Fixed income remains a tricky asset class

The two FTSE Corporate Bond indices include the four credit-rating series that are considered investment-grade: AAA, AA, A and BBB. Of these, the FTSE Sterling Corporate Bond Index generated anaemic total returns of 0.7 per cent in sterling terms over 2013, while the FTSE Euro Corporate Bond index produced total returns of 1.8 per cent in euro terms.

For investors, funds included in the Morningstar Corporate Bond sector for the 12 months to January 22 2014 have generated returns of 3.1 per cent, while over three years it returned 25.1 per cent.

However, a survey by F&C Investments’ multi-manager team showed only one fund in the IMA Sterling Corporate Bond sector recorded consistent top-quartile returns over three years in the fourth quarter of 2013. This was marginally better than the IMA Global Bond and the IMA Sterling Strategic Bond sectors, which failed to record any funds at all that achieved this consistency of returns.

Rob Burdett, co-manager of multi-manager funds at F&C Investments, comments: “Bond funds remain one of the most difficult areas to pick winning funds from, and this trend comes at a time when many are questioning the risk-reward characteristics of the asset class.”

Chris Higham, portfolio manager of Aviva Investors Corporate Bond Fund, observes that US dollar corporate bonds lagged euro and sterling corporate bonds in 2013 because of fears that the interest rate cycle might be starting to turn.

“These fears haven’t really gone away as we enter this year,” he says. He expects the US to raise rates before the UK, and certainly before Europe, where expectations are “very much anchored”. Mr Higham retains a preference for sterling corporate bonds because yields tend to be higher in sterling than in dollar or euro corporate bonds.

Owen Murfin, a member of BlackRock’s Global Bond team, highlights deleveraging by financials as a key theme for investment-grade bonds over 2013. He expects that trend to continue in 2014, especially in Europe. Post the financial crisis, banks have come under political and regulatory pressure to reduce the size of their balance sheets and raise their capital levels. In Europe, banks will be subject to Asset Quality Reviews and stress tests by the European Central Bank during 2014.

“That’s generally good news from the point of view of credit investors,” says Mr Murfin, as it means the supply of senior financial bonds, especially in Europe, will be far lower. Instead, European financials are likely to continue issuing capital securities such as contingent convertibles (CoCos) and Additional Tier1s, which will provide some interesting opportunities in the high-yield market.

The opposite trend of releveraging has been apparent among non-financial companies, particularly in the US, where confidence is returning and company balance sheets appear healthy.

Mr Higham observes: “You are starting to see less credit-friendly activity from corporates such as an increase in mergers and acquisitions and share buybacks.”

This often results in deterioration of balance sheets as companies borrow more and leverage themselves up.

Two of the largest ever investment-grade bond deals came to the market in 2013, with Apple issuing $17bn (£10.3bn) in April and Verizon selling a colossal $49bn in September. Mr Murfin believes this trend could accelerate in 2014, which will have repercussions for credit spreads.

“Investment bond yields have done very well since 2009, so there’s not much of a cushion to compensate you if companies decide to embark on an aggressive re-leveraging exercise,” he cautions.

Alison Warner is a freelance journalist