Probably the biggest question facing allocators today is how to think about bond exposure. Credit risk or duration risk? Inflation or recession protection?
Phil Collins, chief investment officer at Sarasin,says the rule book “has been torn up this time”.
He said: “The normal way you would play this market, where growth is slowing, is to think about long duration, and the expectation that central banks will stop putting rates up.
“But economies have performed better than expected in our view, and because rates rose from such a low level, central banks are continuing to lift rates, despite economies slowing down. That’s why we think in this market, duration is not key, and instead are focusing on being in the right sectors, rather than on the duration.”
While average allocations to fixed income in the balanced portfolios we monitor have been rising, and stand at 28 per cent at the end of August, there has been a shift away from certain parts of the market.
The radical revising of inflation expectations is most keenly observed in the market for index linked bond funds.
The average exposure in the balanced portfolios we cover has dropped from a peak of 2.5 per cent last September to just less than 2 per cent today.
The house with the largest exposure to these types of funds is Progeny at 6.8 per cent, while Liontrust has 5.9 per cent.
The bulk of the portfolios we monitor have zero exposure here.
Short duration bond funds, which would similarly be expected to perform best when inflation expectations are rising, similarly have been falling from favour, peaking at 2.2 per cent of the average portfolio in February 2022, but now account for 1.2 per cent.
Sarasin’s Collins prefers investment grade for his bond exposure right now, saying that he feels the demise of QE makes high yield bonds too risky.
Among the peer group we cover, which includes Sarsin, the average exposure to investment grade bond funds has remained largely static over the past year, at around 8.5 per cent.
The house with the biggest exposure here is M&G Wealth, at 27 per cent, the next highest exposure is Charles Stanley at 19 per cent, while Hawksmoor is among the first with zero exposure there.
Collins acknowledges that current conditions are when high yield might normally be expected to do well, with rates near their peak and economies proving more resilient, but he is wary as he prefers to see bonds as a dampener of volatility rather than a return seeking assets in their own right.
And on high yield, Collins' thinking is broadly in line with his peers, as the average exposure to that segment of the market has declined over the past year, from a peak of 2.7 per cent last November to 2.2 per cent today.
The winners, as we have discussed in recent weeks have been strategic bond funds and government bonds, with the latter now accounting for 7.2 per cent of the average allocation, up from 5.1 per cent as recently as September 2022.
