Investors have been rediscovering the defensive attractions of corporate bond funds. Ben Lundie, head of Vantage Development at Hargreaves Lansdown, reports: ‘Corporate bond funds have made a welcome return to our top ten
buy list. Many bond fund managers are seeing excellent prospects and think this is the best buying opportunity for years.’

Guy Monson, CIO at Sarasin, explains the background for these opportunities. ‘Fixed income markets have experienced a dramatic front-end led correction, with euro, sterling and dollar two-year yields around 0.75 per cent higher than the mid-March lows. The introduction and expansion of unconventional monetary policy measures, most recently by the UK, has led to a reassessment of aggressive interest rate cuts previously priced into markets. Yield curves have flattened, despite the poor inflation outlook, as flight-to-quality and curve steepening trades have been unwound.

‘Credit conditions have tightened globally and while liquidity injections may help ensure bank solvency, these measures are not going to encourage fresh credit creation. As such, it appears inevitable that central banks, especially the MPC and ECB, will have to cut rates aggressively later in the year. Therefore, the setbacks in two to five-year yields in Europe and the UK look overdone and provide value at current levels.’

Meanwhile, Gartmore’s bond fund managers have been raising their exposure to financials. Karl Bergqwist and Simon Surtees, Gartmore’s co-heads of fixed income, believe the worst may be over for the financials sector and have been adding to their positions in the bonds of a number of banks and other financial institutions.

They report: ‘We have become increasingly positive about financials following the sharp falls of January and February and consider the rescue of Bear Stearns by JPMorgan in March to have been a pivotal moment in the bank sector’s rehabilitation. Banks and other financial institutions were the first victims of the credit crisis and the indications are that they will be the first to emerge.

‘Banks worldwide have been rebuilding their balance sheets following substantial credit-related losses and we note a marked improvement in investor sentiment and an attendant reawakening of the new issues market. A heavy new supply of investment-grade paper has been absorbed readily by investors.’

A balance to equities
The investment strategy team at Investec Asset Management also sees value in key areas of the corporate bond market. Its latest report argues: ‘The most important message contained in the Bank of England’s Financial Stability Report issued on 1 May is that it believes that the turning point in the current credit crisis has now been reached.’

The report points out: ‘Typical investors have a habitual bias towards equities that leads them to ignore the attractions of bonds. This is partly because equity indices are widely disseminated, their performance charted and their outlook discussed, while bond indices are available only to the geeks. The performance data, however, is not nearly as supportive as the propaganda. From the start of each of the last two US recessions, high yield (‘junk’) bonds actually outperformed equities in the US over the following three or four years.’

It concludes: ‘For cautious investors, buying corporate bonds rather than equities, but switching later, is perfectly sound strategy. However, this may be trying to be too clever.’