Fixed income sectors have struggled in the past year and the Investment Association (IA) Sterling Corporate Bond sector is no exception, returning an average of just 0.03 per cent over the past 12 months.
But the sector’s relative stability has seen it outperform both the IA Sterling Strategic Bond and IA Sterling High Yield sectors over one-, three- and five-year periods to April 28, with a three-year return of 9.4 per cent. This compares with the average of 7.6 per cent for the IA Sterling High Yield sector and 7.9 per cent return by the IA Sterling Strategic Bond group for the period.
In spite of this consistency and a year-to-date average return of 2.6 per cent, net retail inflows into the sector have been patchy. In September 2015 the category saw outflows of £237m, making it the second worst selling sector in that month, but net retail inflows of £112m in March 2016 made it the fourth bestselling group in the IA universe.
So what is driving investors into and out of corporate bonds? One key issue is the monetary policy action of central banks in the UK and Europe. While both institutions kept policies unchanged in April, the potential for further negative interest rate policy action in Europe and the European Central Bank’s (ECB) move into non-bank investment-grade corporate debt as part of the expansion of its quantitative easing programme may change the dynamic for investors in European markets.
Bryn Jones, head of fixed income at Rathbones, notes that the ECB’s purchase programme could force investors into riskier assets.
He says: “It announced a fairly large universe: non-bank financials will be included, but also bonds from corporates with an overseas parent. There’s a 70 per cent issuer limit too – this is a very aggressive programme. But the ECB will only be buying senior debt, and this means crowding out smaller investors, who will be forced to buy lower-quality paper and be pushed into riskier assets.”
Marilyn Watson, head of global fundamental fixed income strategy at BlackRock, points out: “With the inclusion of corporate bonds out to 30 years, issuance may increase significantly in the long term, perhaps with tenders for shorter-maturity debt. The long end of the corporate market has previously had limited pockets of natural demand, but with ECB issue purchase limits up to 70 per cent, the ability for issuers to get long-dated deals done has improved significantly. This may be the start of a much deeper 15-year-plus corporate bond market in Europe.”
Central bank policy is not the only issue likely to affect corporate bond investors in the next three months. The UK referendum on EU membership scheduled for June 23 is already creating volatility and uncertainty in the domestic market, which could offer opportunities for investors willing to do the work.
Jeff Boswell, co-manager of the Investec Investment Grade Corporate Bond fund, says: “The next opportunity created by higher levels of volatility may be in the run-up to the referendum. Until then, we expect the market to remain supportive and believe valuations are still reasonable at current levels, even if the underlying fundamentals are weaker than a few years ago.”
SOURCE: ftadviser.com
