The era of easy money is oddly back upon us, though no one appears to have told the markets this. The US government is giving the stuff away, and the Bank of England isn't far behind with a staggering 1.5% rate cut. The problem, of course, is that regardless of all this extra liquidity in the system, lenders still don’t trust each other or their customers. It is getting better, at least according to fixed-incom
e executives we speak with at the likes of BlackRock and Pimco, but the healing process is slow and trust remains in relatively short supply.
The well documented problem is, to paint with a very broad brush, the rampant under-pricing of credit risk that defined markets in the years leading up to 2007. Spreads narrowed to frankly unreasonable lows and funds had to stretch further and further for yield. Factor in the failure of the credit-ratings agencies to effectively analyse risk in certain areas of the market, and you had all the ingredients for a meltdown.
In the ensuing snap back to reality, spreads have widened sharply, which of course means that prices dropped, and dropped more for higher-risk issues. In the £ Corporate bond sector, the damage has been far greater than in UK Gilts, but less than in £ High Yield. Funds with higher degrees of exposure to lower-rated issues have been hurt badly, and the month of October proved especially brutal.
Old Mutual Corporate Bond's Steven Snowden--for whom we have much respect--has gotten absolutely creamed. There's no getting around it--his fund dropped down 24.9% over the past twelve months, and fell 9.3% in October alone. It is the sector's worst performing fund in the last year. Two things occur to us here: One, he took on a significant amount of credit and sector risk--the fund has been burned by its stake in financials, including the likes of Lehman Brothers, Northern Rock, and Bradford & Bingley. Snowden's boldness could pay off over time, but it has been a painful near term call. Two, he hasn't sought the safety of gilts to the same extent as some of his peers. For example, SG Core Plus Bond--which is in this sector that requires 80% exposure to corporates--was nearly 50% government debt at 30 September and also was short the pound versus the US dollar. That's extreme, but you get the idea.
For investors seeking a fund in this area, we continue to think highly of Invesco Perpetual Corporate Bond, which won the Morningstar Best Sterling Corporate Bond Fund Award 2008. Causer and Read bring a wealth of experience to the table and even though they've slipped a bit below the sector median for in the past 12 months, they've proven themselves across a variety of market conditions. The pair has been fishing in financials this year, but has still stayed competitive. As we've noted in the past, they do court a fair amount of credit risk here, so investors need to be prepared for the volatility that entails. For those who prefer a high quality tilt, M&G Corporate Bond's Richard Woolnough continues to impress us--we wrote in late 2006 that his style would hold up better than its peers going forward, and it has done just that. With north of 60% of assets in paper rated A and higher, the fund has more shelter from the slump in lower rated issues than its peers, and has lost just 5.2% over the past 12 months. It can look a bit sluggish when credit-risk pays off, but we believe it's a fine long-term holding.
A version of this article previously appeared in Investment Adviser, Financial Times Ltd.
