Mark Dampier: Corporate bonds still worth a punt

Regular readers of this column will know how keen I have been on corporate bonds for more than a year. I admit that I was little bit too early with some of my recommendations; however, the rally that we have seen since March in corporate bonds should mean that most people are now in profit. The question I am constantly being asked at the moment is whether the rally is over or if corporate bonds are still a buy.

Clearly after a rally which has seen the corporate bond index move up over 23 per cent from its low point, it is easy to say that such performance won't be repeated over the next six months. Yet, while bonds were compelling value in the early part of the year, I still feel they look good value today.

The prices seemed to assume that we were facing a second Great Depression, but now they have risen to a point that suggests we are in for a more ordinary recession. I would not argue for taking profits, since you have to ask yourself where you will put the money. If you go back into cash then it will be more secure, but returns after tax are no more than about 1.5 per cent, if you are lucky. I believe that interest rates will stay at these low levels for at least another year (and only move up very slowly) and, on that rationale, corporate bonds are still a reasonable buy that are worth the risk.

One fund that has not had much publicity recently is the Royal London Sterling Extra Yield Bond Fund. Although the fund has been recovering of late, it has lagged behind many of its fellow, high-yield, high-risk bond funds. I therefore believe it has a little bit further to go.

As one of my colleagues put it, a quarter of the portfolio is still not going up at all and some parts are actually falling. The fund is effectively flying on three of its four engines, but even below full power the fund is currently performing well. If the other quarter gets going, the potential gain could still be significant.

Eric Holt, the manager of this fund, is one of the most dedicated investment professionals I have met. Clearly, like many bond managers last year, he made mistakes, but the market changed so much and so quickly that it would have been impossible not to be wrong-footed every now and then.

There are two main areas of the portfolio where the recovery has been very muted. One area is the building society sector.

While bank bonds have recovered significantly, bonds including those issued by Coventry, Kent Reliance, Newcastle and Nationwide building societies have suffered setbacks. In July alone this hurt the fund for some 0.5 per cent of performance. The yield on each of these bonds is now between 15 per cent and 20 per cent and Eric Holt believes they offer great value.

The other key area is structured corporate bonds. One example is Dragon Finance, the bonds of which are secured on a portfolio of Sainsbury's supermarkets. The bonds remain unchanged at 50p, despite the underlying security of Sainsbury's, which seems highly unlikely to get into serious difficulties.

Mr Holt would like to add to his positions in some of these bonds, since he believes they are fundamental undervaluations, but none are being offered to him. That tells its own story I think; existing holders want to hang on to these bargain bonds. The fund has a distribution yield of 10.53 per cent at the present time, which should scream loud and clear that this is a higher risk bond fund.

However, I suspect we have well and truly passed the worst and patient investors could be rewarded. For the record, I continue to hold this fund and, in fact, added to my own investment in it last week.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

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