02/11/2007
Investment Week Article
2 November 2007 – Alasdair MacLean
While the major theme of the first half of 2007 was the risk of further interest rate rises in the UK to contain growth in the housing market, this theme was shoved very abruptly out of the limelight by the accelerating credit crunch as we moved into the second half of the year. As this dislocation of debt markets gained momentum, bond investors spent much more of their time monitoring signals from the short term money markets to determine which financial institutions were in the most difficulty with a view to avoiding taking exposure to their bonds.
While both the short term money markets and the investment grade bond markets appear to have re-established a certain degree of normality, we think that the causes of this year’s credit crunch continue to have the potential to cause further volatility in credit markets. Investors would therefore do well to adopt a cautious approach to investing in corporate bonds for the balance of the year and into early 2008.
The US sub-prime mortgage market continues to provide gloomy headlines and investors still have less clarity than they would like over who ultimately will bear the biggest losses from structured bonds linked to this asset class. The lack of transparency and liquidity in this market has made it difficult for financial institutions to quantify their losses on such structured bonds so far. To the extent that US homeowners continue to default on their mortgages, there will be further losses that need to filter through the financial system. These will need to be written off by the banks and other investors who have taken large positions in bonds and other instruments linked to the US sub-prime market.
Perhaps more importantly for Sterling investment grade bonds, UK money markets remain highly selective about whom they will fund, at what rate and for how long. If this situation persists, UK financial institutions will continue to have to pay more than they are used to for their capital. This may result in weaker players drawing in their horns in some areas.
Having said all of this, it should be recognised that it’s an ill wind that blows nobody any good. Credit markets have been extremely benign for an extended period of time and this has led investors and lending institutions alike to relax their credit controls. In just the same way as the bond market is now recognising that irresponsible lending practices in the US have led to the current wave of defaults on sub-prime mortgages, investors are being reminded that they should only buy corporate bonds when they are being paid sufficiently well for the risk that they are assuming. A return to the old-fashioned practice of lending only when you can realistically expect to be repaid may be just what the market needs.
Alasdair MacLean, Manager of the Higher Fixed Income, Select Income & Ethical Corporate Bond Funds at Standard Life Investments.
Standard Life Investments Limited, tel. +44 131 225 2345, a company registered in Scotland (SC 123321) Registered Office 1 George Street Edinburgh EH2 2LL.
The Standard Life Investments group includes Standard Life Investments (Mutual Funds) Limited, SLTM Limited, Standard Life Investments (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Investments Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited.
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©2008 Standard Life Investments.
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