3rd March 2016
Bryn Jones provides an update on the Rathbone Ethical Bond fund positioning and market outlook
Bryn Jones, manager since November 2004, held a conference call this morning to give an update on the fund's positioning and his thoughts on the global economic environment. A summary of his comments follows.
When the US raised interest rates in December, it was the first time we'd seen western central bank monetary policy diverge in about six years. I think they could raise rates again in the summer.
The US banking system has basically been fixed and the economy could give us positive surprises this year.
Economic data was good just last week and we could see more good news later in March and into April. Unemployment is at multi-year lows, wage inflation is increasing and the National Federation of Small Businesses recently said companies just can't find quality staff – so the latter should only increase. Even if oil prices stay level, inflation will start to pick up soon. So I think it is a real possibility.
Closer to home, the European Central Bank meets on 10th March. In contrast to the US, the European banking system is still… how shall I put it… highly strung. It needs more support. I fully expect Mario Draghi to take rates further into negative territory – possibly tiering it as we have seen in Japan – and possibly offering the banks other funding options. I'm not a fan of negative interest rates though. If you create a world where you don't have to do anything to outperform, it impacts on capital expenditure.
In the UK, we are likely to see inflation start to pick up towards the end of the year. I certainly don't expect us to see interest rate rises before we have the Brexit referendum. If we stay in, the Bank of England will probably allow a slightly higher inflation level on a temporary basis. Whatever happens, I think rate rises in the UK are less likely than likely in 2016.
2015 was a good year for the fund. It returned 1.58% compared with a sector average of minus 0.28%. However, we have lost some of that gain in 2016 as we've experienced a higher drawdown than the sector average, which has been disappointing.
A lot of this underperformance has been caused by our overweight to financials, especially the banks, as they've been hit hard as markets have fallen. We've reviewed our holdings and there is nothing at risk of default or write-off, in our view.
The major downward move in gilt yields will also have benefited our peers, but this is just a one-off performance gain. Investors that stick with our fund over three to five years typically benefit from the compounding effect of our higher income target. Currently the yield to maturity of the fund is 5.2% and we estimate the income yield to be 5.3%. We think this should look very attractive to investors who are looking for a long-term solution to suppressed yields elsewhere.
We are currently overweight investment grade bonds. You have to go back to 1988 to see equity markets as bearish as they are today and back to 2008 to see investors shorting equities to this extent. The markets are pricing in a significant recession and we don't think this will be the case.
We have large positions in the insurance sector and some good quality banks where, in our view, there is no reason why they should be yielding so much. For example, the Pru has a yield of 7%, Aviva and AXA 6%.... volatility in the sector is providing us with more, not fewer, opportunities.
Some of the better banks have very stable capital positions now and their core books and asset quality is improving. We think they will do well over the next year.
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Bryn's views are his own and do not constitute financial advice.
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