23.08 Liontrust MA Quarter In Review Q2 Literature (Single) - Flipbook - Page 17
Fund managers look beyond interest rate hikes
How far central banks would continue to raise interest rates to tackle
inflation continued to be a key focus for markets in Q2, but fund managers
are also turning their attention to other issues, such as economic growth,
valuations and even credit differentiation and default levels.
Another fixed income fund manager said: “Last year was all about
interest rates and inflation but so far, 2023 has been all about credit
differentiation. Credit will matter much more. To date, we have had
a rates sell-off, not a credit sell-off.
The meeting of leading central bankers at Sintra in Portugal during Q2
did spur much noise and speculation around the direction of monetary
policy though. Bonds, especially US treasuries, weakened on statements
made at the meeting that tight labour markets were still pushing up
wages and inflation and that stiffer action on interest rates could be
needed. European Central Bank (ECB) president Christine Lagarde told
the conference that there was still insufficient evidence that core inflation
was stabilising or falling.
“Defaults this year have been at record lows. Stripping out Russia
and Ukraine, they’ve been at about 0.5%. That leaves only one way
to go. That said, the average balance sheet is better quality than in
recent history and we don’t expect a significant spike like that seen
in the Global Financial Crisis, but defaults will pick up from here. We
expect a rate of 3-4% in the UK, and 2-3% in Europe.”
The comments, together with fresh data pointing to economic
resilience, were enough to raise fears about future interest rate hikes
and pushed up yields on government and investment grade corporate
bonds. In contrast, more faith in economic strength supported higher
risk, high yield bonds.
We lowered our ranking on high yield bonds in our Q2 tactical
asset allocation review to neutral, having raised it in Q4 2022.
We added exposure to high yield investments at an opportune time,
when they had attractive spreads versus government bonds but these
have since narrowed and we have taken some profits but remain
constructive on the long-term prospects for the asset class.
UK still offers opportunities
UK stocks were the laggards in Q2, weighed down by weakening
oil prices and the Bank of England’s aggressive rate hiking to quell
inflation that is the most elevated among developed economies. The
UK is dominated by energy multinationals and cash-generative stocks
but lacks the technology-centric growth stocks that have
spreads reach levels such benefited from the AI rally in recent months. We are still
positive on UK equities, however, which we see as still
historically seen strong
relatively cheap despite the energy bounce of 2022.
Despite the recent elevated volatility within bond markets, one fixed
income fund manager noted that high yield credit continues to exhibit
resilient fundamentals – including a near-zero default rate, high
recovery rates, declining leverage, and improved liquidity. He said:
“When the risk-free rate and credit
as those observed today, we have
one-year forward returns in the high yield asset class.”
“The market also contains some of the highest interest coverage ratios
we have seen in more than a decade. When the risk-free rate and
credit spreads reach levels such as those observed today, we have
historically seen strong one-year forward returns in the high yield
asset class. This year’s jump in yields has meant this buffer is back
again, providing investors with a powerful compounding effect.”
A fund manager said of the UK: “With the outlook
for inflation and interest rates moderating in the UK, many analysts
are now questioning whether Britain is really heading for a deep
recession. However, the more relevant question is whether the new
economic regime of elevated inflation and higher rates will result in
businesses and consumers continuing to tighten their purse strings –
given Britons have already cut discretionary spending.”
Liontrust Multi-Asset Funds and Portfolios Quarterly Report: Q2 2023 - 17
