Q4 2018 Quarterly Commentary (GBP)

The ‘risk-off’ sentiment we experienced on markets in October and November continued in December with the backdrop of Brexit, trade wars and the impending end of quantitative easing measures by central banks. The price of the fund declined during the month despite a marginally lower 10-year gilt yield of 1.27% and income generated by the fund of almost 0.5%. 

Throughout 2018, while the prices of our bonds fell, the credit strength of the individual companies we invest in improved. Our fund generally invests in investment-grade, financial corporate companies yielding 5-6% or more, and what drives the performance of the fund over time is the credit quality of the issuers that we hold, combined with the steady and predictable income that we capture from their bonds. 

Looking forward into 2019, as we listen to many differing forecasts and assess macro cross-currents, we will continue to focus on the simplicity of investing in a diversified portfolio of strong individual credits paying higher yields than in 2018 and collecting coupon income. With credit quality remaining strong and the effect in bonds – which is not there for equities – of pull to par, prices should recover once the dust settles. 

Evidence of credit strength was shown In December following the stress tests conducted by both the Bank of England and the European Banking Authority. Banks performed well overall, with improved aggregate ,stressed core equity tier one and leverage ratios which reflect continued capital accumulation, denoting the strength and resilience of the UK and European banks and banking sector (to such an extent that Royal Bank of Scotland and Barclays felt able to pay back excess capital by calling a number of legacy capital securities). 

Fundamentally, we have been seeing a secular theme of further balance sheet strengthening as well as deleveraging from the financial sector, which is obviously very supportive for subordinated debt holders. This is not yet to be observed in the prices of securities where the relatively new 5.875% HSBC, with either a call at 100 or an interest reset in September 2026 at 4.276% over 5-year swap rates, has declined in price to just 95.9%, or Barclays 5 7/8% trading at 90 and yielding 7% to maturity. In our view, spreads over five-year swap rates for HSBC of 4.276%, or Barclays of 4.91% (and, at a price of 90, 6.5% per annum to reset), are attractive in and of themselves and, in addition, provide potential upside to call at 100 if, at some stage during the next five to seven years, the market takes on a more positive tone. 

As we enter 2019, we are assured that Income will be a strong driver of performance going forward. We also expect to benefit, at some stage, from capital gains.

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