After Kwarteng’s Mini-Budget Chaos… Are Bonds Back in Business?

At the end of last month, it seemed that this would be the year in which the word ‘bond’ – which traditionally conveyed a sense of reassurance – was instead associated with a sense of increasing alarm.

Suddenly, however, some fund managers look different.

This is despite the 20 percent drop since January in the Bloomberg Global Bond Aggregate Index, which consists of these fixed income investments issued by companies and governments as a means of borrowing.

Bond prices have been hit not only by inflation, but also by successive rate hikes, including this week’s upward moves in the UK and US.

Even more damage was done by Kwasi Kwarteng’s mini-budget to the British government’s gilt-edged government bonds.

Higher interest rates make bond income less attractive, and when bond prices fall, their yields rise.

In June, many investors fled corporate and government bonds as the threat of a recession increased.

Still, as this column reported, a few managers cautiously put money into corporate bond funds, which are the easiest way to gain exposure to this area. Now this trend is expanding as the funds’ distribution yields become more attractive.

Some of these managers express surprise at the fact that they are considering bonds of any kind in the wake of this market’s defeat.

But they point to the generous returns offered in the industry as a result of the price drop. Phil Smeaton of asset manager Atomos says: “These are some of the best return prospects we’ve seen in a long time.”

The sharp drop means prices are already reflecting the possibility of a deeper economic downturn, as some experts argue.

David Zahn, Head of European Fixed Income at Franklin Templeton, says: “The outlook for the future will be volatile, but now is the time to build bigger credit positions.”

In addition, corporate bonds now look “very cheap,” said Peter Harvey, manager of the Schroder Strategic Credit fund.

“Investment-grade bonds, those with a credit rating of BBB or higher, from companies like Aviva, BT and Vodafone, yield about 5.7 percent,” he says.

“If you choose bonds with a lower rating, yields of 11 percent are available.”

Dan Cartridge, of Hawksmoor Investment Management, says he and his colleagues have joined the club of corporate bond fund enthusiasts.

“Not so long ago none of these funds were in our portfolios,” he says. They now represent about 20 percent. We took this step because we believe that these funds can deliver a positive return in three to five years.’

The yields of more than 7 percent offset the additional risk associated with holding corporate bonds rather than government bonds, taking into account the possibility of default. Cartridge says, “For a mix of long and short maturities, we hold Artemis Corporate Bond, Close Select Income, Man GLG Corporate Bond and Schroder Strategic Credit.”

Chelsea Financial Services has also added Artemis Corporate Bond to its portfolios (the fund has holdings in well-known names such as Compass, Pepsi Cola, RAC and Rentokil).

James Yardley of Chelsea Financial Services said: ‘We have been cautiously increasing our holdings in corporate bond funds since the beginning of the year and we think this is a good long-term buy.

“However, we still think rates could rise further, so we’re waiting for real signs of stress before adding aggressively.”

He points out that the Bank of England, which bought £20bn of corporate bonds as part of its quantitative easing programme, has yet to start selling this pile of debt.

Ben Yearsley, of Shore Financial Planning, also takes a foray into corporate bond funds, but with some caution.

“This is not a one-way street, because if interest rates continue to rise more than expected, government bonds and corporate bonds will continue to fall,” he says.

Yearsley favors Allianz Strategic Bond, AXA Global Strategic Bond, Premier Miton Corporate Bond Monthly Income and Ninety One Global Total Return Credit.

The professionals who embrace corporate bond funds have made a reasoned assessment of the outlook, trying to shrug off recent troubling events.

Following their example, I will commit some money to a range of funds. This is not a guaranteed money-making scheme, but at least anyone investing in the sector now can rest assured that we have a government that understands how bond markets work and their vital importance.