Private credit is not the catchiest topic. Put it alongside AI or bitcoin, and you can see why it doesn’t make so many headlines. Yet there has been a growing stream of stories over the past year or so about the potential risks that could be lurking in the sector, to the point where big names such as Marc Rowan of Apollo apparently feel the need to step up and defend it.

Shares in Blue Owl Capital, which is exposed to some of the main worries that investors have about private credit, have fallen about 30% this year. It has done noticeably worse than private-markets peers such as Apollo or Ares, which are big players in private credit, but have a smaller proportion of their overall business there.

These jitters may be pretty much irrelevant unless you are investing in private credit. I am a little sceptical about it as an investment, but that doesn’t mean that losses will have much impact on other markets. If private credit has indeed taken lending off bank balance sheets – as supporters claim – it could even reduce the consequences of higher defaults.

Private credit's link to the AI boom

Still, investors who remember the global financial crisis will recall the structured finance boom – mortgage-backed securities (MBSs), collateralised debt obligations (CDOs) and an alphabet soup of other vehicles. These were also supposed to redistribute risks and make the system safer. They ended up doing the opposite. That does not mean that private credit is likely to do the same – there are very significant differences between direct lending and structured finance. It only means that investors should be alert to unexpected consequences.

One of the intriguing aspects of private credit is the growing link to the AI boom. Data centres cost a great deal of money and private credit seems to be funding more of it: UBS estimated in August that private credit to the tech sector had risen by $100 billion (or 29%) in 12 months.

For example, Meta Platforms is building a $27 billion data centre in Louisiana, financed by Blue Owl’s funds. The accounting in this deal is intriguing: the liability is mostly off Meta’s balance sheet on the basis that the tech giant only enters into a four-year contract, renewable every four years – even though it provides a “residual value guarantee” to protect bondholders if it doesn’t renew. Still, Meta is probably good for the money. Some of the other data-centre firms will not be if their customers walk away.

Does this mean that an AI bust would ripple through credit markets, spreading the pain more than expected? Who knows. That’s the problem with private markets. It’s hard to see where the risks lie and who might be left holding the bag.

MoneyWeek has launched a new weekly email newsletter called Investing Spotlight. Dan McEvoy – who has written here on AI and other topics in recent months – will discuss the latest news and trends in investing. Sign up to the MoneyWeek newsletter to get it every Friday evening.

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Manulife CQS New City High Yield Fund (LSE: NCYF) aims to provide investors with a high gross dividend yield (currently 8.8%) and the potential for capital growth by investing mainly in undervalued, high-yielding fixed-interest securities. Around 87% of the portfolio is in fixed-interest securities, with 13% in equities (there is a 20% limit on equity exposure). With respect to currencies, 69% of the portfolio is in sterling, 18% in US dollars and 13% in euros.

As one of the smaller fixed-income funds, NCYF can participate in highly attractive small corporate-bond issues, which are often inaccessible to larger funds owing to their minimum-size requirements. The manager’s prudent risk-management focus has resulted in only three defaults since the fund’s inception in 2007 and enabled NCYF to increase the dividend every year for 18 years.

Three overlooked companies to consider

The largest holding is Shawbrook Group 12.103% Perpetual. Shawbrook is a challenger bank offering lending and savings services for commercial (real-estate and smaller companies) and retail (mortgage- and consumer-finance) customers. It is highly profitable, and its organic growth has been boosted by acquisitions in areas such as vehicle finance and smaller-company lending. Its Common Equity Tier 1 ratio (a gauge of a bank’s core capital adequacy) hovers around a comfortable 13% (3% is the minimum requirement).

The balance sheet and loan book have more than doubled in the last five years to £20 billion and £17 billion respectively. As is true of most challenger or specialist lenders, underwriting at Shawbrook is often manual, reflected in robust net-interest margins of 400 basis points, and a moderate cost of risk of 40 basis points.

The funding side is driven by retail savings, mostly fixed-rate and term, and 90% of the £16.7bn of retail-savings deposits are small enough to be insured by the Financial Services Compensation Scheme. The bank’s lack of coverage by equity analysts and infrequent smaller bond deals means it is often overlooked.

Consider also Stonegate 10.75% 2029. The firm operates a network of pubs, clubs and bars. It is a large player in a fragmented market with a market share of 10%; a supportive sponsor, as demonstrated by its last £250 million equity injection; good asset coverage, with £3.2 billion of real estate; and an improved financial profile. Although Stonegate still faces headwinds and the environment remains volatile, the company is advancing on its initiatives to optimise its assets through the conversion of pubs, disposals, and reducing the number of late-night venues.

There is also a focus on bolstering its appeal to customers, price increases with limited volume elasticity, and cost control. All these factors should lead to an improved free cash-flow profile. The group has no near-term maturities, while liquidity remains adequate. We believe that at 10.75% the bonds remain attractive.

Frontline (NYSE: FRO), the largest equity holding, is a world-leading shipping group transporting crude oil and refined products with a modern, energy-efficient fleet of tankers. Frontline is a beneficiary of sanctions against Russia and Indian refiners shifting some of their imports into the compliant market.

Should the war in Ukraine end, any exports of Russian crude would need compliant, insurable ships rather than the uninsured dark fleet currently used. We are also seeing a major increase in exports from West Africa to Asia, a highly profitable route for shippers. The high payout ratio makes this stock attractive for income investors.

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Investors are nervous. There are few other ways to read the latest gains in gold – above $3,650 per ounce for the first time this week – or the big moves in long-dated government bonds. Yet some markets look remarkably unperturbed.

Take credit spreads – the gap between the yield on government bonds and corporate debt – which tend to blow out at times of stress.

Spreads for US investment-grade bonds are instead at their tightest since 1998, barely 0.8 percentage points (pp) above the yield on comparable Treasuries. Eurozone investment grade bonds are similar; they have been tighter at times (eg, 2007 and 2018), but remain very low. Spreads for non-investment grade bonds (known as high-yield) are around 2.9pp, a bit higher than they were earlier this year in both the US and European markets. But they are still right at the bottom of their long-term range, and below the 4%-plus area they hit in April – which was not itself exceptionally high.

The growth of private credit

One theory holds that spreads are tight because government bonds are getting riskier and no longer offer a real “risk-free rate” to benchmark corporate bonds against. Some argue that top-grade corporate credit could trade on lower yields than governments (the spread on US AAA-rated bonds is around 0.3pp).

This feels like a stretch. The most likely escape route for governments is to have central banks buy bonds at low yields – a precedent set under quantitative easing. That is probably inflationary and inflation will hurt low-yield corporate bonds. If you expect this, you should demand higher yields, not settle for less.

Another argument with high yield, in particular, is that the corporate bond universe is of higher quality now. The growth of private credit – the hottest area in alternative assets over the past few years – means that lower-quality borrowers have migrated there to get more favourable terms. That has left the better borrowers in bonds. There is probably some truth in this, but spreads still look so tight that they don’t provide much compensation for risk.

Of course, tight spreads also explain why higher yields in private credit have proved so attractive. The challenge with private credit is that it is by definition less public, so it’s harder to have a clear picture of the market and how much risk investors are taking to earn, say, 200pp more yield from something much less liquid.

On the face of it, default rates remain low – around 1% according to a recent paper by ratings agency S&P Global. But this relies on a narrow definition of default and ignores selective defaults, such as converting cash interest into more debt, repayment holidays or extending debt maturities. Include those and defaults have been much higher, says S&P, despite the benign environment. Data from other analysts paints a similar picture. One has to figure there will be a reckoning here when the cycle turns, making low credit spreads in bonds a dangerous reason to reach further for higher yields in private credit.

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London’s retail bond market was launched a few years ago to help private investors buy corporate bonds. It seemed a good idea at the time – private investors in the US and Italy regularly buy individual fixed-income securities, such as tax-efficient municipal bonds. Yet it has never really taken off and in recent years new issuance has slowed to a trickle, mostly from smaller charities.

However, a few commercial issuers have stuck with the retail bond market, among them alternative lender LendInvest. It issued two five-year bonds: one in 2017, paying 5.25%, and another in 2018, paying 5.375%. Both were oversubscribed. The company has now announced a third five-year bond, this time with a substantially increased yield of 6.5%. Even in an era of sharply rising interest rates, this may appeal to some investors.

The new bond will mature on 8 August 2027. It has a face value of £100 – in common with most retail bonds – and will pay an interest rate of 6.5% per annum (£6.50 per bond), with interest paid twice yearly on 8 February and 8 August. The minimum investment at launch is £1,000, but will trade in smaller denominations after launch on the London Stock Exchange’s order book for retail bonds. The offer period for the launch is expected to close at 4pm on 3 August 2022. LendInvest is also offering holders of its outstanding bonds the opportunity to exchange them for this new issue.

Property-backed loans

The first step with a bond like this is to understand the security. LendInvest is an Aim-listed company set up 14 years ago. It makes bridging, development and buy-to-let loans. Its unique selling point is that it uses its own platform to complete loans quickly for borrowers and securitises them for institutional investors. Latest annual results showed assets under management grew 36% to £2.1bn from the year before, and adjusted earnings before interest, tax, depreciation and amortisation (Ebitda) was up 90% to £20.3m.

The bond is being issued by LendInvest Secured Income II, a special purpose vehicle that is a subsidiary of LendInvest. The subsidiary has its own ring-fenced balance sheet that consists of a basket of property-backed loans with an average loan-to-value of around 65% to 70%. There’s a partial 20% guarantee by LendInvest, which means that if the property market collapses, the loans go into default and don’t produce enough cash to repay the bonds, LendInvest will make up the shortfall in interest or principal to a maximum of 20%.

For investors content with the underlying credit risk, the next question is whether you want to invest in a corporate bond now. In market terms, the timing looks terrible. Inflation is around 10%, so a yield below that is eroding capital. Rates are going up, which will have a knock-on effect on corporate bond values. In terms of direct competition, UK government five-year bonds now yield 1.67% so you are getting 5% uplift from a riskier lender. The S&P UK Investment Grade Corporate Bond index yields 3.9%, so you’re getting an extra 2.5% on that.

However, many investors look at retail bonds as products to hold to maturity and let the income roll in, so the effect of markets on bond values don’t matter so much. The two key points are whether you are happy with the credit risk and whether the yield on offer for the full five years is enough to reward you for taking that risk. That hinges on whether you think inflation will remain elevated for the five years and whether rates will surge and then stay there for many years.

This product is not like a savings account – your capital is at risk here. But for reference, the best rate you can get on a five-year fixed-rate savings account is 3.3%. So the LendInvest bond gives you a 3% uplift for taking extra risk. For some income-orientated investors, that will look much more attractive.

High-yield bonds are finally living “up to their name”, says Randall Forsyth in Barron’s: yields on debt issued by companies with lower credit ratings plunged during the pandemic, as prices rose owing to ultra-low interest rates (yields move inversely to prices).

But now yields in the US high-yield market have soared by 4.2% since the start of the year to more than 8%, says Rachna Ramachandran of GMO. “There have been only two other instances in which yields have doubled so quickly” in the past 30 years: the 2008 financial crisis and the start of the pandemic in 2020.

The yield spike has brought painful losses for existing bondholders. The iShares iBoxx ETF, which tracks US investment grade debt, is down 15% this year, with a Bloomberg index of high-yield, or “junk” debt also falling 14%. Euro-denominated corporate debt is being similarly hard hit, says Sophie Rolland in Les Échos. Down 13% in the year to 20 June, the market slump far exceeds the 4% it lost in 2008, until now the worst year on record.

As well as feeling the effect of higher interest rate expectations, European debt is being hit by the European Central Bank’s (ECB) move to stop purchasing fresh debt with printed money this month. The ECB holds nearly 15% of all investment-grade euro corporate debt following previous rounds of asset purchases. Tightening credit conditions have seen “dozens of corporate bond deals” pulled from the European market, says Ian Johnston in the Financial Times. New corporate debt issuance fell 17% in the first half compared with a year before, with European high-yield debt issuance plunging 78%.

“Bond markets have had a rough year,” says Matt Grossman in The Wall Street Journal. “Red-hot inflation makes the fixed payments offered by most debt investments less appealing.” Yet as the yields offered by corporate debt rise, investors are “giving bonds another look”. Debt issued by blue-chip firms with reliable balance sheets is appealing: “it offers higher returns than government bonds but with relatively little additional risk”.

Will defaults spread?

The key uncertainty is to what extent defaults will rise. In past downturns investors could count on central banks stepping in to ease lending conditions, says Joe Rennison in the Financial Times. Yet now, with inflation soaring, they can’t.

Credit rating agency S&P Global Ratings thinks US corporate defaults will “rise to 3% by next March, up from 1.4% the previous year”, says Julia Horowitz for CNN Business. Still, most corporate balance sheets are reasonably solid after firms “took advantage of rock-bottom borrowing costs over the past two years to stash cash and… refinance their debt”. For now, “those who trade corporate bonds aren’t overly anxious”.

The least surprising bond default in the world happened this week.

Evergrande – the big Chinese property developer – has been declared in default.

Evergrande owes a lot of money. And it's only the tip of the iceberg that is the Chinese property sector.

So is this just the first domino to topple? Is it something you need to worry about?

The Chinese property sector is in a lot of trouble

Credit ratings agency Fitch has declared that overseas bonds issued by Chinese property developer Evergrande are in default.

Fitch, to its credit, is early on the scene compared to its peers. But as with most of the things that credit ratings agencies pronounce, it's merely a statement of the bloody obvious.

On Monday, Evergrande was meant to shell out $82.5m in interest payments on some of the IOUs that overseas investors own. It didn't, and so far it hasn't. When someone who owes you money misses a deadline to pay it back, that's a default.

Evergrande had missed payment deadlines before but it had been avoiding actual technical default by making the payments within 30-day grace periods. That's not happened this time.

So what's the effect been on the market? The Evergrande share price fell by nearly 4% – but in the context of Evergrande that's a pretty mild move. Wider Chinese indices basically shrugged.

Why? How can this be when just a few months ago we had people talking about how this would be China's “Lehman Brothers” moment?

This wasn't a Lehman Brothers moment and it was never likely to be.

Lehman became a “moment” mostly because of one thing: the element of surprise. Everyone knew there were problems in the credit markets, but not the extent of the problems. And everyone assumed (or rather, hoped) that Lehman would have a managed sale, rather than be allowed to collapse abruptly.

Evergrande has been on the market radar for a very long time indeed. The share price most recently peaked in July last year and has been on the slide ever since. So this has been expected for a long time.

And there's a good reason for that: the Chinese government has deliberately cracked down on the property sector; they thought house prices were too expensive and a source of social unrest, so they've been trying to pop the bubble, and that's been clear for a while.

In some ways, it's a bit like Turkey's woes (although those are being inflicted in a less deliberate manner). The immediate situation is bad, but it's been bad for so long that most of the people who were most exposed have reduced their exposure to manageable levels.

No one is trying to pretend that it's not a problem (which was very much the case with the credit crunch). So no one – or certainly no one systemically important – is going to get caught off guard.

Of course, saying that a financial event is not a Lehman Brothers moment is not the same as saying that said financial event is entirely harmless, in much the same way as saying you'd rather be punched in the face by an ordinary adult male rather than Mike Tyson is not saying that you would relish either option.

So none of that is to say that this doesn't matter. But as I said a few months ago, this is more of a chronic than an acute problem.

No bailouts – but there will certainly be managed wind-downs

So what happens now? More of the same, probably. As you'd expect, given that this is a sector-wide crackdown, Evergrande is not the only troubled property developer; Fitch also downgraded Kaisa, another in the sector.

The Chinese government itself is making it clear that a full-on bailout is not an option. Yi Gang, the head of the Chinese central bank (the People's Bank of China – PBOC) said at a seminar in Hong Kong that Evergrande's default is “a market event", notes the FT.

However, there are market events and then there are market events. Evergrande might not be being bailed out, but the company now has a new risk management committee on which four of the seven seats “are held by representatives of state-owned enterprises". In other words, civil servants.

So you've got the government already stepping in to oversee and manage the dismantling of the company and to untangle its web of debts and obligations and connections.

At the same time, the central bank is also making more money available to wider markets to soothe the impact of any jitters. Meanwhile, the crackdown on the property sector has become less severe: last week, the government said it would take steps to “boost public housing and support the housing market".

It's a juggling act for sure, but China has been a juggling act for a very long time; a constant swing between permissive and restrictive policies, because on the one hand you can't allow too much wealth inequality, but on the other hand you need constant economic growth and you also can't risk blowing up the entire financial system.

This is one reason why, generally speaking I'm not a big fan of investing in China. You are very much subordinate to the goals of the government and, while you might do fine for a while if you buy at the right time, eventually your property rights and their five-year plan have a good chance of coming into conflict, and there's only one winner there.

However, in terms of how this affects wider markets, I just struggle to make a big scary story out of it. China will want to contain the fallout. There's a lot of it, but if it dismantles it slowly and keeps markets lubricated with cheap money at the same time, then that'll be manageable.

There are plenty of things for investors to worry about that could trip up markets at any moment – rampant speculation and overvaluation, the threat of rising interest rates, inflation. But fingers crossed, China's property market is not one that I'd put high on that list.

Trouble is afoot in China’s $15trn bond market, says Rebecca Choong Wilkins on Bloomberg. State-owned firms once enjoyed an implicit state guarantee, precluding defaults. Yet in recent years Beijing has allowed more to default. The aim is to allow debt markets to function normally and price risk more efficiently, but there have been surprises along the way. Last month Yongcheng Coal & Electricity became the tenth state firm to default this year when it missed a payment on a ¥1bn (£114m) bond, says The Economist. The news rocked markets as Yongcheng had recently been given a “top-notch” credit rating and was well connected to the powers that be. Debt offerings designed to raise “at least ¥20bn” were then paused as investors scrambled to work out what was going on.

Foreign buyers still only make up 3% of the world’s second-largest debt market, says Chris Flood in the Financial Times. Yet global investors and bond indexers are piling into China, where yields are far more attractive than in the West. The local ten-year government bond yields 3.3%, compared with 0.9% for the equivalent US Treasury. Yet pricing risk is a headache: it is hard to predict how the authorities will respond when one of their own firms gets into trouble. Investors joke that “they will soon have to read tea leaves to decide which bonds to buy”, says Logan Wright of Rhodium Group.

In the jargon-filled world of Wall Street and the City, few financial terms are quite as evocative as the phrase, “fallen angels”.

So what does it mean, and why might an investor want to invest in a fallen angel?

When high-flying companies take a tumble

If we use credit ratings as a measure of risk, then sitting at the top of the fixed-income (bond) market hierarchy are those entities – businesses or governments – that have an investment-grade rating. This is the highest available, meaning that they are regarded as very low risk.

“Fallen angels” are companies which have been downgraded from investment grade to sub-investment grade. In short, they were once viewed as low risk by the credit ratings agencies, but have now fallen on harder times.

Their numbers include some of the best-known names in the corporate world – Ford, Kraft Heinz, Renault and Marks & Spencer are just a few of the issuers that have become “fallen angels” so far this year.

Why do these downgraded bonds attract such interest? Some of it is pure schadenfreude at seeing a once high-flying brand take a tumble. But there’s a harder-edged rationale too – many bond fund managers focus on these investment-grade dropouts because they believe that the market has been overly judgemental. In simple terms, fallen angels can present good investment opportunities.

To understand why fallen angels can be so lucrative as an investment, you need to understand that categories matter a lot to bond investors. Everything has its place, and everything is judged on risk.

Investment grade (IG) bonds and high-yield (HY) bonds are typically treated as entirely different silos in bond portfolios. So if a bond moves from one category to another following a downgrade, it’s not unreasonable to expect a sudden burst of trading activity as some institutions become forced sellers.

Here’s a hypothetical example. A globally recognised company might boast a very high grade rating – say Aa3 (using Moody’s) or AA- (for S&P and Fitch). But then its profit margins start to deteriorate, and it starts to pile on debt. As a result, it finds itself downgraded at first to single A status, and then to the much riskier BBB (or Baa, using Moody’s) category.

Once a bond issuer has a BBB rating, the next downgrade is to BB or even single B (or Ba and B using the Moody’s system) ie, non-investment grade. That move takes it out of the most liquid bit of the bond market into a less liquid segment regarded as much riskier – high yield or “junk”, as it’s called.

A key point here is that many large institutions, such as pension funds, have strict investment criteria which specify just how many junk bonds they can hold – in some cases, none at all.

A downgrade to high-yield status also results in those bonds being kicked out of any index that only invests in investment-grade bonds, forcing tracker funds and exchange-traded funds (ETFs) to divest them too.

Thus, a downgrade from investment grade to high yield will almost automatically trigger a wave of forced selling.

The state of play in today’s junk bond market

Such downgrades happen with alarming regularity. Ratings agency S&P, for instance, in the year to April 17th, had already taken negative rating actions on 383 investment-grade rated issuers affected by Covid-19 and the oil price slump. Meanwhile it had also “junked” 23 issuers, sending them sliding from BBB- to BB+.

By the start of September, that figure had risen to 34, making 2020 the third-highest annual total ever (the highest came in 2009 in the wake of the financial crisis, with 57 fallen angels in total).

Meanwhile, in terms of total value, 2020 is on course to be a record-breaker: it looks like a we’ll see a total of $640bn in global fallen angel debt this year. The previous record was $487.86bn in 2005.

The coronavirus and ensuing lockdown is mostly (though not wholly) responsible for the downgrades seen thus far. Not only has coronavirus hammered corporate creditworthiness, it has also seen companies race to raise cash to tide them over through tough times.

However, while such a huge wave of fallen angels might have been expected to cause serious turbulence in bond markets, central banks have stepped in to underwrite the market. At the start of the current crisis, the Federal Reserve, for the first time ever, declared that it would be able to buy fallen angels, provided that they had recently held investment-grade ratings.

As a result, noted Nick Kraemer of S&P in September, “thus far the speculative-grade bond market appears to have comfortably absorbed debt that was recently downgraded from triple-B”.

Why would anyone invest in a fallen angel?

So where’s the appeal? Well, after a downgrade, as the selling intensifies, it’s quite possible for the price of these bonds to fall more sharply than is deserved. The difference between BBB- and BB+, in balance sheet terms, may be quite incremental. It’s the forced selling of the bonds that can push them into “cheap” territory, especially as many fallen angels tend to be market leaders.

The trick for smart bond fund managers is to spot the fallen angels that have been oversold and still boast a decent business model – and balance sheets that can be repaired over time with careful hard work.

If such a business survives and restructures, the recovery might even result in the original downgrade being reversed, as the business re-acquires an investment grade rating. That’s a strategy that can pay off.

A recent analysis of returns since 1997 (through to 2020) found that global fallen angels have produced an annualised return of 9.11% compared to 5.3% for global original issue high-yield bonds; 5.3% for global investment grade; and 6% for all global high yield bonds.

That said, those superior returns have also come with much higher volatility, which is another way of saying that not all fallen angels are a good investment. Indeed, fallen angels are actually more likely to default than those bonds originally classed as high yield when first issued.

Sometimes a once well-known name turns into a fraud (Enron), or is pushed into decline by structural market changes (retail property jumps to mind). But of the fallen angels that survive the first downgrade, most have a high chance of regaining an investment grade rating after a period of balance sheet restructuring.

The moral of the story? Investing in cheap fallen angels can pay off – but only if you stick to those with a chance of redemption!

With average interest rates on savings accounts falling to under 1% for the first time, promises of 8% returns are bound to attract attention. But don’t be fooled into placing your cash in high-risk mini-bonds. A mini-bond is a high-risk form of corporate debt.

You lend your money to a company in return for a fixed interest-rate and the promise you’ll get your money back at the end of the term. The interest rates are attractive – typically around 8% – but you are taking a big risk with your cash. If the business goes bust, you are unlikely to get your money back.

This is something investors in restaurant group Chilango are just discovering. More than 1,000 people bought £5.8m of its mini-bonds. The investments were dubbed “burrito bonds” because if you invested more than £10,000 you could claim one free burrito a week. In November 2018 MoneyWeek warned readers to “think long and hard before you sink your money into the burrito bond”.

Now the vast majority of those bond holders stand to lose their money after Chilango announced it is entering administration. They “will be reliant on returns from the sale of its assets, which the company warned last year could lead to them losing 99% of their investment”, says Sarah Butler in The Guardian.

This is only the latest example of the significant risk mini-bonds present. In 2015 Secured Energy Bonds collapsed, losing investors more than £7m. In January 2019 London Capital & Finance (LCF) went bust, leaving 12,000 investors facing a £236m loss. “Mini-bonds are examples of high-risk investment products that should come with a health warning,” Myron Jobson, a personal finance campaigner at Interactive Investor, told The Times. “If something seems too good to be true, it usually is.”

Mini-bonds are an unregulated product

The problem with mini-bonds is that while the marketing is regulated, the product isn’t. This means that, unlike cash savings, money invested in mini-bonds is not protected by the Financial Services Compensation Scheme, which will compensate you with up to £85,000 if your bank or building society goes bust.

There is also confusion because firms authorised by the Financial Conduct Authority (FCA), the City regulator, sell mini-bonds. This prompted a surge of investments in LCF’s mini-bonds as “the firm was able to boast of authorisation from the FCA, despite the fact that the risky ‘mini-bonds’ it sold were unregulated,” says Adam Williams in The Telegraph.The Treasury has said it intends “to tighten industry rules following concerns that there was not a ‘strong enough safeguard’ against unregulated financial firms whose adverts are misleading and unclear”, says Williams. The FCA brought in a temporary ban on marketing mini-bonds to ordinary savers in January and will now make it permanent.

“We aim to prevent people investing in complex, high-risk products which are often designed to be hard to understand,” Sheldon Mills, interim executive director of strategy and competition at the FCA, told the Financial Times.

As with any investment, make sure you understand it before you buy it. Remember, a higher interest rate usually means higher risk. Finally, don’t choose your investments based on the free food that comes with them.

The corporate bond market continues to deliver unlikely returns, writes Tom Howard in The Times. Investors rushed into blue-chip paper during lockdown and have since been richly rewarded. Intel’s $1bn 40-year bond has risen to nearly 145 cents on the dollar since it was sold in March. Another $1.25bn UPS bond is up to 140 cents on the dollar. For these instruments to deliver such large capital gains in such a short time frame is rare indeed.

When markets plunged in March many feared that the overleveraged corporate debt sector would be at the centre of the fallout. But America’s Federal Reserve stepped in with unprecedented support, pledging to buy up to $750bn in corporate bonds. This week the Fed announced its first-ever purchases of individual corporate bonds. It had previously only bought them indirectly, through exchange traded funds (ETFs). The move looks like a “mistake” because bond markets are not stressed and don’t need the extra help, Christopher Whalen of Whalen Global Advisors told Jeff Cox on CNBC. The Fed ought to avoid “diving into this stuff” unnecessarily. The wall of central-bank money has triggered a debt bonanza. US “investment grade” corporate debt issuance this year has eclipsed $1trn and will soon surpass 2019’s overall total, says Joe Rennison in the Financial Times.

The Bank of England has also intervened in corporate bond markets. It plans to buy £10bn of non-financial corporate bonds, taking its total stock of corporate debt up to £20bn. As MoneyWeek went to press the Bank’s Monetary Policy Committee was expected to announce a further £100bn-£150bn increase in its £645bn quantitative easing programme, which mainly buys government gilts. Central bankers will not be taking away the market’s “punch bowl” anytime soon.

Corporate bonds have begun to recover their poise, says Marcus Ashworth on Bloomberg. High-yield credit spreads – the gap between yields on government bonds and those of riskier debt – are still double what they were before the crisis. “But almost half of the widening from the early days of the coronavirus lockdown has been reversed.”

That’s partly because investors remain desperate for yield. However, sentiment was also buoyed by the US Federal Reserve’s announcement back in March that it would buy corporate bonds. This backstop, which finally started last week, may not cost the central bank very much, says Kate Duguid on Reuters: in the first two days it bought just $305m (through bond exchange traded funds) – trivial given that firms issued $58bn in investment-grade bonds and $11bn in high-yield bonds last week. But the Fed has $750bn to spend if needed; knowing this will “have the desired effect of keeping the credit market afloat”.

Of course, central bank buying only solves liquidity issues – ie, making sure firms have access to financing – as Fed chair Jerome Powell noted last week. Many firms will have seen their solvency (ie, their ability eventually to repay their debt) affected by the crisis. Hence credit ratings are coming under pressure. For example, there have been 24 fallen angels (borrowers downgraded from investment grade to high yield) so far this year, says S&P Global Ratings, with a record 111 potential fallen angels on watch for potential downgrade.

That said, this particular trend may not be all bad for investors, say analysts at Bank of America – since forced selling by investors who can only hold investment-grade bonds means this debt often ends up temporarily cheap. “History shows that fallen angels tend to outperform after downgrades,” it notes.

I’ve just been reading the latest piece from Albert Edwards at Societe Generale. Edwards has a long-running reputation as one of the market’s biggest bears. He’s also stuck stubbornly to his view that bond yields would continue to collapse around the globe, with huge consequences for global financial markets and the economy.

And guess what? He’s been proved absolutely right so far. So what’s he saying now? Brace yourself to be terrified.

The Ice Age is drawing closer by the minute

Albert Edwards has a well-earned reputation for being something of an uber-bear. He’s claimed on a few occasions that he expects the S&P 500 to revisit its “666” low, seen in the wake of the global financial crisis in 2008. Given that stockmarkets have surged since 2009, that has sometimes led to him being lumped in with other “permabears” who are always looking for the next crisis.

However, that’s very unfair. For one thing, Edwards has had a long-held and logical thesis behind his views. His long-running “Ice Age” theory has been that, in effect, Japan was just a dry run for the rest of the world. Eventually, we’ll all end up in a deflationary pit, which in turn means that bond yields across the globe will collapse.

So far he’s been absolutely right on this. Yields just won’t stop falling. I thought that the madness of the likes of the governments of Japan and Germany and Switzerland being paid by lenders to look after their money was the nadir. I was wrong.

Yields on US government debt – the most important set of interest rates in the world – have collapsed this week, to unprecedented lows. This morning, the US government’s cost of borrowing over ten years has dropped to below 0.7%. In the jargon, the ten-year Treasury yield is now below 0.7%.

Given that the Federal Reserve is meant to do all in its power to make inflation average around 2% over the long run, this suggests a huge lack of faith on the part of investors. By one view, they are queuing up to lose money in “real” (after inflation) terms.

There’s more. The real yield on inflation-linked 30-year Treasuries has fallen below 0% for the first time ever.

If all of this is baffling you a bit, don’t worry – it’s technical and it’s unprecedented, but, long story short, it’s saying that the market expects to see rampant deflation and it doesn’t think that central banks can prevent it.

That leads me onto my second point about Edwards, which is that, despite his bearishness on equities, if you’d followed his advice to stick to bonds over the last few decades, you’d have done just fine.

So all in all, for all the grumpy-sounding headlines, Edwards has been far more right than wrong. (And – hands up – the more inflation-inclined like myself have so far been wrong.)

So what’s he saying now?

The coronavirus could be the pin that bursts the corporate debt bubble

Here’s the problem in a nutshell: the global economy is heavily indebted. Companies have loaded up on debt because it’s cheap. Unlike the last financial crisis, the debt now is in “proper” companies rather than the banking sector.

The risk, as John Plender puts it in an article for the FT that Edwards references, is that the coronavirus batters earnings and makes it harder for companies to service their debt. In turn, investors would suddenly take fright when they wake up to just how low quality a lot of this debt is. That’ll drive up borrowing costs and make it even harder for troubled companies to make their interest payments.

“In effect, the coronavirus raises the extraordinary prospect of a credit crunch in a world of ultra-low and negative interest rates,” says Plender.

Spiking interest costs for companies would of course be bad news for shareholders too, because bondholders get paid first – if they can’t get their cut, the equity is worthless.

And even then it would still be bad news for anyone who owned said debt, because its poor quality means that recovery rates (the amount of money you get from a bankrupt company) would be much lower than we’ve seen historically.

That’s scary. The underlying issue is that the entire financial market is structurally short volatility, and that’s the fault of central banks, led by the Federal Reserve.

What does “structurally short volatility" mean? It means that because central banks always step in to prop up markets when they fall, investors have decided that there won’t be another crisis. So they take bigger risks – because why wouldn’t you, when there’s always the Greenspan safety net to catch you?

So investors are very long complacency, and very short black swans. And when you get yourself into that position, it doesn’t take much of a black swan – maybe a black cygnet even – to swoop down and knock over your carefully constructed portfolio.

I suspect we’re not far from the point now where we move from crisis prevention mode to “preparing for the clean-up” mode. We’ll almost certainly see unprecedented monetary and fiscal policy coming out of all this – but we're probably going to have to go through some pain first.

Sluggish economic growth and historically low bond yields are pushing investors towards growth stocks and away from cyclical value shares. Growth stocks are bought for their long-term cash flows, which are worth relatively more as yields fall. An equity manager’s performance over the next year will almost certainly depend on whether they get the call between growth and value correct. Managing equities has become much more dependent on top-down judgements.

While equity managers are struggling with the polarisation between growth and value stocks, bond managers like me are wholly driven by value: there is no growth in fixed income (the clue is in the name). But where is the value in bonds now?

Bonds used to be regarded as the safe asset class and UK government bonds (Gilts) as a risk-free return. But the ratio of income to potential capital losses (as yields rise) has reached a level that makes the asset class anything but safe. Globally, government bonds on negative yields (there are still $13trn of them out there) have become a return-free risk.

Shop for retail bonds...

So where do bond managers turn to find returns without taking excessive duration or credit risk? This is not easy for bond managers and even harder, I would suggest, for private investors. Corporate bonds tend to be sold with large minimum denominations these days, putting them out of reach for most private investors. One way, however, in which an investor can find a decent yield is to accept some degree of liquidity risk, or look in places where institutional investors can’t invest owing to their size. The UK retail bond market is one such place.

There are a number of smaller businesses that use the retail bond market to issue bonds in smaller sizes and at a lower cost. Small companies are not necessarily a poorer credit risk, even when they haven’t got an official credit rating. If you have the time to look at these companies carefully, you can find many with reliable cash flows established over long periods and comfortably above their financing costs. We think this makes them attractive, especially if you buy and hold to maturity – normally for around five or six years.

... in the property sector

We invest in some of these issues on behalf of our clients and to a limited extent in the Waverton bond funds. Our favourite issuers in this market are property companies. One example is Bruntwood. This is a well-established landlord of commercial property in the Manchester region. It has just launched a five-year bond with a coupon (interest rate) of 6%. That is more than ten times the income you will receive on a UK gilt to the same maturity.

Another low-risk property bond issuer is Regional REIT, with a nationwide portfolio of properties, mainly offices, supporting a bond with a 4.5% coupon, although this trades at a 4% price premium so it may be better for those investing through a tax-free wrapper such as an Isa or a Sipp.

Finally, Provident Financial, the sub-prime lender, has a three-year bond with a coupon of 5.125%, which trades at a small discount and gives a total return of around 5.5%. The company has had its problems with the Financial Conduct Authority, the City regulator, but appears to be well on the road to recovery, making these bonds attractive.

Investors are "flocking" back to the same kind of debt instruments implicated in the financial crisis, says Joe Rennison in the Financial Times. So-called "synthetic" collateralised debt obligations (CDOs) bundle together derivatives ultimately linked to bonds and loans. But where banks piled into CDOs backed by subprime mortgages in the years prior to the 2008 crash, this time hedge funds have a new darling: corporate debt.

There's plenty of it to bundle up. Non-financial business debt-to-GDP in America has ballooned over the past seven years to a record of around 78% of GDP, almost as high as household debt. Loans going to already heavily indebted borrowers, known as leveraged loans, grew by 20% in 2018 to $1.1trn, while their share of the market is at a record high.Defaults are low for now, but if the American economy weakens or interest rates shoot up thanks to an inflation scare, it'll be a different story.

Why the debt binge? Record-low interest rates are one reason; financing share buybacks to juice earnings-per-share and stock prices are another. S&P 500 firms doled out a record-breaking $1.25trn in dividends and buybacks last year.

Buybacks have been a crucial "pillar of support" for US markets in the post-crisis years, says Robin Wigglesworth in the Financial Times. Any corporate "buyback diet" would undermine the post-crisis bull market.