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There’s still value to be found at time of transition


Brian Dennehy, managing director, Dennehy Weller & Co

To date in 2010, while at one moment the financial world was losing its head (sovereign debt, China taking the steam out of its economy) and then bouncing sharply (OK, this is mostly the UK stockmarket), corporate bonds were remarkably phlegmatic.

A small bounce early in the new year was replaced by a sideways drift and a renewed positive trend in the second half of February.

There was undoubtedly some profit-taking among investment-grade earlier in the year and rising risk aversion in all asset classes would have played a role but there has been nothing extreme. After all, if you sold out of corporate bonds where would you invest the proceeds? Cash? Of course not. Gilts? May be short-dated in extremis, as many did in autumn 2008, but that’s hardly relevant now. Ten-year gilts? James Foster, manager of Artemis strategic bond fund, said he would buy when yields hit 5.5 per cent and as they are currently about 4 per cent, there is no hurry there.

What about equities, particularly high-yielders? There has been a lot of comment on this, prompted by some blue- chip equities enjoying dividend yields a chunk more than their bonds. Perhaps that means those equities have attractions but it certainly highlights that bonds issued by those companies have limited value and not surprisingly feature little in actively managed bond funds, in particular, the better-performing ones.

Consider two other points. First, the UK stockmarket has attracted considerable press comment in recent days, having bounced sharply from early February. Big deal. From the new year to the end of February, the FTSE 100 index went down by 0.4 per cent whereas Henderson New Star sterling bond was up over 4 per cent, as was Old Mutual corporate bond, and with little volatility.

In the long run, we expect equities (particularly highyielders) to sharply outperform bonds (whether corporate or sovereign) but in the year of transition that lies ahead (as government stimulus is withdrawn, and countries learn how to cope with huge deficits), there will be pain for equities.

’Corporate bonds are not immune but the last two months highlight that their reaction need not be extreme and lack of volatility gives you a fighting chance of selling with profits intact’

Corporate bonds are not immune to this but the last two months highlight that their reaction need not be extreme, and lack of volatility gives you a fighting chance of selling with profits intact.

Second, it has been mooted that you should be switching out of corporate bonds into high-yielding equities. This might be fine for multi-managers punting around between asset classes but should have no relevance for private investors.

For example, our client portfolios are split between three risk buckets, with the precise allocation dependent on their attitude to risk and age.

Mainstream equities are in one risk bucket and bonds are one part of another, lower-risk, bucket. You cannot(you must not) switch between different buckets (except, say, to tactically take profits in equities and hold the proceeds temporarily in bonds). This disciplined structure ensures diversification and that you do not take daft risks piling in and out of the latest fad sector.

You might sell your bond holdings now if there was a clear and wide-ranging lack of value but that is not the case and good value remains for stockpickers both within investment-grade and high yield.


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