below shows the asset allocation for a balanced investor, and may not reflect an individual's risk/return profile. (To view investment portfolios tailored for different risk profiles, click here for our Fundsupermart Recommended portfolios).

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