“We can’t expect corporate bond markets to deliver strong double-digit returns again in 2010, but the backdrop for credit is supportive,” he says.
Companies have cut costs, the economy has bottomed, governments are likely to keep stimulus in place and the financial sector is now generally profitable, making a good environment for credit.
Bennett says corporate bond investors would give up a lot of potential yield by sticking to investment grade bonds. He says Last year’s exceptional markets will not be repeated, when even AA-rated bonds gave double digit returns.
Tim Cockerill, Adviser Fund Index panellist and head of research at Rowan, agrees, saying that bonds are now returning to their pre-credit crisis function.
“Bonds' traditional role was to provide diversification and income generation. They were supposed to provide a total return, with low volatility and low correlation to equity markets. Last year’s figures truly were exceptional in every sense, but we now see them returning to pre-2009 figures. It’s hard to get excited about bonds going forwards,” he says.
Bennett outlines three main risks to bonds in the coming year; an economic boom, an economic double dip, and sovereign credit risk.
“An economic boom could lead to an aggressive rise of rates. Also, low yielding, non-cyclical companies are likely to be vulnerable to rising government bond yields.”
| Sector | Best performing fund 1yr | TR %1yr | Volatility % 1yr |
| Global Bonds | Threadneedle High Yield Bond TR in GB | 43.83 | 11.45 |
| £ Corporate Bond | Old Mutual Corporate Bond TR in GB | 48.62 | 14.65 |
| £ Strategic Bond | Old Mutual Dynamic Bond TR in GB | 63.13 | 16.40 |
| Gilt | Scot Wid Gilt TR in GB | 3.89 | 7.39 |
To hedge against this, investors can keep the duration in their investments short, and buy credit with a wide yield, Bennett says.
He also warns against an economic double dip. “This would threaten issuers who are reliant on the consumer sector,” he says. Avoiding cyclicals such as carmakers and retailers can help hedge against this.Then there is sovereign credit risk.
“There is a risk that the market becomes uncomfortable with the amount of debt governments have taken on since the financial crisis,” he warns.
“One of our strategies involves buying subordinated bonds to pick up the extra yield, protecting us from higher yields should the economy boom, while simultaneously purchasing insurance – through the credit default swap market – on senior financials in case sovereign credit risk materialises,” he says.
Mark Dampier, head of research at Hargreaves Lansdown says bond performance in 2009 was an opportunity that only comes round once per generation.
He favours bonds which are tactical and strategic, and which have room to manoeuvre.His examples include M&G Optimal Income, Invesco Perpetual Tactical and Royal London Sterling Extra Yield.
He agrees with Tim Cockerill that bonds are “back to where they should be,” and says the real bond value still lies in the financial sector. Strong returns are still possible, but investors must be wary of the potential risks.
“By combining an aggressive underlying portfolio with tail-risk hedges, corporate bond returns should still be attractive in 2010,” Bennett concludes.