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Corporate punishment

Fears over the European debt crisis are taking its toll on the corporate bond sector, reports Joanne Ellul

Corporate bonds became a top five IMA sector in July for the first time in nine months but managers remain wary of the impact the European debt crisis may have on the sector.

According to IMA retail statistics for July, corporate bonds saw net retail sales of £85m, 467 per cent above the monthly average of £15m for the previous 12 months.

It was the fifth-highest selling sector in July, with sales reaching their highest level since October 2010.

Net retail sales of bond funds in general reached just £361m in July, 33 per cent below the monthly average of £539m for the previous year.

Christine Johnson, manager of the £569.4m Old Mutual corporate bond, sold out of French banks at the beginning of August on the back of concerns about Europe. She previously had less than 1 per cent exposure.

Johnson says: “At the end of July, we had seen this crisis in peripheral Europe but Italy and Spain still appeared able to lend and yields were not rising.

“We came in one morning to find Italian yields 100 basis points wider. We had to ask who has bigger material exposure to Italy and Spain’s government bonds and corporate exposure with lending to those economies.

“The French banks are by far the most exposed of the European banks to Italy and Spain.”

Johnson is also more cautious on non-financial credit and will not be increasing the fund’s exposure to the sector.

She says: “A low to medium-growth environment is priced in at the moment but slowing growth with the potential for an actual recession in Europe is not anticipated. There is a 50 per cent chance of a recession in 2012 and core corporates will start to underperform.”

Johnson has sold 2 per cent in retail, 1 per cent in travel and leisure and 1 per cent in media companies.

She also cut exposure to commodities from 4 per cent to 1 per cent in response to concerns about performance in a global slowdown to the first week of September.

Johnson intends to add back into high yield once the volatility in the market has subsided.

She says: “In a severe environment, you could see default rates of 2 per cent ticking up to 4 per cent. The spreads you are getting paid for in high yield are defaults of up to 8 per cent. Even in a much worse environment, you are being compensated twice as much as what you need.”

Manager of the £80.8m JP Morgan strategic bond fund Nick Gartside raised the high-yield content of the fund from 25 per cent to 30 per cent in August, buying corporate debt of US defensives.

He says: “High yield now yields on average 8.5 per cent. Investors are getting nothing on cash and so you go out the yield curve and down the credit curve. We could get to 50 per cent at some point, up from the current 30 per cent position, but we would need a little less volatility.”

Gartside says corporate bonds look attractive because of low returns on gilts and wide spreads. He believes stock selection is going to be critical as some companies perform poorly against a background of anaemic growth.

Rathbones investment director David Coombs says he is not yet planning to go back into corporate bonds. Between December and June, he cut his 13 per cent weighting in the £33.4m Rathbone multi-asset total return fund and his 7.5 per cent exposure in the £51.8m Rathbone multi-asset strategic growth fund to zero.

Coombs says the eurozone would need to solve the sovereign debt issue to tempt him back into corporate bonds. He says: “I do not think gilt yields are sustainable given the inflation outlook. I need to see gilts come back to pre-crisis levels. I would go back into corporate bonds again if I saw gilts back up at 3.5 per cent.”

Bestinvest senior analyst Ben Seager-Scott says: “The rest of the investment sector is pretty choppy. It would be reasonable for an investor to go for a corporate bond, especially as cash investors are currently starved of income with low interest rates, as they can get a reasonable yield off corporate bonds.

“You might be happy with that if you want to derive an income without taking the risk of high yield or equities.”



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