Investment Note March 2015



Avoiding falls on the fells


“Whenever people talk about the weather, I always feel certain that they mean something else.” Oscar Wilde 
As far as I know, the great Lakeland fell walker, Alfred Wainwright was, for all his supposed grumpiness, never a keen follower of the Gilt market. But if he had, his eloquent writings about the mountains, in all their moods, would at times be perfectly suited to the challenges faced by mountaineers and bond managers alike. 

This occurred to me last week during a spot of climbing in the Lake District which, some might think, is a perfect getaway for your Square Miler. But there are no instant market updates, no wifi. In fact, no phone signal at all. In spite of this, the hours of contemplation and free thinking whilst walking can throw up a seemingly endless stream of metaphors that remind us (or maybe it’s just me) of the stock and bond markets. The ups and downs, the headwinds and ever present herds of sheep….

There are calm days punctuated by fearsome storms coming out of nowhere that fuel a growing suspicion that, just maybe, the sunlit uplands don’t really exist despite your evidence, and more importantly experience, to the contrary.

It was during one such storm (pictured) that many years of climbing experience was put to the test in a scenario that neatly mirrors what it has been like to be underweight Gilts as bond prices rose to new highs at the end of January. Climbing steadily towards the summit, a dark cloud descended and the wind, a headwind naturally, cranked up to 60mph out of a clear blue sky complete with
hailstones.

I’ll admit that it wasn’t this particular moment that my thoughts turned immediately to the bond market, but it’s not stretching it too far to say that a constant blast of hailstones to the face is an analogy not lost on a fund manager underweight Gilts against which he’s benchmarked, when the 10-year yield, which moves inversely to prices, reaches an all-time historic low of 1.33% as happened on the last day of January this year.

As it happened, we had already weathered the very same storm before further up the valley earlier in the day. Like experience of the markets, everything we knew, or thought we knew, told us it could not last. It must pass. We didn’t know when exactly, maybe 20 or 30 mins, and so carried on. If you have the courage of your convictions, you stay the path because whilst you cannot see the summit, you know it’s there. However, at the worst part of the storm, there was a blinding flash of lightening and a boom of thunder overhead. This was a new wrinkle which forced a decision to either carry on, sit still or go back down. 

Those that have been watching Gilts in the last month can probably guess what happened next. The storm cleared in a matter of a few minutes and suddenly the mountain was basking in bright sunshine and blue skies. Someone said “I can’t believe it. It looks like the summer ’76”

Well, you wouldn’t have to go back quite that far (and I wasn’t that warm as I recall. If my cheeks were red, it was hail burn) but as far as the TAM benchmarks are concerned, the move in the 10-year Gilt yield from 1.33% to 1.8% represents the biggest fortnightly loss to Gilts in 20 years.

A bit like an investment decision, your casual walker can easily call it a day and seek out the relative safe-haven of a local inn and not be bothered much by the opportunity lost. However, (and I’m not sure what the landlord would think of his pub being compared to the Bank of England engaged in quantitative easing) coming back off the mountain, if you absolutely believed that the storm cannot last, is
akin to throwing in the towel and buying more Gilts on the 30th January.

Of course, this is where the analogy breaks down because Gilts are far from being cosy pubs. They are, we believe, fraught with danger at a time when central banks are repeatedly warning that interest rate rises are closer than the market thinks and is pricing for. As we have said before, in our lifetime, Gilts and most developed world government bonds, have been considered as “risk free return” in valuation calculation. But a 1.33% yield on the 10-year Gilt looks more to us as “return free risk”.

TAM has maintained a large underweight in Gilts this year; a position we have articulated more than any other asset class. This move has had a marked positive impact on TAM portfolio performance across almost all risk mandates and we are pleased to see that not only are portfolios outperforming relative to their benchmark but, for defensive mandates, portfolios are enjoying the double whammy of rising absolute values even as the benchmarks fall, pulled lower by the falling Gilt index. 

We expect to maintain a long term underweight in Gilts for the foreseeable future but are mindful that the market is vulnerable to short term volatility when any number of external factors, economic or geopolitical, can throw at us all the seasons in one day. As always, we will explain our investment rationale even if sometimes it comes in the middle of a market storm. 

 



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