By Dylan Emery US corporate bonds are beginning to offer excellent value, according to Investec Guin...
By Dylan Emery
US corporate bonds are beginning to offer excellent value, according to Investec Guinness Flight, which is increasing its weightings to the sector.
Its offshore global managed fund has a nominal benchmark of 50% equities, 30% bonds and 20% cash. It has just reduced equities from 50% to 48%, boosted bonds from 29% to 33% and cut back cash from 21% to 19%.
This has been combined with a lengthening in the average duration of bond holdings from 5.6 years to 6.2 years, moving the bond length further away from the 5.5 year benchmark.
The group believes bonds offer reasonable value for now and protection against equity market volatility.
Investec Guinness Flight director Philip Saunders said US corporate bonds are beginning to offer excellent value, strategically. He said: "A diversified portfolio of BB-rated securities would currently yield over 10%. Assuming a pessimistic default rate and an inflation rate of 3%, our central forecast is lower, this translates into a real rate of return approaching 6%.
"Investors remain structurally oriented towards government debt but this is likely to change over time, particularly as the mathematics of defined contribution pension schemes at low interest rates become more fully appreciated."
After a torrid 1999, government bonds in the US and Europe are now showing signs of bottoming out, Saunders said.
He added: "Monetary tightening has lent support, as have positive fiscal prospects. However, corporate credit spreads have continued to widen, as have emerging market credit spreads, following their powerful positive run in 1999."
US consumer spending has since accelerated and ran at the blistering annual pace of 7.5% in the six months to the end of April.
The consensus has now shifted and it is recognised that getting the genie back into the bottle is not going to be easy, even for Federal Reserve chairman Alan Greenspan.
According to Saunders it is quite possible that prior monetary tightening and higher bond yields will have some impact in the coming months and that the US economy's growth rate will experience natural fluctuations.
There are now definite signs that a wide range of prices are likely to rise. This is what the Fed has to address to sustain the long run expansion.
He said: "As a consequence, hard landing concerns are likely to flare up from time to time in the coming months, even if the eventual outcome turns out, as we suspect, to be bumpy but sufficiently soft not to endanger the transition to a more broadly-based global expansion."
On the equity side, Saunders said that from a broad stock selection point of view, Investec Guinness Flight's stance is paradoxically to favour attractively valued growth stocks in the growth sectors.
According to Saunders, the compression of the equity risk premium has probably been excessive, most obviously in the US equity market in general and the technology, media and telecoms sector in particular.
He added: "Provided inflation remains broadly under control and the variability of economic growth remains less volatile than has been the case historically, our central premise is that the secular equity outlook remains constructive.
"As a consequence, although a relatively defensive posture is appropriate at the moment, market weakness resulting from periodic 'hard landing' scares should, in our view, be used to accumulate equity exposure."
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