Ariel Bezalel, who has 10 years' experience working in credit markets at Jupiter Asset Management, believes credit markets present a potentially historic opportunity, particularly in the investment grade space. He says: "The investment grade market is pricing in a severe recession and the high yield market is pricing in a sharp rise in defaults. Whilst I am cautious on the economic outlook, current valuations seem to offer potentially handsome rewards for the risk. This situation presents the most compelling investment opportunity in credit we have seen for many years.
"We're seeing conditions like we've never seen before. Investment grade bonds are pricing in 3.5 per cent default rates - the norm is close to 0.
"This is an opportunity we haven't had for many years. You can acquire blue chip companies on attractive yields. We see very low default risk.
"We are positive over the next year to 2 years. Spreads are not going to tighten overnight. Corporate bonds are looking super attractive."
With corporate bonds, it seems you either love them or hate them. While manyindependent financial advisers (IFAs) recommend corporate bonds for their diversification benefits, others are not so keen.
Dr Kate Warne, market strategist with IFA and stockbroker Edward Jones says: "Bonds are boring but that's good. On the equity side there is too much excitement. In a market like this where you have volatility in the shares market people need to be concentrating more on fixed income.
"You can get about the same return with lower risk by adding corporate bonds to your portfolio. They bring critical diversification benefit. Even if you are starting out you should have some in fixed income."
However, Andrew Wilson, head of investment at IFA Towry Law is not a massive fan of corporate bonds. He thinks gilts are a better diversifier. "Corporate bonds tend to do well when equities are doing well," he says. "When you need them, when equities are doing badly, gilts do better. Gilts performed well last year but corporate bonds struggled when equity markets went down."
Towry Law's clients have just 3 per cent in corporate bonds but 15 to 25 per cent in gilts. Mr Wilson doesn't recommend high-yield bonds to clients. "You might as well be doing equities if you are taking on that risk," he says.
How to invest
There are several ways for investors to get exposure to corporate bonds. First, you can buy individual corporate bonds. Dr Warne says: "The advantage is you can lock in yields. You know what you're going to get in terms of interest payments."
Most investors, however, opt for corporate bond funds. Dr Warne explains that bond funds give inflation protection. "Corporate bond funds have an advantage over individual bonds if inflation moves higher as you'll get exposure to bonds with higher rates in future. The income is variable and you're not stuck with a fixed payment."
To understand bond funds, you need to know that some bond funds concentrate on investment grade, others on high yield, while some funds have the flexibility to invest across all types of bonds.
For example, Jupiter Strategic Income fund which launches on 2 June has a broad remit. Although fund manager Ariel Bezalel will initially invest in investment grade and high-yield bonds, he says: "This is a go anywhere fund. We could also put chunks into gilts if they rally as they did last year."
The fund is more heavily weighted to investment grade, with a big chunk in financials (a third of the portfolio). "There are lots of interesting opportunities in financials, which are pricing in default rates over 4 per cent. Financials are doing all the right things for bond holders," says Mr Bezalel.
"Banks are quite a defensive sector - they're going to be more regulated and less levered than in the past. They seem to be becoming more utility-like."
There is a lower proportion in high-yield bonds. "High-yield looks interesting but only in parts of the market," says Mr Bezalel. "You need to tread quite carefully. We're going for the better quality within high yield."
Jupiter Strategic Income is offering a 7 per cent yield, plus the opportunity for capital gains as spreads tighten. www.jupiteronline.co.uk
Bond fund recommendations
Although many income-seekers are drawn to corporate bonds for the income, Mark Dampier, research director at Hargreaves Lansdown, warns: "There is a danger in just seeking the highest yield. Investors should look for bond funds that can do anything, including investment grade and high yield."
Among "do anything" funds, he likes the Artemis and Henderson Strategic bond funds.
Artemis Strategic Bond Fund is managed by James Foster and Alex Ralph. They say: "April was an absolutely cracking month, especially amongst financial bonds. The intervention by the Bank of England, rights issues from major banks, the massive write downs by the banks and the bail-out of Bear Stearns has created the most perfect scenario for bank bonds." www.artemisonline.co.uk
Henderson Strategic Bond Fund is managed by John Pattullo and Jenna Barnard, who say: "April was the strongest month for credit markets since September 2007. We have said for some time that valuations are compelling, but it is only recently that technical factors and market momentum have turned from very negative to positive." www.henderson.com
However, Mr Wilson is no fan of actively managed corporate bond funds. He says: "There doesn't seem to be any prudent active outperformance among corporate bond fund managers. Those outperforming are going for high risk.
"We prefer the passive approach. For example, there is an iShare that tracks corporate bond indices. It's a lot cheaper than actively managed funds. You can then worry about getting good active management in other asset classes."
The iShares £ Corporate Bond (SLXX) is an exchange traded fund (ETF) that aims to provide investors with a total return, taking into account both capital and income returns, which reflects the total return of the sterling denominated investment grade corporate bond market. Traded like normal shares, ETFs allow you to spread your investments across a wide range of securities, thus tracking the performance of an entire index, but within a single share. Launched in 2003, the iShares £ Corporate Bond has a Total Expense Ratio of just 0.20 per cent and has 40 holdings. It is eligible as a holding for individual savings accounts (Isas) and self-invested personal pensions (Sipps). For further information visit: www.ishares.co.uk.
Corporate bond basics
Corporate bonds are issued by companies as a way of raising money to invest in their business. They have nominal value (usually £100), which is the amount that will be returned to the investor on a stated future date (the redemption date). They also pay a stated interest rate each year - usually fixed. Corporate bonds are bought and sold on the stock market and their price can go up or down.
They come in two types:
• Investment grade: A bond that is assigned a rating in the top four categories by commercial credit rating companies. S&P classifies investment-grade bonds as BBB or higher, and Moody's classifies investment grade bonds as BAA or higher.
• High yield: Also known as a junk bond, this is a bond rated BB or lower because of its high default risk.
Gilts are risk-free bonds issued by the British government. The name "gilt" comes from the original British government certifications that had gilded edges.
