Retail corporate bond investors hit

With inflation replacing recessionary fears as the primary concern for markets, retail investors who piled back into corporate bond funds in recent months are likely to be licking their wounds this week.

Fatima Luis, manager of the F&C Strategic Bond Fund, said: "It has been a turbulent week for corporate bond investors as the market has decided that interest rate cutting is over for now and priced in hikes for the remainder of the year. This is clearly a painful prospect for mortgage-payers who are already feeling the pinch of inflation and slowing growth but it has also had a more immediate impact on investors in investment grade corporate bond funds."

"Spiralling oil, energy and food prices are just some of the factors that have put inflation at the forefront of concerns for central bankers. For the Bank of England in particular, which has an explicit brief to control inflation, further cuts, which were being urged by retailers' not so long ago, seem a distant prospect. The outlook of rising rates on deposits has had a punishing impact on investment grade bonds as capital values have dropped to accommodate widening spreads and rising yields."

Luis, who's F&C Strategic Bond Fund is one of a handful of retail corporate bond funds with a brief to invest across the entire credit spectrum, has positioned the fund to reduce its exposure to increases in yield in anticipation of the sell-off continuing over the short-term.

"The advantage of the flexible mandate on the F&C Strategic Bond Fund is that we are not boxed into long-dated Sterling corporate bonds and therefore have a wider range of tools in our kit to lessen exposure to further rises in yields."

Luis explained: "We are currently holding 13.2% of the Fund in Floating Rate Notes which is close to the highest levels we have had in the Fund. These tend to perform well in a rising yield environment. Additionally we have shortened the duration profile on the fund to 3.8 years and have raised cash weightings to 8.8%. Furthermore some 51% of the underlying portfolio is currently invested in Euro and Dollar assets, with all the returns hedged back to Sterling which means we are able to both reduce our exposure to rising UK yields while at the same time benefiting from high sterling cash rates."

While many retail investors naturally equate investment grade corporate bonds as a safe port in storm, Luis believes that high yield credits may be better positioned to withstand higher inflation for the time being. She therefore retains a 37.5% exposure to high yield bonds believing that prices are already factoring potential rises in defaults.

"As this adjustment in expectations works through," said Luis, "we believe that credit spreads will offer a once-in-a-cycle opportunity for investors to get into the asset class at very attractive levels. However, we believe that in the short-term things will remain challenging. When the time is right we expect to move the Fund aggressively."