By Ruth Alexander Pep and Isa rule alignment may lead to the underperformance of corporate bond Peps...
By Ruth Alexander
Pep and Isa rule alignment may lead to the underperformance of corporate bond Peps, which do not take advantage of the wider investment remit, according to Credit Suisse Asset Management.
Fay Watson, manager of the Credit Suisse Corporate Bond Monthly fund, said the alignment of rules will lead to greater global bond exposure in corporate bond Peps, which will lead to the widening of spreads over gilts. This will be due to reduced demand for bonds of companies that are incorporated in the UK.
At present, the corporate bond Pep market is £5.6bn in size, while the entire corporate bond market is worth £12.2bn. According to Autif, there are 61 Pepable corporate bond funds and 54 corporate bond funds that are Isable available, although there is some overlap between the two.
The main differences between the rules involving corporate bond investments under Peps versus Isas is that Peps are restricted to bonds of companies incorporated in the UK, although they can be listed in the EU, whereas there is no geographical restriction for Isas.
Peps also cannot hold any bonds issued by financial companies, whereas Isas can, and they cannot hold gilts, while Isas can. Pep holdings must also be denominated in sterling, while Isas can invest in any denomination.
Watson said: "At the moment, EU non-financial corporate bonds do trade quite tightly because the Pep funds have to hold at least 50% of them. Going forward, we will have a much wider universe of bonds to invest in as the new rules will make financial companies eligible for Pep investment, as well as global companies."
Watson added she would possibly now be interested in buying overseas corporate bonds. She also felt people may continue to hold their EU non-financial corporate investments and add more investments on top.
She said: "Whether spreads widen or not will really depend upon the supply and demand situation in the market at the time. At the moment, there is a lot of supply. For example, BT is currently issuing, and other telecom companies may well do the same because they need to raise a lot of cash to cope with the cost of the third-generation licences.
Jeffrey Mushens, executive director of M&G, said he thought many fund managers would take advantage of the wider bond universe and funds that do not take advantage could be missing out on a good investment opportunity. He said: "It is a change for the better and while fund managers could keep with the narrower objective most will say the extra flexibility will be good for investors."
Watson said another positive aspect of the rule alignment will be the possibility to improve credit quality.
She said: "For example, AAA supernationals, such as the World Bank and the European Bank for Reconstruction and Development, are not Pepable at the moment. Products such as these becoming Pepable will increase credit quality for those investing in them.
"This sector has suffered most from event risk, owing to its old economy status. When the old economy became unfashionable in 1999, these companies came under pressure to enhance shareholder value. This situation has made it difficult to increase credit quality."
Watson said currency risk should not be too problematic for her fund as it moves into overseas bonds. "We will be able to invest in euros, which will change the profile of bonds. But it will not be a problem for Credit Suisse as we forecast returns either on a hedge basis or a non-hedge basis," she said.
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