For a firm that is avowedly active, portfolio turnover at Hawksmoor has been surprisingly low for a considerable time.
As much as this might suggest over-confidence or even hubris, it is actually much more a reflection that the global economy has been, and is, extraordinarily dull.
Opportunities for wide-ranging changes to asset allocations have been as close to nil as makes no difference almost since the start of the post-crisis bull market.
This year, however, there is real potential for change and portfolios need to be repositioned accordingly.
The change is that monetary conditions are tightening. Interest rates in America are rising and the Federal Reserve is starting to unwind its balance sheet.
The Bank of England has raised bank rate and the European Central Bank, having lowered its rate of monthly bond purchases, is due to end quantitative easing in the autumn. What this means, no one knows. It is the next step in the Great Economic Experiment.
For us, however, it is a reasonable assumption that a tightening of monetary conditions is likely to lead to lower economic growth. For markets high on the improvement in the global economy over the past six months, that (should it happen) would come as an unpleasant surprise.
Should markets start to lose confidence in robust economic growth, high yield is right in the crosshairs. Our response to this has been to reappraise the assets that have benefitted most from QE, those most dependent upon expectations of economic growth and those where valuations appear to be the most vulnerable. That has led us directly to the door of high yield bonds. These tick every box.
There is important context to understand here. We like high yield bonds. As an asset class, the long-term total return is not vastly different to equity and comes with the benefit of significantly lower volatility.
They are very important long-term portfolio assets for us and thus a decision to make a significant reduction in our exposure is not taken lightly.
All bonds have benefitted from QE. That is a very simple truism. It is our view that this has been especially so in Europe, where the ECB’s distortion has lowered yields that make no sense once its stimulus has been withdrawn.
That the German sovereign curve is still negative out to five years reflects not so much that markets believe in imminent recession, but much more the extraordinary distortions of a central bank with too much money to spend and too few assets to buy.
Bunds remain the base reference for all other bonds and the extended negative yields have dragged all other bond yields down with them. This has been very profitable for high yield holders.
Towards the end of last year, when yields troughed, one of the most widely followed indices of European high yield bonds yielded an extraordinary 2 per cent.
It has since drifted upwards, but not much. In round numbers, European junk bonds (to give high yield one of its previous names) are now yielding the same as the US 10 year Treasury.
When we ask ourselves the theoretical question ‘which of these is going to perform worse in slowing growth?’, the answer is not hard to see.
The same arguments hold true, albeit to a lesser degree, with both the US and UK high yield markets. Yields are too low in both absolute and relative terms to withstand a slowing of – or even an expectation of slowing – economic growth.
Across the board, high yield bonds are vulnerable to the double whammy of a rise in absolute yields and a widening of spreads.
Should markets start to lose confidence in robust economic growth, high yield is right in the crosshairs. It now represents a significantly lower part of our weightings than at the start of the year.
Jim Wood-Smith is chief investment officer, private clients, at Hawskmoor
