In recent weeks, as the aftermath of the coronavirus pandemic worsens, politicians, scientists, and economists around the world have agreed that we are entering unknown waters. As we saw during the Brexit negotiations (albeit to a much lesser extent), the markets hate uncertainty. In these uncertain times, when it can only be agreed that the uncertainty will continue, it can be difficult for investors to find the right way.
It is often said that investors turn to gilts and high quality bonds as the market slows. They are generally considered less risky than other asset classes such as stocks or real estate (indeed, this has been confirmed by the collapse of global stocks and the gating of real estate funds in recent weeks).
Despite their valuations, we at FE Investments have always maintained a high allocation in Gilts. Gilts anchor our portfolios and ensure capital preservation in times of market stress. High beta stocks are combined in a bell bar approach so portfolios mark time with the markets as they go up. While this strategy was not adopted by many during the recent equity bull run, we believe that this asset class offers a large amount of diversification benefits and is now fully unfolding.
As the chart above shows, almost all IA sectors have declined over the past month, while UK government bonds have held a relatively stable position since February 18, falling only 1.01%, with much of it only in the past few days. Compare this to smaller UK companies that fell 34% over the same period. To qualify for this sector, funds must invest at least 95% of their assets in sterling (or sterling-backed) triple-AAA-rated government-backed securities, with at least 80% invested in UK government securities (gilts) . Although the recent fall in sterling is another problem overall, this approach appears to remain stable for the time being.
At fund level (as the chart below shows), the best performers in the sector have largely held their own. While the decline from a high of 16.57% on March 9 to the ASI Sterling Long Dated Government Bond on March 17 to -0.58% on March 17 appears alarming, other funds in other sectors saw a much stronger decline over the same period. The fact that the majority of gilts gained value in the first weeks of the crisis shows their attractiveness for investors.
The Allianz Gilt Yield Fund is currently a particularly interesting fund. The consistency of the fund has long been recognized by our analysts and has a 5 crown rating (the highest possible). The goal is to maximize total return in line with capital preservation and prudent investment management, particularly by investing in UK government securities. It is actively managed by Mike Riddell and Kacper Brzezniak, who have jointly managed the fund since 2015 and 2017, respectively.
Over the next few weeks and months we will see how quickly the markets recover. Some sectors will surely take longer than others. Gilts suffered like many other assets in the 2008 recession, but did not fall as long or as much by comparison. As investment professionals, however, we are not calling into the future. Indeed, given the current climate, it would be a foolhardy professional to do so. Instead, we can only monitor and seek a diversified selection list of funds that remain stable. In such troubling times, UK gilts remain a cornerstone for any diversified portfolio. Unless inflation expectations rise or inflation actually rises, government bonds remain the best diversification tool for investors alongside existing equity allocations. We'll find out soon if they're worth their weight.
Charles Younes is Research Manager at FE Investments