Taking such a huge proportion of assets is unsurprising, considering the natural flight to safety in times of turmoil, but the money appears to be flowing to relatively few providers. Cofunds’ figures show that M&G took 18.4 per cent of gross sales over the first quarter while Invesco Perpetual accounted for 16.7 per cent. The two groups account for the top six best-selling funds on the Cofunds platform over the first three months of the year.
These two houses have fared well on the back of their long-term performance and reputations in bonds – and income – but they are about to be faced with further competition. A rally in financials is pushing once underperforming bond funds to the top of the returns’ table and legislative changes are paving the way for close-ended bond portfolios in the UK.
Investment trusts have historically faced difficulty in running bond portfolios due to taxation issues on distributions. At the AIC’s annual directors conference last week, it was revealed that new rules coming to the market will enable a more tax-efficient mechanism to distribute income via investment companies, enabling the creation of onshore- listed bond trusts.
With illiquidity plaguing areas of the bond market, particularly financials, the ability to run a closed-ended portfolio in the past few months would have been advantageous to some open-ended fund managers who struggled to contend with redemptions. Managers of open- ended bond funds with big financials weightings, which became difficult to value let alone sell during the height of the crisis, faced a spiral of redemptions as the bonds dragged down performance. But whether or not this situation will still exist or if the current popularity of the bond sectors is still around by the time groups are able to get away a fixed-interest investment trust – predicted to be later this year – remains to be seen.
Already, managers who were mired in financials are starting to see some recovery feed through to their portfolios and even intermediaries are starting to see attraction in buying managers who have holdings in this area. One of the higher-profile managers caught in this cycle has been Old Mutual’s Stephen Snowden, who over one year to April 23 has fallen by more than 32 per cent, according to Trustnet figures, ranking the fund 88 out of a peer group of 89. New Star’s sterling corporate bond fund, managed by Phil Roantree prior to the takeover of the firm by Henderson, is the only fund which did worse over that period and he too has been heavily exposed to financials, with 18 per cent of his portfolio in tier-one bank debt.
But over recent weeks, things have changed. Chelsea Financial Services managing director Darius McDermott says bond managers with financials have seen a bounceback in performance. He says: “If you are looking for a capital return out of corporate, then you want those with riskier positions.”
Over one month to April 23, Snowden’s AAA-rated Old Mutual portfolio has jumped to the top of the pile, ranking fourth on the back of returns of 4.9 per cent compared with a sector average gain of 0.7 per cent. New Star’s fund is ranked 15th out of 93 over the past month.
Of liquidity in the corporate bond space, Liontrust head of fixed income Simon Thorp says: “It has got significantly better.” Although he notes that there remain liquidity issues in the high-yield market, the situation has improved for investment-grade corporates. With new corporate issuance being snapped up, the popularity of the primary bond market has had a waterfall effect on the once-clogged secondary space.
Thorp says new buyers of credit are coming in, including equity players and institutional investors.
He says: “Six months ago, there were 10 sellers to every buyer and now there is a greater balance between buyers and sellers.”
But he adds that the bid/offer spreads on many issues remains wide. With regard to bank debt, Thorp says that what has been an area of great uncertainty and one investors were avoiding, the risk/reward dynamics now looks more favourable.
He says: “Tier-one financials have begun to see buying from high-yield, distressed debt and vulture funds.” He is starting to see the attractions of financials. “We think we have seen the worst of the surprises in the banking sector and I would expect financials to outperform corporates over 18 months.”
In his March factsheet, Snowden says he was continuing to buy financials despite his more recent difficulty in the sector. With regard to the market in corporates, he says: “While a definitive end to the global market downturn has yet to be seen, we believe that credit markets are very well placed to deliver strong returns over the medium to long term. With banks buying back their own debt and with the Bank of England purchasing corporate bonds, the supply/demand dynamic should support the asset class which has been savaged almost continuously for nearly two years.”
Corporate bonds have seen record inflows in recent months despite relatively lacklustre performance and as wary investors continue to seek shelter in uncertain markets, their popularity is likely to continue.
The structure of the fund as well as the type of holdings within it in the context of wider market movements will require greater scrutiny and research from intermediaries in the months ahead. With new bond investment trusts undoubtedly set to launch and with resurgence in once struggling portfolios, intermediaries will be faced with numerous choices within the once plain vanilla investment-grade corporate bond sector.