with some fund managers advocating a return to equities, new bond investors may find they will get priced out of the market
With bond prices still near record highs, some managers are counselling a cautious return to equities.
Bond funds have attracted investor support as a result of the equity bear market but with bond prices high, new investors may be getting in at the top of the market.
John Cornes, manager of the Edinburgh Monthly Income Portfolio, said investors have become disenchanted with equities because of the three bad years of performance and many are worried about further weakness in the stock market.
'I think things have turned, that circumstances will improve and equities will rise but investors will remain cautious,' he said.
'Pension fund managers who have been running into bonds will have a lot to answer for in future years if they do not begin to reverse that trend and get back into equities.'
Cornes believes while equity yields are set to increase over time, bond returns will remain the same.
'This is not to detract too much from corporate bonds but I think gilts look a little bit expensive,' he said. 'Gilts on average yield about 4.2% gross while equities yield about 3.9%. However, equity dividends will increase from time to time and I believe they could rise to 5% this year.'
Cornes said the 20% rise in equities since March is likely to be followed by a pause. He recommends investors wait until the summer months before buying.
'Equities are cheap,' he said. 'In my fund I had 75% in bonds last autumn but in the first few months of this year I have been rolling this back to a lower bond weighting. On the FTSE 100, just over 30 companies currently yield more than 5% gross.
'I think equities will continue to grow their dividends and increase more in time but I do not think investors should ever lose sight of bonds because they do provide a real return.'
Mark Dampier, head of research at Hargreaves Lansdown, believes the corporate bond market has been good, especially for BBB bonds, but is not as attractive for new investors.
'Investment-grade corporate bonds are too expensive,' he said. 'You cannot expect the same returns that were there five years ago, when interest rates were at 7.25% when currently they are at 3.75%. Interest rates could fall again but it is unlikely they will go any lower than 3%.'
Figures from intermediary Baronworth show running yields on bond funds have been falling over the past five years.
Over the five years to the end of April 2003, M&G's Corporate Bond fund's running yield has declined from 6.21% to 4.98%. Throughout the same period, the yield on Fidelity Investments' Money Builder Income Fund fell from 6.58% to 4.3%, while the yield on the Henderson Global Investors' Preference & Bond fund fell from 6.78% to 5.78%.
'If bonds continue to rise in price, that is suggesting investors are still cautious in their market outlook,' Dampier said. 'Recently, both bonds and equities have rallied but they have done so for different reasons and one of them has to be wrong.'
He added high-yield bonds are up about 10% so far this year and there has been some investor optimism but he still prefers to stay away from corporate bonds at the moment.
'There is currently a large demand and less supply, so prices are increasing,' Dampier said. 'If bonds increase sales, it will have a negative impact on the economy.'
UK corporate bond sales have risen quite dramatically over recent years. Over the 12 months to the end of March 2001, investors bought £1.97bn worth of UK corporate bonds, making them the fourth most popular of 52 IMA sectors.
Sales over the 12 months to the end of March 2003 were more than double that figure, at £4.9bn, ranking them second in the IMA sectors.
Total bond sales over the 12 months to March 2003 were £6.7bn, up from £4.3bn during the same period two years earlier.
Jim Leaviss, head of fixed interest at M&G Investments, remains positive on the prospects for the bond sector, believing low inflation is supporting the market.
'The global trend at the moment is one of disinflation,' he said. 'Prices of goods and services are going to keep falling and this supports the bond market by allowing central banks to keep interest rates at a low level.'
However, Leaviss conceded new investors into bonds will have to accept they will be buying at more expensive prices than were available a year ago.
Rod Davidson, global head of fixed income at Aberdeen Asset Management, agrees it is still a good time to invest in bonds.
He said: 'People have been talking about the bond market rally having been over for at least five years.
'I think other managers and analysts do not pick up on the fact the market has moved into a different secular picture that could be in place for the next five years.
'This means there may be low yields and interest rates for a longer period of time. Although it may feel like it is not the right time to put your money in bonds, it actually still is.'
Leaviss believes the key issue for bond investors is whether issuers are able to repay their debts and what would happen in the event of default.
He said: 'Investors need to be able to protect themselves from fraud and to spread their risk. A bond fund needs more than 100 stocks.
'Corporate bonds have had a good run but there are also the firms like Fiat and WorldCom that have had a bad time. Investors cannot rely on credit rating agencies or investment banks to give a full picture of the underlying credit fundamentals of a company. They need to do their own research.'
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