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Corporate bonds – the next bubble to burst?

With cash yields nearing zero investors are looking for somewhere else to park their money. Enter corporate bonds. But with rising default levels and multiple rate cuts forecasted do credit markets really offer such good value on a risk return basis?

In this week’s Money Marketing multi-manager boutique Thames River Capital has questioned the recent wholesale shift into corporate bonds and says it has all the hallmarks of the commercial property bubble of 2006.

Co-head Gary Potter is concerned by the number of clients switching out of cash and into corporates bonds in search of higher returns and warns that the asset class carries significant risks.

He says: “I can see the argument that cash yields are very low and corporate bond yields are quite high but I’m not completely convinced. It worries me that clients are being encouraged out of cash and piling into corporates as it is one hell of a different asset class and there are still significant risks of capital destruction.

“This has all the hallmarks of people piling into property two years ago then piling into commodities in May last year. It’s almost such an obvious trade that it rarely goes the same way as expected.”

Thames River remains guarded on corporates and is not piling in and out of cash but tactically adding to them, favouring managers such as M&G and Invesco Perpetual.

Potter says: “You might say you’ve got a coupon of 8 per cent but if you lost your 8 per cent you might as well have been in cash as your risk return profile is worse. I can go along with the whole thing to a point with good managers but they’re taking huge amounts of money and people need to be careful.”

OPM Fund Management chief investment officer Tony Yousefian is mindful of valuing corporate bonds and their spreads on historical comparisons as current market conditions are different to previous economic downturns.

He says: “Everyone says investment grade bonds are really good value because of the spreads they are trading above gilts. Either something is very expensive and can get cheaper or something is cheap and can get dear. There is the outside chance that gilt yields will pick up and close that anomaly.”

Invesco Perpetual’s corporate bond fund launched in July 1995 and hit £3,105.14m at the end of January. Fund managers Paul Read and Paul Causer anticipate default rates to increase, particularly in the high yield space, but believe credit markets offer attractive medium-term value. They say: “The market is currently discounting unprecedented levels of default, especially in investment-grade bonds. In our opinion, these levels are unlikely.”

Fidelity International fixed income product manager Curtis Evans says a bet against corporate bonds is a bet against the central banks and policy makers who are determined to boost the economy.

He says: “We think credit does offer substantial value and is certainly not showing signs of a bubble. What’s in the price of corporate bonds is something of a depression and you get ample compensation for both default risk and risk of a rating downgrade.”

However he warns that deleveraging and effectively gauging the amount of forced selling that may still be coming is the key challenge for the market.

Premier Wealth Management managing director Adrian Shandley says: “People are going into corporate bonds because they’re perceived as the next to cash option but investors shouldn’t really be in one single asset anyway, they’ve got to be diversified.

“I don’t think corporate bonds should be singled out as gold, corporate assets, gilts, absolutely everything has the hallmarks of a nightmare waiting to happen.”

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