Why are retail bond investors showing increased interest in corporate bonds despite the higher risk?

Retail bond investors are showing increased interest in corporate bonds due to growing fixed-income yields, particularly as the yield gap between a gilt and sterling corporate bond is about 0.5 percentage points on 10-year instruments. This has driven nearly £2.2bn into sterling-denominated corporate bond funds in the 12 months to May.

The allure of yields in the region of 5% and higher is attracting investors who seek to boost their income, especially when dividends are forecast to decline. However, investors seem to be downplaying certain risks, such as the possibility of corporate borrowers struggling to repay debts or facing insolvency amid the UK's economic pressures and rising interest rates.

Despite the increased interest, investment managers highlight the risks and potential rewards in corporate bonds and urge caution in portfolio allocation, as rising interest rates could impact bond values and cause difficulties for some investors.

Additionally, the relatively illiquid nature of corporate bonds makes it challenging for investors to sell as needed. The preference for shorter-duration corporate bonds and government bonds for longer durations is evident, with caution against speculative behavior in chasing higher credit spreads.

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