UK - Pension funds that recently invested in corporate bonds could have locked in lost returns of £500m or more when compared to government bonds, according to the investment practice of Hewitt Associates.
Since July, problems in the credit markets have created problems for corporate bonds by raising the interest rate 'spread' which investors demand over safer gilts.
Returns on corporate bond investments (UK and overseas) have turned negative and fallen sharply relative to government bonds, resulting in a risk of locking in lower returns relative to government bonds.
Hewitt calculations have shown the scale of this, as corporate bond allocations (UK and overseas) have risen in pension fund portfolios to as much as 13% of total assets, or about £115 billion in defined benefit pension schemes alone.
Datta said: "Our consultants took a pretty cautious view on corporate bonds and advised our clients to stay away from anything related to credit, not just corporate bonds.
"Into the first few months of this year, what really struck us was spreads were narrowing further but we were also seeing significant industry inflows into corporate bonds.
"It was really as much to do with the search for yield, because government bonds had carried on falling and these assets looked like they had that extra bit of return. But also a lot of pension funds were trying to de-risk by reducing their equity positions and looking in the fixed income space for a sensible alternative.
"This hasn't been a brilliant case of timing."
According to data from the UK Office of National Statistics, during the first half of 2007, net investment into corporate bonds by pension funds amounted to over £15billion. This is more than 50% up on the total for all of last year.
Andrew Sutherland, head of credit at Standard Life Investments said corporate bond spreads had moved out since the summer, as the credit crunch had taken effect.
He said: "From spreads being quite tight, they are now historically very wide and are discounting a lot of bad news which we feel is inappropriate for investment grade companies.
"We do not expect investment grade default rates to pick up; corporate balance sheet and borrowings are in much better shape than the last time spreads were anywhere near here, in 2002.
"The banking sector will take time to get sorted and until that happens, spreads might not make much progress; however the scope for spreads to tighten sharply in 2008 say is huge. The main risk is prolonged US recession and sharply higher defaults as a result."
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