Mark Dampier: Corporate bond rally will only run

The Analyst

In January, I highlighted the Invesco Perpetual Corporate Bond Fund in these pages. At the time, interest rates stood at 1.5 per cent and I was convinced they were going to head lower. This indeed proved to be the case and, together with a marked improvement in sentiment, contributed to a sharp rally in corporate bonds.

So what is the outlook for corporate bonds today? Well, with interest rates at 0.5 per cent, clearly the next move is going to be upwards, but the key question is: when will this actually start to happen?

Given the poor state of the economy, rising unemployment and the fact that taxes are only likely to go up, I believe it is highly unlikely that rates will rise for at least a year. So, despite the strong rally, corporate bonds still seem good value to me.

I am pleased to say that Invesco Perpetual Corporate Bond Fund has outperformed strongly since January. So too has another fund – run by the same team of Paul Read and Paul Causer – called Invesco Perpetual Monthly Income Plus. This fund has risen a staggering 42.1 per cent since it bottomed out in March.

Monthly Income Plus has a wider brief than the other fund and is more risky; it can invest in high-yield bonds and up to 20 per cent of the portfolio can be in shares. Incidentally that share component is looked after by Neil Woodford, who I consider to be one of the best fund managers in the UK.

He has had a difficult time this year as his defensive stance has not paid off, but given the outlook for the economy, I would not bet against him performing well in future.

At its heart, however, Monthly Income Plus is a bond fund. When I met Paul Causer recently he foresaw a structural shift in favour of corporate bonds. By this he meant that they will become a bigger part of people's portfolios over the coming years as the yield on corporate bonds seems set to be better than cash for quite some time.

Corporate bonds still look undervalued and, although the sharp rally of the last few months will inevitably slow, there is still money to be made. More of the return is likely to come from yield in future and here the Monthly Income Plus Fund comes into its own with a running yield in excess of 8 per cent.

Bank bonds have been among the best performers for the fund as government bailouts have provided a foundation of confidence. In addition, banks have been buying back some of their own debt at prices significantly higher than most investors had expected. When I asked Mr Causer which of the funds he managed he thought had the best short-term prospects, his answer was Monthly Income Plus Fund and the Invesco Perpetual Distribution Fund (which has an even higher level of shares).

He feels that the high levels of income generated by the bonds and what he called the "Neil Woodford factor" is a recipe for strong performance over the coming months. I happen to agree and am adding to my own holding in the Monthly Income Plus Fund.

Those media commentators who talked shrilly of a "corporate bond bubble" six months ago have been made to look somewhat daft. The argument never held water; how can there have been a bubble when prices were the lowest they had ever been? Now much of this undervaluation has corrected, but I believe there is still good value to be had in corporate bond funds. Any setback following this sharp rally should, in my opinion, be viewed as a buying opportunity.

Mark Dampier is the head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more information about the funds included in this column, visit www.h-l.co.uk/independent