The Independent's journalism is supported by our readers. When you purchase through links on our site, we may earn commission.

Mark Dampier: 'Rates are flat on their back, so high-yield bonds stand out'

Investors are searching desperately for better returns than the low level offered for their cash holdings

Mark Dampier
Saturday 14 November 2015 01:15 GMT
Comments

The end of the great bond rally has been forecast many times over the past four years, yet so far it has failed to materialise. It continues to trundle on, not because bonds offer good value, but because interest rates show little sign of rising.

I take this to mean the world is not yet back to "normal" – the effects of the financial crisis are still being felt.

It is quite possible, in my view, that the next move in UK interest rates could be down rather than up. Even if I am wrong, I would be surprised if they rose before 2017.

The US Federal Reserve could raise interest rates in December but I'm not convinced they would remain at an elevated level for long. Indeed, I remain of the view that the Americans could introduce a fourth round of quantitative easing at some point next year.

Much of this is predicated on the fact the world post-2008 has a higher level of debt than prior to the financial crisis.

It's incredible, but interest rates in at least eight European countries are currently in negative territory – something bond fund managers told me a few years ago was not possible. This is causing investors to search desperately for better returns than the low level offered for their cash holdings.

This is not an easy environment for any fund manager. However, Eric Holt, who manages the Royal London Sterling Extra Yield Bond fund, is going some way to offer a solution.

I hold his fund in both my Isa and self-invested personal pension (Sipp) and am quite happy to receive a yield in excess of 7 per cent tax-free.

The capital value of the fund has struggled recently due to uncertainty surrounding interest rates. However, I am persuaded to hold on as I see little sign of the low-inflation environment changing; with inflation low, the fund has less of a hurdle to beat in order to gain back these losses.

Indeed, I suspect China will devalue its currency further, which will make its exports cheaper to the rest of the world, in effect driving inflation lower in the countries importing its goods.

The fund is at the higher end of the risk spectrum for bond funds, as most of the portfolio is invested in high-yield and unrated bonds.

Mr Holt's focus on the higher-risk end of the market leads him to believe he can continue to generate an attractive income, and he feels he is currently identifying many interesting opportunities.

That said, high-yield bonds in general have encountered a difficult time. Slowing growth in China and falling commodity prices have contributed to negative sentiment.

The US energy sector has been under considerable pressure, which has also pulled the price of global high-yield bonds down.

Like any other asset class it needs a degree of investor confidence in order to perform better, but in the meantime investors are being paid an excellent yield to be patient.

The portfolio also has some exposure to investment-grade bonds. Mr Holt selects bonds in this area provided he feels the yield offered is sufficient.

For example, he recently bought into Legal & General's 10-year bond, yielding 5.5 per cent. In this case, he believes he is being adequately rewarded for the additional risk of holding corporate, rather than government, debt.

In a challenging environment, the fund's flexibility to invest across the bond market spectrum and hunt for opportunities off the beaten track becomes far more important.

While I don't expect exciting capital growth from the fund, if it can continue to pay out a 7 per cent yield against an almost non-inflationary background and ultra-low interest rates, I am happy to tuck away the quarterly dividend payments.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds in this column, visit hl.co.uk

Join our commenting forum

Join thought-provoking conversations, follow other Independent readers and see their replies

Comments

Thank you for registering

Please refresh the page or navigate to another page on the site to be automatically logged inPlease refresh your browser to be logged in