Recent economic figures from the UK and Germany have shown economic growth has returned. However, many governments are not out of the woods yet and have a lot of debt problems to tackle.
The same isn't true for many companies though. We believe that many companies are in good financial health. Yet corporate bonds are still priced for recession and a higher level of defaults than the asset class has actually experienced historically. We therefore think that corporate bonds continue to offer value for investors, for a variety of reasons.
We do not see any threat to corporate bonds from inflation. As long as there is free trade, globalisation and technological improvements, prices should be driven down. Also, large output gaps have opened up in the economy over the past couple of years, so there is plenty of slack in the economy. It will take some time for this gap to close, so inflationary pressures should remain muted.
And if the worst were to happen and economies moved back into recession, we do not expect corporate bonds to suffer, they are already priced as if we are in recession.
Our core view is that economic growth is most likely to remain weak but positive. If you look at how investment grade corporate bonds have performed throughout history, they have traditionally done well in this sort of low-growth environment. When growth is very strong, bonds tend to suffer because there is a risk of inflation, and because investor money then tends to flow rather to equities. But if growth is too low, there is a greater risk of default, which of course is a negative for bonds.
And corporate bonds offer good yields - an important consideration when interest
rates are at very low levels and are expected to remain low for a long time. Corporate bond spreads (the amount of extra yield they offer over government bonds) have fallen substantially since the all-time wides seen in early 2009. Nevertheless, they remain as wide as in previous recessions and investors are being overpaid for the risk of companies defaulting on their debt. This is especially true in the investment grade space (that is, bonds rated BBB and better), but also in certain parts of the high yield market.
To hear more views from the fixed interest team visit their blog at www.bondvigilantes.co.uk
For Financial Advisers only. Not for onward distribution. No other persons should rely on any information contained within this article. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The registered office is Laurence Pountney Hill, London EC4R 0HH. Registered in England No. 90776.
