AAA-rated Bowie: corporate bonds could fall up to 40%

Chris Bowie, head of credit at Ignis Asset Management, believes corporate bond prices have limited upside but could suffer a big fall if government bonds - or gilts - tumble.

Citywire AAA-rated Bowie, who manages the £256 million Corporate Bond fund, said investors could lose up to 40% of their capital in corporate bonds if a sell-off in government bonds occured.

When bond prices rise - as they have done in recent years - their yields fall, as it costs investors more to buy their fixed level of income. Corporate bonds are heavily influenced by movements in gilts, which in turn are susceptible to changes in forecasts for inflation and interest rates.

A key measure of corporate bonds is the 'spread' or gap between the yield on corporate bonds and the yield on gilts. Spreads on corporate bonds, particularly longer-dated ones, are wider than they have been since 2008, indicating they are very cheap, Bowie said.

Sterling investors in US-firm Citigroup, for example, see a yield difference of 290 basis points between a three-year bond and a 26-year bond, a level of steepness that is an incentive to take risk and buy the longer-dated bond in the bank.

‘But is it worth it?’ asked Bowie. ‘In our view, no, not at this stage.’

Bowie said the timing on this trade is running out and that when yields on government bonds are below the level of inflation, they are not sustainable, as history has shown.

‘Ultimately I firmly believe that real [afer inflation] yields on gilts will adjust back up towards +2.5%,’ said Bowie. ‘When this adjustment takes place, fixed income returns will be hit hard. As a rule of thumb, credit loses 8% of its capital for every 1% move higher in gilt yields.

‘So, in short, this adjustment will be very painful for credit investors. This leaves the obvious question: when will it happen?’

For the moment, Bowie believes slower inflation is still on the cards and that gilts will not fall dramatically. ‘Wage inflation is not a problem in the UK, and consumer prices have retreated from the levels seen in the recent past.’

However, as long as persistent deflation does not rear its head, real yields will adjust upwards, Bowie said.

‘The timing of this adjustment is really difficult to call, but whilst the Bank of England leaves the option open of printing more money, my suspicion is that this is months, or a low single digit number of quarters, away,’ said Bowie. ‘Certainly not years.’