17 May 2022
There is a line in the spoof history book ‘1066 and All That’ that refers to the sides in the English Civil War of the 17th century: Cavaliers (Wrong but Wromantic) and the Roundheads (Right but Repulsive). As a child I wanted to be a Cavalier but as an adult I find myself being a Roundhead.
In cultural terms it means I have developed a bit of a puritan streak. National lotteries are a case in point. The latest EuroMillions prize (£184m) is an obscene amount of money. It encourages unrealistic expectations and can create hardship for those that become addicted.
In political terms it means I am suspicious of centralisation. Watching a recent repeat of ‘Yes, Prime Minister’ I was struck how the storyline was so relevant: civil servants and politicians desire for central control. I thought about this episode when I read about Michael Gove’s latest policy initiative of neighbourhood votes on building extensions. On the face of it a good example of decentralisation but, in reality, a gimmick to ease tension with MPs, and not rooted in a coherent political philosophy. Actually, a very Jim Hacker solution.
Our Fixed Income team structure reflects my view that focused teams, working together in a collaborative way, will outperform larger and more centralised teams. This has, at times, been a hard sell because we are often programmed to think ‘big is better’. In terms of optical resources this may be the case but when motivation, collaboration, and team ethos are factored in, I believe the opposite is true. I believe that teams ideally should not exceed 12 people – the curse of diseconomies of scale is often unappreciated and accountability disappears in large groups.
My inner puritanism was also reinforced by the sell-off in cryptocurrencies last week. But this should be seen in the context of a wider rout of ‘risk assets’, particularly tech. Credit was caught up in this, with investment grade and high yield spreads taking a hit. It is just worth looking at some spread moves we have seen this year. In sterling, the non-gilt spread started at 96bps and is now 141bps. However, financial bonds have performed much worse. Senior 10-year Barclays has widened 100bps whilst M&G subordinated debt is marked at over 400bps, over 100bps wider in five months. Another area taking a hit was the corporate hybrid sector – subordinated debt within the capital structure of companies; as an example, VW’s euro hybrid bonds have widened 200bps. These moves have impacted relative performance in our sterling credit strategies but the effect has been mitigated by the returns achieved by secured bonds and asset backed securities. Our emphasis on sector and security diversification has certainly been helpful, avoiding over-concentrations in weak sectors.
Sentiment was not helped by data releases. In the US inflation came in above expectations, with headline Consumer Price Index (CPI) at 8.3% and core at 6.2%. In the UK Q1 growth came in at 0.8%, compared with a 1% consensus. The economy lost further momentum in March with weakness seen in the wholesale/retail sectors; industrial production also fell while construction provided an offset. More positively, April Purchasing Managers’ Index (PMI) business surveys are consistent with relatively robust activity although weak consumer confidence and negative real pay growth suggest consumer expenditure will remain under pressure.
Labour markets remain a conundrum. The UK unemployment rate remains well above pre-Covid levels, yet businesses are reporting staff shortages and difficulty in filling vacancies. A key question is whether people who have recently withdrawn from the labour market will return, as the squeeze on disposable incomes intensifies. The Bank of England must hope so.
Government bond markets defied expectations of further weakness. Despite the inflation headlines investors focused on the growing ‘recession’ threat. This looks more pressing in Europe and the UK but did not stop a material rally in US treasuries where 10-year yields went from 3.1% to 2.9%. In Germany 10-year yields fell back below 1% while in the UK yields rallied from over 2% to below 1.75%.
Cryptocurrencies are not the only asset to have had a torrid 2022. Last week the longest dated UK index linked bond hit a low of £200; six months ago the price was nearer £400. It has fared slightly better than Bitcoin – but not by much. The significant rise in real yields this year is somehow less newsworthy than the latest crypto sell-off.
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.