BONDS form the traditional investment insurance against falling share prices. With the present stock market environment shot through with uncertainty it may be time to increase holdings of lower-risk asset classes. The bond market investment choices are not as simple as they might be, however. It is hard to argue that gilts — bonds issued by the British Government — represent anything like value for money at present. Far from being a hedge against equity market volatility, the value of gilts could fall irrespective of the fate awaiting shares.

Gilt prices are high because big pension funds have chased the market up to comply with the minimum funding requirement (MFR). Meanwhile the relatively healthy state of government finances means new gilts have been in short supply.

Gilt prices are also vulnerable. They are below the peak, but values could soften further. Thought is being given to relaxing MFR rules to allow pension funds more funding leeway. It is possible that the supply side of equation will ease, too. Labour’s public spending commitments may not mean the Government borrows more, but it may mean it does not pay back borrowings as quickly.

Unattractive gilt prices shift the focus on to corporate bonds. Historically, UK companies have made relatively little use of the bond market, but this has changed in recent years as firms sought to appease shareholders by retiring equity and replacing it with debt. Debt has also been seen as a cheaper form of finance.

The appearance of larger amounts of corporate debt has enhanced the liquidity of the market and that has encouraged more investors to explore the potential.

The higher interest rates paid by corporate borrowers, as opposed to governments, add to the attractions. And while investors in corporate bonds demand a yield premium because corporates are reckoned to be less creditworthy than the British Government, many see that margin as more than generous.

Non-government agency debt such as that of the European Investment Bank, is also worth looking at.

There is a possibility that MFR rules will be relaxed in a way that encourages the powerful pension funds to invest more in corporate and non-government bonds. In consequence the demand and price could increase — just as demand for gilts might wane.

Changes in the way corportate bond issues are structured also suggest that the power of bondholders — who have long played second fiddle to shareholders — is rising. Some bonds are now structured so that the interest coupon increases if the credit rating attached to the firm reduces. In the process this lessens the risk of firms following strategies harmful to bondholders’ interests.

It is not all one-way traffic in favour of corporate bonds. Liquidity may be improving but it is far from perfect. Bond prices can also suffer in the same way as equity prices if issuers’ trading prospects or financial status deteriorates. And profit warnings have been appearing thick and fast of late.

The opportunities for private investors to buy corporate debt are also underdeveloped. Corporate bond funds are around, but carry fees. Some argue that funds also increase risk because they trade debt rather than hold bonds to maturity.

Given the degree of uncertainty in equity and bond markets, it will be brave investors who make big calls at this time. But the sensible policy is to keep all options covered. For many that will mean increasing exposure to bonds, especially non-government bonds.

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