MICHAEL MATTHEWS, fund manager at Invesco Perpetual on Bonds
Recent months have seen an almost unrelenting fall in government bond yields. The eurozone sovereign debt crisis, uncertainty ahead of the results of the European bank stress tests, banks de-risking their portfolios and escalating fears the US economic recovery could stall have all seen gilts, treasuries and bunds benefit.
Yields are at or near record lows and offer limited value from these levels. For example, the yield on the 10-year gilt fell as low as 2.85% in August and the price stood in excess of £115.5 against a redemption value of £100.
Similar to government bonds, the highest-quality corporates only offer limited value. IBM, for example, recently took advantage of the record-low government yields to issue $1.5bn of three-year notes at just 1%, the lowest corporate bond interest rate on record.
By way of contrast, I see more value in higher yielding investment-grade names and in better-quality high-yield issuers where I can find higher yields without taking excessive duration risk. The aggregate yield on sterling BBB-rated corporate bonds is currently 5.6% while on sterling and euro B-rated bonds, the aggregate yield is in excess of 9%.
Corporate balance sheets remain strong and there has been little issuance by high-quality corporates this year. Yet by contrast there is continued demand for income from investors. In high yield, with many credits still offering double-digit yields and both markets and corporate issuers in a recovery phase, the market continues to offer opportunities.
One area I continue to see particular value is financials. The recent Basel Committee consultation document on banking reform and the results of the European bank stress tests, which included bank-by-bank disclosures of government bond holdings, have increased transparency.
Furthermore, many banks have successfully recapitalised, returned to profitability and, in a few cases, have recommenced dividend payments. The drive for more regulation of the banking industry looks inevitable, though I do not believe any of the regulatory changes are being made to impair banks. A de-levered banking system that holds more capital and has higher levels of liquidity should be positive for bond investors.
Looking ahead, markets are likely to see further bouts of volatility for some time. However, while the focus remains on governments with excessive debt levels, it should be remembered there are reasons to be positive in the current low-growth, low interest rate environment.
Michael Matthews is fund manager at Invesco Perpetual
