Market Overview
Bond markets were calmer during the second quarter than the preceding one, largely because the banking sector’s troubles, dominated by the collapse of Silicon Valley Bank and the UBS-Credit Suisse merger, were largely confined to the prior period. That said, there was initially some contagion when First Republic Bank fell into trouble in April. This kept the subject of banking sector stability on investors’ minds when assessing risk and return and this consideration factored into how we managed our funds during the quarter.
The Bank of England (BoE) hiked the base rate twice over the period, by 0.25% in May and surprising many with a 0.5% rise in June. This sudden acceleration in rate rises appears to reflect a turning point in BoE strategy. Like many commentators, the UK central bank had expected inflation to fall as energy prices declined. However, while there have been modest declines in CPI and RPI data, the issue of core inflation remains a problem.
In the UK, inflation has become an internalised issue. Service sector inflation has been climbing even as macroeconomic data in the global economy has weakened. This appears to have prompted the BoE to act more aggressively, though higher rates could feed wage inflation if workers are able to secure offsetting pay rises from their employers. The BoE likely needs to generate some form of slowdown, perhaps even a recession, to regain control of inflation.
Fund Review
Over the cycle of each Monetary Policy Committee (MPC) meeting during this rate hiking phase, the fund performed broadly in line with SONIA.
We have sought to protect the fund by holding around 15% in overnight deposits, maintaining a ladder of short-term maturities and allocating around 25-30% to floating rate notes (FRNs). These FRNs reset to new interest rates within five working days, which allows us to efficiently take advantage of rate hikes. We can participate in them via private placement deals organised by various banks, which helps us access one-year floating rate notes with AA-rated banks, providing us with a return of around 45-50 basis points above SONIA. That said, we have also been looking to periodically add longer-dated holdings where we feel the risk/return profile works and they would represent value to the fund over term to maturity.
Outlook
The imminent holiday period could potentially bring calm to bond markets, as there are no major reports or macro data due to be published. By August, we should have a clearer idea about the stubbornness of inflation and in turn how the BoE will act. If the MPC feels progress has been made, we could see a return to 0.25% rate hikes (or even no hikes) and this would bring relief to the market. Conversely, perhaps motivated by being criticised for acting too slowly in previous months, further unexpectedly high inflation data could lead it to implement further aggressive rate hikes. If the base rate continues to go up in 0.5% increments, it could cause greater volatility as traders reassess how far the trend has to run. There is potential for the expected peak rate to edge higher.
We will reassess the likelihood of each of these scenarios as fresh data appears. We are taking positions in the fund to secure the higher yields available – but we are proceeding with caution. We will continue to manage the fund to maintain a degree of liquidity that gives us options when opportunities arise.
One area we would like to invest in more is covered bonds, but this is difficult as there is a dearth of opportunities. We are able to access them when they appear, but due to their scarcity we have to act quickly and establish significant positions when we identify good value. We will also continue to target floating-rate private placements when they make sense in the context of the risk/return profile of the fund.
Overall, our aim is to keep the fund nimble and able to take advantage of opportunities when they arise, in what is likely to continue to be an unstable market until the cycle returns to a rate-cutting phase.
Important Information
The value of investments may fall as well as rise and investors may not get back the amount invested.
The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice.
The LF Canlife Sterling Liquidity Fund is a UCITS scheme and a standard variable net asset value (VNAV) money market fund (MMF). The MMF is not a guaranteed investment, nor does it receive external support to guarantee its liquidity. Unlike bank deposits, investment in MMFs can fluctuate and investors’ capital is at risk.
This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available in the literature section.
Promotion approved 21/07/23
