Corporate bonds still offer value: Standard Life

NEW YORK (Reuters) - Even after this year's meteoric rally, U.S. and European corporate bonds still offer value to income-oriented investors, a major asset management firm said on Friday.

"As of today we would say that there is still value in holding corporate bonds because the valuations are still attractive, although with a small 'a' rather than a big 'A'," said Andrew Milligan, head of global strategy with Standard Life Investments in Edinburgh in a telephone interview with Reuters.

Investors currently demand a much smaller premium for the risk of holding corporate bonds instead of safer government bonds than they did in late 2008.

U.S. investment grade corporate bond yield spreads over Treasuries have narrowed to 216 basis points as of Thursday, from record wides of 656 basis points at the height of investor panic in the financial crisis in December, according to Bank of America Merrill Lynch data.

Given the dizzying speed and magnitude of that 11-month rally, Milligan warned that investors are starting to buy corporate bonds as a long-term way of collecting income rather than as a short-term bet on capital appreciation.

"The rationale for holding them is changing" in both Europe and the United States, Milligan said. "It would not be a surprise that corporate bonds would become less attractive during the coming year simply because valuations will become less attractive as spreads tighten further," he said.

Standard Life Investments has some $219 billion of global assets under management. Of that sum, $96 billion is invested in fixed income, roughly $37 billion of which is invested in corporate bonds.

The company added heavily to its corporate bond holdings earlier this year, Milligan said, although he did not specify by how much.

"We are still sticking there with very heavy positions, but during 2010 we will be paying more attention to valuation arguments" in corporate bonds, Milligan said.

"The balance of supply and demand, will need to be looked at more carefully," he added.

SUPPORTIVE FACTORS

That said, interest rate decisions do not pose an immediate threat to corporate bond markets, he said.

Milligan does not expect any rapid hikes in short-term interest rates in 2010, either in the U.S. or Europe, while the peak in corporate debt defaults is approaching and many pension funds continue solid buying of corporate bonds: all factors likely to support the market, he said.

As investors become more leery of sovereign debt markets because of massive government debt issuance they may favor corporate bonds instead, he said.

Milligan said the chances of a full blown dollar crisis in which investors sold U.S. assets, stoking major inflation and causing U.S. bond yields to spike, are slim.

If the dollar depreciates modestly against other currencies, that would help the United States rebalance its large current account deficit and to foment a little inflation to counter currently substantial disinflationary pressures, he said.

However, should a major dollar weakening come about, "inflation could rear its ugly head in America more so than in other countries, suggesting that U.S. Treasuries are not giving very good value," he said.

(Reporting by John Parry; Editing by Kenneth Barry)