Risk factors in corporate bonds during Brexit

Corporate bond value is determined by a range of economic factors, shares, government policies, and credit ratings, and these can get attractive returns (except in case of low risk - zero coupon or floating rate bonds). These bonds are, basically, smaller units of money given by the investor to the holder company for some specified business project. It is a legal commitment, where the company has to pay interest/returns on the money given. In the last few months, the value of corporate bonds declined radically in the UK market – mainly, due to Brexit. The rate of corporate bonds fell behind Euro and dollar securities in August 2018, as the exit is now getting irrepressible and the investors suspect UK getting out of EU without an appropriate deal.  The rates are increasing in US and UK and the impact of withdrawal of ECB is expected to create a huge impact on the markets. In addition, the trade war and other political clashes are raising doubts. Many buyers are adopting wait and see approach to reduce risks.

There is volatility in corporate bonds during Brexit and some of the strong balance sheets of the US companies have been giving weak returns in the past few years and this can be seen across all kinds of bonds in the US. The rise in interest rates has not declined the bond rates. E.g. Vanguard (intermediate term bond) fund lost 3 per cent in 2018 first half and iShare lost 4.4 per cent. Both these funds have strong credit ratings and are considered superior bonds.

On the whole, the rate of the corporate bond is determined by the term, quality of issuing company (its credit ratings) and the interest rates. The term of these bonds can be short, medium or long, and most of the higher term bonds are riskier and offer better rates. These bonds are graded by Moody and S&P, and most such bonds are competitive and have volatile rates.   These bonds offer diversification opportunity, attract income and can be sold anytime in primary or secondary trading markets. The risk factors are similar to other types of government bonds. The company offering the bond may fail to repay and default. Most credit rating organizations try to predict the reliability of the company or organization that offers the bond and the predictions are based on market and other factors. These ratings are revised when the conditions of the company change. The risk factors in these bond investments include interest rate risk, liquidity risk, inflation risk, call risk etc.  These risks can be reduced by diversifying – holding for both short-term and long-term, balancing and mixing various types of bonds.

To reduce risks many investors are looking for underrepresented emerging market investments. Some of the funds and portfolios offer geographically diversified options across an assortment of sectors in corporate bonds where the emerging market corporate bonds are less levered as compared to US, and about 50 per cent of the holdings of these bonds are found in the country of origin.     

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