28th October 2009

Are bonds still attractive?

With UK base rates currently at 0.5%, interest rates on high street savings accounts seem unattractive, relative to the potential returns from investment grade corporate bonds. I believe that corporate bonds currently offer an attractive alternative to cash and government bonds.

Last December, US and UK BBB credit spreads hit levels higher than during the Great Depression. Spreads have since tightened considerably, leading to very strong returns from the asset class over the past few months. Corporate bond spreads however remain above historical averages and consistent with a 'typical' recession. Although credit is not as attractive as earlier this year, we believe that there is the potential for credit spreads to continue to tighten, providing good opportunities for corporate bond investors.

Source: Morgan Stanley, Moody’s, The Yield Book, NBER , Bloomberg/Merrill Lynch, as at 05 October 2009

I see the greatest value currently in higher-quality, investment grade corporate bonds. We give internal investment grade ratings to companies that in our view are able to withstand a sharp recession. It is also worth remembering that bond investors have a higher priority claim over a company’s assets than equity holders. Investment grade companies can usually adjust their business plans and capital expenditure in order to survive the economic cycle. This is great news for bond investors as it decreases the risk of the company defaulting.

Both the M&G Corporate Bond Fund and M&G Strategic Corporate Bond Fund that I manage are ‘blue chip’ corporate bond funds that will always be around 80% invested in investment grade corporate bonds, however the M&G Strategic Corporate Bond Fund is a bit punchier and allows me to express my views with greater conviction.

Despite signs of economic improvement, the economic environment remains problematic. Nevertheless, many issuers are responding in ways that are extremely positive for bondholders, through reducing capital expenditure and capital raising, and the likely period of low inflation over the next one to two years should also be supportive for bonds.

For more of Richard’s view visit: www.mandg.co.uk/iview

For Financial Advisers only. Not for onward distribution. No other persons should rely on the information contained in this advert. This Financial Promotion is issued by M&G Securities Limited which is authorised and regulated by the Financial Services Authority and provides investment products. The company’s registered office is Laurence Pountney Hill, London, EC4R 0HH. Registered in England No. 90776. Sep 09 / 26399