Twitter icon Email alerts icon Latest News RSS icon Magazine icon Stay connected:

View the article online at http://citywire.co.uk/wealth-manager/article/a659894

Jenna Barnard: the Keynesian animal spirit threat to bonds

on Feb 19, 2013 at 14:40

As anyone who has heard us talk in recent years will know, the primary threat to investment grade bond returns is from rising gilt yields.

The correlation between these two asset classes is 85% over the long term* as moves in gilt yields drive the majority of the return for investment grade bond funds that do not actively manage their duration (interest rate) sensitivity.

Animal spirits

This has been enough of a challenge for most investment grade funds in the last six months. However, there is another risk to investment grade bonds, one that we have not seen for a number of years – the return of Keynesian ‘animal spirits’.

Simply put, as investors and companies become more confident we see more corporate activity, which aims to juice up returns for equity investors at the expense of top-quality bond investors.

Taking on greater amounts of debt to make aggressive acquisitions is typically done by private equity firms. The effects can be dramatic if you hold the wrong investment grade bond as holders of the Heinz 6.25% GBP 2030 bond can testify to – these bonds lost over 14% in value in two days last week when the Warren Buffett and private equity combined bid for the company was announced.

It is not just baked bean and sauces that have been the target for leverage‑driven acquisitions in recent weeks. Virgin Media and Dell are two other household names, which have been targeted and caused significant losses on investment grade bonds.

Many of these bonds trade at a price which is at a significant premium to par and on correspondingly low yields. The higher yield needed to compensate investors for the greater risk in a highly indebted balance sheet involves significant price falls.

For the few investment grade bonds that do have a covenant, which demands the bonds be repaid at par if taken over, that is of limited protection if your bonds trade at 113p in the pound, as holders of the 5.5% GBP 2021 Virgin Media bond discovered when the price of these bonds fell to 102p in the pound after the takeover was announced.

The clock face

Where did this activity come from and is there more to come? 

Many have used the analogy of a clock face to describe the investment cycle; the clock face is broken up into four quarters: recovery, growth, boom and recession.

Sign in / register to view full article on one page

leave a comment

Please sign in here or register here to comment. It is free to register and only takes a minute or two.

News sponsored by:

Sponsored Video: Bringing it all back home


As the UK coalition government strives to rebalance the national economy, so called 'reshoring' looks set to play an increasingly important role in economic recovery.

Today's top headlines

Investing for income in a changing environment


With talk on interest rates on the horizon, our latest roundtable debate covers income investing against a changing backdrop

More about this:

Look up the funds

  • Henderson Strategic Bond A Net Inc
    Register or Sign in to receive email alerts for items in your favourites whenever we write about them

Look up the shares

  • Vodafone Group PLC
    Register or Sign in to receive email alerts for items in your favourites whenever we write about them

Look up the fund managers

  • Jenna Barnard
    Register or Sign in to receive email alerts for items in your favourites whenever we write about them
  • John Pattullo
    Register or Sign in to receive email alerts for items in your favourites whenever we write about them

Archive

On the road

Click here to find out more from the Audience Development team.

Sorry, this link is not
quite ready yet