Global Short Duration UK strategy - July 2021
The relentless government bond rally continues
- Investment grade credit spreads were unchanged while high yield spreads were wider
- Government bond yields continued to fall despite higher inflation data
- The risk profile was further reduced
Despite positive corporate results, credit spreads were mixed in July as continued worries about inflation and the global spread of the Delta variant of COVID-19, combined with a slump in Chinese equities due to concerns about a regulatory clampdown, all weighed on sentiment.
The US Federal Reserve adopted a relatively dovish tone at its policy meeting, keeping interest rates at record lows while indicating that the process to start winding down its massive bond-buying programme was drawing closer. Meanwhile, the European Central Bank insisted that it would maintain policy support as long as necessary, despite worries about growing inflation.
Despite rising inflation, US treasury, German Bund and UK gilt yields fell in July, with the yield on the US 10-year treasury bond hitting a five-month low, as rising COVID-19 infections unnerved investors due to concerns that the economic recovery might be weakening.
Portfolio positioning and performance
Sovereign: In order to further de-risk the portfolio, we increased our sovereign exposure by another 10% in July to 28% by adding to short-dated US, UK and German nominal bonds. We also increased the duration of the portfolio to 1.8 years from 1.2 years to benefit from the fall in government bond yields.
Investment Grade: We decreased our exposure to investment grade markets by another 5% to 35% in order to reallocate towards sovereign debt. We were active in both primary and secondary markets, selling mostly expensive cyclical names in euro and sterling.
High Yield and Emerging Markets: We slightly decreased our exposure to high yield and emerging markets by 2% to 36%, as we mostly reduced our exposure to some Chinese credit names facing increased regulatory headwinds. We also tactically bought protection on the Markit iTraxx Xover in order to hedge some of the credit risk in this portion of the portfolio.
As we expect continued monetary and fiscal support over the medium term to ensure a full economic recovery, we believe the second half of 2021 will remain all about carry.
However, with valuations remaining very expensive, we plan to retain our barbell strategy by keeping a higher exposure to sovereign bonds and high yield / emerging markets, for defensiveness and carry purposes respectively, while keeping a lower exposure to investment grade markets.
We continue to expect higher yields by the end of the year as successful vaccination programmes in most developed countries should lead to a faster and sustainable reopening of their economies.
No assurance can be given that the Global Short Duration strategy will be successful. Investors can lose some or all of their capital invested. The Global Short Duration strategy is subject to risks including credit risk, liquidity risk and interest rate risk and counterparty risk. The strategy is also subject to derivatives and leverage, emerging markets and global investment risks.
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