Thinking about duration in investment grade credit hasn’t been top of clients’ minds in recent years – with good reason. Bond yields have been exceptionally low, with the Sterling five-year corporate bond yield falling from around 4% in the middle of the previous decade to almost 1.5% by the end of 2020 (Figure 1).
Figure 1: Sterling five-year plus Corporate Bond Index yield, 2014-24
Source: ICE indices, 30 April 2024
But between 2020 and 2022 we saw a period of bond yield normalisation and now the yields and income on offer are high: over the past three or so years index yields have risen from that 1.5% low to 5.7% today – close to the highest on offer in the past decade. With expectations that central banks will soon begin to cut interest rates, clients are seeing the value in ”locking-in” these higher levels of income for as long as possible.
Furthermore, UK pension schemes, which have recently moved from deficit to healthy surplus as yields have risen materially (Figure 2) might also choose to lock-in the security of that position. As such, they could seek to match their longer-dated liabilities with closely matched assets such as medium- and long-dated investment grade corporate bonds. These are just the kind of investments we like to make in our CT Medium and Long-dated Non-Gilt strategy.
Figure 2: Funding position of UK pension schemes, 2017-23
Source: The Pensions Regulator/Refinitiv, September 2023. Figures shows technical provisions (TPs) for all DB schemes, based on rolling back and projecting forward the data held on 30 September 2022 (rather than using historical data at historical dates). This is an aggregate analysis based on highly summarised data. Overall, the changes in market conditions and aggregate pace of schemes’ funding plans mean that deficits on a TPs basis as at December 2019 and March 2020 are expected to have turned into surpluses as at December 2022 and March 2023.
Why Columbia Threadneedle for fixed income?
At Columbia Threadneedle Investments we pride ourselves on a robust investment process based on high-quality independent credit research. The strategy has a long track record of consistent out-performance and has been built using the same investment philosophy and bottom-up research-driven process that has provided long-term risk-adjusted returns across our business.
Risk and return are targeted on issuer and security selection in a team-based approach that focuses on downside risk management, allowing it to consistently perform through a variety of market environments in a risk-adjusted manner (as illustrated by the information ratio1), not just by taking more risk or yield than the benchmark.
Relative return | Information ratio | |
|---|---|---|
1 year | +44bps | – |
3 years | +42bps per annum | 0.75 |
5 years | +59bps per annum | 1.11 |
Source: Columbia Threadneedle Investments, as at May 2024
Conclusion
Yields are much higher than during the extended period of low interest rates and quantitative easing that followed the global financial crisis in 2008/09. Additionally, most market experts suggest we are at the top of the Bank of England’s recent interest rate rising cycle and are predicting falling base rates into the year-end and beyond. If this proves to be the case, bond yields should follow – which would add capital return to the already high starting yield.
