Corporate bonds have recovered this summer too. Where will they go now?
With markets enjoying a glorious summer fling, investors have only had eyes for stocks and shares.
And who can blame them? Everybody likes a bit of summer lovin', especially after the harsh investment climate we have just endured.
But it means that we are likely to have overlooked our old companion, corporate bonds, and missed its spectacular recent makeover.
Forever autumn
Corporate bonds went off the rails last autumn, when the collapse of Lehman Brothers soiled their hitherto respectable reputation.
In October, their reputation went from respectable to hellish. With many bond funds invested more than 30% in financials, the sector went completely off the rails. It didn't help that people were pricing in default rates of around 35%.
Funds with the heaviest exposure to financials, notably Old Mutual Corporate Bond and New Star Fixed Interest, fell by as much as 45%. That simply wasn't supposed to happen to a fixed-interest fund.
But then, the collapse of Lehman Brothers wasn't supposed to happen either, so perhaps they can be forgiven. And anybody who invested in corporate bonds in, say, March, will be in a very forgiving mood.
Summer lovin'
The dash for trash wasn't restricted to equities. Corporate bonds were flogged off by all and sundry during the crash, but when the banking system stabilised, canny bond fund managers snapped them up on the cheap.
Old Mutual Corporate Bond sounds like a name you can rely on, a fusty old dowager with all the strength and security of a whalebone corset. But after losing its stays last year, it has since lifted up its skirts and has been enjoying a right royal knees-up.
It is now up more than 40% on March, streaking ahead of the sterling corporate bond sector average. New Star is another party animal, while the European high yield sector is also up more than 40%.
For once, private investors made the party in good time. The corporate bond sector was the most popular among retail investors in the second quarter, according to the Investment Management Association. Well done, guys.
Will the party soon come to an end though?
A little more action
The corporate bond rally isn't over yet. Like stock markets, they have continued to reward investors throughout July and August.
You don't need me to tell you that bonds won't double their value in the next six months, because now they are no longer chronically undervalued.
But the recovery could still have a little further to run. These look like relatively benign times for fixed interest.
Inflation isn't a problem, at least not yet. Interest rates are set to linger at historic lows for most of 2010, if not beyond. Defaults are also expected to be low, especially on investment grade bonds. Returns on cash are dismal, unless you are keen to lock your money away for five years.
So a bit more corporate bond action wouldn't go amiss right now, provided you aren't looking to settle down for the longer-term. Because at some point, this could turn into an abusive relationship, with you on the receiving end.
Goodbye, so long
I was talking to Mark Dampier at Hargreaves Lansdown yesterday, and he said corporate bond investors are starting to get jumpy. "People are expecting gilt yields to increase, which will push up yields on corporate bonds, and erode the value of your capital. But I have a sneaking feeling that gilt yields might actually fall. There are still plenty of buyers out there, particularly given the low returns on cash."
Whatever your view on gilt yields, most analysts agree that at some point, inflation and interest rates will rise. That invariably spells disaster for fixed-rate investments.
Before that happens, it could be time to say thanks for the memories, and kiss corporate bonds goodbye.
The danger is that you will find yourself trampled in the rush for the exit. A lot of people have made big profit from corporate bonds, and will be looking to take them before things turn sour.
Breaking up is hard to do
If you don't like hopping in and out of sectors, it might be worth looking for a fund manager who can shift from investment grade to high yield bonds, as market conditions dictate.
Some managers also use derivatives to boost performance by making money on shifting interest rates and spreads. If that takes your fancy, Dampier recommends M&G Optima and L&G Dynamic.
Personally, I sold my Invesco-Perpetual Monthly Income Plus yesterday. Happily, our summer romp helped me recover from last year's losses. But while summer romances are fun while they last, they rarely extend into winter.
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