Time to bond

The irony is plain for all to see. Legal & General’s investment management arm is promoting the ‘stellar opportunities’ of investing in corporate bonds while Legal & General Group is boosting its reserves to £1.2bn to cover potential defaults in its corporate bond portfolio.

In a briefing LGIM credit strategist Ben Bennett said: “The investment grade corporate bond index currently yields 5% more than government bonds. History suggests that is an extraordinary level of compensation for the level of potential annual losses from companies defaulting.”

Bennett admitted that there was significant ‘fallen angel risk (bonds which are downgraded from investment grade to speculative grade) remaining, but that the corporate bond market as a whole was currently providing long term investment opportunity not seen since the 1930s.

Meanwhile, L&G Group had to inject £650m into reserves to shield against defaults this week. This has raised concerns among some investors and analysts about its financial strength. In a statement the group said: “The planned additional reserves, which are before tax, follow a thorough sector by sector review of our portfolio, and default experiences from the 1930s and subsequent recessions.”

The Group said it would increase credit default assumptions for the next four years from its long term assumptions of 30bps per annum for corporate bonds to approximately 130bps per annum, before tax. But Tony Silverman an analyst at S&P equity research said: “It is equivalent to a 68 basis points per annum default rate and some of their peers have more than that as a percentage fault per annum. We are forecasting a cut in their dividend. Our view is that the regulatory capital for L&G is OK, but only just. It [the increase] falls a bit short of prudence, but it’s more prudent than what it was.”

However, Silverman believes LGIM does deserve some credit. “The problem the group is that they have invested in these bonds at a higher price. What he investment management arm is saying is ‘you may want to buy them at their current low price’. If you bought them at 100 and then the price came down to 80 then you have some awkward announcements to make.”

He adds: “What’s a more relevant question is: What was its investment management arm saying two years ago when corporately they group was buying bonds at 100bps - were they saying then it was also a good idea?”