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Bond fund managers take action as spreads narrow

Spreads have narrowed in 2014 and there are signs the bull market in bonds is ending, meaning investors should consider taking risk off the table, a Threadneedle report has suggested.

The report, When Will the Corporate Cycle End?, suggests the cycle has 12 to 24 months to run, but adds that a mixture of monetary policy, stretched valuations, corporate health and risk premia might set the corporate credit market up for a “material period of underperformance”.

The report, authored by Jim Cielinski, head of fixed income, and Tammie Chan, fixed income manager, said: “Conditions can change quickly. Outsized excess returns are a thing of the past.

“This is not a matter of opinion. It is a matter of mathematics. Both yields and spreads are unusually low today, and the starting point simply does not allow for returns to come anywhere close to matching returns of the past five years.”

Excess bond returns over 20 years

Excess return (annualised)Five years10 years20 years
US investment grade7%1%1%
US high yield18%6%3%

Source: Threadneedle/Bloomberg

The report said four major credit corrections have occurred in the past 25 years – in 1990, 1998, 2000-2002 and 2007-2008. During the latest credit crisis, cumulative losses in high yield were at 47 per cent, while investment grade excess returns were at 25 per cent – the greatest drops seen in the 25-year period.

Other investment houses have repositioned portfolios in the belief the 30-year bull market is drawing to a close. Alan Burrows and Simon Callow, senior fund managers at Seneca Investment Managers, have warned that investors piling into fixed income risk being caught out by a “painful market correction”.

The duo highlighted the £4.5bn put into fixed income funds, according to IMA data, in the first six months of the year.

Mr Borrows said they are making “a determined and systemic move from bonds into real assets”, adding that the end of quantitative easing will “see fixed income sink”.

Adviser view

Tom Elliott, international investment strategist for global advisory firm deVere Group, said: “I do not see why there could be an imminent crash, unless interest rates were to rise suddenly, but you only need a few skittish sellers for bond-holders to find there is nobody to sell to.”