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Analysis: Bond opportunities for those who tread with care

For the last year or so concern has grown over whether a bond bubble is developing, especially given current fiscal policies being pursued by policymakers across the globe.

Despite this, experts suggest there is plenty of fixed income opportunity available to those who make careful choices and take advantage of fiscal measures being implemented by governments.

Current investor sentiment is reflected in net retail sales from the Investment Management Association where bonds have been toppled from their perch as the bestselling asset class by equities in recent months. Bonds only saw £317m of inflows in September 2012, the lowest amount recorded in the last year.

Skerritt Consultants head of investment Andy Merricks rejects the suggestion that a bond bubble is being created. He says bonds are still a safe asset class, if you are selective, and will continue to be so next year.

He says: “Corporate bonds are a good place to be, a lot of people talk about bubbles and so on but if you think about any bond, it doesn’t matter whether its a gilt, US treasury, corporate bond or junk bond, they either mature or default and they can’t do anything else.”

“If they do not default they Will mature and that is important with corporate bonds because all of this trouble we have been having in Europe, has been turned on its head because the biggest risk has been countries and not companies.”

Dennehy Weller & Co managing director Brian Dennehy says the biggest issue in bond markets is the fact prices are being manipulated by governments, something investors can play to their advantage.

He says: “The government bond market is driven by central banks, so the market is being manipulated. We can either get grumpy by the fact markets are being manipulated or we can figure out what the best thing to do is in that context.”

Henderson Global Investors Strategic Bond fund manager John Pattullo is seeing plenty of opportunities. In September he added more risk to his stable of bond funds, suggesting decisions made by both the US and European banks to support quantitative easing had resulted in a risk-fuelled, liquidity rally.

When it comes to managing his Strategic Bond fund, Pattullo says: “The bulk of our fund is structured around BBB – which is the bottom end of investment grade – and BB credit – which is the top end of high yield – in core countries in Europe.”

He explains: “In core businesses which aren’t particularly cyclical, there is no value in gilts and AAA credit because the price has been manipulated by governments. There is also not much risk adjusted value in our opinion at the bottom end of high yield, the CCC market. In this environment there’s not much growth, there’s no inflation and hence it is hard for companies to grow and unless you’re growing you can’t pay debt and if you have a triple CCC balance sheet it means you’re very levered.”

JP Morgan Asset Management international chief investment officer Nick Gartside is also positive about bond investment opportunities. He predicts interest rates will remain low for longer than many expect

The JP Morgan Strategic Bond fund currently yields around 3.7 per cent and is looking to increase this above 4 per cent next year.

Gartside says a third of assets are in investment grade corporates, a very global allocation, a third are in high yield companies with about 10 per cent in covered bonds. Around 15 per cent are in mortgage bonds and 5 per cent is in emerging market debt.

Alongside opportunities there are dangers that should not be overlooked. Pattullo warns investors against chasing excessive yields.

He says: “Chasing yield in an environment where businesses cannot de-lever is tough because there is no growth, it is probably not a good strategy.”

“We are currently yielding around 6 per cent, the value lives in those bonds which yield between 4 and 8 per cent. Gilts yield only at 1.8 per cent and I don’t think there is any value there. Then the triple CCC’s yield between 0-12 per cent and I don’t think that yield is stable.”

“The strategy is to go for the yields in double BB part of the curve in core businesses which are non cyclical, in core countries.”

He says this method has worked well for his strategic bond fund this year and he does not expect next year to be wildly different.

Dennehy agrees the outlook will not change drastically for bonds in 2013.

He says: “You will continue to get 5-6 per cent on high yield bonds but don’t expect any capital gains. You will get 3-4 per cent on investment grade bonds, but again don’t expect any capital gain and on government bonds 1-2 per cent

“People have to be on their toes, you have to be very wary. There are a lot of issues out there and any one of them could spook the bond markets. They are very fragile.”

Merricks says: “There is no reason why high yield can’t return a 6-7 per cent yield in 2013 and with default concerns beginning to disappear that is an attractive yield in this environment. I also believe 3 to 4 per cent for investment grade is not unreasonable. I don’t expect us to be reducing our exposure as I believe the corporate picture will improve in 2013.”


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