Last week, the central bank’s Financial Stability Report for June said the compensation sterling corporate bond investors have received for risk has been close to zero for the past two years, when adjusted for lower credit rating, term premia and longer duration.
However, Philip Milburn (pictured), fixed income manager at Liontrust, has scorned the Bank’s downbeat assessment, describing it as disingenuous “when a large part of this is their fault due to monetary policy”.
Bank of England view of compensation for risk in £ corporate bonds
Milburn says the government bond yield has fallen the most in absolute terms over the last 20 years – the length of time the Bank of England tracked in its chart, which goes back to 1998.
“This is particularly pronounced since the credit crunch,” he says.
“Maybe, just maybe, if the authorities had not been asleep at the wheel leverage in the financial system would not have risen so high before 2008 and needed such a prolonged policy response.”
“It strikes me as more than a little ironic that the single thing that would cause the most instability in these yields is the reversal of QE – and boy do I wish the BoE would hurry up and do it; let’s get the yield on the gilt market to levels where investors are receiving positive real returns from lending to the government.”
Expensive
Despite criticising the Bank of England’s lack of self awareness, Milburn concedes sterling credit is expensive, while gilts are one of the most expensive rates markets in the world.
“Certainly we believe that taking a global approach is the best way to counter the effects of a small rigged market,” he says.
The Liontrust Strategic Bond fund is short gilts relative to the US, he says.
Darius McDermott, managing director at Chelsea Financial Services, says investors should be cautious of bond markets that have been artificially distorted by quantitative easing.
“With spreads as low as they are there is very little protection for investors should the economy worsen,” McDermott says, adding that does not even take into account political risk and the possibility of a far-left government.
Milburn reckons the BoE should sell their £10bn of corporate bond holdings and transfer any profit back to the Treasury to benefit the public purse.
Credit selection
The BoE’s Financial Stability Report could be warning market participants to be selective in the type of bonds they’re buying, reckons AJ Bell head of active portfolios Ryan Hughes.
“Right now where we are in the cycle plays very nicely to taking an active approach to corporate bond and high yield bond selection, for these very reasons.
“In some respects, the Bank of England’s comments reinforce that: that credit selection could become very important over the next couple of years, particularly if we enter a slowdown and high levels of volatility.”
Unsurprisingly, Milburn agrees.
“This is an environment where you do not want to buy generic beta,” he says.
McDermott says a good active manager will have a much greater chance of preserving capital in a major sell-off versus “blind” passive money which is unable to react.
Backing passive
However, Jose Garcia Zarate, associate director for passive strategies at Morningstar, disagrees the BoE is encouraging active credit selection.
Garcia says: “They were using the index as a proxy for the market; but the lack of value across the investment-grade corporate bond market is a well-noted phenomenon at the moment.
“It’s all to do with ultra-loose monetary policy settings and the search for yield theme that has prevailed amongst investors.”
Despite being part of Morningstar’s passive team, Garcia concedes active corporate bond managers can add value, particularly in the current market environment, where they could up credit risk and overweight high yield.
“Still, it requires good skill on the side of the active manager. And ultimately, the low price of a passive fund is a very good advantage in the long-term.”
