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Article 6 The haves and the have-nots.
Wednesday, 22nd April 2009
In its recent meeting, the Bank of England made no change to interest rates - the first such decision since last September. It also reiterated its commitment to quantitative easing (QE) and in fact has already started to buy both government and corporate bonds. Since QE started in earnest, the bonds of the companies bought by the Bank of England have sharply outperformed other credit issues. Interestingly, to date the lucky ones are those with strong balance sheets, like National Grid and Astrazeneca. High-yielders like ITV and Cable & Wireless - companies that arguably have a greater need - have not benefited from the programme. We anticipated this demand and our recommended bond funds should continue to benefit.
Credit where it's due is our recommendation. In our recommended portfolios, bond exposure is almost entirely focused on the quality end of the Corporate Bond Market. We believe corporate bonds will benefit from the QE programme, although the £400 million bought so far has been in the highest-quality issuers. Our enthusiasm for credit extends beyond QE. However, in the long term, gilt yields should eventually rise as the economy recovers, while credit spreads should contract. In this environment, holding investment grade bonds gives us some insulation from rising gilt yields and consequently falls in capital returns.
It is still very apparent the risk from quality bonds are minimal and that the high levels of credit spreads are pricing in a doomsday scenario. We believe 6% income is achievable with some potential for capital growth. Currently, we expect this situation to remain relevant for the next 18 months as the economic cycle develops.
Dangerous Ground
At the moment, we believe Corporate Bond Funds should be assessed carefully before investment. They are definitely not all the same. Our recommendation would be to have very little exposure to high-yield, with only a small current weighting of index-linked bonds, although we anticipate buying both as the economic cycle progresses. We expect high-yield bonds will offer value on a longer-term basis, while index-linked debt will protect the portfolio if the QE programme leads to higher inflation. At this moment we however feel the potential for capital loss is greater among the high yield, (less financially sound corporate) and as such we urge individuals to take independent financial advice before purchasing a corporate bond fund.
