Corporate bond markets have rallied after an uncharacteristic summer rush for the asset class. Wh...
Corporate bond markets have rallied after an uncharacteristic summer rush for the asset class.
While global bond markets have been strong over the calendar year, this month's rally can be explained by a number of technical reasons, says Stephen Snowden, investment manager at Aegon Asset Management.
'Over the last month we have seen a pretty strong rally globally and in sterling bonds. This is in part due to the US economic slowdown being more protracted than first thought, but since the start of the third quarter we have also seen technical factors come in,' he explains.
While falling equity markets are often a precursor for more frenzied activity in the bond market, Snowden believes the main driver behind the rally has been life companies attempting to meet their liability requirements.
Snowden says investment grade corporates are a preferable asset class for pension fund managers looking to comply with the new accounting standard FRS17.
The requirement of pension funds to match their free asset ratio with their liabilities leads many life companies to divest from equities and buy bonds. Investment grade corporates and gilts are treated as far less risky investments and are not subject to the same discounts as equities and therefore allow the matching of liabilities.
This practice of window-dressing, the selling of equity holdings to meet liability requirements, typically happens later in the year, Snowden says, and is followed by a return to equities to achieve the fund's long-term growth targets.
But, with the FTSE All-Share down over 13% over the calendar year to 21 August, life companies have been keen to up their fixed interest weightings earlier, he adds.
He says: 'The underlying gilt curve has rallied strongly this summer because of FRS17.
'We have also seen a rally in long dated corporate bond yields. Since the start of the third quarter, the 30-year yield has gone from 5% to 4.5%, which is quite a rally. Typically you would expect it in September or October.'
While investment grade corporates have been the asset class of choice for bond investors, the massive demand has led to a necessary spill over into gilts.
Snowden says: 'There is a limit to how much fund managers can put into sterling bonds in a quick manner and there is more liquidity in gilts.'
Chris Tracey, investment director at JP Morgan Fleming Asset Management, says that US Treasury bonds have also undergone a yield contraction over the summer. He believes the second quarter represented a trough for the US economy and a process of stabilisation in the stock market is under way.
He believes the fall in US Treasury yields represents a turning point with regard to investor attitudes to bonds versus equities.
Tracey says: 'One feature of July that was not present in May or June was the significant fall in bond yields, with the 10-year US Treasury, for example, falling by almost 40 basis points. Combined with the fall in equities, falling bond yields have resulted in a significant valuation shift in favour of equities.'
• Rally in corporate market.
• Favourable bond climate globally.
• Rally in the gilt market.
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