Is now a good time to buy corporate bonds? – Plus 3 bond fund ideas

When it comes to bonds the higher the yield is, the higher the return you can typically expect back. However, a higher yield can also usually mean the bond is riskier.

Corporate bonds normally have a higher yield compared to government bonds.

This because governments are considered less risky borrowers than companies. It’s very unlikely that the UK government isn’t going to pay their investors the interest and maturity payments linked to their bonds.

This might not be the case for a company, who could go bust and hence not be able to pay.

Investors therefore demand a higher return for the additional risk of lending money to a company compared to a government.

However, there is a but coming.

And it comes in the form of a question.

Are companies actually riskier to lend money to than governments?

The answer?

It depends on the company.

This might seem fairly obvious, but it’s also very important when thinking about what bonds to invest in and / or how to invest in bonds.

This article isn’t personal advice. Remember, investments rise and fall in value, so you could get back less than you invest. If you’re not sure if an investment’s right for you, ask for financial advice. Yields are variable and no income is ever guaranteed.

High yield versus investment grade? – What bond investors need to know

There are some areas of the corporate bond market that are riskier than government bonds.

High yield is an example.

These could be companies who’ve experienced falling revenues and profits recently, those who’ve nearly gone bust in the past, or those who are thought to have too much debt and might struggle to make their repayments.

To lend money to a company like this, you’d naturally expect to get a higher return – it’s clearly a genuine possibility that the company won’t pay its debts.

But what about investment grade corporate bonds, those issued by companies with better credit ratings?

It’s unusual for a company with an investment grade corporate bond to not pay those debts, but it can, and does, happen.

What’s happened over the last few years?

As a result of the large increases in interest rates across most developed economies after the pandemic, government bond yields are higher today than they have been for a number of years.

The last time they were around today’s levels in the UK and US was in 2008.

This means that they’re arguably a more appealing investment than they have been.

Corporate bond yields have increased in recent years too, but not by as much as government bonds.

This is because as government bond yields have increased, corporate bond spreads have reduced.

During COVID-19, interest rates were slashed to very low levels and government bond yields followed, falling a lot. But corporate bond yields didn’t fall very much.

In fact, initially during the pandemic, they increased.

This was because no one really understood what the implications of COVID-19 would be and what policies governments would adopt to try to keep the virus under control.

There were genuine concerns that a lot of businesses would go bust once lockdowns were put into place. This made lending to those companies much riskier.

But when governments announced various support measures for businesses, yields fell again.

However, they didn’t fall as much as government bonds and spreads remained elevated.

Therefore, when this effectively reversed as the world came out of covid, it’s reasonable that spreads reduced again.

Where are we as of today?

Let’s look at UK and US corporate bond yields over the last 25 years, broken down into investment grade and high yield.

At an overall level, yields available on investment grade bonds today are higher than average over that 25-year period, by about 0.75%.

For high yield it’s the opposite though, with yields being a bit lower than average, by about 0.65%.

Spreads, however, are lower across the board.

For investment grade, they’re about 0.55% lower than average over the last 25 years, and for high yield they’re about 1.85% lower.

This means that investors are getting a smaller additional return for buying corporate bonds compared to government bonds, on average, compared to the last 25 years of data.

Thinking about high yield bonds specifically, this data is telling us that an investor today is getting a lower annualised return than they would’ve done on average over the last 25 years, to the tune of around 0.65% per year.

It’s also saying that the additional return compared to government bonds is lower by around 1.85% per year.

That doesn’t sound overly attractive. Or put another way, they sound expensive.

For investment grade corporate bonds, it’s a more mixed picture.

Overall returns are a bit higher today than on average as the yield is around 0.75% higher, but the extra return compared to government bonds is lower.

The combination of this perhaps means these bonds aren’t necessarily expensive. But compared to government bonds it’s hard to describe them as ‘cheap’.

But what about default risk?

So far, we’ve only considered the returns available, and not the risk that bond issuers don’t actually pay their interest or maturity payments (they default on their bond).

Looking over the last couple of years, data from S&P, a global bond ratings agency, suggests that the number of companies defaulting on their bonds has been high compared to the average over the last 40 years.

But when this is broken down, nearly all of the defaults were from bond issuers with credit ratings of either CCC or C – the worst available.

In fact, in 2024, for all other credit ratings apart from CCC or C, the proportion of defaults was lower than or equal the median over the last 40 years (there were no defaults in the highest credit ratings bands of AAA, AA, and A, which is typical and hence is equal to the median).

While it’s interesting to know what’s happened recently, that doesn’t really help us consider how risky things are on a forward-looking basis.

Bringing it all together

Yields on government and investment grade corporate bonds are generally higher today than they’ve been for a number of years.

While yields within the riskier, high yield, market are also higher today compared to recent years, they’re not noticeably higher.

And looking over the last 25 years, they’re below the average.

Spreads are smaller today for both investment grade and high yield bonds.

So, the extra return available on corporate bonds compared to government bonds is lower than it has been historically.

This is especially true for the high yield part of the market.

Default rates outside of the lowest-rated bonds have recently been lower than their long-term average.

Arguably this means that the smaller spreads are reasonable, but it doesn’t give us much of an indication about what might happen in the event of a recession in future.

At a high level, it feels like investment grade bonds continue to offer potential value to investors, even if they aren’t cheap compared to history.

It’s less clear when it comes to the high yield part of the market, because the additional return compared to government bonds is quite a lot lower than it has been in the past.

This area is expensive relative to history.

Finally, investors need to remember though that the yield and spread data discussed here are averages. They represent the overall market, rather than specific individual bonds.

There are bonds that are expensive and others that are cheap. Some for good reason and others less so.

Investing in bonds passively means that it’s these average figures that matter, but investing in bonds through an actively-managed fund allows for bond selection to add value.

How can I invest in bonds?

Using an actively managed fund is a good way to invest in corporate bonds.

Finding and selecting specific corporate bonds that offer good returns with low default risk is something best left to the professionals.

Here are three actively-managed bond funds that are looking to invest in different ways.

Investing in these funds isn’t right for everyone. Investors should only invest if the fund’s objectives are aligned with their own, and there’s a specific need for the type of investment being made. Investors should understand the specific risks of a fund before they invest, and make sure any new investment forms part of a diversified portfolio.

For more details on each fund including its charges and risks, use the links to their factsheets and key investor information.

Royal London Corporate Bond

Artemis High Income

Invesco Tactical Bond