A more positive outlook for corporate bonds

It’s been a tough year for UK corporate bond funds – but managers appear increasingly optimistic that now is a good time to consider the asset class.

The average fund in the IA Corporate Bond sector is down 11.5% year-to-date* and the situation has been blamed on a combination of factors, including rising investor fears about high inflation and the ongoing cost of living crisis.

But how do managers at the helm of funds in the sector see the outlook? Here we look at the broader industry factors and how portfolios are being positioned.

What has happened?

It’s certainly been a challenging period, according to the latest M&G Corporate Bond fund review from managers Richard Woolnough and Ben Lord.

“Most major financial markets lost ground because of investors’ fears about high inflation, the threat of slowing growth, ongoing international events, and interest rate volatility,” they wrote.

Wider credit spreads (the difference in yield between a government bond and another debt security of the same maturity but different credit quality) were a drag on fund returns and corporate bonds overall (because rising yields means falling prices). But this valuation signal may offer some potentially interesting buying opportunities in the coming months.

“The fund’s slightly more defensive view on credit, especially in the UK where we are cautious as the Bank of England continues to slow its bond purchases, has helped relative performance,” the managers said.

Reasons to invest in corporate bonds

Chris Bowie, manager of the TwentyFour Corporate Bond fund, believes there are key reasons why now is a good time to consider investing in such a portfolio. “The aggressive repricing of fixed income over the last nine months has taken corporate bonds to their best yield levels in years,” he told us. This, he believes, is providing opportunities.

“For higher quality investment grade corporate bonds, we think the entry point now is very attractive, especially when comparing to higher beta asset classes as we deal with the risks of recessions worldwide over the next year or so,” he says.

Sectors looking attractive

Chris Bowie has been finding potential holdings across a variety of sectors, largely because they’ve all been under pressure during a challenging year.

“Very attractive yields can be found in both financials and non-financials,” he said. “We’d also highlight selective corporate hybrid issues where some yields are the highest they’ve ever been.”

Meanwhile, in terms of fundamental credit quality, he favours financials as solvency and capital ratios are at all-time highs in many cases.

The outlook for corporate bonds

Whilst the deeper parts of the high yield market remain too risky for Chris Bowie, he believes investment grade has moved too far towards pricing in a “doomsday scenario” that he believes is overblown.

“With further interest rate hikes and risks of recession there will undoubtedly be losers, but provided you stay away from deep cyclicals and companies needing immediate refinancing, we believe the yield on offer more than compensates for these risks,” he said.

In addition, he believes the higher level of yield now available gives “the greatest probability of a decent positive return” over a one year holding period that there’s been for years.

Flexible approach

The backdrop that’s been endured this year has illustrated the importance of having a more flexible mandate, and this is one of the factors in favour of BlackRock’s Corporate Bond fund.
Its manager, Ben Edwards, is also able to tap into BlackRock’s resources, including its specialist fixed income analysts and quantitative risk tools.

According to the most recent fund factsheet, financial institutions are the most prominent sector with a 37.8% share of assets**.

This is followed by industrials on 24.6% and utilities with 16.9%**. On a credit rating perspective, just under half the fund (48%) is held in bonds rated BBB**. BBB bonds sit on the lowest rung of the investment grade corporate bond scale, being of “adequate capacity to meet financial commitments, but more subject to adverse economic conditions.” But just one wrong move and they could be downgraded to BB and get a high yield or “junk” status.

Which fund to choose?

Those investors looking to tap into the growing opportunity in corporate bonds could consider any one of the seven funds in this sector which are Elite rated by FundCalibre: Artemis Corporate Bond, BlackRock Corporate Bond, Liontrust Monthly Income Bond, M&G Corporate Bond, M&G Strategic Corporate Bond, Rathbone Ethical Bond, or TwentyFour Corporate Bond.

*Source: FE fundinfo, total returns in sterling, 31 December 2021 to 21 July 2022
**Source: fund factsheet, 30 June 2002