Corporate Bonds – A Safe Haven For 2012 By Guest Blogger Imogen Reed. The US economy may have turned a corner, growth in Asia may still be impressive, and the Eurozone may have been saved from going into free fall, but 2012 still promises to be an ‘interesting’ year, and a difficult one for investors. The US recovery is still not entirely secure, and if the last few months are anything to go by it is likely that this recovery will be a much slower affair than previous ones, partly at least due to the high levels of personal and government debt, which will inevitably act as a dampener on expansion for several years. Asian growth rates whilst still impressive are gradually moderating, affected not only by the slowdown in the western economies, but also by increasing costs of production resulting from indigenous wage pressures and external increases in the cost of raw materials. Meanwhile, crisis in the Eurozone may have only been deferred rather than averted. The Greek tragedy may have been largely discounted by the markets, but countries such as Portugal and Spain remain perilously close to the edge, and even countries outside the Euro such as the UK are experiencing almost no growth, and are under threat of having their AAA debt rating downgraded.
Balancing Risk
With these factors in mind it is more important than ever for investors to find a safe haven for their money. Obviously, attitudes to risk will vary considerably amongst investors, and that will be reflected in the balance of individual portfolios, but nearly all will want at least a proportion of their money to be held in lower risk investments, and that is why they should consider corporate bonds.
Most investors understand that corporate bonds are necessary, in the same way that they know that household bleach and static caravan insurance is necessary, but they don’t find them sexy enough for real discussion. If tech and bio-med stock are the Ferraris of the investment world, then corporate bonds are more akin to the standard pickup truck. A Ferrari may be high performance, but as we all know they can also be temperamental, whereas the pickup is slower, but generally more reliable.
Surprising Performance
It may surprise some that corporate bonds were amongst the best performing asset class in 2011 and that British asset manager Barclays is projecting investment grade corporate bonds to outperform US Treasuries by 4.5% in 2012. This is largely because, unlike the sovereign sector, the corporate sector is showing strong fundamentals in terms of robust earnings, strong balance sheets and liquidity, and continued scope for cost reduction, which should allow them to ride out any but the most severe of shockwaves that may hit the world economy in the next few months. This has not gone unnoticed and the last quarter of 2011 in particular saw increased activity in the market, but rising cash values have given way to small falls in March, prompting fears that corporate bonds have peaked. However, minor adjustments are inevitable in all markets, and with research predicting the supply of primary paper likely to reduce in 2012, this should offer some protection to the underlying value of bond market.
Selectivity
As always it is important to be selective about the particular areas of investment. Auto makers, most telecoms, non-food retail, and non-service companies highly reliant on public sector contracts, with only a few exceptions, are largely seen as having weak performance prospects in the short to medium term. This is due to legacy issues such as debt or poor acquisitions, the growth of on-line commerce, and prolonged restrictions on public sector capital spending. Meanwhile, despite the costly events of recent years, industrial oil and gas operations are seen as positive, as are food production and consumer goods, due to the continued increase in demand from developing economies, and media and bio-tech are beginning to rebound. Therefore, although some sophisticated investors may choose to invest in individual corporate issues, most will elect to invest in one or more funds, and should be looking for those with the appropriate investment bias. It may also be worthwhile examining the investment strategy in some detail to ensure that the manager is active in rebalancing to higher yielding bonds from banks and other financial institutions as a cushion against any rise in Treasury yields.