The outlook for fixed interest securities

Despite recent falls in the value of equity investments, investors with well diversified portfolios have done well from their exposure to fixed interest securities.

In their latest market view update, the fixed interest team at M&G investments make some interesting points about the outlook for this asset class.

Looking at the link between the housing market and economy, they predict that the UK economy will remain weak.

Richard Woolnough from M&G comments within the market view update on the ratio of housing sales to stock of housing for sale. This currently indicates that house prices are likely to fall further over the coming months and therefore suggests further weakness in economic growth.

As a result, they share our belief that interest rates are likely to remain lower for longer. There is virtually no scope for further fiscal stimulus to boost the economy and the banks find themselves unable to recycle their capital profitably.

Richard Woolnough goes on to explain how he feels corporate bond valuations are currently at very attractive levels, with investors being well rewarded to take credit risk.

Spreads over gilts for BBB rated bonds are currently at 447 basis points, compared to a more typical 300 basis points during periods of severe economic weakness. These spreads were far lower in the period of time just before the credit crunch, at around 70 basis points.

These spreads indicate a higher probability that companies will default on their corporate bonds in the coming years. However, Woolnough points to strong corporate balance sheets with debt levels greatly reduced since the credit crisis. He believes the markets are pricing in too much bad news, which can benefit investors prepared to take these risks should this bad news fail to materialise.

Our latest Investment Outlook for the final quarter of the year shares many of these views. We are currently tactically overweight in corporate bonds, neutral for index linked gilts and underweight for gilts. You can read our latest Investment Outlook report here:

Q4 2011 Investment Outlook report

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