Tom Whitfield

So, we started the year with the Gorton and Denton bi-election. Then we went into the May elections where Labour suffered some heavy defeats, and it's gone on then to a bit of a crisis within the Labour party and a leadership challenge. So, David going back to Gorton and Denton first, how have we changed the position in the portfolio and then we can go through the timeline on how it's evolved.
 

David Coombs

Sure. Yeah. I mean just when you thought things couldn't get worse, they got worse and we've been quite positive on gilts for some time because the real yields were quite attractive, then we've had two factors really affecting yields obviously the Iran war which we'll probably come back to later but in terms of the shenanigans going on in number 10 and the leadership challenge, that brings another element of risk to the gilt market and we've had to really rethink our approach to gilts, so having been overweight duration longer maturity than the benchmark or the index if you like, we've completely shifted our position and that started as you say just before the bi-election because it was very clear that there was a chance that Labour would lose that bi-election to reform.
 

Tom Whitfield

Probably not quite as heavily as we thought it actually did happen.
 

David Coombs

Indeed, but the opinion polls were pointing towards that and that made us think that if they did lose that election you would start to build that narrative of a challenge to Starmer and so we sold some gilts before the bi-election the day before in fact and obviously that turned out to be the right thing to do. Of course, then the narrative moved on fairly quickly towards the local elections. When I say quickly, it felt like an incredibly long time when you look at the markets on a daily basis, but clearly that was the next big kind of scorecard if you like for the administration. And again, you know, it didn't look overly positive, and so we reduced gilts just before the day of the election. And again as proved that was the right thing to do and then streeting put his name forward, oh sorry he resigned. So that was another signal.
 

Tom Whitfield

Yeah, it’s gone a little bit quiet now, hasn't it?
 

David Coombs

He has but of course that's opened the door to Burnham. He then got the bi-election for Makerfield. As these news stories are broken, we've lost more and more conviction around gilts in the short term. I have to say it is the short term because now we're in a situation where Burnham and Streeting are going to outdo each other in trying to appeal to the members of the Labour Party to vote them in. And let's just remember that one of the reasons Starmer is in this problem, mess if you like is because the backbenchers in the Labour party are more left-leaning which is why they weren't able to reduce welfare spending which has already unnerved the bond market to a certain extent, with what Burnham has said in terms of nationalisation, wealth taxes which Streeting is also talking about all of these are very much talking to that electorate in the Labour party rather than the wider electorate.
The point being though they are talking to that electorate that microcosm of electric but of course the bond market's watching and the bond market doesn't like what it's seeing, it's a bit like what Liz Truss was saying to the electorate but I mean we're literally in the same situation and this is to if you're an outsider looking in from a global investor if you're on New York or Tokyo going do I want to buy UK government bonds right now you're probably mm I think I might wait and see.
 

Tom Whitfield

It's the uncertainty, isn't it?
 

David Coombs

It is. Now, unfortunately, we've had this sell off in global bonds at the same time because of the Iran war and the oil price, and I know we're going to talk about that a bit more detail. So, you've had these two negative forces hitting the gilt market. And so, as I said we went underweight if you like, duration earlier around the original Denton bi-election.
We are probably natural buyers where the yields are now. The 10 year went to 5.2 a couple of days ago. Even with inflation at three that's still a 2% real yield. So on in some respects gilts look super attractive.  The problem is the political risk is very high, and right now it’s a we'll wait and see, please. 
You know, what do I think is likely to happen, if I had to put a bet on it, and I'm not going to I'm not a betting person, but it looks like Burnham with maybe Rayner as the dream ticket for the Labour Party, I don't think that's a dream ticket for the gilt market.
 

Tom Whitfield

I was going to say from an investment point of view, who is going to be a good outcome and who's going to be a bad outcome, do you think?
Well, I think it's who's the least worst outcome. Yeah. Okay. Yeah. Which is probably Starmer and Reeves actually. Although they haven't covered themselves in glory in the bond market because of all the U-turns and the issues we know about already, the
bond market knows what they're going to do. With Burnham and Streeting, I think Streeting would probably, despite the rhetoric he's saying be Starmer Esque. I think he is probably towards the center right of the party and the bond market would be reassured.
I just think it's unlikely he can win right now. I think it's very the odds are stacked against him and so we have to think about a Rayner and Miliband triumvirate. 
Frankly as a bond investor, I'm a seller, we've even reduced in some of our multi- asset funds, the income funds where we have a bigger UK equity waiting. We've been trimming a lot of our UK domestic names because we are we just feel in the UK economy right now the risks are very high. So, what have we done with those gilts that we sold? We've bought some two-year gilts or quasi cash, and we've also diversified into US treasuries where yields are also being pushed up, and we've started buying some US index linked as well.
 

Tom Whitfield

Okay, very good. And so obviously yeah, we do see some value in that space. But if we think of what's the difference between buying government bonds and corporate bonds and our on our view so credit spreads are still quite tight and so credit spreads are the difference between yield of a government bond and a and a corporate bond but so talking about corporate bonds is there any space for them to squeeze into the portfolio at the moment? 
 

David Coombs

Short answer, no. I mean, optically they look quite attractive because the yield on investment grade and high yield is 5 and a half 7%.
 

Tom Whitfield

They have they look like they got good balance sheets as well and they run quite well run better than the government anyway.
 

David Coombs

Well, yes indeed in most cases. I mean, there's a number of issues going on in the corporate bond market. First of all, to your point, spreads are quite tight and corporate bonds are less liquid than sovereign bonds. So, if you're needing to trade quickly to move your strategy around and be really active like we are and given what's going on, geopolitics is so volatile. We've also got Russia Ukraine which sounds like it could be coming towards the end but you know the geopolitics is so fast moving and with Trump tweeting this that and the other you want to be able to be dynamic, and you want to have liquidity.
 

Tom Whitfield

It's even more exacerbated when liquidity dries up, these will get hit a lot harder than the government bonds.
 

David Coombs

Yes, the point being with corporate bonds spread so tight that means you're not being paid for the extra risk or we call it liquidity premium. So, on a risk-reward basis, corporate bonds versus sovereigns don't look very attractive. Now, some would say, well, yes, but at the moment, you've got all the big hyperscalers, that's the, you know, the Amazons, the Google Alphabet, the Metas, etc., all borrowing loads of money and issuing corporate bond debt. And one might say, well, Alphabet's balance sheet looks more coherent than the UK right now. So, I have some sympathy with that and maybe they should have a better rating than the UK, you know, whatever. But right now, you're not being paid for the risk in the corporate bonds. You can't trade as actively in size and you can't be as active and as nimble in terms of reacting to these events. So, for us right now having a much broader sovereign bond exposure through US, Norway, Australia, New Zealand, and yes, still the UK to a certain extent. We can move quickly and react and hopefully take advantage of some of this volatility in geopolitics. You can't do that in the corporate bond market. And also, in the UK corporate bond market around 60% of that market is UK financials. So, it's quite a concentrated sector as well. So on a total return basis corporate bonds are quite interesting. So, I can understand why some of our peers are buying corporate bonds but for our style where we're using the fixed income to manage risk. We need that liquidity to help us be nimble and fast moving.