Until recently, the Bank of England had been looking upwards since last raising the official interest rate in November 2017. It sent messages for months that a ‘gradual, limited’ rise in interest rates would be needed to stop inflation rising above its 2% target and this led LIBOR (London Inter-bank Offered Rate) rates to edge up as the markets anticipated another hike. Floating Rate Notes (FRNs) – bonds that have short durations and reset their coupon as rates move – were in great demand during this period.
When constructing a fund for investors, the first question a fund manager ought to ask is: “How will I account for redemptions from this fund?” As Jack Reacher, from the famous book series, would say: “Monitor your surroundings and always have an exit.” Such advice is most relevant when the fund is named after the strategy, which is why we make liquidity the most important step in our investment process.
It is uncertain when the current economic cycle will come to a halt, but what is certain is that we are undeniably approaching full time. This has put pressure on investors, who are shying away from ‘traditional’ fixed income assets – such as investment grade corporate bonds – in favour of alternative-style absolute return bond funds and more strategic, esoteric offerings.
We all know how events have a way of creeping up on us: birthdays, Christmas, Money Market Reform (earlier this year) and now the end of the London Interbank Offered Rate (LIBOR). While the infamous reference rate doesn’t officially become extinct until the 1st of January 2022, we need to look at what liquidity or pricing issues might occur during this immense transition away from it to alternative risk-free rates.
Triple-B rated corporate bonds have attracted much attention this year as they now represent more than half of the Investment Grade market. The growing number of BBBs is largely attributed to how Quantitative Easing and an unusually long period of low interest rates have made it easier and cheaper for companies to lever up and finance their businesses. Concerns about the amount of leverage this adds to the financial system have also put these credits into the limelight, particularly at a time when growth is slowing and recessionary threats loom.