Fixed Income June 2017  

How to find different yield sources for clients

  • To understand why yield is hard to find.
  • To ascertain which asset classes are providing yield.
  • To understand how yield and risk work for investors.
CPD
Approx.30min

This is perhaps in the hope of a greater-than-gilts return, for a commensurately higher amount of risk - but over the past year, this has also proved to be a false hope for many of those remaining invested in the UK corporate bond market.

In August last year, the round of fiscal manipulation implemented by the Bank of England saw the average sterling-based UK corporate bond yield drop to 2.25 per cent - higher than gilts, yes, but not high enough to compensate for the price paid for the narrow spread.

Sterling corporate bond yields 2014 to 2017 (Source: FT.com)

That said, investors who have sought out UK corporate fixed income funds over the past few years will have seen the average performance of the fund outshine the total returns they have been getting on cash or government bond funds, and for relatively low risk compared with UK equities.

According to data from the Investment Association, the average UK corporate bond fund has returned 9.4 per cent over the past year, 20.2 per cent over the past three years and 39.3 per cent over the past five years - net income reinvested. (Data according to FE Analytics, as at 26 May).

Even with the shock for sterling after the UK's vote to leave the European Union, making sterling-denominated assets more expensive for UK based investors, it is understandable that investors will have wanted to move up the risk curve from cash to gilts to corporate bonds to get a better capital return and a slightly better yield.

Going slightly up the risk spectrum - into BBB and BB rated fixed income - could be one way to generate extra yield.  

Chris Iggo, chief investment officer of fixed income at AXA Investment Managers, says he finds opportunities in "high yield and financial corporates".

That said, investors just sticking to the UK are not diversified enough: there are other fixed income opportunities to be found.

Going global

Some investors continue to believe that UK firms generating the majority of their profits overseas represent the best option for income.

However, Sebastien Jory, strategist at Liberum Capital, is expecting an uncertain outlook for the UK economy, which he said may affect domestic companies.

“UK GDP projections have been higher since initial post-Brexit estimates with 2017 GDP growth forecast at 1.8 per cent,” he says. “We believe this looks tough given the inflationary headwinds and declining credit impulse.

Therefore, he is favouring high-quality international defensives, especially pharma.

According to data from the Investment Association, the 146 funds in the IA Global Bond sector have held up pretty well, returning 8.1 per cent, 13 per cent and 25 per cent on average over the past one, three and five years respectively.