Should you invest in corporate bonds this ISA season?

Is now the time to consider corporate bonds? It’s fair to say that last year was extremely difficult for fixed income due to the challenging economic backdrop.

But where does that leave us? Are the sector’s prospects finally looking more attractive after a tough period – or is there further pain to go?

Here we take a look at the outlook for the asset class and highlight four funds in the IA Sterling Corporate Bond sector that might be worth considering this ISA season.

Bonds looking attractive after a decade in the doldrums

Having had a torrid 2022 – when bond markets experienced one of their sharpest selloffs on record – and a lacklustre previous decade due to low interest rates, 2023 could be the ‘year of the bond’. The income they promise is much more attractive and, when interest rates peak then start to come down, capital gains are in the offing.

M&G certainly believes bond investors have entered 2023 in better shape, with current yields looking compelling as inflation finally starts to ease. “We see especially good value in investment grade credit, which we believe offers natural diversification qualities and a source of resilience during uncertain market conditions,” the company said.

Four corporate bond funds to consider

M&G Corporate Bond

The M&G Corporate Bond fund is a pretty straightforward way to play this asset class. Managed by the experienced Richard Woolnough, it invests primarily in sterling denominated investment grade.

Richard has a top-down investment style, which means he manages the portfolio according to his outlook for economic growth, inflation, and interest rates. In a recent fund update, he explained that he had reduced duration (the price sensitivity to interest rates), given the economic outlook for the UK is less positive than the US, while UK government bond yields look likely to rise.

“With credit spreads widening (the difference in yield between government and corporate bonds), we sold some higher-risk assets,” he said. “We still favour high-quality financials (the sector having outperformed industrials this year) and resilient US blue chips.”

Currently, the largest issuers include Thames Water, Lloyds Banking Group, Heathrow Funding, Imperial Brands Finance, and Legal & General*. As an aside, M&G also has a particular advantage in this area, courtesy of its wide-ranging and expansive team of credit analysts, which is one of the biggest in Europe.

TwentyFour Corporate Bond

Chris Bowie, manager of the TwentyFour Corporate Bond fund, is also feeling more optimistic about the prospects for the rest of this year. In recent fund updates, Chris branded 2022 as “the worst year for bonds in living memory”, confirming that the fund’s positioning remained cautious in terms of duration and spread risk.

However, he also noted that the available yield was the best for years, with levels consistent and making for a very attractive entry point. “The risks of very deep and very long recessions have clearly receded, but this remains an economic cycle that is very difficult to call, and which still exhibits some late-cycle signs,” he wrote.

His TwentyFour Corporate Bond fund, which was launched back in 2015, aims to achieve the highest possible income, with the least amount of volatility. Its focus being on minimising risk means the fund has a bias towards investment grade bonds.

Liontrust Sustainable Future Monthly Income Bond

The aim of this fund is to produce a monthly income, along with some capital growth. It pursues this objective by investing mainly in corporate bonds, as well as some government bonds. Stuart Steven has been at the helm since its launch in June 2010, with Aitken Ross joining him in 2012 and Kenny Watson the following year.

The team believes the market is approaching “a potentially important transition period” that could see the headwinds of last year start to ease. “Inflation has shown definitive signs of peaking, and while still too high in an absolute sense, it could prove a positive surprise if price pressures ease faster than expected,” they wrote in an update.

While economic growth and corporate earnings are expected to decline in 2023, the team believes such expectations seem to be fully priced into equities and bonds at current levels. “We believe the focus of the market should turn to single name issuers and fundamentals and move away from monetary policy tracking,” they added.

The team has a diversified sector exposure, while the fund’s 10 largest issuers include the UK Government, HSBC Holdings, AT&T, and Deutsche Telekom*.

Rathbone Ethical Bond

If you want to put your faith in quality investment grade bonds with a principled slant, then the Rathbone Ethical Bond fund could be up your street. Its managers, Bryn Jones and Noelle Cazalis, steer clear of mining, arms, gambling, pornography, animal testing, nuclear power, alcohol, or tobacco.

The first step in the investment process is analysing the economic environment to determine which industries they want to own – and the likely duration of investments. They will then scrutinise other factors such as ensuring a company isn’t over-borrowing and has the cash to repay debts, as well as its’ managers having integrity and competence.

In a recent update, the managers noted that both government debt and corporate bonds have enjoyed a good start to 2023. “The growing belief that central banks are probably nearing the end of the current rate-hiking cycle, together with signs that the global economy is slowing but isn’t falling off a cliff, drove strong demand for corporate bonds,” they wrote.

*Source: fund factsheet, 31 January 2023

_{Photo by Kelly Sikkema on Unsplash}