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Britain’s largest retail investment platform has launched a corporate bond fund as it reacts to investors chasing growing fixed-income yields.
Hargreaves Lansdown last week joined Invesco, Janus Henderson and Vanguard in launching a fund in the past 12 months that is geared towards corporate debt. It followed a 23 per cent increase in demand for corporate funds from Hargreaves’ customers in the year ending May 2023.
While most retail investors choosing bonds stick to gilts, UK government debt, there is growing interest in other products offering higher yields, despite the higher risks. The current yield gap between a gilt and sterling corporate bond is about 0.5 percentage points on 10-year instruments, according to S&P Global.
This has helped drive nearly £2.2bn into sterling-denominated corporate bond funds in the 12 months to May, according to Morningstar. This compared with net outflows of £2.5bn in the previous 12-month period.
“Central banks haven’t won that battle with inflation yet, we’re seeing yields in the region of 5 per cent plus again and that naturally piques investors’ interest,” said Richard Troue, head of multi-manager funds at Hargreaves Lansdown. “If we think about the level of additional yield on offer from corporate bonds relative to government bonds, that extra premium is quite attractive.”
Investors appear to be downplaying certain risks, including the danger of corporate borrowers struggling to pay debts — or even going bankrupt — in the face of the UK’s economic pressures, not least rising interest rates.
UK corporate bonds play a smaller role than gilts in the market, with a market worth some £734bn compared with £2.3tn in government bonds, according to Bloomberg and the UK Debt Management Office. But they are particularly attractive to those seeking to boost their income at a time when dividends are forecast to decline.
“Fixed income is back — fixed income in all its forms. Government bonds, corporate bonds, emerging market debt, high yield, because the term rate is back,” said Patrick Thomson, chair of the Investment Association, the UK’s asset management trade body.
Thomson said he expected rates to go further and suggested they will normalise at levels much higher than the past decade. He argued that this offered an opportunity for investors to diversify their portfolios, including in medium and long term corporate bonds.
“It gives you more choice, and all things being equal it gives you more ability to diversify your risk,” said Thomson, who is also Emea head at JPMorgan Asset Management.
His comments are emblematic of a shift in the way bonds are perceived by investors. Rising interest rates have brought yields on “investment grade” corporate paper above levels seen on riskier “junk” bonds in the past decade.
But investment managers say there are risks as well as potential rewards in corporate bonds.
If central banks continue to raise rates, bonds already issued with lower coupons, will fall in value. Some investors are already experiencing difficulties as peak interest rates surpass expectations. Any economic slow down would also put extra pressure on companies paying down debt and increase the risks of insolvencies.
Corporate insolvencies are forecast this year to exceed pre-pandemic levels in several major economies, including the UK, France, Germany and the US, according to a report in April by insurers Allianz.
But investment managers say savers remain keen. Waverton decided earlier this month to rebalance its multi-asset portfolio to a “modestly overweight” fixed-income position. It said this hinged on a deterioration in markets and the risk of a mild US recession hitting equities.
However, the fund manager is cautious about where corporate bonds fit into portfolios. “There’s not much new issuance. And the increase in money coming into bond markets is just suppressing those credit spreads,” said James Carter, a portfolio manager at Waverton.
Carter said that Waverton has invested in some long-dated corporate paper in its multi asset portfolio, but is primarily focused on government bonds for longer durations. “We don’t think this is the time to be speculative or to chase higher credit spreads,” he said.
Unlike gilts, corporate bonds are relatively illiquid and this makes it difficult for investors to sell as needed. Institutional investors who buy at issuance generally hold to maturity and this limits the range of bonds available on the market.
Waverton’s fixed income team sees some benefit in shorter duration corporate bonds, particularly where they are trading below face value, and offer a respectable yield if held to maturity. These have generally been issued three to five years ago and the bulk of returns are generated on the difference between current prices and face value.
As corporate bonds bought directly from the issuer are, like gilts, not subject to capital gains tax, the bulk of returns are tax free. Income tax still applies to the coupon. However, funds are subject to capital gains and income tax, as with gilt funds.
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