Corporate bonds are expensive - over priced and offering yields that do not compare favourably with shares, this is not the time to buy.
Yet over the past five years UK pension funds have doubled their exposure to the asset class, with the average pension portfolio now holding 20% in corporate bonds at a time when many asset allocators are warning investors off the sector.
Ignis bond manager Chris Bowie even controversially recently encouraged investors to avoid his own asset class. He said that investors were better off holding cash and gilts than buying up more corporate bonds.
In a paper by J.P. Morgan Asset Management, ‘Credit when it's due - the sustainability of sterling credit’, bond manager Nick Gartside revealed that against this backdrop UK pension plans have almost doubled their allocations to sterling corporate bonds since 2008 to nearly 20%.
UK Pension Scheme Asset Allocation
While Gartside and the paper’s co-author JPMorgan strategist Paul Sweeting say that they do not believe bonds are heading for a bubble, this asset allocation is not the most profitable move for pension savers.
Sweeting said, "Our analysis shows that whilst we are certainly not at panic stations when it comes to sterling corporate bonds, they are not the best value for pension schemes."
Speaking to Morningstar last month, Ignis manager Bowie said he had a less than constructive view over the medium term on bonds.
“What worries me is that real yields are still negative and I think investors should be compensated for using their capital by receiving a positive real return,” he said. “So, I think over the medium-term bond yield should rise, so that tenure yields become positive from a real sense and that would imply a sell-off of somewhere between 0.5% and 1% to at least where we are today.”
Pension funds are also out of tune with private investors’ conviction. The latest Investment Management Association sales figures revealed that in July investors favoured equity funds over bond funds. Investors poured £1.4 billion into equity funds in July, the largest inflows recorded since April 2011. In comparison just £77 million was invested in bond funds.
While pension funds need fixed income exposure to provide investors with a diversified portfolio, Gartside said that UK pension fund managers need to look outside of the UK for bond exposure.
“UK pension plans need to be aware that staying exclusively on home turf for their credit exposure is not going to offer the best value,” he said. “Accessing credit markets and currencies on a global scale can offer yields more in line with those that pension plans are looking for."
Within the asset class investors can diversify between bond grades as well as geographically.
Schroders fixed income manager Wes Sparkes said that high yield bonds will still provide the best total return within the fixed income asset class over the next year.
“The high yield asset class provides a greater yield than other fixed income sectors and also has a lower correlation to changes in US Treasury yields than other sectors. High yield is likely to produce better total returns than other fixed income asset classes as Treasury yields rise over the next few quarters,” he said.
