Revival of the UK government’s 1939 motivational war slogan ‘Keep Calm and Carry On’ has been much in need over recent months. The country has had to adjust to events including, but not limited to, the resignation of Boris Johnson and appointment of a new prime minister, Liz Truss, the death of Queen Elizabeth II, a controversial mini-budget and subsequent fallout in the fixed income markets, dismissal of Chancellor Kwarteng, the exit of his boss prime minister Truss, the serious possibility that Mr Johnson could make a return to No.10 Downing Street and then finally the appointment of the next prime minister, Rishi Sunak.
Sterling also hit its lowest ever level against the US dollar at 1.035 during this period. That is almost a footnote now, as the shortest Prime Ministerial term in British history was accompanied by the greatest volatility in the long history of the UK government bond market. The long-dated 2073 indexed-linked gilt was trading at 127 when Mrs Truss walked into Number 10 on 6th September, it then fell to 41 intraday on 28th September, a 68% loss due to pension funds’ liability hedging problems brought on by Kwasi Kwarteng’s mini budget, before more than tripling, halving and rallying to 134 when Mrs Truss resigned on the 25th October, a net gain of 5.5%*.
Volatility – to play or not play?
As investors we get asked, do we sit out the volatility or do we try to capture the gains on market pivots?
It would be folly to always change positions based on volatility. Higher volatility is typically a result of a fall in market values. Hence, we would be selling at a low price and then buying back at a higher price when volatility has reduced. Therefore, we have to be choosy about when we do react and when we feel it is best to ignore.
When there is a clear catalyst or rationale for further falls it makes sense to react early, such as at the start of the pandemic in 2020. Then, we have to analyse markets to understand when assets are cheap enough to buy back. Our focus and impulse for portfolio changes has been economic considerations and informed market analysis over second guessing the next turn in markets.
We didn’t increase our exposure to risk assets when volatility was low, post the global financial crisis and you should not expect us to unilaterally reduce exposure to risky assets as volatility returns to financial markets. This is different to say that we haven’t been active. We have been.
Positioning for weak growth and more uncertainty
Over the last couple of months, we have been reducing equity exposure on overall growth concerns and are currently underweight versus our longer-term strategic asset allocation. However, we have retained an overweight to the FTSE100 whose constituents should benefit from weaker sterling and the continued higher energy prices. We don’t think that equities have fully re-priced and therefore, if we do fall into a recession then we would expect equities to have further downside.
In fixed income, as the growth outlook is fairly gloomy, the case for holding high quality fixed income has started to look quite attractive. We think that most of the re-rating has already occurred and that future interest rate rises are already priced into the market. This prompts some readjustment of weights between government bonds, corporates and high yield.
There is clearly still a significant amount of uncertainty in the markets, not least through the self-inflicted political turmoil in the UK, which means that we would expect to see on-going higher levels of volatility from both fixed income and equity markets.
