Fundwatch: Corporate bonds

Professional Adviser takes a closer look at the Corporate Bond sector and which funds to watch in the year ahead.

Despite strong chances of a challenging 2011 for corporate bonds, thanks to the resurgence of inflation and likely interest rate hikes, advisers believe there are still opportunities in the sector.

Professional Adviser asks top industry figures for their predictions for the year ahead and their fund recommendations.

Mark Waters, investment manager at Skerritts
The term corporate bonds covers a wide spectrum, ranging from government bonds to high yield. To a large extent, the easy money has been made in this sector as spreads have tightened considerably. Inflation and interest rate risks now abound, questioning the rationale of remaining within this asset class. However, opportunities still remain, particularly in the high-yield space for those seeking income. Our current favourites are:

Invesco’s Perpetual Monthly Income Plus. The two Paul’s, Causer and Read, have an outstanding record with this fund that offers an attractive monthly income, mostly from high-yielding corporate bonds. The fund has also benefited from an equity kicker of up to 20%, which has boosted capital returns.

Also, Invesco Perpetual European High Yield. With the credit environment in Europe gradually improving, and the risk of the break-up of the euro subsiding, there are significant opportunities in the European high yield market for higher income streams and capital growth as yields tighten.

Finally, M&G Optimal Income. This is a truly flexible fund with no restriction on the amount of government bonds, investment grade, and high yield bonds that can be held. Investment decisions are left in the hands of manager, Richard Woolnough who is free to allocate up and down the bond spectrum. He has done a superb job steering this fund through turbulent times and we would expect this to continue.

Meera Patel, senior analyst at Hargreaves Lansdown
2011 is going to be a more difficult one for high-quality investment grade corporate bonds and government bonds. As inflationary concerns mount and expectations of interest rates rise, this is likely to see a rise in yields and fall in capital values for gilts and many of the high-quality corporate bond funds.

For this reason, I believe investors should be looking at funds that have the greatest degree of flexibility, because these are most likely to cushion some of the falls in the bond market.

Strategic corporate bond funds that can invest in the entire corporate bond spectrum are well placed for this, and funds like the Invesco Perpetual Tactical Bond and the M&G Optimal Income funds should be able to withstand the headwinds currently facing the bond markets. Investors should expect the majority of the returns to come in the form of income during an environment of rising inflation and expectations of higher interest rates.

Adrian Lowcock, senior investment adviser at Bestinvest
Bonds have had a good run for the past couple of years. However, in future things are looking more challenging. The easy money has been made and yields have come down quite significantly.

In addition, inflation has made a reappearance making the yields on bonds less attractive. The problem for bonds is the income they generate is fixed and cannot grow to combat the effects of inflation. While we believe that inflation will stabilise, there is likely to be a period of above target inflation in the UK. So when it comes bond funds, we prefer managers who have the most flexibility in managing their funds, such as Invesco Perpetual Tactical Bond and Legal and General Dynamic Bond.