Good environment for corporate bonds

UK fixed income fund managers are finding a slow growth/low inflation environment positive for corporate bonds, according to Standard & Poor's Fund Services in its latest review of the sector.

"All the fund managers we talked to remained positive on corporate bonds, as companies are forced to maintain balance sheet discipline and resist the temptation to leverage up," said S&P fund analyst, Markus Graf. "Most expect slow growth/low inflation to result in interest rates staying low for some time."

The managers of the S&P AA rated LV= UK Corporate Bond Fund echoed the new consensus, saying that high debt levels in the public and private sector and imminent public spending cuts will stifle economic growth.

Similarly, inflation was seen as being moderate in the medium term, despite short-term bumps that will come as the VAT increases feed back into the market.

While hyperinflation might loom further out, according to Richard Hodges at Legal & General, he felt stagflation was a real threat in the nearer term. "However, Hodges is convinced that policy makers will try everything in their power to prevent asset price deflation," said Graf.

Graf noted the contrasting position taken by Henderson's John Pattullo, who pointed to inflation persistently coming in above expectations. "Pattullo is convinced that ultimately there will be inflation as a result of quantitative easing in 2009 and early 2010," he said.

Sterling corporate and strategic bond funds have overall continued to enjoy inflows over recent months. Most managers believe that new investment has come from a structural shift out of deposits for retail investors and out of equities in the institutional space, and the consensus seems to be that significant outflows are unlikely, given the low interest rate outlook.

"Many fund managers are keeping between five and ten percent in cash or cash equivalents in order to take advantage of primary issues and market volatility, as well as to account for patchy liquidity and potential outflows," Graf said.