UK bond prices have plunged recently, after a sharp sell-off in government bonds (gilts) was compounded by forced selling from distressed UK pension funds. Year-to-date, the worst-hit parts of the gilts market have given up 15 years of gains. Sterling-denominated corporate bonds have also fallen sharply and are looking very cheap by historic standards (Display, above).
With the whole sterling market selling off, two categories of corporate bonds look particularly good value:
- bonds from US issuers with global operations that are less sensitive to the UK and European growth outlooks, and
- issues from companies in less cyclical industries that are better placed to ride out economic fluctuations
Can sterling bond spreads stay this wide? We think they have already peaked.
For now, some forced selling remains as UK defined benefit pension funds strive to meet margin calls on the leveraged interest-rate hedging strategies they instituted as part of liability-driven investing (LDI) programs. These pension trusts have struggled to raise cash collateral, particularly as their holdings in private markets and property cannot be liquidated promptly. This has exacerbated selling pressure on the pension funds’ saleable assets—notably, UK gilts and credit.