Ken Taylor: Are the good times over for corporate bonds?

The Olympics has dominated headlines, but investors have been keeping at least one eye on the financial pages in recent days – and with good reason.

August is typically a quiet time in investment markets, as most of the City decamps to the usual holiday haunts. However, the volatility we’re experiencing means more attention is being paid to markets than is the norm for this time of year.

Particular attention is being paid to corporate bonds, on the back of rather startling headlines suggesting that a leading fund group in the UK doesn’t want you to buy into its fixed interest funds any more.

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The rather disturbing implication was that yet another investment bubble could be about to burst, understandably prompting investors to ask for some explanation of the imminent disaster awaiting their portfolios.

Corporate bonds is an asset class I have always found a place for in any portfolio. Immediately following the financial meltdown in 2008 corporate bonds accounted for the bulk of many people’s investments, with phen­omenal results.

In the past year alone, decent bond funds have delivered returns of around 10 per cent, with very little risk to capital. But is the party now over? If so, should investors seek alternative safe havens for their capital?

Let’s look at the macro economic factors first. While it appears that the US is perhaps further along the road to recovery than either Europe or the UK, its progress is at best tardy.

In Spain, unemployment is above 25 per cent and its economy is progressively weakening due to increased borrowing costs. Moving to the UK, we would be well advised to heed the words of the governor of the Bank of England, who has calmly warned us that we are still less than halfway through this crisis.

All this points to a high probability that interest rates remain ultra-low for quite some time. .

In terms of prices paid for corporate bonds, spreads over gilts are much greater than normally seen in a recession, and it is also clear that the reality of our economy being back in recession is fully priced in.

Additionally, non-financial businesses have balance sheets with less debt than ever before, so clearly they anticipate the current climate remaining unchanged for some time yet. This is crucial, as it implies that many businesses believe that consumers will be similarly conservative going forward. In other words, we are being canny with our money. All of this makes it very difficult for the much-predicted return of inflation to materialise in a significant way.

But all of this also points to a relatively good environment for corporate bond investors. The real enemy of fixed interest is inflation, and for the immediate future at least it is extremely benign.

Corporate debt continues to offer significant value, and investors are being extremely well rewarded for taking risk. The main concern in these markets is issuance. Firms are reducing their debt levels where possible, and those investing in bonds need to be more diligent than ever in ensuring they only lend money to those companies best placed to manage the repayments.

The biggest single differentiator in terms of corporate bond funds has been in how they manage exposure to financial debt. Fund groups hold different views on this area, and correct judgment will be defining.

Banks are all deleveraging and have been for some time. The truth is they still have a long way to go, and they remain under pressure to accept downgrades.

Investors who have embraced corporate bonds have been rewarded with real positive returns and are likely to continue to enjoy further gains from here. Care needs to be exercised as to which are held, but then that is surely part of the process when selecting any investment.

• Ken Taylor is director of Mackenzie Taylor Wealth Management