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Monthly commentary: reduce corporate bonds

By June 10, 2010No Comments

SUMMARY Signs of stress in markets, some subtle, continue to build. Action in May hints at trouble ahead for some corporate bond funds, and there are three in this bulletin out of which we suggest you switch.

Since our last commentary, earlier in May, market volatility continues and nervousness continues to build.

Other than the widely reported stock market falls, there are a number of more subtle signs which hint at trouble ahead, and one of these is the corporate bond market. Please stay with us while we explain what is going on and why you need to reduce some of your corporate bond fund holdings.

Most of you will know that to sell shares you can do so on-line. You select the shares you wish to sell, you are offered a price (which is guaranteed), you press a button to accept that price, and the deal is done. It couldn’t be easier, whether you are a private investor or an institution.

Not so the corporate bond market (which is dominated by institutions). You can see the prices on a screen at which different institutions might buy your corporate bond, but it is only an indication of the price which they might pay. Usually it is a decent indication, but when stress rises in the market, those prices can be meaningless.

So it was earlier in May. Fears rose that Greece might default on the bonds it has issued as a country, so people began to fret about who might be holding those Greek government bonds (sovereign debt). A very high proportion is held by European banks, but no one knows precisely who and in what volume (though it is reported, for example, that French banks hold Greek bonds to the tune of $79bn).

As a result the corporate bonds that had been issued by European banks (a large part of the whole corporate bond market) were coming under pressure. We know fund managers that wished to sell such bank bonds held by their funds, but the prices they saw on their dealing screens were meaningless.

This situation is very uncomfortable for fund managers, and a worry for investors in certain bond funds. It was like this in the Autumn of 2008 but worse, and prices fell very sharply. The concern is that as the threat of sovereign default grows throughout Europe, concerns over European banks will rise still further, putting further pressure on corporate bonds issued by these banks.

And European banks weren’t in great shape before this latest hiccough. For example, Barclays believes that European banks have a fund shortfall of €3,000bn. It is not clear where that will come from as corporate bond markets become unco-operative, and at a time when austerity measures will depress economic growth and the banks will suffer growing bad debts.

That’s a long way of saying that corporate bond funds that have suffered over the last month may not benefit from an early respite. Funds out of which we would switch are:

  • Artemis Strategic Bond
  • Henderson Fixed Interest
  • Henderson Strategic Bond

These are not suddenly bad funds, or bad fund managers. It is simply that in the midst of the events which we believe are unfolding, these funds may be more exposed than others, and it won’t be easy for the managers to sidestep these problems.

As mentioned in the previous e-commentary, and with capital preservation in mind, we suggest switching into lower risk funds which have illustrated an ability to hold steady or even move up in recent days and weeks.

For example, Newton Global Dynamic Bond, Standard Life Global Absolute Return, andFidelity Moneybuilder Income. For the avoidance of doubt, our concerns are with certain funds, and not the whole corporate bond sector.

Please email with your instructions or queries, or you can go online and make fund switches.

Please bear in mind that if you wish to phone we anticipate lines being very busy.

Some final notes, so you are clear:

  • the three funds noted here are lower risk not no risk, and are represent one generic idea not a recommendation tailored for you
  • it is perfectly conceivable that on new news the markets can bounce sharply, after you have already switched out, so you would not benefit
  • we can’t know precisely how events will unfold, in time or scale, but feel that some emphasis on capital preservation right now is prudent
  • our concerns here do not extend to all corporate bonds or the better global bond funds, but we continue to monitor the situation
  • if you make fund switches outside an ISA or pension/SIPP wrapper this might generate a capital gains tax liability, and you should be clear on whether this applies to you before you take any action
  • if your fund is sold today we will not know the price at which you sold until it is fixed, typically, the day after
Dennehy Wealth