What is the outlook for corporate bonds today? With interest rates at 0.5 per cent, clearly, the next move is going to be upward but the key question is when this will happen.
Given the poor state of the economy, rising unemployment and taxes likely to go up, I see it highly unlikely that rates will rise for at least a year so, despite the strong rally, corporate bonds still seem good value to me.
I am pleased to say the Invesco Perpetual corporate bond fund has outperformed strongly since January and so too has another fund run by the same team of Paul Read and Paul Causer – Invesco Perpetual monthly income plus. This fund has risen by a staggering 42.1 per cent since it bottomed out in March.
Monthly income plus has a wider brief than the other fund and is more risky. It can invest in high-yield bonds and up to 20 per cent of the portfolio can be in shares. Incidentally, that share component is looked after by Neil Woodford, who I consider to be one of the best fund managers in the UK. He has had a difficult time this year as his defensive stance has not paid off but, given the outlook for the economy, I would not bet against him performing well in future.
At its heart, however, monthly income plus is a bond fund. When I met Paul Causer recently, he foresaw a structural shift in favour of corporate bonds. By this, he meant they will become a bigger part of people’s portfolios over the coming years as the yield on corporate bonds seems set to be better than cash for quite some time.
Corporate bonds still look undervalued and, although the sharp rally of the last few months will inevitably slow, there is still money to be made. More of the return is likely to come from yield in future and here the monthly income plus fund comes into its own with a running yield of over 8 per cent.
Bank bonds have been among the best performers for the fund as government bailouts have provided a foundation of confidence. In addition, banks have been buying back some of their own debt at prices significantly higher than most investors had expected.
When I asked Causer which of the funds he managed he thought had the best short-term prospects, his answer was the monthly income plus fund and the Invesco Perpetual distribution fund, which has an even higher level of shares.
He feels that the high levels of income generated by the bonds and what he called the “Neil Woodford factor” is a recipe for strong performance over the coming months. I happen to agree and am adding to my own holding in the monthly income plus fund.
Those media commentators who talked shrilly of “a corporate bond bubble” six months ago have been made to look somewhat daft. The argument never held water. How can there have been a bubble when prices were the lowest they had ever been? Now much of this undervaluation has corrected but I believe there is still good value to be had in corporate bond funds. Any setback following this sharp rally should be viewed as a buying opportunity.
There is life in the sector yet but the “easy money” has been made (that is a silly phrase, it is, in fact, the most difficult time) but with interest rates going nowhere, the yields still look good.
Mark Dampier is head of research at Hargreaves Lansdown