Investors attempting to reduce risk on the back of recent equity market uncertainty could be jumping out of the frying pan and into the fire with so called ‘safe’ corporate bond funds, according to Fundexpert.co.uk’s Brian Dennehy (pictured).

The IFA points to the significant number of portfolios that have in excess of 15 per cent exposure in banks, which he believes remain susceptible to another all-out crisis in the medium term.

“The banking system is under increasing strain across Europe with the S&P recently reminding us that those operating in the UK are certainly not immune,” he explained.

“The fact remains that market and regulatory pressure combined with the general fragility of the eurozone means a banking crisis is never far away. Investors seeking refuge in corporate bonds should look very carefully under the bonnet of the funds.”

“In particular, they should avoid funds with large exposures to bank bonds and instead invest in investment grade bond funds.”

UK retail banks have once again been in the news headlines for the wrong reasons in recent weeks. Bob Diamond announced his resignation as chief executive of Barclays earlier today in the aftermath of the Libor-fixing scandal, which some fear will spread to other institutions in the coming weeks.

The likes of Invesco Perpetual Corporate Bond, which has in excess of 38 per cent in banks, have rallied strongly over six months, but Dennehy says these now look exposed.

“Over the last six months the average corporate bond fund was up 5.02 per cent, and in a number of months has been the best-selling IMA sector,” continued Dennehy. “However, funds with high bank bond exposure underperformed in May. This should be an early warning to investors.”

Bond funds with high bank exposure

Name	Bank exposure (%)
Invesco Perpetual Tactical Bond	48.75
Invesco Perpetual Corporate Bond	38.57
Rathbone Ethical Bond	38.1
Threadneedle UK Corporate Bond	28.31
Cazenove Strategic Bond	20.29

Source: FE Analytics

According to FE data, there are 16 funds across the IMA Sterling Corporate Bond and Sterling Strategic Bond sectors with more than 15 per cent in banks. The fund with the highest exposure – Paul Read and Paul Causer’s Invesco Perpetual Tactical Bond portfolio – has almost half of its assets invested in the sector.

Other notable funds in the group include the £2.5bn Halifax Corporate Bond fund, as well as David Oliphant’s Threadneedle UK Corporate Bond portfolio.

Dennehy says investors looking for safety in fixed interest funds should instead look to the likes of M&G Corporate Bond and Fidelity Moneybuilder Income, which are underweight banks and have a bias on solid, stable investment grade corporates.

Performance of funds versus sector over 10yrs


Source: FE Analytics

The two funds have underperformed their Sterling Corporate Bond sector average over six months, but were marginally up in May. Both are top quartile performers over a three, five and ten year period, with less volatility than their sector average.