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Really Interesting

Currently financial markets are nervous about a few things.  From the media headlines of last year worrying their readership about growth being too strong in the US economy and interest rates needing to rise, we now have worries about recession in most developed economies and the yields on their government bonds plummeting to reflect this latest scare.

What may strike many investors as unusual is that the prospect of rising bond yields in the second half of last year caused equity markets to puke – not once but – twice in October and again in December 2018.  Now equity markets are unnerved by bond yields heading sharply in the opposite direction – heads you lose, tails you lose.  Of course there are other influences in play like the ‘B’ word and trade frictions between the US and China.  But the feast or famine backdrop of economic activity seems to be the one most affecting government bond yields.

The recovery in financial asset prices in January and February was facilitated by US Federal Reserve Chairman, Jerome Powell’s volte face on the direction of short–term US interest rates, subsequent economic date and the inversion of the US yield curve (long rates lower than short rates) which has often preceded a recession.  The competition of a higher discount rate (bond yields) in 2018 has given way to a much less competitive discount rate for equities but concern about earnings have brought on a nervous March for equity markets.  Maybe towards the end of a mature cycle you can’t have it both ways.

Interest Risk

For UK investors, ten year UK government bonds (gilts) are a useful valuation metric.  Investors compare the yield available against other assets.  The yield on ten year gilts has oscillated wildly over the past five years as depicted in the chart below from Investing.com, touching a low yield of 0.64% in August 2016 to just below 1% today having yielded 1.57% as recently as September last year.

For those who bought at the low yield in August 2016, they would have suffered a capital loss but almost got back to parity through income (coupons).  Those who invested at the recent high in yield, would be sitting on an unrealised gain of around 6.5% – not bad at all.

Keep it Simple

The problem is, as we have noted before in our comments on ‘the greater fool theory’, when inflation is running around 2% in the UK which is also the Bank of England’s target, there seems little point in investing in ten year gilts yielding 1% and therefore 1% below inflation.  An investor just reduces their

wealth in real terms by 1% per annum.  They might hope to sell their gilts on to ‘a greater fool’ at a lower yield, higher price but as the above chart demonstrates, this supposedly risk-free asset isn’t.

The unattractiveness of ten year gilts was brought into focus earlier this week when I switched the proceeds of an account held with a well-known challenger bank on the high street after the founder’s wife was found to have been paid £17.3 million or thereabouts for designing their branches –we take governance seriously here, right down to a personal level.  The branches are quite striking and my dog certainly enjoyed his visits as they have free dog biscuits – he is a character, he even has his own Instagram account, really!! Not my doing.

The amount in question was a decent sum so I asked the recipient regional bank here in Nottingham what they paid on an instant access savings account.  ‘I’m sorry, it’s only 1%’ was the response.  Fine with me and as the amount is below the threshold for the Financial Services Compensation Scheme (FSCS), it effectively carries the same guarantee as gilts.

In Summary

The T. Bailey Dynamic Fund has an objective of UK inflation as measured by the Consumer Price Index (CPI) plus 3% over a rolling three year period.  Therefore, it aims to preserve and grow investors’ wealth over time.  It’s not without investment risk and will occasionally fall below that objective in a rolling twelve month period during market turbulence but has over longer periods, over-delivered.  As a multi-asset solution, it doesn’t need to own gilts or bonds priced off them as they don’t offer value.  Even the flight to quality/safe haven argument is flawed when for amounts below £85,000, you can probably access sub-inflation rates of 1% without the volatility or duration (interest rate) risk.