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Ignis's Bowie: how to tackle the low yield conundrum

on Nov 14, 2012 at 14:07

These bonds are generally issued by large stable companies, such as German utility EnBW and energy company BG Group. They offer two to three times the yield of the senior debt, and while they are rated two to three notches lower, their volatility is far less than that of financials.

I also like sectors where investors are protected by physical asset backing. Examples include companies in the UK like Tesco and Sainsbury’s, where investors can buy bonds that yield between 4% and 5% and are backed by physical supermarket properties.

Physical backing

Similarly, utility asset-backed positions, such as Thames Water or Yorkshire Water, provide investors with physical backing that reinforces the credit worthiness of the bonds, and offer sensible levels of yield.

Where I particularly dislike the risk-reward profile of credit is in banks. Given their extremely high correlations to euro sovereigns and with the constant pressure to rebuild capital ratios in the form of regulatory and self-imposed capital requirements, banks will continue to be a high beta sector with plenty of volatility and uncertain returns.

In summary, the return outlook for credit is for low single-digit returns over the immediate future with a certain degree of volatility. Those returns may be better than the paltry returns from cash, and possibly better on a volatility-adjusted basis compared to equities, but credit will struggle to generate a positive real (ie, inflation-adjusted) return in an environment of record high debt, record money printing and record low yields.

In these conditions, investors may favour a low beta strategy with an element of defence that physical asset-backed holdings provide.

Chris Bowie is manager of the AA-rated manager of the Ignis Corporate Bond fund which has returned 36.84% over three years compared to a 30.45% rise in the Markit Sterling iBox Sterling Corporates index.

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