In the fixed interest environment, investors are favouring Government bonds. The UK is an exception ...
In the fixed interest environment, investors are favouring Government bonds. The UK is an exception where corporate bonds are outperforming.
Mark Parry, director of fixed income at Dresdner RCM Global Investors, says: 'We are positive on global bonds as we are in a period of weak economic growth and controlled inflation.'
Parry explains the environment is supportive of global bonds as central banks continue to cut interest rates. The Fed has been easing monetary policy and so has the Bank of England. Although the ECB has been slow to cut interest rates, Parry expects cuts will be made by the ECB as inflation slows and the economic picture in Europe further deteriorates.
Parry does not expect a recovery until well into next year and says a slowing economy is positive news for the bond markets.
However, the only exception to this in the bond markets is Japan. Parry says: 'In Japan, interest rates cannot go any lower and the country faces enormous structural problems with bond yields at historically low levels.'
In the current market phase, Dresdner RCM Global Investors favours government bonds over corporate because central banks are cutting interest rates. Parry favours shorter maturities over longer.
In the UK, investors prefer corporate bonds. Danny McKernan, head of credit at Aegon, says: 'We are investing in lesser quality lower credits such as triple B or single A as they are not much riskier and are getting higher yields than the banks.'
Corporate bonds McKernan favours are in the property sector. The risk is not high and people have priced in the downsize in the market. He says performance has been good in the market and expects it still has a bit to go.
However, Parry says: 'Investing in corporate bonds depends on what you are looking to gain. You have to be careful about sector exposure and a selective approach is called for.'
In the UK, Parry favours utilities, insurance and food retailers because they reflect Dresdner's fundamental economic view. These sectors are defensive and perform well in an environment of slower global growth.
He says there are also some interesting opportunities in telecoms. However, it is issuer-specific and depends on volatility of the marketplace.
McKernan is negative on telecoms in the UK. He says: 'There is still a bit going on in the telecom stocks and we do not think is a lot of value left. They are close to peaking in terms of spreads.
'In the government markets we have a neutral stance as good cash flows are flowing into the markets and yields are falling further to make the market too expensive.'
fund manager comment: Rothschild
In the UK, with government bond yields of just 5%, corporate bonds have been an increasing point of focus. In the 12 months to the end of the June, investment grade non-government bonds returned 8.4% relative to 3.2% for conventional gilts. The portfolio reallocation continues, but does it still make sense given the recent market move?
Looking at non-government yields relative to LIBOR is instructive. While swap spreads have tightened significantly, led by the fall in interest rates, and the underperformance of long dated gilts relative to shorter maturities, the yields available on single A and BBB rated corporate bonds still look attractive relative to LIBOR. Indeed, by historic standards the yield pick up moving from AAA to BBB bonds looks attractive. At approximately 140 basis points, this yield pick up is wider than it was during the Asian crisis, and compares to only 50 basis points at the beginning of 1998. This widening has clearly been driven by the slowing of economic growth, rising high yield defaults and equity market weakness. Nonetheless we are optimistic that UK economic growth will hold up well relative to other parts of the world, and that credit ratings will show a higher level of stability.
So, what does the rest of 2001 have in store? The medium-term outlook for quality corporates is mixed. While ongoing developments surrounding the MFR and FRS17 are likely to prove supportive, the UK market cannot claim immunity from the negative impact that an economic slowdown will inevitably have on some company finances.
Lucy Speake is director of corporate bond management at Rothschild Asset Management
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