Corporate bonds – the upside of the downside - By Michael Korber Perpetual's Head of Credit

June 15, 2012   Business News
(PRLEAP.COM) Michael Korber, of Pertual, has said the Europeon struggle to bring its government and bank solvency crisis under control, the yields on Italian and Spanish bonds have soared to dangerous levels, while those of supposedly safe-haven countries, the US, Germany, Japan, have rallied to record lows.

Two year German bond yields actually went negative so some investors have been paying the German government simply to mind their money like a safety deposit box. This means markets are pricing in seemingly worst case scenarios for Europe's bank and government debt problems.

I refer to 'supposedly' safe-haven countries, because, their own debt levels, in both absolute terms and in proportion to their GDP, are at historically high levels. Also, their exposure to any broader economic malaise, and their own unfunded future liabilities and ageing populations, means that today they are arguably as great a credit risk as they have ever been. And in the case of Germany, it is under pressure to somehow guarantee the debt burdens of its southern neighbours.

It just goes to show that perceived risk and safety is all relative. Simply put, the flight to safety has few other places to go.

Now there is no doubt that we are living in risky times, particularly while Europe tries to sort out the mess it has gotten itself into.

However, what investors do need to understand is that with all this extreme risk priced into 'safe-haven' government bonds, any sustainable resolution to the Euro problems, and a more stable outlook for the global economy, would see yields increasing and therefore real capital losses for these 'safe-haven' investors. Alternatively, these countries could simply keep printing more money and debase their currency and the real value of their bonds.

In contrast to 'safe-haven' government bonds, the general risk aversion created by the recent turmoil in Europe, has seen credit spreads on quality corporate bonds widen to present their best value in some time.

While it is undoubtedly a risky environment as Europe (hopefully) sorts out it problems, the bottom line is that quality corporate bonds are currently rewarding investors quite well for the risks.

And investing in floating rate corporate bonds that are linked to benchmark bank bills means their credit spreads (or reward for the credit risk above bank bills) are locked in, regardless of the broader economic conditions, interest rates and inflation.

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