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Tipping point

Despite the recent outperformance, it may soon be time to start selling out of bonds. Chris Salih reports

Despite corporate bonds celebrating their 10th month as the top-selling IMA sector in August, rumbles that the credit market has run its course are starting to reverberate among advisers.

Indeed, the past six months have seen some corporate bond funds return as much as 50 per cent, a figure few investors would have ever expected from such investments in that space of time.

Old Mutual corporate bond fund manager Stephen Snowden, who has produced such returns, agrees the market has now moved from a once-in-a-lifetime to a once-in-a-decade opportunity.

Snowden says double-digit returns in the next six months are reasonable but warns that whereas everything was cheap six months ago, a number of areas now look expensive.

He says: “These areas have been described as common-sense corporate bonds, such as Tesco, Unilever, British Gas, EDF and Vodafone. They are all multinational with brand recognition.

“During the worst credit market ever these bonds performed better but they have recovered dramatically and now trade plumb in the middle of their bull-market trading range from three or four years ago.”

Most of the value in the corporate bond sector has already been realised

The latest IMA figures do reflect a growth in appetite for equity investments in the UK as the FTSE 100 continues to ride above the 5,000 mark. In August, bonds represented 34 per cent of all retail sales at £742m and equities took in £696m (32 per cent) in stark contrast to outflows of £229m and £28m for equities in January and February respectively.

Schroders equity income co-fund manager Nick Purves believes a drop in corporate bond yields and increased risk appetite has made the sector less attractive.

He says: “Generally, we do not think corporate bonds are as attractive. What we are trying to do is buy corporate bond-type risk offering equity-type (double-digit) returns. At the beginning of the year you were able to do that but I think it is fair to say that option is no longer available, given that risk appetite has increased quite a lot. Also, an enormous amount of money has gone into corporate bond funds, pushing yields down across the board.”

M&G corporate bond fund manager Richard Woolnough says credit still looks relatively cheap and investment grade bonds still represent good value.

The manager points to narrow credit spreads despite record issuance, while investment grade bond spreads have tightened to levels consistent with a “typical” recession.

He says: “Although Government bond issuance is set to accelerate, activity within the corporate primary market looks ready to decline – all of which is supportive of further spread tightening.”

Henderson head of retail fixed income John Pattullo believes opportunities in the strategic bond sector currently outstrip those in corporate bonds.

He says: “If you look at the corporate bond sector, most of the value has already been realised. Industrials and telecoms are trading at levels seen before Lehmans. At the moment, high yield looks more attractive than the likes of Vodafone.

“Gilts are also looking expensive, thanks to supply. Ten-year gilts are now yielding 3.6 per cent compared with 2.93 per cent in March.”

Advisers have also raised concerns about some of the cash flooding into UK corporate bonds. According to Morningstar data, the M&G corporate bond fund grew by 224 per cent between December 15, 2008 and October 5, 2009 from £1.29bn to £4.2bn. Meanwhile, the Invesco Perpetual corporate bond has grown by 106 per cent, from £2.5bn to £5.2bn.

Hargreaves Lansdown head of research Mark Dampier says: “I believe there will be one last hurrah before there comes a point where we have to sell out of bonds but I do not know when that point will come.

“It is important to recognise that although some funds have risen 50 per cent in the past six months, they are still 25-30 per cent down on some of their highs.”

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