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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.
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.
More about this:
Look up the funds
- Invesco Perpetual Corporate Bond Acc
- Schroder Corporate Bond A Inc
- SWIP Sterling Credit Advantage P Inc Net
- Lazard Sterling Corporate Bond Inst Inc
- Standard Life Inv Select Income Inst Acc
- Aberdeen Multi Manager Sterling Bond Acc
- Aberdeen Corporate Bond I Inc
- CIS Corporate Bond Income Trust
- IFDS Brown Shipley Sterling Bond A Inc
- BlackRock Corporate Bond Inc
- Standard Life Inv AAA Income Ret Inc
- Baillie Gifford Investment Grade Bond A Inc
- Newton Long Corporate Bond Inst GBP Acc
- M&G Corporate Bond I Acc
- GLG Core Plus Sterling Bond Ret Acc
- Fidelity Moneybuilder Income
- Allianz PIMCO Gilt Yield A Inc
- Kames High Yield Bond Acc A
- Investec Global Bond A GBP Inc Net
Look up the fund managers
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