Mark Dampier: With gilt yields low, bond funds look like a good bet
Saturday 14 January 2012
Recent statistics from the Investment Management Association show that investors were net sellers of funds over the past few months. This is hardly surprising given the global economic backdrop and constant flow of poor news, particularly from the eurozone. However, not all news has been negative. In America economic statistics have been improving, and without the eurozone problems I think markets would be higher.
One thing that has struck me is that corporate bond yields have not followed gilts as they marched down to around 2 per cent. In contrast corporate bonds, or at least corporate bond funds, have yields around 4 or 5 per cent. Part of the reason is simply that the Bank of England is buying gilts, not corporate bonds, so there is a natural buyer of gilts. I also believe the market is suspicious of gilt yields at such low levels and investors have been wary because corporate bonds are priced off gilts.
As I have said many times in this column, I cannot see how interest rates are likely to rise for the foreseeable future, probably until 2014. Ben Bernanke, the chairman of the Federal Reserve, has stated that he will not raise US rates until 2013 and it could be argued that the Americans were first into recession, and so will be first to raise rates. It seems likely that with interest rates on hold for some time and with deposit rates so low, corporate bonds look a good bet for those who do not wish to take too much risk.
The Old Mutual Corporate Bond fund is managed by Christine Johnson, who joined Old Mutual in September 2010. She took over this fund when Stephen Snowdon left for Kames Capital in April 2011, and since then she has purged the fund of illiquid and "event driven" bonds (those reliant on a specific economic outcome). She was understandably keen to have a veryliquid portfolio, allowing her toadjust holdings as markets changed. Many investors believe the corporate bond market to be as liquid as gilts, but nothing could be further from the truth. It is highly illiquid, making dramatic changes difficult. Ms Johnson is aided by the size of the fund, though: at £520m it is tiny compared with many of its peers.
Ms Johnson is one of the few fund managers with a reasonable holding in gilts over the past few months. This gives her liquidity but has also boosted growth as gilts have prospered. She also holds about 30 per cent in AAA rated bonds with maturities averaging about eight years. After charges the fund yields about 4.4 per cent – double what a ten-year gilt yields. Bear in mind that in a SIPP or ISA this is also tax free.
Overall the fund is defensively positioned with no exposure toperipheral Europe. Ms Johnson is also building some US exposure. She also wants to be able to respond to any change in situation, which is why there is such a strong liquidity theme running through the fund.
While I believe gilt yields at 2 per cent offer little value, this is of no great consequence if the Bank of England, pension funds and banks continue to buy gilts. It is therefore quite likely that gilt yields will fall and stay below 2 per cent in the near future. Consequently, I think there is every chance that corporate bond spreads could tighten against gilts, giving some capital increase in bond values as well as locking in yields above 4 per cent. I believe this is well worth considering for more risk-averse investors.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.h-l.co.uk/independent
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