Mark Dampier: High-quality bonds minimise risk

The Analyst

Stock markets have had a very strong bounce since reaching a low point in early March. The debate is whether this is the start of a new bull market, or just a so-called "bear market rally" and further falls are around the corner. The jury remains out.

My personal view is that, although I am positive for the long term, I'm not quite convinced that we can have a real bull market just because things have started getting worse more slowly. Only time will tell, but it does seem as we enter the summer that many stock markets are ripe for a short-term dip.

Consequently it is interesting to see that Legg Mason is launching (on 2 June) a global blue chip bond fund rather than an equity fund. It will be managed be Western Asset Management, one of their subsidiaries and a specialist bond house. The obvious question to ask is: why now?

Well, firstly, valuations look very attractive with credit spreads close to their all-time wide levels. In English, that means the difference between corporate bond yields and Government bond yields is the biggest it has ever been. The spread between them tends to widen at times of economic stress and narrow when things settle down.

At the moment the spreads seem to imply that more than 30 per cent of investment grade bonds will default over a five year period. I believe this is unrealistic. To give this some kind of perspective, even in the great depression defaults did not reach 5 per cent over any five year period. So this suggests bonds are being valued far too cheaply and there are excellent bargains out there.

Legg Mason also cites stronger balance sheets in the US as companies put things in order for a tough period ahead. Supply and demand have both also picked up this year, and while I expect demand to remain strong, supply will probably tail off as companies stop issuing debt to buy back their stock. Additionally, there has been a trend of pension funds in the US moving more money into corporate bonds. This should be a positive environment for bond prices.

So where does the new Global Blue Chip Bond Fund invest? Well the name probably gives it away, but it focuses on the high quality investment grade corporate bonds from across world markets. The managers will seek to minimise risk where possible and so will have a maximum weighting in the finance, insurance and property sectors of only 10 per cent. This is the area that has caused bond investors the most grief over the last year or two.

It will also have a requirement to invest only in bonds with a relatively high credit rating (at least A-) – in essence the fund is looking to produce a yield of a little over 5 per cent but with minimal risk. So in practice this could be seen as the first stepping stone for investors who want to move away from Government bonds towards corporate bonds, moving to the next stage in terms of risk. The biggest holdings at launch are to include bonds from firms such as Hewlett Packard, AT&T and AstraZeneca.

Western Asset Management may not be well known but they manage a vast amount of money in bonds across the world and have one of the largest credit analyst teams around with an average experience of over 16 years.

Bonds funds should not be seen as a replacement for cash, but if you already have enough on deposit and are looking for ways to boost your return then they are worth considering. Although a cautious fund such as this should have relatively low volatility it should be remembered that it can still fluctuate in value – that's why it is not a substitute for cash.

Although stock markets have rallied, bonds have only rebounded a little way. This means corporate bonds still have ample room for long term growth.

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.