Can corporate bonds beat the turmoil?
As the FTSE 100 took another battering on Tuesday 8 July, shares dived and dragged the City into its first bear market for five years.
The turmoil has left investors with a headache as household names take a battering and they search for a sound place to invest. Some experts suggest corporate bond funds could deliver the required results.
The classification of a bear market is a sharp slide in stock value over a prolonged period or more specifically, a 20% drop in two months. The last bear market, which encompassed three years of investment turmoil, ended in March 2003.
The bears are back. At one point on Tuesday(July 8), the FTSE 100 index of the UK's largest firms collapsed by more than 150 points to 5358.7, compouned by fears a recession is on the way.
Ted Scott, fund manager of the F&C UK Growth & Income portfolio, said: ‘At present the UK economy has only just begun to slow after a robust 2007 when GDP growth was above trend.
‘Despite months of gloomy headlines, house prices have so far only fallen a few per cent from their peaks and unemployment is low, albeit rising. Therefore, if a recession does become a reality - and the risks lean that way - there could be further to go.’
Over the past year the market has witnessed shares in many household names tumble - M&S is down nearly 70% from its 2007 high, while Halifax Bank of Scotland has endured a near 80% fall.
During the last similar period, the 2000-2003 bear market, equities tumbled from 1999 highs when the FTSE 100 touched the 7,000-mark and bond funds took centre stage as investors fled markets in search of a safehaven for their cash.
What are bonds?
A bond is another way of describing a company or government borrowing money - they are a form of IOU. Investors, lend money to a company for a fixed period and it pays them a return for doing so.
In recent years, returns from bonds have been very poor, often paying less than you could get on a good savings account. A year ago, a cursory glance at the performance tables for UK corporate bond funds revealed that not a single portfolio, available to small investors, had made money in the previous 12 months.
But the tide has turned and experts are seeing strong reasons to invest. Jonathan Brownlow of City wealth management group, The Route, adds: 'Yields are very attractive on corporate bonds but people are still less confident putting money with institutions especially in the light of what's happened at Northern Rock credibility is in tatters. But having exposure to corporate bonds in any investment portfolio is very important it diversifies assets.'
The reason for the turnaround for corporate bonds is largely due to the credit crunch. Firms are willing to borrow money from bond buyers rather than banks, because banks are being ultra-cautious in terms of lending at the moment. So to encourage bondholders, companies are offering them more attractive returns.
Adviser Whitechurch Securities says the asset class has been returning to favour recently, with bonds being the most popular sector for unit trust sales as investors shy away from the volatility of equity markets.
Ben Yearsley of adviser Hargreaves Lansdown says: 'Some bond funds, as well as offering more stability in rocky markets, are now delivering inflation and cash beating yields, as well as the potential for some capital growth.'
Gavin Haynes of Whitechurch adds: 'We believe that corporate bond returns have potential to exceed those of cash on a twelve-month view and the medium to long-term view for corporate bond funds is enticing.'
Haynes says this is reflected by some bond funds that are offering investors yields of up to 10% at the moment.
'Obviously, the economic outlook will have a significant influence on the areas of the corporate bond markets in which to focus. Should the US slowdown mutate into something more serious we will see high quality investment-grade bonds outperform and this is the safer area to focus as investors are showing a greater willingness to retain credit quality as uncertainty remains,' adds Haynes.