0Sterling corporate bonds were the top-performing asset class last year, beating cash, gilts and equ...
0Sterling corporate bonds were the top-performing asset class last year, beating cash, gilts and equities. So far this year, bond markets have been challenged by growing evidence of the global economic recovery and the prospect of higher interest rates.
First-quarter growth in the US economy rebounded to 5.8% from 1.7% in the fourth quarter of 2001 and markets are now braced for interest rate hikes over coming months.
Yet sterling corporate bonds have remained a solid performer, having continued to benefit from a wave of institutional demand which continues to outstrip supply. Just look at first quarter performance numbers across UK markets. These show that (on an annualised basis) the return on A corporate bonds was 6% while the return on gilts was -3%.
The UK equity market moved sideways in the first quarter. These trends were accentuated even further in April. Corporate bonds outperformed gilts by 1% in April taking (annualised) year to date returns to 10.75% on A corporate bonds, 1.5% on gilts while the FTSE 100 was still at its start of year level at the end of April.
Unlike last year, however, the relative performance of corporate bonds has been more disparate. Better quality corporate bonds, such as AAA-rated corporate bonds, have not matched the performance of the A category.
Looking again at first-quarter returns, (annualised) returns on AAA bonds were closer to those of gilts at -1.3%. This means that the performance of the various retail corporate bond funds on offer is likely to vary widely this year. The HSBC corporate bond fund has been moving down the credit curve out of AAA bonds into A bonds to recognise their relative value for some time. The average rating of the fund is a strong A. A typical A name would be something like BAT, the UK tobacco company.
AAA bonds are now very expensive as a function of the tightening in swap spreads that took place through last year as the Bank of England's Monetary Policy Committee slashed interest rates from 6% to 4%. AAA bonds look vulnerable to the prospect of higher base rates.
On the other hand, sterling investors are increasingly turning to A-rated bonds. The drivers here include legislative reform in the pension industry which is encouraging widescale investment in blue chip corporate bonds.
The improving economic climate is also a positive factor for lower rated blue chip companies.
Recent surveys of UK industry, such as the CIPS survey of manufacturing and the CBI survey of the retail sector suggest that the recovery in US demand and the low level of domestic interest rates are supporting these two main segments of the UK economy.
Rating agencies predict that the ratio of credit rating downgrades to upgrades, which deteriorated through the US recession last year, will stabilise later this year as economic recovery filters through.
The lessons so far this year seem to be twofold. Corporate bonds can continue to do well in a recovering economic environment, and should outperform government bonds significantly this year.
Demand outstripping supply.
Macro environment boost to credit.
Trends in credit quality set to improve.
Cautious, Balanced & Dynamic Growth
Cowardly, boring or sensible
Latest news and analysis
‘Most significant’ upgrade since launch
Changes happening over coming months