For all but the last two months of 2009, sales of corporate bond funds trounced everything else in the UK investment universe, as income-hungry investors balked at the meagre returns on cash and fled from equity funds after the meltdown of late 2008. Then, the tide turned. Bond fund sales are in retreat, and many experts now think it’s time to take the 'fixed' out of 'fixed income'.
Some institutions have started doing just that. Chris Taylor at Blue Sky Asset management says institutional money managers are reducing their exposure, because they're afraid of a price bubble developing. T Bailey recently reduced the bond exposure of its cautious managed fund from 20 per cent to 5 per cent, while John Chatfield-Roberts at Jupiter told The Sunday Times that the 'easy money' had been made and that now was the time to sell.
Spreading it thinner
The stampede into corporate bonds and bond funds kicked off when credit spreads – the difference between corporate and sovereign debt – widened sharply in late 2008, as fearful markets priced in Depression-era default rates. Seeing the opportunity, investors moved in quickly. As prices recovered, those spreads narrowed again, to pre-crisis levels. The risk-reward equation is no longer so favourable. Bonds look fully priced.
Companies weren't slow off the mark, either. With bank lending moribund, there was also a flood of new bond issuance. Dealogic estimates that 2009 European corporate bond issuance alone increased by 55 per cent in 2009 from 2008, to over $1.34 trillion.
Bubble trouble
That's led to fears of a bubble, and there are several sharp objects that could burst it. One is resurgent inflation, triggered by the energetic expansion of narrow money around the world. Inflation is always bad for bonds because their interest payments are fixed, and so easily eroded by rising prices. Another is potential problems in the sovereign debt market. Gilt auctions are still well subscribed, but as Chris Dillow has pointed out, sentiment can sour quickly. If it does, falling gilt and Treasury prices would certainly drag corporate debt down with them.
Bond-market veterans point to the precedent: 1994. Back then, interest rates were slashed to drag economies out of the early-1990s recession. But they soon went back up when growth resumed. Mark Holman, managing partner at TwentyFour asset management, points out that at the start of 1994, 10-year gilt rates were a little over 6 per cent, but had topped 9 per cent by September, thanks largely to a series of US interest-rate hikes. "In price terms, that eroded almost 20 per cent of investors' capital," he said.
So if bonds are no longer the answer, what is? You need to get creative, and look beyond the traditional income-generating staples. Hybrid securities, structured products and dividend growers (as opposed to yielders) are some examples.
