Although pre-war jitters and the recent surprise 0.25% cut to UK base rates continue to fuel the ral...
Although pre-war jitters and the recent surprise 0.25% cut to UK base rates continue to fuel the rally in investment grade bonds, the top of the market may have already been seen last year.
According to James Foster, manager of the Isis Extra Income Bond fund, the growth in capital values in the investment grade sector had all but topped out by last October.
'We pointed out then that gilt yields were at their lowest for almost 40 years and tried to warn investors that it would be the high-yield bond market that would be next to benefit from outperformance,' he says. 'In our opinion, the bull-run enjoyed by investment grade bonds has come to an end. Terror attacks, the threat of war in the Gulf, and an epidemic of corporate frauds all combined to push investors toward the safety of the investment grade market, fuelling a boom in performance.'
With this in mind, Foster says those expecting the UK Corporate Bond sector to replicate last year's performance should think again.
He says a clear indication of investors' increasing risk appetite is the fact the Merrill Lynch High-Yield Index has returned about 11% over the last quarter alone.
JP Morgan Fleming remains more upbeat about prospects for the credit sector, backing UK corporate bonds to outperform gilts over 2003.
Maria Ryan, portfolio manager on the group's global fixed income team, says: 'There is some real value to be found in the corporate bond market, particularly given the combination of factors that are likely to help this sector to perform strongly this year.'
Among these bullish factors, she lists a positive economic environment, with moderate growth aided by a modest global recovery and continued stability on inflation helping corporate bonds.
In addition, Ryan feels fewer corporate bonds are likely to be issued this year, which will improve the relative value of debt already in circulation. She believes declining risk aversion among investors should fuel demand for higher-risk areas of the bond market.
'Of course,' she adds, 'there are other factors that could dampen the prospects for corporate bonds: any further developments in geopolitical events, such as further terrorist action, could spark renewed risk aversion. Also, the UK market is vulnerable to a sharp consumer slowdown if there is a severe reversal in house price gains.'
While the latest rally in the investment grade market might makes the popularity of the sector appear justified, Foster believes nothing of consequence has changed.
'Capital values have risen on investment grade bonds as the stalling of conflict in the Gulf has triggered a run on major stock markets, of which the investment grade bond sector is an obvious beneficiary,' he says.
'The important point to retain here,' he says, 'is that this is a temporary position generated by institutional investors anxious to protect their portfolios, regardless of the market implications. There is no way Isa investors can afford to emulate them because, by the time they have completed their fund transfer forms, the rally will have ended.'
However, unlike previous years, where former winners such as technology drew such attention only to disappoint in the most spectacular fashion, Foster acknowledges the potential for pure bond funds to blow up is far more limited.
Fewer corporate bonds issued this year.
Potential for bond blow-up limited.
High yield index returns of 11% last quarter
Recent rally could prove unsubstantiated.
Geopolitical events may spark risk aversion.
UK market vulnerable to consumer slowdown
Partner Insight: Continuing the Architas education series for clients.
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