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Corporate casualties

The popularity of corporate bonds is dwindling as concerns over liquidity return. Chris Salih reports

It was less than a year ago that corporate bonds were in the midst of a once-ina-lifetime opportunity and investors were cashing in as the IMA sector sat at the top of the best-sellers’ tree.

The rebound came quick on the heels of concerns over liquidity in corporate bonds funds at the end of 2008. At one point last year, some funds were up by 50 per cent in six months but the sector has started to see its popularity dwindle as concerns regarding liquidity have started to return.

Dennehy Weller managing director Brian Dennehy says May was an “ugly month” for corporate bonds, highlighting the fact that it is not the prices of the funds that have collapsed but that the underlying market has become illiquid.

He says all fund managers were aware of liquidity problems ahead of this but says the concerns over the risk of default by Greece as well as Angela Merkel’s shortselling ban reflecting political risks were the catalyst for May’s problems.

He says: “What we have had in May is a warning sign that we still have a liquidity problem in bonds and what is arguably worse now is that significant liquidity in 2008 was provided by the investment banks, many of which are now defunct, so the potential for a ceasing up in corporate bond market is very real.”

Dennehy says there has been a lot of stress in European banks for some time as they are undercapitalised.

“Not only have their economies been turning down, which will increase bad debt provisions, but they also have the problem of being big holders of sovereign debt. The risks are rising so sharply and I do not think people appreciate what they are. This is not a time to be brave but to take some risk off the table.”

Last week, banks and investment funds offered a record £507.3m of corporate bonds to the Bank of England as they look to move into safer areas of the market. The offers into the asset purchase facility reached a record number since its launch in March 2009. The total was £175m greater than the previous high in October 2009. The central bank only buys what it deems to be competitively priced investment grade bonds. It finally agreed to buy £94.2m.

Hargreaves Lansdown investment manager Ben Yearsley says it is some-thing to be wary of, partic-ularly in the banking area.

He says: “Nothing has changed in the past couple of months as liquidity remains an issue. I think the Greek issue has got everyone’s back up and as a result everyone has taken a little bit off the table. The difference is that the banks are not trading on their own books like they used to which is a big problem.”

The Greek issue has got everyone’s back up and as a result everyone has taken a little bit off the table. The difference is that the banks are not trading on their own books like they used to which is a big problem’

Hargreaves Lansdown is currently neutral on corporate bonds, given that you can still receive more interest than you would in a bank account.

Yearsley says: “It is still providing above average yields but the key is to know what you are buying. Whether it gets worse or not depends on Europe as the bank issue could spread to the UK and naturally lots of bond funds do hold banks and banks still make a huge proportion of investment grade debt.”

Henderson strategic bond fund manager John Pattullo says liquidity remains an underlying concern. He says his firm uses credit derivatives to mitigate any liquidity concerns as well as having a high cash weighting – £66m worth – courtesy of strong inflows continuing to come into strategic bond funds.

He says: “The major issue the last time we saw big liquidity problems was forced redemptions due to de-leveraging, which causes more redemptions and de-leveraging and so on. We have not seen that this time as leveraging has not been as strong on this occasion. Also, the Bank of England facility has come in as a backstop bid for those requiring liquidity. That still acts as an advantage to investors.”

Pattullo says it is unlikely we could see any bond funds suspended due to liquidity issues as economic and company data remains strong. He also says policymakers are obsessed with insuring that the breakdown in the banking system is not repeated.

“We think this is more of a wobble than a whole new crisis. The fear is fear itself,” he adds.

Skerritt Consultants head of investments Andy Merricks agrees that the liquidity problems are not the same as those seen in the financial meltdown but says investors would be mad to ignore the risks.

“We are still mainly in the strategic sector but we are not selling out of the likes of JP Morgan global high yield and Invesco Perpetual monthly income plus. We are not selling them down either as the yields are still attractive and I don’t think the default rates are anything like they are projected to be. The bottom line is that liquidity is not a problem unless there is a desperate need to sell.”


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