LONDON Investors' passionate affair this year with corporate bonds -- described not so long ago as a historic opportunity -- is now settling down into something more placid.
They remain happy with the investment play; it's just that the fire has been doused by its rollicking success earlier this year.
In short, credit that has been behaving like equity in a bull market, rising sharply in price, is now likely to become more bond-like, more dependent on its steady coupon -- or the interest rate "carry."
To be sure, this year's performance for corporate bonds has been stunning. In December last year, the spread between global large cap company debt and U.S. Treasuries was 155 basis points, according to Bank of America Merrill Lynch.
It has now narrowed to around 52 basis points.
The performance of high-yield, or "junk" bonds, has been even better. From a spread of 2,193 basis points in December, the BoA-ML global high-yield index now registers 773.
All of which, according to Thomson Reuters' Lipper data, has allowed the likes of Legal & General's Dynamic Bond Trust to return 38 percent year-to-date or Putnam's Global Fixed Income Alpha fund to gain 21 percent.
Lipper's own corporate bond return index shows year-to-date average returns of 27.5 percent, although this may be skewed by some very high returners.
In terms of total return, corporate bonds have easily outpaced stocks over the past two years of crisis.
This validates the position taken by large numbers of institutional investors at the end of last year to put themselves heavily overweight in the asset class.
The main reason was that last year's Lehman Brothers-related market panic had driven corporate bond yields to levels that over-compensated for the likelihood of default.
"The extraordinary level of spreads at the beginning of the year ... implied very high returns, assuming that spreads were likely to normalise," said John Stopford, head of fixed income at Investec Asset Management.
The latest Reuters asset allocation polls show investors in the United States, Britain and continental Europe remain heavily exposed to corporate bonds, with an average overweight position of +1.8 out of a possible +3.0.
This is actually higher than it was in January (+1.4), reflecting the year's huge rally.
But the polls also suggest a pull back may be coming over the next quarter. Asked where they expected to be in three months' time, investors in the three regions projected a +1.0 percent stance.
"2009 was a classic year to buy. 2010 is probably a year when you don't add much more," said Andrew Milligan, head of global strategy at Standard Life Investments.
"Our (retail adviser) clients are becoming less enthusiastic towards corporate bonds, partly because they have been putting so much money into this asset class this year," he said.
The implication of all this is that demand for corporate credit is likely to tail off next year, but the asset class will still be popular.
While the immediate future may be bumpy as managers seek to lock in profits before the end of the year, this will be procedural rather than signifying a sell-off.
Assuming the global economic and financial systems do not turn around and descend into crisis again, the biggest threat to corporate bonds probably comes from governments.
Authorities will be seeking next year to haul back the liquidity that they pumped into the system to reverse the crisis. This will include raising interest rates, pushing government bond yields higher.
Rising government bond yields tend to mean the value of existing corporate debt goes down and the cost of borrowing with new debt goes up.
Ranged against that, however, is the overall economic and financial position. Companies are deleveraging, the global economy is improving, cash still offers little competition and companies have so much liquidity they are unlikely to be flooding the market with supply.
This leaves investors relatively confident that corporate debt will not reverse, even if the heady days of 2009 are fast falling behind them.
"I don't see any need to sell until the spread has changed markedly," said Standard Life's Milligan.
(Graphic by Scott Barber; Editing by Ruth Pitchford)