During the crisis, Sterling Corporate Bond investors suffered from the sharp loss of faith in bank-issued bonds, once the mainstay income providers for the sector. The sector fell around 15 per cent from the autumn of 2007 to the lows of March last year. Some funds dropped much further. Henderson Sterling Bond fell around 40 per cent in that time.
Since then, default fears have receded and some managers are even talking of rehabilitated bank bonds. Confidence and portfolio values have been restored. The average Sterling Corporate Bond fund is now 16.45 per cent higher than it was three years ago. The M&G Strategic Corporate Bond fund is up almost 45 per cent. Only Axa Sterling Corporate Bond and Gartmore Fixed Interest remain in negative territory.
Corporate and government bonds against LIBOR over 5-yrs
Source: Financial Express Analytics
The turnaround in sentiment has come at a cost. Investors have flooded into the sector, pushing up bond prices and pushing down yields. Financial Express data shows the top ten best sellers have attracted over £3bn in the last year, lead by M&G Strategic Corporate Bond, Henderson All Stocks Credit and Fidelity Moneybuilder Income.
Antony Nutt of Jupiter and Bill Mott of PSigma, who both run equity funds, worry that the bond bubble may burst if government policy goes awry and inflation jumps. Even Warren Buffett has questioned the logic of holding bonds versus equities at this time.
Bond portfolio managers disagree. They think muted global growth, unemployment and government policy will keep inflation under control and create a good environment for corporate bond returns. They also think the spread, or extra income paid for the risk of holding corporate bonds, is healthy - all things considered.
Returns on gilts have dropped to historic lows. Ten year yields have fallen from 5 per cent three years ago to just under 3 per cent today. Two year yields are just 0.65 per cent, a slim premium over instant cash holdings.
Corporate bond yields have fallen too but the spread, or difference over gilt returns, is still strong at 2.4 per cent, says Adam Cordery, manager of the Schroder Corporate Bond fund. He added: "In fact, it is twice the historic average spread. The conclusion is that bonds are cheap, but the problem is the overall yield."
Howard Cunningham of Newton's Corporate Bond fund says the sector's average yield of 4.9 per cent looks about right. Investors should expect a low return, low growth and low interest world as the government works through its austerity programme. Investors should be happy with the 4 to 5 per cent they get on relatively low risk sterling corporate bonds.
The best income producing funds in the sector are the Rathbone Ethical Bond and Royal London Corporate Bond. Both have historic yields over 5.8 per cent.
Excluding riskier equities, investors would struggle to better such rates elsewhere. Property investors were recently warned by IPD that yields and rents were under pressure. Property yields have dropped almost 200 basis points (bps) in the last year.
Savers are doing little better, with the likes of Northern Rock offering cash ISAs at 3 per cent or less. Non-ISA savers wanting instant access cannot top the 2.30 per cent on offer from the West Bromwich building society.
Those willing to tie up their cash until 2015 in Birmingham Midshires or Rothschild fixed rate savings bonds will receive 4.60 per cent gross. If investors change their mind, Rothschild will not allow them to access their money early. Birmingham Midshires will charge up to one year's interest for early redemptions.