05 Dec 2023
November was a strong month for fixed income despite weakness in the last few days. US treasuries led the way, with 10-year yields falling 60bps, ending the month at 4.3%.
This was despite US Q3 growth being upgraded to 5.2% (annualised). Anecdotal evidence suggests that the US consumer is cutting back spending in Q4, with a number of companies warning about slower demand. Black Friday data looks reasonable but that may be at the expense of margin. Looking at market curves, investors are still pricing for the Fed Funds rate to be heading towards 4% by the end of next year. In the UK 10-year gilt yields dipped to 4.2% at month end compared to 4.5% at the end of October.
Similarly, there was weakness in the latter part of last week, in part reflecting new UK employment data which indicates that labour markets are tighter than previously thought – with the implications that rates stay higher for longer. This jolted the short end but rippled through the curves and longer dated yields backed up, with 30-year yields settling above 4.7%. My colleague Ben Nicholl also pointed out that recent long data gilt auctions have seen weaker demand, suggesting that investor appetite for long-dated debt may be waning. This may be the reason why the Debt Management Office seems to be favouring issuance in the 15 – 30-year area rather than testing ultra longs.
The rally in government markets also propelled strong gains in credit with the November return for investment grade sterling non-gilt bonds approaching 3%. Issuance continues to be meet with good demand but it is expected that supply will reduce in coming weeks that could take spreads below their current year-to-date lows. There is an argument that credit spreads are artificially low – due to technical factors of low supply as issuers wait for lower yields before committing to new debt – but in my view that does not stand up. Balance sheets look surprisingly healthy and companies brought forward issuance to take advantage of ultra-low yields in recent years. Overall, I think that credit still looks reasonable value, with investors still being paid well to take risk. Short-dated credit spreads, whether high yield or investment grade, look attractive and remain an area of preference.
Financial debt continues to be a focus, with banks having funding opportunities across the capital structure. The Additional Tier 1 rehabilitation continues, as Virgin Money demonstrated last week. Yes, the coupon was high but money is available. The existence of Virgin Money, built out of the Northern Rock wreckage, is testament to the steps taken during the financial crisis to shore up the financial system. A major player, and vastly under-appreciated, was Alastair Darling who died last week. Probably the best chancellors of the last 50 years – and there have been a lot.
During November we’ve benefitted from some longer than benchmark duration positions and greater sensitivity to credit spread moves. One notable area has been our unconstrained income strategies, overseen by Eric Holt and Rachid Semaoune. Their approach is to invest on a global basis, looking more widely than many investors and focusing on their perception of risk, rather than just taking credit ratings at face value. This is an under-appreciated art in credit fund management, where risk aversion dominates. By thinking differently, they have been able to deliver for clients over the long term, offering exposure to bonds that are often neglected; their approach is a great diversifier for clients.
Yes, these income strategies have faced headwinds this year –notably Thames Water and Credit Suisse – but the strength of Eric and Rachid’s approach was highlighted in our latest weekly Attribution & Risk meeting. There are two distinct approaches within this strategy. One is more sterling focused, with higher exposure to structured debt (a familiar Royal London trait), the other has a higher weighting in global issues and more exposure to insurance and industrial names. Both, however, have historically done well on converting risk into return and, despite their focus on under researched pockets of debt market, offer daily liquidity via the pooled vehicles we manage. Our Attribution & Risk meetings, I should add, are led by our Portfolio Risk Team, who provide an independent assessment of risk, liquidity, and stress testing.
I am looking forward to our Asset TV Investment Outlook debate, which will go out this Thursday; there will be a lot to discuss in 45 minutes. Key issues will be whether rate forecasts in the market reflect our views on growth and inflation, and how asset classes will fare against our scenarios. I remain more pessimistic than most of my colleagues on growth, but recent yield curve moves have anticipated a more material slowdown. There may be better opportunities to extend duration, although that is my preferred direction of travel.
This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.