Investment-grade debt appears to be losing its lustre as investors become split between the search for income and perceived value in equity markets.
The sterling corporate bond sector became the focus of attention in the aftermath of the Lehman Brothers’ collapse as investors took advantage of opportunities in the asset class. Between August 1, 2008 and July 31, 2009, the sector saw net inflows of over £6bn as forced sellers and panicked markets forced spreads out to historical highs.
Retail investors are often accused of buying into assets only after the rally has taken place, but on this occasion such sentiments proved false. From November 2008, net monthly inflows into the sterling corporate bond sector began to pick up pace, peaking at over £1bn in January 2009.
Between January 1, 2009 and October 1, 2011, the average fund in the sector has returned 24.23 per cent. This compares favourably with the return of 21.55 per cent from the sector over the preceding decade.
Close Asset Management portfolio manager and fund research specialist James Davies says: “I think, with the exception of this year, the past few years have been a bit of a golden age for corporate bonds. It was almost unique in that you pretty much knew that spreads were going to come back in. Certainly, I believe it was something of an anomaly.”
Despite the impressive returns, investors are now faced with a growing dilemma. While yields on British corporate debt continue to offer a premium to government paper, they have been hit by uncertainties surrounding the eurozone debt crisis. Indeed, Fidelity strategic bond fund manager Ian Spreadbury wrote in a note that credit spreads had reached their “widest level in over two years”.
He said: “Falling margins reduce the ease with which companies can service their debt. This is a negative for corporate bond investors but at this point I expect fundamentals to weaken at the margin rather than decline dramatically.”
Many of the investors who successfully read the overshoot of pessimism in 2009 may now be wondering if the current market environment offers a similarly compelling case. The likelihood of repeating the returns of the past few years, however, is slight and concerns over the medium-term economic outlook appear less focused on fears of a sudden economic collapse as a gradual, painful decline.
Davies says: “People are being pushed down the risk spectrum. As gilt yields look set to stay low for a prolonged period they have been forced to move into investmentgrade credit. People will continue to need income and if government debt is not providing it, then investment-grade is likely to be the first port of call.”
That said, the flows suggest a more cautious approach is being taken to the asset class than was the case in 2009. Over the 12 months to August 31, the sterling corporate bond sector saw net retail outflows of £449.8m as investors reflected broader negative sentiment in markets.
Although flows have been positive in recent months there are few signs of overoptimism at current levels. Yet there are equally few signs of a panicked flight from the sector, which may indicate many investors are following a wait-and-see approach to their fixed-income exposure.
A lot of attention will be focused on the outcome of the G20 summit of finance ministers and central bankers taking place next month. In order to maintain confidence in fixed-income markets, investors will need to see policymakers go some way to reassure them that corporate Europe can break free of concerns over further demand weakness and demonstrate that current fears over default risks are exaggerated.
Data supplied by Financial Express