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Strong bonds

It has been a long time since the corporate bond sector was the talk of the town for the right reasons.

Having been in the shadows of equity funds in all shapes and sizes, all of sudden the sector has been seeing inflows hand over fist as attractive yields continue.

Bond funds saw inflows of £1.1bn in February, with corporate bonds the sector of choice for the fourth consecutive month according to the latest statistics from the Investment Management Association. The corporate bond sector took in £854.8m of assets in February alone.

This comes as equity funds have seen a total of £268m of outflows in the first two months of 2009. A final analysis of the recently concluded Isa season will make interesting reading, with corporate bond funds likely to lead the way.

The average fund size in the corporate bond sector has now grown from £302m in December 2008 to £322m in March 2009. That is likely to rise as the last-minute Isa numbers are factored in.

But as is often the case with success stories, the bad news is not far behind as concerns grow that we are in the midst of a bond bubble with some funds having nearly doubled in size.

Morningstar data shows M&G’s corporate bond fund has grown by 86 per cent between December 15, 2008 and March 30, 2009, from £1.29bn to £2.4bn, while Invesco Perpetual’s fund has grown by 36 per cent from £2.5bn to £3.4bn.

Other leading firms to see assets increase include Jupiter and Schroders, while M&G’s strategic corporate bond, the leading fund in the sector over three years, has risen by 153 per cent from £254m to £643m.

M&G bond manager Richard Woolnough does not believe there is a bubble, saying there are three characteristics that define a bubble in the bond market, with the growth of inflows being the only one that is applicable at present.

He says: “The asset class has to perform well for a number of years and that is the definition of a bubble, the returns for corporate bonds have been poor for the past three or four years as credit spreads have widened, coupled with lower inflation and interest rates. The asset class also has to look about as expensive as it has ever looked and at the moment it is arguably the cheapest it has ever looked.

“What we are looking at is the beginning of a bull market. The asset class is cheap before money flows in and assets start to rise. I think we are currently in that phase.”

Jupiter corporate bond manager John Hamilton, who has seen his fund grow from £103m to £160m in the past three months, believes there has been a lot of interest in sound valuations, not stretched valuations, as they were when the bubble burst in 2007.

He says: “Despite the money going into the sector, we are still seeing wide credit spreads, so we should be seeing asset prices rising, especially if you take banking bonds out of the equation where there are some concerns. But this is not the case. The level of defaults priced into corporate bonds is also high, making them look more attractive.”

Schroders head of UK retail Robin Stoakley says the argument for corporate bonds remains strong and we are likely to see capital appreciation in the next two years as yields come down.

“They still look attractive. I think we are likely to see upward pressure on gilts due to issuance, however, the For more investment news, see investmentprice of depression is being priced into corporate bonds,” he says.

Informed Choice director Martin Bamford says: “It can cause pressure and much depends on the scale of the operation. My concerns would not be with the likes of M&G but with boutique firms who have seen their assets double in a short space of time.”

Hargreaves Lansdown investment manager Ben Yearsley says: “There are concerns if you do not have the right manager at the helm. A move out of financials to defensives at the wrong time, for example, could lead to big problems.

“Saying that, however, yields are still pricing in high default levels and the characteristics of a bubble are not exactly present, given that it is usually defined by lots of people piling in at the top of the market.”

Skerritt Consultants head of investments Andrew Merricks says: “The big problem is that bonds look like the obvious choice and that worries me.

“Mind you, it usually is the case – as it was with the dotcom bubble – that corporate bonds were the first to fall and will subsequently be the first to bounce back.”

Merricks says the bubble in government bonds may take time to form and that people may actually be pre-empting this situation.

“I think we are likely to see more money in financials which is likely to mean a flight to quality back into gilts. Essentially, I think leaving the corporate bond sector if you are already there would be a bit premature as there has to be more bad news from time to time.”


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