The economic outlook for 2009 is extremely challenging as we are now in a sharp recession. In response, central banks have reduced interest rates aggressively and governments are boosting fiscal expenditure in an effort to shore up the global economy. However, amid the doom and gloom we are starting to see some attractive opportunities within the fixed-income markets – particularly in investment-grade credit and convertible bonds.
That’s because the market is already pricing in a sharp rise in default rates. That makes the yield offered by investment-grade corporate bonds very attractive. Corporate-bond investors should be rewarded handsomely over the next few years as prices rise and the gap between corporate- and government-bond spreads gradually sinks to more normal levels. As at 6 February, for example, the total yield on the Merrill Lynch Sterling Non-Gilt Index stood at a hefty 7.42%, compared to 3.74% for ten-year gilts and a 1.00% base rate. The following three funds should offer investors exposure to some of the more interesting elements of the fixed-income market.
M&G Corporate Bond Fund (tel: 0800-389 8600, www.mandg.co.uk) has an income yield of 5.02% and is managed by Richard Woolnough, who has considerable experience in managing corporate-bond funds. Woolnough’s style is top-down and macroeconomic, and he is not afraid to act on his convictions. Woolnough draws on the credit research generated by M&G’s team of analysts to select bonds for the portfolio, and he avoids any firm facing a downgrade risk. For example, one of the key drivers of performance in 2008 was a low fund allocation to the banking sector, with little consequent exposure to its high-risk bonds. The fund remains underweight on banks for the time being.
Cazenove Strategic Bond Fund (tel: 0800-015 9592 www.cazenovecapital.com) has an income yield of 7.4% and a more flexible mandate. This allows manager Peter Harvey to invest in investment-grade and high-yield bonds. Harvey therefore considers the fund a ‘defensive’ high-yield bond fund. Consequently, the fund has been skewed towards investment-grade corporate bonds and higher-quality, high-yield issues in an effort to avoid downgrades and defaults in today’s challenging environment. Currently, the fund holds around 45% of its assets in investment-grade bonds and cash, with the remaining 55% in high-yield bonds. We would expect Harvey to start to add more risk to the portfolio as we approach the peak in the default cycle. That should enable the fund to benefit from some exceptional yields available in the high-yield segment of the market.
Finally, the RWC Global Convertibles Fund (tel: 020-7227 6000 www.rwcpartners.com) is managed by Miles Geldard. This is a high-conviction, convertible-bond fund, which is well positioned to benefit from the terrific opportunities available in convertible bonds at the moment. The convertible-bond market was hit hard by the financial crisis primarily because the asset class was heavily owned by leveraged players such as hedge funds. But forced selling in the fourth quarter of 2008 has thrown up some exceptional opportunities in this area. Indeed, around 40% of all convertibles are estimated to be trading below the ‘bond floor’ (their minimum expected price). So convertibles look even cheaper than conventional corporate bonds.