UK corporate bond issuance is helping ensure the sector underperforms gilts. With the share prices o...
UK corporate bond issuance is helping ensure the sector underperforms gilts.
With the share prices of many old economy stocks performing poorly, these types of companies are increasingly issuing debt to raise capital, which is leading to rising yields.
Property firm Hammerson has seen its share price fall by 7.98% in the 12 months to 11 April while the FTSE All-Share Real Estate index is down by 9% in the 12 months to 10 April. The spread over gilt yields for Hammerson's debt issues has widened by 50 basis points this year with its corporate bonds now yielding 7%.
The trend towards increased issuance in the corporate bond market contrasts with the situation in the gilt market where there is a shortage of supply at the long end of the curve with public finances in good shape.
Patrick Edwardson, fund manager at Baillie Gifford, says: "The UK corporate bond sector has not done well recently, reflecting the pick-up in economic growth around the world.
"Around the turn of the year 1998/1999, the consensus forecast was for continuing low growth and falling inflation, which led to yields falling to low levels. As the economy has improved, people's expectations have become more optimistic about growth. People are also expecting higher inflation and higher interest rates, meaning yields have gone up. However, over the long run one should buy corporate bonds for income. Capital growth is a bonus."
The spread of corporate bonds over gilt yields is currently around 150 basis points. Edwardson expects this spread to continue to be supported, in the belief that gilt yields at the short to 10-year end of the market will remain fairly stable.
Edwardson holds corporate bonds including issues from tobacco firms Gallaher and Imperial Tobacco.
He says despite market concern over these companies on the back of tobacco litigation in the US, they should not be affected as they have no US exposure. Gallaher corporate bonds are yielding 7.4%, while Imperial Tobacco corporate bonds are yielding 6.6%.
James Foster, senior fund manager at Royal & SunAlliance Investment Management, adds: "One area of the UK corporate bond market where there is a chink of light is the high-yield sector, which has been performing well based on new economy stocks such as telecoms.
"Financials issues have also been doing well recently as these companies seem to have issued much of their debt already and are not coming to the UK corporate bond market as much as other companies."
Foster is keen on corporate debt issues from HSBC and is buying into the bank's tier one capital, equivalent to a preference share, which yields 7.9%.
Foster also holds tier one capital issues from Lloyds TSB which are on a yield of 7.25%. In the telecoms area of the market, Foster has exposure to Colt Telecom and Energis on a yield basis. Colt Telecom corporate bonds are yielding 8.5%, while Energis corporate bonds are on a yield of 9%.
Edwardson includes convertibles in his corporate bond portfolios and holds Slough Estates to get exposure to the rising property market. These offer a running yield of 6% and a redemption yield of 4%.
He also holds a corporate bond issue from City Airport, which offers access to the cashflow of London City Airport and is on a yield of 7.5%.
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