Portfolio Adviser

Top 10 corporate bond funds

M’star Fund 1 year 3-year 3-year 3-year 3-year 3-year Launch Domicile Rating size (£m) chg (%) chg (%) Sharpe Sortino Alpha Beta date M&G Strategic Corp Bond A Acc ★★★★★ 2,255.15 27.61 11.23 1.05 2.03 7.50 0.56 20 Feb ’04 UK M&G Offshore Corporate Bond ★★★★★ 141.50 25.60 8.63 0.68 1.22 5.17 0.60 13 Nov ’00 Guernsey CF Canlife Bond Inc ★★★★★ 129.05 17.60 8.26 0.54 0.99 4.92 0.59 30 Jun ’81 UK Fidelity Strategic Bond ★★★★★ 374.69 28.36 7.93 0.51 0.75 4.68 0.67 18 Apr ’05 UK M&G Corporate Bond A Acc ★★★★★ 4,013.73 22.80 7.87 0.62 1.03 4.39 0.55 15 Apr ’94 UK PIMCO GIS Glb Inv Grd Cdt Ins£Hdg ★★★★★ 721.47 21.51 7.81 0.54 0.78 4.47 0.63 2 Sep ’05 Ireland Sch’der All Maturities Corp Bd I Acc ★★★★★ 1,246.13 20.93 7.22 0.56 1.00 3.69 0.49 30 Jan ’01 UK IP Corporate Bond Acc ★★★★★ 5,600.32 29.11 6.95 0.36 0.53 4.06 0.89 24 Jul ’95 UK MS Sterling Corporate Bond I Acc ★★★★★ 35.85 21.44 6.52 0.38 0.60 3.29 0.68 11 Dec ’00 UK Fidelity MoneyBuilder Income ★★★★★ 1,902.77 23.60 5.15 0.19 0.28 1.98 0.66 3 Oct ’95 UK

Source: Morningstar

He adds: “We think we are now past the financial crisis and having looked at previous cycles – such as the 2002-03 credit crisis when investment grade then peaked at around 220bps over – we are now at 180bps and the low must be around 60-70bps. We do think that investment grade credit spreads with the additional yield pick-up are still attractive, particularly for the risk that you are taking on.”

l Examining the risks

Ben Bennett, credit strategist at Legal & General Investment Management, identifies three broad risks facing corporate bond markets in the year ahead. In his first scenario, an economic boom, interest rates would have to be raised to slow the economy down. Further recovery would initially be supportive, but low-yielding non-cyclical companies could become vulnerable to rising government bond yields. In the contrary threat of an economic doubledip, more pressure would be placed on issuers who are reliant on the consumer sector. Finally, Bennett warns of a sovereign credit risk with the market becoming increas-

ingly uncomfortable with the amount of debt governments have taken on in recent months. He suggests buying subordinated bonds to pick up extra yield. Another tactic is to purchase insurance, such as credit default swaps, on senior financials in case sovereign credit risk materialises. Given that we have all seen how quickly sentiment can change in markets, is there not a further threat of liquidity risk in corporate bonds? Could investors exit the sector as fast as they entered it, perhaps heads will be turned to a prolonged bull run in equities? M&G, which holds considerable retail assets in the sector – around 2% of the total UK corporate bond market – concedes that it has seen some outflows from its (£4.14bn) Corporate Bond Fund, but nothing significant and it says that these have been more than offset by inflows into its £2.25bn Strategic vehicle, £1.42bn Optimal Income Fund and Inflationlinked funds. Leaviss, who is head of retail fixed income, points out that liquidity levels are back to where they were prior to the collapse of Lehman Brothers and while new issuance is not

as strong as last year, it still remains pretty healthy. Howard Cunningham, co-manager of Newton Corporate Bond Fund, asserts that the argument now for corporate bonds is one of risk-adjusted value, rather than stunningly high yields and an accommodative gilt market.

l Fresh innovation

He says the most likely reason you would see an exit from corporate bonds is because the underlining government bond market misbehaves, and that has a knock-on effect on credit, with people turning to high yielding or growth equities instead. He says: “Last year any new issue got hoovered up and just about every new issue performed well. What we have seen in 2010 is a lot more polarised. Some issues have done well, up 2-4% immediately, while others have bombed.” Cunningham has addressed illiquidity concerns by increasing cash levels as a norm and by investing in government or quasi-government bonds where he can quickly get access to several percentage points of liquidity. As previously mentioned, strategic bond funds may

FIXED INCOME CORPORATE BONDS

make for an ideal route into the asset class at present given market and economic uncertainty. Flexibility is the key here, and intermediaries and providers alike expect innovation to take more of a front seat as groups look for new ways to draw in investment, particularly through offering some form of protection on the downside. A good example of this innovation coming to the fore is Liontrust’s new Credit Absolute Return Fund, a Ucits vehicle which mirrors its long/short credit hedge fund. Headed up by Simon Thorp, focus is on taking credit risk, rather than interest rate risk which will be hedged out on a case-by-case basis and at portfolio level. Although aiming to generate the bulk of returns through alpha generation, the fund will position itself to profit from directional trends in credit spreads. The marketing push is focused on the 10-year track record of the hedge fund version run by the same team, and Thorp is hopeful of inflows at the expense of traditional corporate bond funds. However, he does not believe that investors are ready to ditch these funds en masse.

The fact that there was an opportunity last year to buy bonds and make a shed load on the capital side is fine, but it is about what people are buying them for now, and people should go back for what they were originally – a source of yield “ ” Mark Smith, head of research, Andrews Gwynne

SUMMARY

Spreads have tightened and new issuance in the corporate bond market has declined, but fund managers still see good opportunities, and intermediaries agree. There remains a risk of investors exiting the sector as fast as they entered it, though fund managers say the market remains liquid. Many prefer strategic bond funds to traditional corporate bond funds, while absolute return products could become more widespread.

MARCH 2010 [www.portfolio-adviser.com] PORTFOLIO ADVISER

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