Companies that have borrowed at 3 per cent to 4 per cent may now face costs of 8 per cent to 9 per cent. Some of this will be mitigated by the expected lower interest rates in the latter part of this year, but not all companies will be able to avoid the problem.
The Bank of England estimates that around 20 per cent of high-yield bonds will need to be refinanced by 2025.
Interest rate cuts
Most corporate bond fund managers still expect rate cuts in the year ahead, even if these may emerge later in the year than initially thought.
Watson says: “We remain confident that both the economic slowdown and strong disinflationary momentum from late 2023 are set to continue throughout 2024.
"As inflation comes back to target, we believe that central banks will become more cognisant of the weakening growth outlook and will have to acknowledge that maintaining rates for a prolonged period will cause more harm than good.
"Therefore, we expect central banks to pivot to monetary policy easing through interest rate cuts.”
Rate cuts would have a greater benefit for investment-grade bonds than high-yield bonds.
The team on the TwentyFour Corporate Bond fund says focusing on quality is particularly important in this environment.
Manager Gordon Shannon says: “We still face many unknowns. Geopolitical risks are multiplying. Economists are still unsure whether the US will achieve a hard or soft landing, and the UK and Europe are flirting with recession.
"The current level of yield gives a useful buffer against volatility, but it is still important to build robust portfolios that can dynamically change with the evolving situation.”
He says there may be relative value opportunities if central banks start to diverge on their interest rate paths.
Royal London says the current yields on corporate bonds compensate investors for rising credit risk, preferring them to government bonds as a result. Nevertheless, for the Royal London Corporate Bond fund, the team prefer bonds that are asset-backed and strongly covenanted.
The team say they are looking for “security and downside protection, while ensuring that portfolios are diversified across issuers and sectors”.
Against this backdrop, the early strength of high yield over and above investment grade could be reversed.
That said, skilled high-yield managers with a good track record on credit selection, such as Mike Scott on the Man GLG High Yield Opportunities fund or Thomas Hanson on the Aegon High Yield bond fund, should be able to navigate a tougher environment.
There remains a place for both in a portfolio.
Darius McDermott is managing director of Chelsea Financial Services and FundCalibre
