Fixed Income  

Government vs corporate bonds

Uncertainty in Europe, stagnating growth around the world and a drop in equity markets made 2011 a good year for fixed income across the board, as investors fled from riskier assets to what has been perceived as safe havens.

As a result, the IMA bond sectors saw net inflows of £911m in the year to January 31 2012, according to Morningstar.

Nonetheless, not all bond markets were as attractive as others. Last year government debt in the UK and US – two core and stable economies – outperformed, as investors looked to shelter from the storm and take risk right out of their portfolios.

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Gilts – the cream of low risk UK investments – were being snapped up at rapid pace by investors, buoyed by the UK’s quantitative easing policy, and as such were the best-performing government debt in 2011.

The FTSE British Government Debt All Stocks index returned 18.27 per cent in the 12 months to January 31 2012, compared with the US Treasury index – Barclays US Government – which returned 13.34 per cent.

The IMA UK Index Linked Gilts sector experienced inflows of £379m in the year to January 31 2012, according to Morningstar.

As expected, while government debt flourished, high yield markets suffered on the back of expectations that default rates would increase due to the global economic slowdown, with the IMA Sterling High Yield sector losing 1.24 per cent in the year to January 31 2012.

However, the new year has seen this sentiment change, as risk appetite has slowly but surely begun to return.

Gilts have seen their price fall while yields have climbed, after the IMF predicted that UK growth would fall from previous estimates of 1.6 per cent to just 0.6 per cent in 2012.

Richard Woolnough, a fund manager in the M&G retail fixed interest team, says: “The question is, which way will gilt yields go? They are historically expensive compared with current inflation and equity valuations. Therefore from a fundamental basis gilts look relatively dear.”

Bryn Jones, fixed income director at Rathbone Unit Trust Management (Rutm), says that this has created “almost the perfect storm” for corporate bonds.

With macroeconomic data in the US improving significantly, manufacturing on the up and unemployment falling, he thinks that corporate credit will be in a good position.

“[Companies] have cash on their balance sheets and are being cautious with their spending,” adds Mr Jones.

Julian Marks, senior vice president and portfolio manager specialising in non-US credit at Neuberger Berman, agrees: “In general the ideal environment for corporate bonds would be one where there’s growth, but fairly low positive growth, where companies are seeing good demand for their products in general, but are also acting fairly cautiously, trying to maintain profit margins, scaling back costs, not looking to leverage up their balance sheets, buy back shares.”

US high yield has generated a positive return for investors this year of 3 per cent due to less chance of a recession in the US and relatively low leverage levels for US high yield businesses.