Is it finally time for interest rates to go up? The Bank of England’s conundrum has left everyone guessing. Even the alarming inflation rate, which hit a five-year high of 3 per cent in September, was not enough to stop sterling from falling amid the dovish statements emanating from the central bank.
A recent speech by Bank of England governor Mark Carney was expected to give markets a clear indication of an impending hike at the Bank’s next meeting this month. However, his statement that an increase may be appropriate “in the coming months” has pushed expectations further out than November.
A faltering growth outlook and the uncertainty over the Brexit process will make the interest rate decision a finely balanced act for the Bank, and a difficult one for investors and markets to predict. What does all of this mean for UK fixed income? Sluggish economic growth keeps a lid on yields, boosting bond prices, while an increasing inflation rate tends to push yields up amid expectations of an interest rate hike.
Despite the ongoing uncertainties, the UK corporate bond market has shown resilience, returning a total of 3 per cent year-to-date to the end of September, according to the Bank of America Merrill Lynch Sterling Corporate index.
The Bank of England’s bond-buying programme, which ran from September last year to April this year, propped up the sector but it continued to do well even after that ended. Investors further benefited from improved credit quality as companies worked hard to strengthen balance sheets.
Sector: IA £ Corporate Bond
AUM: £4,056m as at 30/09/2016
Launch Date: 15/04/1994
Management: Richard Woolnough
FE Alpha Manager rated: Yes
FE Crown Fund Rating: 4
*Source: FE Analytics as at 30/09/2017
Reports show corporate bond issuance has been robust this year, with investor demand remaining strong. However, bond spreads have been tightening, reducing the premium investors earn from holding riskier assets. That said, there is still value to be found and investors should pick funds wisely.
The M&G Corporate Bond fund, managed by FE Alpha Manager Richard Woolnough, could be a good option. The fund invests primarily in high-quality investment grade corporate bonds. Foreign currency investments are currency hedged, which means the fund’s performance is not affected by currency fluctuations. Woolnough’s attempt to forecast the direction of factors such as interest rates, inflation and economic growth help him define the amount of risk suitable for the fund and identify the sectors he wants to buy. The final step is estimating the creditworthiness of companies, which is conducted by the large team of credit analysts at M&G.
Given the fund’s current large size, individual company selection will have a limited impact on its returns, and interest rates and credit positioning will be more important.
The performance of the M&G Corporate Bond fund has been somewhat mediocre, having fallen into the third quartile over three and five years, although it has retained a first quartile performance over 10 years. Its performance lagged in 2012 due to its reduced exposure to companies with low-quality debt. From 2014 to 2016, the fund further underperformed due to its cautious view on interest rates.
For 2017, however, Woolnough believes the market is underestimating the strength of the US and UK recovery, so the fund is positioned for rates to rise faster than the consensus and for the economy to improve sooner than expected. This means it should do better if the US and global economy does well, and will suffer relative to peers if the economic news is poor. Woolnough is also positive on the investment grade sector, in particular.
The fund is a good option for investors looking for exposure to high quality UK bonds. However, M&G funds charge 0.6 per cent in a “swing” to cancellation price in months the fund is suffering outflows, which increases the total cost of investment if money is withdrawn during such conditions and can increase the volatility of the value of the fund on a daily basis when outflows are followed by inflows and vice versa.
This M&G Corporate Bond fund is best suited to those willing to invest for at least three years and who are looking to diversify their equity portfolios. It has an OCF of 0.66 per cent and has an FE Risk Score of 36 (zero being cash and the FTSE 100 has a FE Risk Score of 100).
Namrata Nanada is institutional marketing manager at FE