Is the party over for corporate debt?

It's been quite a ride for corporate-bond investors. Investment-grade corporate bonds returned 9.2% this year up to June, beating Treasuries (US government bonds) by a staggering 13.7%, according to Merrill Lynch. That's the biggest margin on record, and proof perhaps that the bankruptcy of Lehman Brothers once a blue-chip bond issuer has become a distant memory. What's more, "you could have bought any corporate credit in January and February and made out like a bandit", says Richard Lee, a managing director at broker-dealer Wall Street Access in New York on Bloomberg.

But making decent money in the second half of 2009 will be tougher. Bond prices, which were as low as 10p per £1 of debt for some firms at the height of the crisis, have recovered as investors have piled into the market. Of the new money pumped into funds in May, for example, £717m went into corporate bond funds. That made it the most popular sector for the seventh month in a row, according to the Investment Management Association. The result has been rising prices and falling yields. Indeed, yields have fallen both in absolute terms and relative to government bonds, so new investors are no longer being paid a big premium to stomach the extra default risk.

And that risk is rising. This week, the UK subprime lender Cattles failed to make an interest payment on a £400m bond. Moody's, the credit-rating agency, predicts the overall default rate on higher yield US corporate bonds will rise to 13.8% by the fourth quarter. Worse, Standard & Poor's estimates that the default rate for speculative-grade firms between 2008-2011 in Europe could be an eye-popping 30%-35%. So investors may be about to get a reminder about why junk bonds "earned their original name", says Jenny Davey in The Times.

Start your trial of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up for MoneyWeek’s free twice-daily newsletter.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

However, all is not lost for corporate-bond investors, even if yields have fallen. Some lower-risk, blue-chip funds still offer decent yields and the safety of diversification, says Ben Yearsley at Hargreaves Lansdown in The Daily Telegraph. He recommends the Jupiter Corporate Bond Fund (tel: 020-7314 7600), which yields 5.04%. Despite the rising default risk, Yearsley thinks "there is still more to come" from higher-yield debt. If you agree, the Henderson Strategic Bond Fund (020-7818 1818) yields 7.6%.