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.
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.
Gilt yields are historically expensive compared with current inflation and equity valuations, which makes them look dearThe 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.
The general view is that the US is a lot more advanced than both Europe and the UK in dealing with its anaemic growth outlook through aggressive and unconventional central bank monetary policy actions.
Mr Marks says that if there is a positive resolution in the eurozone crisis then confidence could also return in European debt, especially eurozone corporates and financial institutions.
“A lot of that risk aversion would be adverted and confidence would pick up among investors,” he says.
James Ind, portfolio manager at Russell Investments, argues, however, that a lot is dependent on eurozone policy.
“It remains a very uncertain backdrop and one can’t rule out the fact that conditions could deteriorate, in which case assets that look cheap, like corporate bonds, could do poorly.”
Following the ECB’s long-term refinancing operation (LTRO), investment professionals are looking increasingly at sovereign debt, as well as corporates.
The ECB launched its emergency funding scheme on December 8 2011, which extends the maximum repurchase term from 13 months to three years to provide banks with much needed longer term liquidity.
Bank credit default swap spreads have fallen since the LTRO was launched and have remained significantly lower.
Nevertheless, Bill Gross, managing director at Pimco, stresses that investors should avoid “Venus flytrap” peripheral European paper at all costs.
In his latest investment outlook, Mr Gross says with a lack of creditor trust and only a small range of choice in the region financial markets are slowly imploding.
“Italian bonds at 7 per cent for instance are enticing but have trap door possibilities that could see further price defaults in 2012,” he says. “If Italian banks buy Italian bonds then Italian yields are artificially supported – even at 7 per cent.”
Mark Parry, senior investment manager at Aberdeen Asset Management agrees: “It is possible that you could see certainly volatility in European bond markets going forward, so investors need to be very careful. Credit valuations look reasonably attractive, but just because something is cheap doesn’t mean it can’t get cheaper or vice versa.”
However, Thanos Bardas, managing director and head of global interest rates at Neuberger Berman, argues that government bonds overall play an important role in the context of a global portfolio.
“They offer diversification and in the difficult times they can provide upside. Someone doesn’t need to hold government bonds because of the fears of the economic outcome, but they should own government bonds because diversification benefits they offer in the context of a global portfolio,” he says.
While there are pros and cons for corporate/high yield compared with government debt, choosing one over the other might not prove worthwhile. Nevertheless, for those investors who want to achieve higher returns and can stand the added volatility, then high yield/corporate debt may do well in 2012.
That said, Mr Jones warns: “There are lots of risks and it’s going to be a fragile recovery. It’s kind of like being at a party. My advice is enjoy yourself while you can but stand near the door in case you need to exit.”
Simona Stankovska is features writer at Investment Adviser
