For triple-A, investors can read A-plus

For triple-A, investors can read A-plus

What's the chances of Tesco going bust? Most people would say the odds of the superstore group defaulting on its loans is infinitessimally low. Yet as the credit crunch has swept the globe, bonds issued by the likes of Tesco and other "triple-A" rated companies have fallen steeply in value. The result, say fund managers, is that corporate bond funds now offer the best value for a decade.

Bond funds are at the low-risk, low-return end of the investment spectrum. They promise to pay a yield - typically around 4-5% - and preserve or slightly grow your capital. Returns have been drab since 2005, but many managers now think 2008 will see 10%-plus returns from what are widely considered conservative investments.

Before the credit crunch, the yield on top corporate bonds had fallen to little more than that on government bonds (known as gilts), - currently 4.5%. That suggested markets were extremely relaxed about risk in triple-A corporate bonds - Tesco was almost as safe as the Bank of England.

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But since the credit crunch, corporate bond yields have shot up. At big banks, such as RBS, yields have widened out from 100 basis points (1%) over gilts to around 350 basis points. The ones with financing models bearing any resemblance to Northern Rock (such as Alliance & Leicester) have ballooned out to 500bp (5%) over gilts.

Non-banking top-quality bonds such as Tesco have seen their spreads double. In the junk bond market for higher risk companies - those with credit ratings below double-B - yields have soared to 10% above gilts or more.

This should signify deep distress and a market anticipating widespread defaults. But although default risk has risen, it's not at levels to justify such spreads, says Paul Causer, co-manager of one of the UK's biggest bond funds, Invesco Perpetual Corporate Bond. Instead, he points to technical credit crunch issues creating major price moves and opening opportunities.

The issues come from esoteric "collateralised loan obligations" (CLOs) which financed many takeovers, and helped drive stock market gains until mid 2007. Causer explains: "There's a huge log jam in the leveraged loan market, including CLOs, because when the music stopped the banks were left with unsellable products. The last time yields shot out was after the dotcom bubble burst. But then, there were a lot of defaults. The thing is, for now at least, we're not seeing the defaults. The fundamental picture has not changed. This is about the market being in turmoil."

Pessimists will argue that Causer might be making a big mistake - that in fact the market is giving us an early warning about a steep rise in defaults. But Causer doesn't see it that way.

"The $64,000 question is how bad the macro position is going to get. But a lot of pricing action has gone above and beyond where we should be." Causer sees value in bonds issued by banks and utilities. But Jim Leaviss, who is in charge of the £60bn in bonds run by M&G and Prudential, is more cautious.

He prefers to stay in government bonds for now, as he is concerned that the credit crunch still has a lot further to go. He is deeply pessimistic about the outlook for global growth and predicts that interest rates will be slashed in the US to bail out the banks. "There are some really nasty things happening in the banking sector. We expect global interest rates to fall like a stone; you could see the Fed dropping rates to as low as 1% by the end of the year. The US is probably already in recession and it will deepen during 2008 and last through to 2009."

He thinks we are not yet at the point of "maximum panic" in credit markets, and worries that the decade of low growth that followed the Japanese asset price bubble of the 1980s could be repeated in the US and UK. That era saw Japan government bonds collapse in yield from 8% to 1%, but for bond holders that meant a huge increase in capital value.

At Fidelity, Ian Spreadbury, who manages Moneybuilder Income and Sterling Bond funds, stands somewhere between M&G and Invesco Perpetual. He sees value in utility and telecom bonds, but is less keen on banks.

You can invest in corporate bond funds with a lump sum from £500 upwards, or start a saving scheme with as little as £10 a month at M&G.

If you want to buy, try a fund supermarket such as h-l.co.uk or fundsnetwork.co.uk for the best deals.

guardian.co.uk © Guardian Newspapers Limited 2008