Gareth Isaacs, a fixed income fund manager at Société Générale Asset Management, warned that the secondary bond market does not look set for recovery in 2009.
Despite the group’s Core Plus Sterling Bond fund producing a rare positive return of 5.68% over the year to December 12, Isaacs says this was a result of taking a pessimistic view of Britain’s economy.
“We had to restructure the fund after we suffered from sub-financial exposure [exposure to subordinated debt]” he says. “In September  we took the decision to sell all of those bonds into very short-dated bonds and we haven’t changed our positions since then. This year has been about the curve steepening strategy as we’ve been bearish on the UK economy since the fourth quarter of last year.”
Many investors were hit after the bail-out of Bear Stearns and the widening bond spreads that ensued stoked expectations that they had reached the bottom of the market. Following the collapse of Lehman Brothers, however, corporate bond spreads blew out from about 300 basis points to about 1,100.
A combination of forced sellers and a new-found sense of caution drove money out of the sector. Because of this investors have been prevented from taking advantage of distressed prices in the market.
“The problem post-Lehmans was that liquidity disappeared from the market,” says Isaacs. “Until we start seeing some liquidity in corporate bond markets buying at second issue is going to be difficult. What this credit crisis has brought to the fore is that the value of an asset is what someone is willing to pay for it.”
This recovery may not take place until the end of next year at the earliest as weak consumer demand and lack of access to financing continues to pose significant default risk.
The Core Plus Sterling Bond fund has invested in government guaranteed bank debt, which is paying 100 basis points above the Bank of England base rate. Isaacs says, however, that if further bank recapitalisation is needed the government may struggle to guarantee more debt without compromising sterling.
“There’s only a certain amount of sterling debt that the world will be willing to buy,” he says.