Bond investors should be thinking global for returns

“Moribund” growth in sterling corporate bond market means limited investment opportunities.

The sterling bond market is a difficult one to make money in at the moment – a comparatively small number of bond issuers, relative illiquidity and low volatility are all hampering investors, says Andy Weir, Fixed Income Portfolio Manager at Fidelity International. However, if they have the research to find them investors can potentially generate returns from global bond markets – particularly with euro and US dollar denominated bonds.

“Sterling is a throwing up challenges for bond investors across the board. There are simply fewer investment opportunities – measured by the number of investment grade corporate bond issues, the euro market is over three times larger than sterling and the US dollar market is nearly four times larger. Growth has been relatively moribund – the value of the sterling market grew 247% in the ten years to the end of 2006 compared to a 329% growth in euro bonds.

“Central bank activity is also prompting investors to look away from sterling. The Bank of England, when it has changed interest rates since 2004, has mostly moved them upwards, which generally causes yields to rise and limits capital gains. Contrast this to falling growth in the US and the possibility of interest rate reductions – from this perspective yields on US dollar bonds should be more attractive.

“The situation for investors in sterling is compounded by low volatility. In fact it has come down recently across all four main bond markets – the UK, US, Europe and Japan. This is hugely important because higher volatility means more opportunities to trade bonds but the wider your universe of bonds to select from the more you can counteract this by finding instruments that can help you generate returns.”

Mr Weir continues that, “if sterling has disappointed, investors eager to generate more returns from their bond allocations should be thinking global. This can mean a more diversified portfolio with exposure to a wider range of issuers, more economies and more yield curves – ultimately a portfolio that can generate desired returns.

“Eurobonds are particularly interesting because the market is now of a comparable size to the US market. It offers good diversification because over a third of European corporate debt is now issued by companies from outside the European Union and the market for structured debt and asset backed securities, which can display higher yields and lower volatility than straight corporate debt, is now nearly as large as that for corporate bonds.

“The US market, despite a backdrop strewn with predictions of economic slowdown, is also attracting attention because spreads on US dollar corporate bonds are wider than those of their sterling counterparts, which means higher yields.”

Mr Weir concludes, “When one market offers limited prospects portfolio managers should look elsewhere for returns – something they can only do if they have analysts digging out ideas across the globe – and investors in fixed income should look for funds that have this latitude to go global.”