What the UK interest rate rise means for bonds
The Bank of England’s decision to raise interest rates by 0.25% to 0.5% on 2 November has been...
“With the Bank of England bringing interest rates down even further post-Brexit vote, floating rate Notes (FRNs) stood out as an investment opportunity,” said James Mahon, co-manager of the Elite Rated Church House Tenax Absolute Return Strategies fund, when we met him in late October.
The fund, which has enjoyed stellar performance since the EU referendum in June, is a multi-asset fund and the managers look for a low correlation of returns between assets to reduce the volatility of the portfolio. They are prepared to hold high proportions in cash, or cash-like products, in pursuit of the fund’s objective of consistent positive returns.
“With one-year UK government bonds earning 0.1% if you were lucky, FRNs at LIBOR (a benchmark rate that some of the world’s leading banks charge each other for short-term loans) plus 0.3%-0.4% looked very good as low-risk alternatives [to bonds],” James continued. “Around 26% of the fund is invested in high quality FRNs.”
The fund is very cautiously positioned at the moment, with just 13% in equities. “It’s not that the world is terrifying, there are just not many opportunities out there,” said James. “The bulk of the fund’s equity exposure is in dollars, so it would be impacted if sterling bounced back, but that has helped performance since the pound dropped in value so dramatically.
“The fixed income element is still in bonds with a short time to maturity. People seem to have forgotten about interest rate risk. Inflation is on the way back in the UK and US, so inflation-linked bonds should, in theory, be interesting. In reality, I think they are overpriced though.
“The property portion of the portfolio is invested in real estate investment trusts (REITs). The yield in the sector has been compressed a lot and you really need to be in areas where the income can still grow. I have exposure to some medical-related property such as GP practices, which are in need of modernisation and supported by the government, so the stream of income is far steadier. I also have exposure to some warehouses. Did you know that 10 years ago John Lewis used to have 60% retail space and 40% stockroom at its stores? With the internet and delivery options, they now have warehouses in different areas of the country.”