Sterling Credit Short Duration strategy - September 2023
Mixed market performance as inflation remains elevated
- Sterling investment grade credit spreads widened on the back of concerns about the ailing Chinese economy and still hawkish stances from central banks
- UK gilt yields rose, reversing last month outperformance, as inflation remained stubbornly high
- The risk profile was broadly stable
Sterling investment grade credit spreads widened on the back of concerns about the ailing Chinese economy, the downgrade of the US credit rating from AAA to AA+ by Fitch citing rising debt levels, and still hawkish stances from central banks due to stubbornly elevated inflation.
The US Federal Reserve chair Jerome Powell failed to commit to a course of action at the Jackson Hole Symposium, unnerving markets which continued to expect no further rate rises for the remainder of the year. The Bank of England increased interest rates by 0.25% to 5.25% in August as governor Andrew Bailey said policymakers needed to ensure inflation ‘falls all the way back to the 2% target’.
Yields on UK gilts rose despite UK inflation falling sharply in July, as expected, to 6.8% from 7.9% due the drop in energy prices.
Portfolio positioning and performance
Sterling investment grade primary issuance recovered in August to £4.4bn. As such, we participated in seven new issues, focusing on A-rated or better names. As a result, our exposure to financials increased by 2% to 44% while our exposure to cyclical sectors decreased by 2% to 16%. Our exposure to BBB-rated bonds was broadly stable at 45% while our exposure to A-rated names increased by 2% to 31%.
The macroeconomic outlook remains very uncertain given high (but falling) inflation, rising (but peaking) interest rates, slowing (but resilient so far) growth and tighter lending conditions. As such, we expect market conditions to remain very volatile with an increased likelihood of a global recession early next year as central banks’ ability to cut interest rates to support growth is curtailed by still elevated inflation.
With valuations looking fair to expensive, we plan to continue gradually reducing the level of credit risk so that we could benefit from a potential widening in credit spreads late this year or early next year by re-risking the portfolio at much better levels.
No assurance can be given that the Sterling Credit Short Duration strategy will be successful. Investors can lose some or all of their capital invested. The Sterling Credit Short Duration strategy is subject to risks including credit risk, interest rate risk and counterparty risk. The strategy is also subject to derivatives and liquidity risks.