Why, hello there! I am back from a week’s hiatus, recharged and ready to go. I hope you have all had a wonderful week and are looking forward to the weekend and so let’s not waste any time and get straight into this week’s News, Views and Truths.
This is the final part of the 3-part series, detailing the investment themes that are driving our portfolio decisions for the next twelve months. If you haven’t seen the previous two, we covered the topics of innovation and inflation – click each to read in full. This week is bonds.
I do not think any investor can doubt the influence that bonds have had on portfolio performance over the past 30 years. This chart by Morningstar below shows the huge outperformance of global bonds against global equities (MSCI World) over that timescale and contextualises the positive role that fixed income securities of all types have had over the longer term.
Source: Morningstar
More recently, the performance of bonds, in particular high-quality sovereign bonds such as UK Gilts and US Treasuries, has been nothing short of astounding. Investors within our portfolios have benefited directly from this; during July 2019, we initiated a position within longer maturity UK Gilts, along with an increase in our allocation to conventionally dated UK Gilts. The performance since then can be seen in the chart below.
Source: Morningstar
However, in March 2020, we wrote to our clients advising them that we had fears regarding the potential volatility of these bonds due to the spectacular performance and recommended that investors sell the assets, crystallising the profits and holding this allocation in cash until investment opportunities present themselves.
This is because, in our view, fixed income bonds are not a tool for long term growth. We view our fixed income allocation as a lower volatility dampener to equity volatility excesses, giving the resulting portfolio a return experience in line with a client’s stated risk grade. I know, crazy.
Yet against the pre-Covid backdrop of slowing global growth, many investors were allocated to bonds with a primary focus of capital generation as opposed to preservation. During the pandemic crash, those birds came home to roost, with sub investment grade high yield bonds suffering double digit falls in value. This, we believe, validates our volatility view on fixed income.
So where next? Again, to contextualise, I thought I would use a tweet by the US Investment Advisor, Ben Carlson.
The P/E ratio is a technical measure of the relative value of a share, with the “P” being price and the “E” being earnings; the higher the P/E, the more expensive it is as the more price the investor needs to pay to access the earnings. The UK FTSE 100 is currently trading on a P/E of 18.270 according to ceicdata.com.
Ben’s tweet above estimates that 10-year maturity US Treasury bonds are trading at an equivalent P/E of 192.3.
192.3. That’s expensive. Again, for context and according to gurufocus.com, Amazon has a current P/E of 123.99. And what do you currently get for owning that 10-year US treasury? 0.52% according to the FT.
It is our conclusion that the risk to bonds is pretty much skewed to the downside and as such, we are focussing upon the risk as opposed to the reward. Therefore, to minimise the potential damage that a rise in inflation and a lowering of fixed income demand can create, we are reducing the maturity of all our fixed income allocations. This has the effect of dampening down the short-term volatility of bond price movements as the bond reaches its maturity date, as shown in the chart below which compares both conventionally dated and short dated UK gilt funds.
Source: Morningstar
We will continue to maintain the focus on using fixed income bonds as a volatility dampening tool, we just simply believe that one of the biggest risks to clients’ portfolios is the exact asset that is present to protect them from this.
This week’s “When Andrew Met…” video is on the website here with an update from Julian Cook on the T Rowe Price US Large Cap Equity Growth fund. Since our last video back in March a lot has changed and Julian outlines the performance of the US market and how T Rowe Price is managing the fund assets throughout the pandemic.
Once again, my weekly podcast is also live here, with this week’s guest being Richard Lightbound, CEO of Europe and Asia for ROBO Global, a research company wholly focused on helping investors capture the unique opportunities of fast-growing robotics, artificial intelligence, and healthcare technology companies around the world. Importantly, ROBO Global creates and manages the Legal & General Investment Management Robotics and Automation fund and Richard outlines the significant investment opportunities within this cutting-edge sector.
Stay safe, stay UV factor 50 protected and I shall see you all next week.
