Corporate and high yield bonds are set to be the worst performing debt investments in 2006, as rising levels of interest rates, defaults and leverage take their toll, Schroder Investment Management said on Friday.
"We do expect some degree of re-leveraging in 2006 and for default rates to rise, neither of which is good for credit," Louise Davies, global fixed income fund manager, told a news conference.
"Corporate and high yield bonds will probably be towards the bottom end of the performance table," she said.
Global corporate and high yield bonds have delivered solid double digit returns of 10.1 percent and 15.7 percent so far this year, according to Schroders, though this is some way behind the 22 percent returned by emerging market bonds.
Emerging markets should continue to do well into next year, according to Davies, as credit ratings trends remain positive.
So, too, should asset-backed bonds.
"Collateralised debt will do well," she said. "I think mortgage bonds in the US will continue to offer good returns."
Global government bonds, meanwhile, should move from bottom to mid-table through 2006 as the trend for pension funds to cut equity exposure in favour of fixed income gathers pace.
Government bonds have largely been on the back foot since August, with rising interest rates and worries about inflation finally driving yields higher.
Even euro zone yields have moved up from record lows touched in September, adding about 40 basis points to the yield on the 10-year Bund, the euro zone's benchmark issue.
But at 3.4 percent, the yield is still around 25 basis points below where it started the year.
The 10-year US Treasury yield has added about 55 basis points to its 2005 low point, though at around 4.45 percent, the yield is still some way below the level which is typical for this stage in a rate hike cycle.
Despite this relatively recent retreat, Davies believes yields will turn lower.
"I think that over the next six months there will be some degree of a rally in bond markets," she said.
But the key to capturing the best returns will be to be invested globally. "As a euro-based investor, we think the best thing you can do is look across global markets and global sectors. You have to look for relative value trades across different markets," Davies said.