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To: maceng2 who wrote (365)	8/19/2003 12:09:03 PM
From: maceng2	Read Replies (1) \| Respond to of 1417

"There are two big sharks circling, one marked deflation and one inflation. Bonds have to be sold with great care at the moment - deflation creates higher credit risk, and increases the risk of firms going bust. news.ft.com (UK slant, but generally seems to be the case) Bond market troubled by 'big sharks' By Isabel Berwick Published: August 15 2003 12:24 \| Last Updated: August 15 2003 12:24 It is not just the summer temperatures that have been sizzling. The corporate bond sector is showing signs of overheating. The vogue for this hitherto rather dowdy corner of the investment world has been confirmed in recent weeks by a spate of "manager moves" as investment houses battle for the top fixed-interest fund managers. For the management firms, the new hire often brings the opportunity of a fund launch; anything with the word "bond" tacked on to it will bring in millions from income-hungry investors. The latest to move is Richard Woolnough, the manager of Old Mutual's corporate bond fund. Woolnough will launch a new fund for M&G to tie in with the peak 2003-2004 Individual savings account season, and the company says it will be designed to fit "between M&G's existing investment grade and high yield funds". As M&G already runs 12 fixed- interest funds, it is hard to see what can be gained other than a marketing coup by launching another. Other recent successful poaching expeditions include Insight investment's swoop on Schroder's fixed interest team, involving the managers of its corporate bond and monthly high-income funds. It is worthwhile for investment houses to lure top performers with fat pay packets: corporate bond funds are an "easy sell" to financial advisers and investors. A recent advert from ISIS investment management for its bond fund summed up the allure of the sector: "Don't want a stock market Isa? How about a 5.7 per cent p.a tax-free income instead?" Strictly speaking, a bond fund is not a stock market investment. But less-than-financially astute investors (and some financial advisers) seem to be carried away with the idea that the bond fund is somehow "safe", and this advertisement plays on that desire for security. Independent adviser Brian Dennehy of Dennehy, Weller & Co, conducts in-depth research into corporate bond funds and shocked by how little research is carried out by the public and financial advisers. Corporate bonds may not be as volatile as equity investments, but what is less well-known is that they are sensitive to wider economic trends. "There are two big sharks circling, one marked deflation and one inflation. Bonds have to be sold with great care at the moment - deflation creates higher credit risk, and increases the risk of firms going bust. "A bond is just a promise to pay back money in future - and deflation creates a default risk. "In a normal bond fund you get no hedge against the risk of rising inflation. It will eat into the value of the bond. Bonds have been a great place to be in a low inflation environment, but if we get deflation ahead, or gradual inflation again, it will reverse all the good work in bonds of the last few years." The short-term lure of a bond fund lies in its running yield - the amount of income that the fund generates each year. When held in an Isa, this cash is tax-free. The amount of income generated depends on the quality of the bonds and other fixed-interest investments held by the underlying fund. Bonds issued by companies considered financially secure are rated AAA and pay little income. The higher the perceived risk, the higher the income paid to bond investors. Running yields on bond funds range from 3.5 per cent to 12 per cent a year. Theo Zemek, director of New Star asset management, says that the interest-rate outlook for bond investors is potentially dodgy - but only if they stick to ultra-safe investments: "If they stick to gilts and top corporate bonds they will have less money at the end of the year than they have now. Some of the bonds at the lower end of the credit spectrum - rated BBB or BB - are still good value. "Companies are improving their balance sheets and the credit quality is beginning to improve. "They are a nice quiet safe haven to ride out concerns about interest rates." Experts warn that would-be investors who are still interested in bonds should make it a priority to look beyond the headline interest rate to find out what is in the fund. At the "secure" end of the spectrum, Steve Marriot of independent brokers BestInvest highlights the L&G Fixed Interest Trust. "This is a steady fund invested in corporate bonds rated AAA or AA," he says. Running yield is 5.24 per cent. For those seeking higher income levels he suggests hybrid funds, where the bonds will be split between those from highly secure firms and others offering higher income levels because they are rated below BBB for financial strength. This boosts the income level, but helps out investors who might feel jittery about investing in a fund solely composed of high-yielding bonds - Marriot likes the Threadneedle Strategic bond fund, currently paying 6.66 per cent. Sometimes the headline income rate does not offer a true picture. Colin Jackson of independent advice firm Baronworth produces a monthly corporate bond fund review that gives the crucial information about bond fund holdings, and also tells investors how each firm charges for its funds. About half the management firms take annual charges from the capital in the fund, rather than deducting it from the advertised yield from the fund - giving a misleadingly high running yield. "Take Artemis, for example. Its running yield is 6.14 per cent, but it takes 1.4 per cent a year - so the yield is effectively about 5 per cent. Particularly in funds like this where the risk rating is medium to high, investors are not getting a medium to high yield." Companies that do not take charges from capital include Fidelity, Insight, L&G and Norwich Union. Among those that do are Framlington, Gartmore and Schroders.