Traditionally viewed as a 'sleep at night' sector, corporate bond funds burst into the limelight in November 2008 when proponents hailed an unprecedented opportunity - yield spreads (the difference in yield between government bonds and corporate bonds) had blown out to levels not seen since the 1930s. Believing that corporate bonds were massively undervalued due to the credit crunch, investors started moving into corporate bond funds en masse.
As a result, sterling corporate bond has been the top selling Investment Management Association fund sector in every month from December 2008 to June 2009 - in June it accounted for 13 per cent of gross retail sales of UK domiciled funds.
In June, 89 per cent of gross retail sales into the sector were via financial intermediaries. Rob Harley, senior research analyst and bond specialist at independent financial adviser Bestinvest says: "Currently, the bond sector is our asset class of choice due to our belief in a protracted low growth, low inflation environment".
This and unprecedented opportunities aside, most independent financial advisers think that corporate bonds should always be a core holding in a balanced portfolio - and perhaps not surprisingly, they also think that holding them via a fund is better than holding direct.
They argue that while active fund managers may struggle to beat broad-based equity indices such as the FTSE 100 or S&P 500, corporate bonds is one area where active fund managers can add significant value. Also, individual corporate bonds can be extremely illiquid - they are easy to buy but can be tricky to sell.
Professional fund managers also understand exactly where the bond fits in the structure of the company - where you might sit in order of creditors - something that requires a lot of research on the part of the individual and may be particularly difficult to determine with the bonds of smaller companies.
Another argument in favour of investing via a fund is that corporate bonds entail risk so it is essential to have a wide enough spread that if some default they don't destroy your wealth. A corporate bond fund will spread this risk for you, even if you have a mere £1,000 to invest.
Although there may be arguments in favour of holding fixed interest securities directly - such as tax efficiency - financial advisers cite the old adage about not letting the tax tail wag the investment dog.
Bond fund choices
Choosing a corporate bond fund is relatively tricky. Your choice of actively-managed funds is limited to open-ended funds, although a change in the Budget allowing investment trusts to invest tax-efficiently in bonds has paved the way for the development of corporate bond investment trusts from September 2009.
Fans of passive investing may like to consider the iShares sterling corporate bond exchange-traded fund (ETF). With a total expense ratio of 0.2 per cent, this is a very cheap way of gaining exposure to a basket of UK corporate bonds. It has 49 holdings and a flat yield of 6.37 per cent.
Best actively managed funds
In July 2008, the Investment Management Association split the UK Corporate Bond and UK Other Bond sectors into three sectors named sterling corporate Bond, sterling strategic bond and sterling high yield. This should help you to sort corporate bond funds more easily. For details visit www.investmentuk.org.
Investment management group M&G is a big player in the field of corporate bonds and has several attractive funds.
The M&G Corporate Bond fund sits in the sterling corporate bond sector and is a relatively traditional product, focusing on a broadly diversified portfolio primarily of sterling-denominated investment-grade bonds, with strictly limited (maximum 5 per cent) exposure to higher risk, high yield bonds. It is designed as a low-risk, plain vanilla bond fund and is managed by the highly regarded Richard Woolnough, who has 20 years of investment expertise spent in corporate bond portfolio management.
Mr Woolnough also manages the M&G Strategic Corporate Bond fund (also in the sterling corporate bond sector) and the higher risk M&G Optimal Income fund (sitting in the strategic bond sector), which launched in December 2006 and is the one in which he has the greatest flexibility to follow his convictions and identify which are the most attractive bonds at the particular stage of the economic cycle.
Among funds managed by other investment management groups, a firm favourite among independent financial advisers is the Invesco Perpetual Corporate Bond fund (sterling corporate bond sector) which has a slightly higher-risk strategy than the M&G Corporate Bond fund. The fund is co-managed by the very capable Paul Read and Paul Causer, who co-lead the fixed-interest team at Invesco Perpetual and have a good long-term track record, despite being caught out by the downturn following the Lehman episode.
Independent financial adviser Bestinvest recommend the Legal & General Dynamic Bond fund (strategic bond sector) as a "five-star" bond fund that is definitely one to buy for investors.
Launched in April 2007, the fund is managed by Richard Hodges who has over 20 years experience within fixed-income markets. He was previously Head of Pan European Portfolio Construction for Fixed Income at Gartmore Investment Management (1998-2006).
Bestinvest's Mr Harley says: "This is a 'strategic' bond fund, which means the manager has more freedom to structure the fund. It enables Mr Hodges to maximise the risk/reward profile based on the prevailing market backdrop. This compares favourably with other fixed-income mandates which can be more constrained.
"Mr Hodges' mandate also enables him to use derivative instruments to manage overall portfolio risk and as a means of making money from both rising and falling security prices. This is an approach he has been actively involved with in the past as a means of adding value for investors.
"Mr Hodges has been particularly adept relative to his peers in navigating the difficult markets we have experienced over the last year. He has made effective use of the tools available to him, while his active asset management has been very strong. As a result, Mr Hodges has been able remove risk from the portfolio in a timely manner, waiting until the market stabilised before reintroducing it into the portfolio.
"The fund currently has approximately £250m in assets under management, with plenty of scope to grow. We believe this combination of strong portfolio leadership, supported by the resources of Legal & General Investment Management provides an attractive proposition for investors seeking core fixed-income exposure."
