It's well-known in financial journalism that if you want to know where the money is flowing in the market, follow the flacks (smooth-talking financial PRs types.) For example, I recently received a missive from a well-known London PR firm highlighting its (previously undisclosed) expertise in marketing bonds to investors. This is most unusual. Financial PRs' traditional role is to act as the official press representative (apologist, cheerleader, enforcer) for companies listed on the stock market.
So, if an industry as smoothly mercenary as PR has spotted that there is money in fixed income, then something really fundamental is happening. It seems that everyone with serious money has started to make their own calculations about how to adapt and survive in a deflationary economy, with the bond market set to play a much more prominent role.
Is the stock market dying?
Related to the rise of bonds is the serious slump in shares that has challenged many of the assumptions attached to the asset class. The lack of return is not only bad for investors' savings, but in the long run it damages a company's ability to find new capital. In fact, it presages a prolonged slump in the fundamental viability of the market itself.
The number of initial public offerings (IPOs) has been falling steadily since 2006; IPOs on the London main market reached a peak of 89 listings in 2006, raising a total of £20.1bn. But the IPO market collapsed to just nine listings during the whole of 2009. Since then, the appetite for new shares has recovered somewhat - there were 31 listings in 2011 - but what many investors may have noticed is that the best-performing mainstream asset class last year was index-linked gilts. Simply put, it is currently better for capital appreciation to lend to the boring old British government than to buy shares in an IPO.
This situation isn't helped by a reversal in investment trends; for the first time in 30 years, IPOs have tended to be overpriced initially (think Betfair, Ocado and Glencore). If that trend is reinforced over the next couple of years, it implies that whole sections of the share-buying public have simply given up and, sooner or later, the stock market will cease to be an important way of matching capital to investment opportunities. In this scenario, the bond market emerges as the primary vehicle for companies to raise capital at a reasonable price.
What now for bonds?
The sovereign market is increasingly distorted by panicky demand as understandably nervous Greek, Italian, Portuguese and Spanish savers have shifted funds en masse into German and Sterling assets (E100bn [£78.6bn] left Spain in the first quarter of this year) and accepting negative bond yields in the process.
As a consequence, the funding situation for peripheral European governments is becoming ever more precarious; Spain's funding costs are again moving above the unsustainable 7 per cent, despite a €30bn injection into the country's rotten banks direct from the European Union's bailout funds.
The problem for equity investors is that there is increasing evidence that the world is heading into a co-ordinated slowdown for the second time in five years. China, in particular, is a source of worry, with both consumer and producer prices falling this year and signs that many industrial sectors are slipping into a deflationary spiral. For instance, the fall in M1 money supply is particularly stark, with the year-on-year supply of money on loan and deposit contracting by two-thirds, indicating that credit creation is stalling more quickly than planned.
When combined with anaemic job creation in the US economy, the end of the 'Fukushima' effect as Japan finished rebuilding after last year's Tsunami and the chance of a co-ordinated recession across each of the world's main economic hubs has risen dramatically. That doesn't make much difference to the bond market, in fact the lack of growth further underlines how inflation is not much of a problem. In such a scenario, trying to tempt investors away from bonds issued by AAA-rated governments is like trying to make water flow uphill; a similar pattern of bond buying was seen in the early 1970s in the aftermath of the oil price shock, with the difference that investors then were seriously caught out by suddenly rising inflation.
Finding a pivot
The economic problems we now face support the view that the prospect of deflation, which is really short-hand for a fundamental lack of confidence, is the main feature that we share with the solvency crisis of the 1930s. The parallels with that sorry decade - political paralysis, disagreements over co-ordinated action - are ever more apparent (minus, perhaps, the vicious fascism and overly utilitarian furniture).
Is it possible to invest profitably during a period of instability? Political analyst Ian Bremmer calls this period in our history the 'G-0' world, where the decline in the West's world leadership is not necessarily replaced by the rising countries of the East. In fact, China seems pathologically hostile to assuming the 'burden' of maintaining global trade routes and intervening in local trouble spots.
The answer, therefore, might lie in buying the debt or equities of countries that can 'pivot' between the large trading blocs. These countries are able to sell a variety of commodities and can ensure their own strategic independence within their regions - examples of these include Canada, Australia, Kenya and Turkey - and can operate successfully on the world's major economic, political and cultural frontiers. As a good example of the trend, German fund managers have been pouring money into Australian government bonds. The result is that the Australian government’s borrowing costs have fallen to their lowest level since the 1950s, meaning that foreigners now own 80 per cent of the country's debt.
There are signs that major brokers and investors are starting to think along these lines. Merrill Lynch has reportedly started to advise clients to prepare for the end of US Treasuries as the ultimate store of value. It sounds disturbing, but it is illustrative of how investors have to adapt to an unstable reality. After five years of waiting for central banks/governments/the Chinese to rescue the global economy, they are increasingly being forced to find their own solutions to the instabiity.
That brings us in a round-about way back to the outlook for the UK bond retail market. Investors and companies have woken up to the lower costs of funding and better yield that the retail market offers and the past few months have seen the arrival of a new group of listed companies seeking to diversify their capital funding arrangements. Most of these examples have yet to be traded on the open market.
WHAT'S NEW AND WHAT'S AVAILABLE
The following bonds are the most recent to emerge on the London retail bond market. Michael Dyson at Investec, which handles a lot of new issues, reckons that the most recent bonds indicate a market that is steadily maturing. New participants are largely FTSE 350 companies that have traditionally relied on bank debt, he said.
The broker with a deal?
One of the more interesting non-financial issues is from inter-dealer broker ICAP, which is offering retail investors a new bond paying an annual coupon of 5.5 per cent, with a redemption date of 31 July 2018. This is Isa and Sipp compatible and well above the best rates available for fixed-rate savings – 2.99 per cent is about the best rate for fixed-rate deals of similar maturity. As a financial services firm, the bonds aren't secured against fixed assets (one market observer said: "Most of their assets go up and down in the lift every morning"). That means taking a strict view of the company's credit worthiness.
The doctor will see you now
Primary Health Properties (PHP) offered a bond paying a coupon of 5.375 per cent. The real-estate investment trust had to close the offer a week early due to high demand, with retail investors latching on to PHP's solid rent roll of doctors' surgeries, pharmacies and health centres. The seven-year bond is unsecured, so investors won't have a claim on specific assets and PHP does not have a credit rating due to its small size. Still, the shares yield only marginally higher at about 5.8 per cent. With no inflation worries, these types of bonds should offer a decent yield without the volatility of equities.
All leaks fixed (mostly)
Water companies need a lot of cash to cover high working capital requirements. Severn Trent’s recent offering also received a great deal of attention, mostly due to the bond’s index-linked nature. The offer is now closed, but Severn Trent raised £75m in the funding round, in the middle of the forecast range. The indexation of the coupon is what catches the eye, particularly as the premium on index-linked gilts of similar maturity now means yields on linkers are flat at best, or negative in some cases. Severn Trent follows in the footsteps of National Grid, which launched its first index-linked bond specifically for retail investors last year.
Places for cash
Social housing provider Places for People was one of the first non-financial smaller firms to launch a bond in the retail market. The bond now trades almost at par, but its main attraction is a 1 per cent coupon linked to the retail price index. However, the recent rapid drop in the inflation rate has eroded the attractions of index-linked issues.
