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Bond funds caught out by bank crisis

Funds such as the £5 billion Invesco Corporate Bond fund have been hit by their hefty exposure to the troubled banking sector. 

 
Bond funds caught out by bank crisis

The eurozone debt crisis has revealed that some corporate bond funds are taking too much risk with investors’ money.

Big bet on banks

Managers who placed up to 50% of their investors' money in bank bonds, believing they offered exceptional value, have been among those caught out by this summer’s stock market rout, which led this week to the collapse of Belgian bank Dexia.

Investors in funds such as Invesco Perpetual Corporate Bond , Schroder Corporate Bond  and SWIP Sterling Credit Advantage (run by Scottish Widows, the investment arm of Lloyds Banking Group) have suffered losses of between 2% and 6% over the summer as a result of this bet.

Although these are not large losses in comparison with funds invested in shares, they raise awkward questions, particularly as corporate bond funds were meant to be less volatile investments suitable for people more used to sheltering their money in building-society savings accounts.

Key questions are:

  • What will happen to these funds if a solution to the eurozone banking crisis is not found?
  • Why did the funds have between 30% and 52% in banks when trouble hit? Funds such as M&G Corporate Bond and Fidelity Moneybuilder Income  that did not buy into bank bonds so heavily have seen their returns hold up.

What are bonds?

Corporate bonds are a form of IOU issued by companies when they borrow money from investors. Because bonds pay a fixed level of interest, known as a coupon, they have in the past been regarded as safer than shares.

However, with the sovereign debt crisis wiping out bonds from Greece, Portugal and other European countries, that view of bonds is now a dangerous simplification. Nevertheless, corporate bonds from big, strong companies are still seen as a good option for people seeking a regular income when interest rates languish at an all-time low.

What has gone wrong?

As Europe's financial crisis worsened over the summer investors panicked, thinking the eurozone's problems could tip the world into recession. Shares, bonds and commodities were all dumped in August as investors took flight into cash.

Bank bonds bore the full force of this sell-off as above all else investors feared another banking crisis to match the dark days of 2008-09.

It was the collapse of US investment bank Lehman Brothers three years ago that sparked a credit crunch that threw stock markets into turmoil and threatened to plunge the world into a great depression.

In the banking crisis that followed, bank bonds slumped in value, presenting fund managers with a good investment opportunity. As the crisis receded the bonds rose in value, making this look like a good move. Unfortunately, fund managers have been caught out by the speed with which the banking crisis has resurfaced this year.

The failure of European leaders to get to grips with Greece’s insolvency has spread the economic contagion to other ‘peripheral’ countries such as Portugal, Spain and Italy. The stress has been conducted to the banking sector as banks are big holders of sovereign bonds. As the economic crisis has intensified bank bonds have come under huge pressure as investors have worried about their stability.

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26 comments so far. Why not have your say?

Michael O'Leary

Oct 12, 2011 at 07:02

In these strong headwinds of financial restructuring, investment in the majority of previous sound punts are suffering and wil suffer over the next three years or so, safest place for your money in under the mattress, let the bed bugs mind it, no interest, but your money will be there in the morning.

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Tony Peterson

Oct 12, 2011 at 07:08

And worth less, thanks to inflation.

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Michael O'Leary

Oct 12, 2011 at 07:47

Ok, inflation bites, but bed bugs don't dine out on expensive lunches, don't take an enormous bonus for failure to protect your money, and lose more of your money (after deducting their fees) through bad timing, so called experts are guys that know just a little more then you, sometimes....

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Michael Peters Fenwicks

Oct 12, 2011 at 08:26

One TRICK PONY MANAGERS methinks.............

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Geoff Harrop

Oct 12, 2011 at 09:04

Premium bonds are safe and you might even get lucky.

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joe stalin

Oct 12, 2011 at 09:12

The Fund Management industry has a lot of questions to answere particularly as there appears to be little or no accountability for investment decisions that are made. A mitigating factor is that the climate is excessively volatile as a result of an over reliance on leveraged products such as ETF's and synthetic ETF's. Add to this often irresponsible and nonsensical media coverage by "trusted" sources such as the FT and financial networks such as CNBC it is easy to see why "investors" run from one panic to another.

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Patrick Napier

Oct 12, 2011 at 09:16

It is hard to believe that the "experts" took such a risk by investing in this toxic area . They have betrayed the investors in their funds who were seeking safety. The trouble is who CAN you trust nowadays?

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Tony Peterson

Oct 12, 2011 at 09:18

The overwhelming majority of Premium Bond holders are losing far more to inflation than they make in prizes.

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Geoff Harrop

Oct 12, 2011 at 09:29

Tony - yes you are right but surely better than cash in a sock under the mattress.

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rodrigo diaz

Oct 12, 2011 at 09:32

@patrick:

thats the point on my opinion too. and also: which is a RELIABLE ENTITY?

pshhhhhh.....

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Tony Peterson

Oct 12, 2011 at 09:40

Everything is relative, Geoff.

Better than a sock but nowhere near as good as index-linked gilts or high yielding blue chips.

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Knowledgable insider

Oct 12, 2011 at 10:38

I have been in this business long enough to know that in 3 years or so, many of the above comments will appear foolish with the value of hindisight and the same commentators will be expressing the view 'why didnt the public invest then' ....Ha I say to amateur comments such as many of the above

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Michael O'Leary

Oct 12, 2011 at 10:41

The mattress remark was an analogy, as to why ''Financial Experts'' place your money into limp balloon financial investments when negative gale force winds are blowing everything out of the water, is commision, commision, etc, and some of these experts get commission both ends.

I took a company to market, and you would not believe how many experts you end up paying for little or no work, and how they can inflate the value of a company with a few strokes of a pen, in fact I was so impressed by the company we listed, I was eager to buy shares in it, until reminded I owned a decent amount of shares already, smoke and mirrors, smoke and....

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Patrick Napier

Oct 12, 2011 at 10:52

Tony, you are spot on. Half in index-linked and half in high yielding blue chips is the way to invest in these "troubled" times. Some experts will do better than this but they may be taking unwise risks to do so. Trying not to lose is perhaps safer nowadays.

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Michael O'Leary

Oct 12, 2011 at 11:17

hindsight is another country, observation and insight are the tools needed in a volatile global financial world, listen to the experts, dismiss half of what they say, and double check the other half before taking a punt, and only then if gut instinct has no reservations, remember, the Stock Market is a betting shop, and the big race on at the moment is the Grand National, the biggest fence is Beechers Brook, when many so called top form investments will fall.

Your money will be lost, but the 'expert Jockey' will always get paid...

But things will get better three to four years down the road, and as one of the above commentators stated, at least there is a chance of winning a money prize, and no chance of losing your stake.

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electrocash

Oct 12, 2011 at 12:05

Hindsight is a wonderful thing and how many times, after a stock market bull-run have each one of us said something like "If only I had mustered the courage to buy quality equities when they were cheap - particularly when I even KNEW they were cheap at the time". Well, this must surely be such an opportunity now. Doom and gloom will not last forever and there are many stable, profitable, well run companies out there paying upwards of 4.5% dividends, for sale at bargain prices. Three to four years down the road will see the stock market back on valuations that will well surpass all time highs.

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Rose G

Oct 12, 2011 at 12:18

There are more Madoffs out there, they just have not come out the woodwork!

It is amazing how conmen like him populate the world of finance & little wonder that no one can touch them when the SEC itself is a flawed organisation, just like FSA has no teeth, let alone bite!

When I have any cash available to invest, will do it myself, will have only myself to blame or congratulate instead of managers who cannot manage a piss up in a brewery.

One has to ask oneself why they think they should be paid when they cannot manage to blow their noses without extra help?

The financial world is populated with people of no integrity, as is the political one - they seem to occupy that rare space of blind ignorance led by greed; followed eventually by megalomania, which off course is terminal!

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Prudence

Oct 12, 2011 at 12:39

Given that the baby usually gets thrown out with the bath water when markets get nervous, it can often be a time to pick up high quality names at knock-down prices. Buyers may need to weather further volatility before seeing a return on their purchases.

Before condemning Messrs Causer and Read for a bad three months, it would be useful to know which bank names they have invested in. If they believe a bank is not going to go bust then buying its debt at a historically wide spread will prove a good investment in time.

Like Tony Peterson, I'm in index-linked and safe blue chips with nice dividend yields.

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Anonymous 1 needed this 'off the record'

Oct 12, 2011 at 13:17

Corporate Bonds are one thing....... but are you going to invest money in Lloyds RBS ect., with their record........ look at the performance of their share prices over the last 2 years to realise the quality of the Companies you are dealing with, might as well ask me if I would invest in a Labour Govt., these are no brainers you know you are going to loose money. A Companies culture does not change overnight, it takes huge effort to change it and move on the people that are the reason for the problems.

Anyone buying a Western Govt. Ponzi Bond is immoral...... the Govt. has to survive on what it taxes, as Dave has basically said, don't spend more than you earn, if individuals can do it so can the Govt. Perhaps then we might start to have sustainable growth.... not the artificial chaos and manipulation that we have at the moment ........

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JETTE BARTON

Oct 12, 2011 at 15:47

I think that fund managers are "leant on" by various financial authorities to buy bank debt. The problem is, of course, that it is not their money being invested.

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Linda Green

Oct 12, 2011 at 17:32

Hargreaves Lansdown still have the Invesco Corporate Bond Fund in their 'wealth 150', and haven't updated their commentary on the fund since May, which is worrying, as it may not be the best bond fund to invest in at present.

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James Wetherall

Oct 12, 2011 at 19:39

There are some very churlish and unjustified comments above.

Anyone who bothered to do the slightest bit of research into the Invesco Perpetual Corp Bond fund before they invested would have seen that it primarily operates in the BBB arena, making it an above average risk compared to other more vanilla bond funds. Over the last twelve months when many corporates are sat on high cash balances, fishing for better returns lower down the credit gradings made sense and saw the fund returning good performance.

So they made a mistake? No fund manager is infallible. They have made a lot of good calls over the years and are conviction investors. Just because one of their major plays has gone awry it seems very churlish to suddenly make them out to be some sort of investment pariah.

This is not an insignificant event in the funds history and it certainly has seen heavy losses over the last three months, but I am sure they will deal with it and get back on track. You cannot expect even the best fund managers to get it right every time. I have used it in client portfolios and will continue to do so.

The moral of the story for private investors who got burned is always check the credit sector weightings of corporate bond funds. If they are primarily AAA and AA then expect low volatility but lower returns. If mostly A and BBB then expect greater long term returns and greater volatility. If sub BBB then expect equity-like behaviour but higher potential long term returns.

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TrustyBadger

Oct 12, 2011 at 19:41

Anyones who's actually interested in why the corporate bond fund is down should head over to Invesco's investor relations site where you can find a recent video of a Q&A session in which the fund manager answers questions put to him and does his best to justifiy the portfolio decisions.

Personally, I have a 10% allocation to the corporate bond fund and am not fretting about the loss of a few percent over what has been a very difficult quarter for most funds / asset classes!

Frankly if you look at who ultimately benefits from the various bailouts it tends to be banks, so some exposure to senior bank debt (as opposed to soverign debt) may prove to be a shrewd investment over the mid-term.

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William Bishop

Oct 15, 2011 at 10:16

Glad to see the last few sensible comments - no one gets it right all the time, and attempting to make a mountain out of a molehill lasting a few months is not constructive.

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Franco

Oct 15, 2011 at 15:30

Michael O' Leary, I could agree with you more. There are no experts in finance, just boastful impostors. These so called experts could not see coming the biggest financial tsunami in history and now they have the fantastic cheek to be telling us where to invest.

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simone lienhart

Oct 15, 2011 at 15:41

well it might be more risky but definitely more profitable to buy individual bonds in 2 or 3 different currencies, with high yield (9 % plus) and once or twice a year catch another 5 to 10 % by switching currencies...it is possible to buy a corporte bond tht exists in both euro and usd for ex and switch back and forth....

of course one has to have a minimal cost...like 0.30 % a move...which is possible at several banks or buy and sell directly on the german market which is much more user friendly and oriented towards individuals by offering a lot of bonds with a min of 1000 euros, not 50 k or 100k

sorry but bond funds are out of question for me, the onl people making money are the fund people

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