Bryn Jones, manager of the Rathbone Ethical Bond Fund tells MoneyWeek where he'd put his money now.
Yields on the UK's ten-year gilt have strengthened in recent weeks. Investors are worried about domestic and global economic growth, and these fears have been compounded by weaker data out of the US. Particularly disappointing is manufacturing data. The Institute for Supply Management(ISM)index which has a high historical correlation to growth fell to 53.3 in April from 55.2 the previous month.
Manufacturing data has also been softer in the UK, with the Confederation of British Industry's latest manufacturing survey showing a notable increase in pessimism. Meanwhile, economists are revising down their UK growth estimates for the first quarter to 0.5%; the year estimate comes down to between 2.5% and 2.7%. This is already well below Chancellor Gordon Brown's official estimate of 3%-3.5% for the year.
Despite this weakness, we're keeping a close eye on inflation in the UK and the US. The Bank of England (BoE) kept interest rates at 4.75% in June, but we'll be following data closely over the next few months for hints on the direction of rates. The futures market is pricing in at least a quarter-point rise in interest rates by the end of the year. But we believe that a cut is likely, although not in the near term.
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In recent months, our portfolio had been relatively short-duration because we expected the BoE to raise rates to stem inflation. Since the reverse now looks likely, we've been buying duration on dips. We remain underweight duration, but are looking to shift into neutral territory over the coming months should yields provide us with an opportunity. We would look to increase our duration through the use of AAA-rated bonds, the highest grade corporate debt available.
Investing in corporate bonds: the fundamentals are sound
The market has also witnessed an indiscriminate widening in corporate-credit spreads the extra yield over government bonds following the downgrades of Ford and GM. We believe that the market reaction was somewhat excessive, as many companies had recently demonstrated good figures, and fundamentals still look reasonable for some corporate bonds. The correction has thrown up some interesting buying opportunities, and we are selectively adding to positions.
Prior to the widening of spreads, we had reduced our high-beta exposure, but have since bought back into certain names. We bought a position in South African financial services group Old Mutual on a cheap valuation following its talks to buy Skandia, the Swedish insurer. We added a long-dated position in German banking giant HypoVereinsbank on bid speculation, where the recently announced merger with Uncredito Italiano should see HVB's credit quality improve. We continue to back Australia's Macquarie Bank in anticipation of a possible upgrade following a significant improvement in its balance sheet.
Our exposure to the banking and insurance sector is also driven by a preference for sectors that are not structurally prone to the increasing risk of leveraged buyouts. For this reason, as well as their strong cash flow and cash generation, we continue to hold Bank of Scotland, Northern Rock and Royal Bank of Scotland.
We continue to hold retail bank Bradford & Bingley, which we believe is approaching fair value, and would look to take profits on that basisFinally, we have bought into the long-end of Severn Trent Water Utilities Finance. A defensive story, regulatory controls should ensure the bond retains a strong credit rating.
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Also see Anna Lees-Jones of Investec Sterling Bond Fund's recommendations for corporate bonds to invest in: Sleep tight with corporate bonds. For a general overview of bond investments, read: What you should expect if you invest in bonds.
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