Tightening spreads and QE make corporate bonds more attractive

CORPORATE bond issuance so far this year smashed through the $1 trillion mark, the first time that this amount has been raised by non-financial corporates in a single year, figures from data provider Dealogic showed earlier this week.<br /><br />And while the European corporate bond market has typically been less developed than the American market, European deals are driving non-financial issuance, with $426.5bn issued year-to-date, up 47 per cent compared to the $290.4bn raised in 2008. Volumes in dollar, euro and sterling have risen to record annual highs after just eight months of the year, while volumes in yen are close to record levels. Dollar issuance has risen to $487bn, euro to $299bn, yen to $64bn and sterling to $53bn.<br /><br />There are two reasons for the record issuance of corporate bonds in 2009. Firstly, the economic crisis has stifled bank lending and companies are increasingly turning towards corporate bond issuance as a means of raising finance and paying down their debts. In the UK, last month&rsquo;s money supply breakdown was clear evidence that this was occurring as banks looked to repair their balance sheets.<br /><br />Secondly, non-standard monetary policy decisions by central banks have brought down the potential yield on government bonds &ndash; in early March the benchmark 10-year UK gilt yield slid to 2.95 per cent, the lowest since records began in 1958. As a result, there has been strong demand by investors who can gain a better yield on corporate paper.<br /><br />So how do you capitalise on this bonanza? Private investors can access corporate bonds in a number of different ways. One of the most popular methods of adding corporate bonds to your portfolio is through managed funds or exchange-traded funds (ETFs). The attraction of fixed income ETFs is also growing: research by Barclays Global Investors showed that in the second quarter of 2009, the value of ETF fixed income assets rose to $132.8bn from $116.4bn in the previous quarter.<br /><br />But with improvements in technology, investing in corporate bonds through online electronic execution platforms has opened up the bond markets to the private investor. Online brokers include Barclays Stockbrokers, TD Waterhouse, Selftrade and Hargreaves Lansdown. Using these will cut out any fund manager fees.<br /><br />Choosing a managed fund or ETF will relieve you of the need to choose precisely which corporate bonds you should add to your portfolio. But for those of you wishing to be more independent about composing your portfolio you need to select your products carefully from the hundreds that are on offer.<br /><br />Bondscape provides a list of corporate bonds that are liquid enough and accessible to private investors, which is a good starting point for anybody looking to trade bonds. Compared to the pre-crisis days investors are increasingly choosing to hold corporate bonds in established investment-grade companies such as the oil majors and utilities.<br /><br />The Dealogic data indicated that of the $1,103bn raised this year, $989bn, or 90 per cent, has been in investment-grade bonds, with 30 per cent issued by companies in the utilities and oil and gas sectors. Junk bonds, which had previously been popular, no longer hold the attraction for investors that they once did.<br /><br />It is also important for investors to hold bonds with a number of different maturities as this ensures a steady stream of redemptions and therefore cash flow. If you are being fairly conservative then you can get away with a lower degree of diversification because the bonds you will choose will be relatively safe. If you are being more adventurous then your portfolio requires a higher level of diversification so that one bad position will not wipe out your holdings. However, in the event of a company being placed into liquidation, bond-holders rank high among the creditors and will be paid out ahead of the equity shareholders, explains Barclays Stockbrokers.<br /><br />So what is the outlook for the corporate bond market? It is in a much better state than it was six months ago, that much is certain. The spread between corporate bonds and US Treasuries &ndash; which reflects not only the relative risks of the two bonds, but also the potential rewards &ndash; was more than 700 points wide at the end of 200. This has now narrowed to just over 300 points but historically spreads between the two were hovering around the 200 points mark.<br /><br />Better prospects for the global economy and the slimmer chance that companies will default on their debt have increased the attractiveness of corporate bonds and yields have risen.<br /><br />The Bank of England&rsquo;s extension of quantitative easing earlier this month will only serve to increase the desirability of corporate bonds further, says Ariel Bezalel, manager of the Jupiter Strategic Bond fund, adding that he expects the Bank to revisit QE in time for the November Inflation Report.<br /><br />&ldquo;I think interest rates appear set to remain at extremely low levels for the foreseeable future, therefore corporate bond spreads are still attractively wide and quantitative easing is providing a background where investment grade companies with strong balance sheets are likely to show rather mild default rates,&rdquo; Bezalel says.<br /><br />If the Bank continues to expand QE &ndash; yesterday&rsquo;s minutes certainly suggest this could be the case &ndash; then the more adventurous bond investor might expect to see a measure of short-term profit taking after a very strong rally, he adds. High-yield bonds are up some 50 per cent and may also be vulnerable to profit taking in such circumstances.<br /><br />With corporate bond issuance hitting record levels there is more than enough choice in the market for investors who will continue to turn up their noses at low-yielding government bonds.<br /><br /><strong>FAST FACTS </strong> CORPORATE BONDS<br /><br /><strong>&bull;</strong> Global corporate bond issuance (excluding those issued by financial companies) topped $1 trillion in 2009 year-to-date for the first time.<br /><br /><strong>&bull;</strong>&nbsp; European deals are driving the market with $426.5bn issued so far, a 47 per cent rise on the whole of 2008.<br /><br /><strong>&bull;</strong> The majority of investors are choosing to put their money in investment-grade bonds rather than high-risk, speculative junk bonds.<br /><br /><strong>&bull;</strong> The spreads between corporate bonds and government bonds have started to tighten.<br /><br /><strong>&bull;</strong> QE has increased the desirability of corporate bonds due to their higher yields. <br />