14 Mar 2024
UK budgets are not what they used to be. Widely leaked, there were few surprises, enlivened by a bit of ‘Red Wall’ constituency bingo, with call outs for a range of Conservative MPs, and some tax baiting of Labour MPs.
The broad message is that the Office for Budget Responsibility expects growth to be better than previously thought, at around 2% next year and in 2026. Unless we see a big uptick in productivity in the public sector, the weakness of which was highlighted by the Chancellor, it will be difficult to sustain long-term growth at those levels.
The bottom line is that we are in an election year and headlines about tax cuts are more important than setting out a clear fiscal policy. The chopping and changing on National Insurance, tax thresholds, lifetime pension allowances, investment incentives, corporation tax, income tax etc mean that we have not had a consistent approach to taxation over the last 14 years of Conservative led governments. A sad indictment, mitigated by financial and health events, but not excused. The lack of a coherent philosophy is evident.
Last week saw confirmation of a high profile bond fund moving out of the Investment Association’s Targeted Absolute Return fund category – a sector comprising a broad collection of funds, typically seeking a return in excess of a cash benchmark. It has to be said, it has not been easy for bond managers to deliver their objectives against cash benchmarks in a higher interest rate environment. Is this a signal for the demise of this sector? Not yet I think. We have two strategies in the sector, offering our clients exposure to government or credit bonds. Both reflect our core investment philosophies as they apply to these asset classes. From our perspective the choice of sector is less important than a clear articulation of what the fund is doing. In the case of our credit strategy, we build a core portfolio of secured and asset backed corporate bonds, complemented by exposure to attractively priced unsecured debt, then take out the underlying gilt component of the yield through interest rate derivatives. What we want to capture is an attractive credit spread, from a broad range of bonds that we think are undervalued relative to the universe of sterling bonds. Yes, it has got harder with base rates at 5.25% but the strategy has proved its worth, meeting its objective over the longer term and demonstrating few periods of material drawdown. An example, in the investment world, of the merits of a clear investment philosophy, consistently applied over time.
On the US data front we saw strong non-farm payrolls in February. However, there were a significant downward revisions to the previous months’ gains and the unemployment rate hit a two year high, partly reflecting a 150,000 increase in the work force. This backed up last week’s comments from the Federal Reserve Chairman, which were less hawkish than expected, and eased investors’ fears about the tightness of the labour market. In the euro area, the European Central Bank left policy unchanged although inflation forecasts were revised lower. Whilst the emphasis was on watching how data evolves over the coming months it looks likely that a cut is being pencilled in for June. Service inflation remains a concern but the sluggishness of economic activity should exert a downward pull.
Bond markets were cheered by the US data, with the 10-year benchmark yield closing below 4.1%, a 10bps decline on the week. In the UK the budget had little overall impact, with investors more focused on future Labour plans than projections and policies that the present government has little chance of overseeing or implementing. Yields on 10-year gilts moved below 4%, finishing the week 15bps lower. Implied UK inflation, at the 20-year point, moderated to 3.25% with the real yield closing at 1.1%, down from the 1.4% seen in January but materially above the 0.8% of December.
Credit markets steadied as the weakness of the previous week was not followed through. Spreads in both investment grade and high yield remain towards the lower end of their range and heavy supply is expected to stop further compression. That said, I think that ‘all-in’ yields for our sterling credit strategies have attractions in an environment where interest rates are expected to decline later in the year.
In both politics and investment strategy there are benefits from having clear goals and a consistent approach. Voters and clients value clarity, I think.
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.