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Invest in corporate bonds?

Financial Advice | General Helpful? 1

Asked by richy78, submitted 18 July 2012.

Open Quote I'm looking to balance up my portfolio with a good fixed interest fund. I only have around 5000 pounds to invest/switch so I was wondering if you could recommend a good diversified option, and whether you would go hedged or unhedged in the current climate. I'm currently exposed to about 1/3 international shares, 1/3 UK shares (both directly and through funds) 3% International bonds, 1.5% unclassified and the rest is in cash - which I would like to put into bonds given current interest rates. I should also say that most of the international shares are within emerging markets.

Does that sound like a sensible option to you, or would you go even more defensive? The majority of the funds are for long term investment, but I would l still like to balance things up given whats happening in Europe etc.

Any help much appreciated!
End Quote

Answered by Justin on 18 September 2012

When it comes to investing in bonds the main decision is arguably whether to favour higher yielding bonds (which generally means a higher risk of default) or those on lower yields (perceived to be safer).

Higher yielding bonds (sometimes referred to as 'junk') tend to be more correlated with stock markets and less influenced by interest rate/inflationary expectations than lower yielding (referred to as 'investment grade'). And bonds with a longer time until redemption tend to more influenced by interest rates/inflation than those with shorter redemptions.

Then of course, there's currency movements to consider when buying overseas bonds which some fund manager hedge, as you mention.

At the investment grade end of the market most managers struggle to beat indices after charges unless they're very active (and successful) at positioning the fund to benefit from the wider economic picture. M&G Strategic Bond and Fidelity Moneybuilder Income are good examples of such funds.

Pure high yield bond funds have really struggled to beat the index in recent years but those managers with the freedom to invest freely across both investment grade and high yield bonds have generally done well. These funds are found in the Strategic Bond sector (the formerly mentioned M&G fund is actually more conservative and in the £ Corporate Bond sector, confusing name!). Good examples include M&G Optimal Income, L&G Dynamic Bond and Fidelity Strategic Bond (I'm not being biased towards M&G/Fidelity, they just happen to have very good fixed interest managers at the moment).

Bear in mind bond markets have already priced in the low interest rate climate, what's really driven the market forwards is higher demand from investors seeking refuge from volatile stock markets - and the recent stock market rally (probably driven in part by the US Fed quantitative easing programme) has helped higher yielding bonds. There's bound to be a tipping point sometime over the next few years when economies show sustained recovery and interest rates start to rise, at which point investment grade bond prices will probably suffer. Meanwhile, they remain a sought after safe haven.

Unless you have strong views I'd be inclined to opt for a strategic bond type fund in your shoes and let the manager worry about second guessing the future. There's no guarantee they'll get in right, but managers with a good track are probably more likely to get it right than you or I. Given hedging could work either way depending on currency movements I'd be fairly relaxed about this unless you're particularly positive or negative about sterling.

Your overall portfolio strategy sounds sensible. It's a tough call on whether stock markets are getting toppy and ripe for a correction. My gut feeling is that they've been overvalued for a long time given the economic backdrop, but I've been wrong to date as they've continued to rise. Arguably it's because governments/central banks have chosen to prop up the system seemingly no matter what, which may not last indefinitely. But equally I'd be nervous shunning stock markets altogether waiting for a big fall in case it never comes. So, as you're investing long term perhaps ride out the volatility and maintain a sensible spread of investment, which you appear to be doing.

Good luck.

Please note this answer does not constitute a recommendation or financial advice and should not be relied upon when making specific investment or other financial decisions. You should always undertake your own research into whether a product or service is appropriate for your needs and, if necessary, use a qualified professional adviser.

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