The Fed cutting rates was signalled as heavily as cooler temperatures in Autumn, but the decision to cut rates by half a point leaves Asset Allocator to ponder how the portfolios we monitor are positioned for the changed market conditions.
If lower rates are this time a signal of concern around the outlook for growth and a certainty that inflation has been tamed, then the intuitive trade is to own long-duration bonds and shun the short end of the curve. It will also benefit government bonds, while high yield and linkers may suffer.
A glance at our allocations database indicates demand for dedicated high yield bond funds jumped a little in August 2023, and has been quite static since then.
Back then, the average allocation to such funds in the portfolios we cover was 1.4 per cent, before jumping to the 1.7 per cent level at which it sits today.
The average allocation to government bond funds has similarly risen, with August 2023 being the turning point, as the average allocation jumped from 7 per cent to the 8 per cent at which it operates at today.
Nicholas Trindade, a bond fund manager at Axa Investment Managers, says the market may be misjudging the pace and extent of rate cuts, with more actions priced in to long duration bonds and government bonds than may actually happen.
He is particularly wary of the investment case for government bonds right now because, regardless of recessions, he feels the level of new issuance from sovereigns will be very high as they grapple with funding ageing populations, climate action and defence spending.
Such issuance will, he feels, depress bond prices in the years ahead. Trindade is also underweight the longer duration assets right now, on valuation grounds.
A feature of bond markets over the past year or so has been the relatively strong performance of high yield, an asset class which should have sold off in the first instance because the yields available from lower risk bonds rose, and then because of fears around recession.
Yet, as we have referenced in the past, demand for high yield bond funds has remained resolute, at just over 2 per cent across the past year.
Conversely, demand for index linked bond funds has actually risen in recent months, even as investors began otherwise to price in rate cuts.
This may be a function of valuation, such had been the anticipation of rate rises that these assets priced in more than happened, and so were less effective as an investment than might have been the case.
The average exposure to such funds have risen by half a percentage point over the past 18 months or so, to 2.3 per cent.
While the rate cut was expected, the scale was greater than anticipated and equity markets have rallied in response.
That’s good news for the folks at Evelyn Partners, where their active range has 78 per cent in equities, the largest among the DFMs we monitor, and considerably ahead of the 56 per cent which the average allocation to equities among the allocators we monitor.
