Is now the time to cash in your corporate bonds?

They've given us safety and decent returns of late but is that about to change. By Simon Read

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Corporate bond funds have leapt back to the top of the sales charts as investors are attracted by their comparative safety and decent returns over the past year. Cofunds, a fund supermarket, says that corporate bonds were the highest-selling sector in August. But, in fact, now could be the time to rethink your investments, according to one expert.

Independent financial adviser Brian Dennehy produces a monthly Bond Watch and in the latest he strongly recommends investors reduce the amount of money they have in corporate bond funds. Why?

"There is no bond bubble," he says. "But investors could be in trouble if they ignore the big new problem, political risk." Corporate bonds benefited when gilt yields fell, he says, but continuing uncertainty means now could be the time to cash in.

"We are still in the midst of an extraordinary financial experiment, on a global scale, and the range of possible outcomes is mind-boggling," Mr Dennehy says. "In the absence of compelling deep value, and bearing in mind the range of risks and high levels of uncertainty, it is even more important now to diversify your bond holdings."

Is he right? Not necessarily, according to Howard Cunningham, fund manager of Newton's £500m Corporate Bond funds. "It depends on your view of the world," he says. "If we're in a low or no-growth, low-inflation environment, which we think we are, even at the much reduced yields corporate bonds offer at the moment they're still an attractive investment," he says.

Sterling corporate bonds have returned over 15 per cent in the year to date. "That has exceeded expectations and we're not saying that is repeatable. But yields are low for good reasons and may stay low for an extended period, which will benefit corporate bonds."

But those worried about inflation should probably avoid corporate bonds, he warns. "Our view is disinflationary. The period of fiscal tightening that we're going through is going to lead to low interest rates for an extended time," says Mr Cunningham.

Philippa Gee, the managing director of Philippa Gee Wealth Management, says the decision to invest in corporate bonds is all about expectations. "Are you looking to invest because you think you are getting low risk plus a high yield? If so, think again, as the basic rule of the higher the yield the higher the risk really does apply.

"If you are unhappy with the interest rate you get for cash deposits then look at corporate bonds, but understand that there is a higher risk and the higher the yield produced, the more this will apply.

"If you are looking at corporate bonds because the sector has been a strong performer and you believe this is likely to continue, you will be heading for disaster," Ms Gee warns. "Corporate bonds are unlikely to be the asset class delivering the strongest return over the next few years."

Meanwhile, Mr Dennehy advises investors to diversify the lowest risk end of their portfolio, where corporate bond funds should sit. "The lower risk bucket can include gilts, global bonds, absolute return funds, and property," he says.

Expert view: Phillippa Gee, Phillippa Gee Wealth Management

"Managing your own money and wanting a split between equities and bonds? A cautious managed fund – such as Invesco Perpetual Distribution and Gartmore Cautious Managed – is a great solution. Want just one bond fund? It may be best to opt for a strategic holding, such as Jupiter Strategic Bond and M&G Optimal Income. Looking to expand your pure corporate bond holding? Then consider Invesco Perpetual Corporate Bond and Jupiter Corporate Bond."