CLARE FRANCIS: Welcome to our quarterly markets update, where we take a look back at some of the main things that have been going on over the last three months.
And today I'm joined by Will Hobbs, our Chief Investment Officer, and Chris Bamford, who heads up the fixed income manager selection team here. Now Will, let's start by you. We've been dominated again over the last quarter by interest rates and inflation.
We seem to have seen a pause, certainly here in the UK, in rate rises. Inflation looks as though it could be starting to drop back. Now, I know a few months ago the talk was that rates would have further to go. The Bank of England base rate 5.25% at the moment could go higher before it peaks. Has that changed that outlook, do you think, we're now at the peak?
WILL HOBBS: Oh, that'd be nice, I think, wouldn't it, Clare? Yes. I'm always ringing in my ears whenever I hear anyone else’s interest rate predictions are, from an old boss who wisely warned me that the greater the confidence you hear someone predict the future, the less you should trust them. And that is more than ever the case with regards to inflation and interest rates.
But I think certainly central bankers, I think Chris may agree, they've done a lot of the hard work in getting rates up to a level which now looks a bit more restrictive for economic activity. And assuming that inflationary pressures continue to ebb as they seem to be unevenly around the world, then hopefully where there or thereabouts. That was a very wishy-washy answer, but yes.
CF: Well, it's like a politician’s answer, Will. But what's it meant for investment returns? How have they fared, how have our funds been doing, the Barclays funds, over the last few months?
WH: Well, as you can see, the year so far, in a way, it's a boring story. The funds have done well in a way, that it's been pretty boring, pretty humdrum, just getting stuff done. I think if you're looking at the chart, what you can see is that the dark blue line, that's the cheaper version of the asset allocation that we offer. The light blue is the deluxe version. And then you've got the grey and black lines, which show you where the competitors are.
And the first and nice point to make is that both cheaper expression of our investment thinking and the more deluxe version are both handily against the competition on all those relevant timeframes since inception, year to date, one year, three year, and five year, which is always a nice thing to be able to say.
The second point, which is interesting, is actually, as you can see, it's the cheaper version, which is actually ahead, particularly in the run up to 2020, the big crisis, because that was a very good period for the type of investments that this cheaper version represents.
Now, the reason why we call it the deluxe version is because there are still more futures ahead where we think this will outperform. But it's a good statement about all of our product range, which is doing very well relative to the competition still year to date and over the longer periods.
CF: And what's the outlook for recession? Are there still recessionary pressures remaining?
WH: I think always, and again, I'm going to give you a wishy-washy answer, but yes. Theory suggests that if you raise interest rates, what that should do in the economy is increase the appetite to save. And as people save more, they should spend less. So you get the downturn that should come, and that's aimed at cooling inflationary pressures.
Now, what seems to be said by people in the markets, and Chris and I would've heard this millions of times, are apparently the foremost dangerous words in investing: “it's different this time”. I would actually, personally, and Chris may disagree, I think that's absolutely rubbish.
Personally, I think it's different every single time. And this time is different in so many ways. And part of that is this huge savings arsenal that was accrued during the pandemic, which may be dampening the translation of interest rates to customers and businesses wallets a little bit.
And what you're seeing now is that real wages, inflation-adjusted wages are actually turning positive for consumers in the UK, US and Europe. That's really important. So my message would be, don't get too gloomy. There may be a recession ahead, but I think generally the world and UK economy need to be treated as innocent until proven guilty. So I wouldn't get too bleak about the future.
There are potential for accidents as there always are, but generally growth is the norm, not the exception. And that needs to be remembered. And the commentators of which Chris and I are subjected to, which we're part of, they're almost paid to be gloomy, whereas I think the reverse is probably the better one for investors.
CF: And Chris, bringing you in here, I mean, how's the recent environment having come out of that long period of almost very benign interest rate inflationary environment into a much more active one? What's been the impact, how's it manifested itself in the fixed income world?
CHRIS BAMFORD: Yes, I think it's been a really fascinating period for fixed income investors. For once it's actually been a really quite exciting time to be a rate manager. I listen to participants quite a lot and I have to say, given the volatility that's out there, the uncertainty and how much markets are moving, I think it's really creating quite an interesting dynamic for those people.
And they're probably as excited for bond investors as I've seen them in a very long time.
WH: Which looks different to normal human beings! (Laughs)
CB: They're still not that excited, but it’s a relative sense now. I think when I look back over this recent period, clearly interest rates have moved an awful lot, as we say. Most recently we've seen a bit of a rise in the path of expected interest rates. And I think when we came into the start of this quarter, the market was kind of expecting, we were reaching the peak and the Fed was going very quickly get into a cutting cycle, we were going start to see rates come down. And that shifted a little bit as we've gone through this quarter.
And so what's driven that is a couple of things. One, we've had this inflationary uplift potentially coming through oil prices. In general, inflation has been coming down, but actually in the backdrop you've had this oil price that's been moving higher, that just raises that little spectre in the back of people's minds to say, maybe we're not done with inflation. Maybe the Fed has to do a little bit more. Maybe we have to be a bit more worried that the path for inflation is going be more volatile and more uncertain than perhaps we'd thought in the past. And so that's been a factor on people's mind.
Then you've had this element that's come into play where the Fed have had to issue, or rather the Treasury rather have issued far more debt in the last quarter than the market had previously expected.
Now, generally, we don't think the supply-demand dynamics have that much of a material long-term impact, but they do have to be taken into account in the short term. And so you've seen a couple of factors to that come into play that have really changed people's expectations and probably moved the market a little bit more to what the Fed was kind of telling people, which is: “you know what, we're going stay restrictive for a little bit longer”.
And so that part of interest rates, the expectation is that they're going to take a little bit longer before they start cutting. And maybe where they finish the terminal rate is a little bit uncertain. Maybe they don't cut quite as much as people have previously been expecting. And so really that has meant that prices have come off a little bit in rate-sensitive assets, particularly in the US but also in the UK. The UK follows suit with the US. So really that's been kind of the dynamic that we've been witnessing.
WH: And for those of you wondering what the Fed is, it's the Federal Reserve, the US Central Bank, not his best mate Fed or Fred. Yeah. So yeah, the central bank for the world, let's say.
CF: And by fixed income, we're talking bonds and gilts here. Now, when we had our last update in the summer, we covered the asset allocation, which you've referred to earlier, Will, and this is the proportion and the weightings and where we see the investment opportunities.
And one of the things we talked about then was how we'd increased our exposure to lower risk fixed income, so corporate bonds and gilts, and reduced the exposure that we had to higher risk bonds. I'm guessing, Chris, from what you're just saying about that the outlook of interest rates remaining stable and higher for longer, can you just explain a bit about that and how it's impacted returns and the decision process behind it?
CB: Sure. I think when we think about the strategic asset allocation, it really is trying to build a resilient portfolio for a range of uncertain outcomes. So we don’t what the future's going to look like, but we want to build a portfolio that can perform as well as possible in a range of different future scenarios.
And so if we go back a few years, investment grade really didn't offer a lot in a portfolio context. So it was, this is thinking about high-quality bonds, so government bonds, corporate bonds, et cetera. The level of the level that they could contribute in a number of different scenarios was not that great. And there were certain scenarios where they could perform pretty poorly.
Fast forward to today, and we've had this big sell-off in high-quality assets driven by this rise in interest rates that we've been talking about. We are potentially near that peak and so potentially that negative headwind that we've had as kind of abated. But actually now, this starting point that we're at is really quite attractive.
I mean, if I look back this century and it's funny to say this century, but since the start of 2000 when there've been very few occasions where the level of yield, and that's in essence the level of compensation investors get for holding these assets for the long term, but the level of yield has very rarely been as high as it is, only during the sell-off during the financial crisis did we see higher levels in high-quality corporate bonds.
So we think these assets compensate investors pretty well for a range of different outcomes. They're sensitive to the interest rate environment. So if interest rates start coming down, they'll benefit potentially from that. They're sensitive to the corporate environment because ultimately these are big, high-quality corporates that we are lending to. And so, if the growth picture remains reasonably positive, they'll continue to perform, they'll continue to plod along and deliver a decent level of return for investors. And so there's a range of outcomes that they'll do well.
Now for us, we focus very much on a global approach. And this really comes back to this idea around diversification. When we look at global corporate bonds, there are 15,000 bonds roughly in the index –
WH: Is that right?
CB: 2,500 companies. And these are companies that you'll all have heard of, not you won't have heard of all of those companies, but they are very big, bellwether companies, very diversified businesses, lots of levers that they can pull in times of stress and they generally don't default.
Very, very few of them get into any real major credit events. And so you can build a portfolio that holds these high-quality instruments that can perform in a range of environments that are offering a positive real return with inflation now having come down a little bit, and you can hold them for the long term. Now, they're definitely going to be volatile. There'll be times when they're more attractive and less attractive, et cetera. But as a long-term investment now they look pretty, pretty reasonably priced.
CF: And it's important as we always talk about, Will, to have that diversification and exposure to a whole mix.
WH: Well, totally right, Clare. And I think, if you want to do a personal exercise, think back to last year, the year before, and go back to the beginning of the year. And think of what of these events that we are now living through good, bad, ugly, indifferent that you could have predicted in advance. And you'll probably come up with very few to be honest. And that in a way is what you've got to think about with regards to investing. You're planning for the futures that don't stand in a straight line from the recent past. And Chris's point is well made. Asset prices, the way that you can interact them and interlock them, they will move around and you've just got to, we hopefully do all the work for you, to make sure that you're constantly optimally exposed to the many potential paths ahead.
CF: You've just mentioned, we can't predict, I'm going to ask you –
WH: I love predictions.
CF: What, what lies ahead? The next three months. There could be some curb curve balls that we no one is anticipating or expecting.
WH: Yes.
CF: But based on what we're seeing at the moment and what we can see on the horizon, what do you see as being the main things to be focusing on and thinking about for the remainder of the year?
WH: Well, As long as you don't remind me of what I say in our next version of this. Clare, I think still, what you've seen and what we've been discussing is, whereas we came into the year with a lot of people thinking, literally braced for a recession, now that's less the case in markets. People are not so much expecting the recession. People are now assuming that there's a degree of resilience that we can rely on, I hate saying that word.
Actually my personal feeling is that what may be underestimated is that there are upside scenarios from real wages coming through a little bit better than people suspect. So yes, I think that stock markets do look quite expensive in the US in particular at the moment. And people are worried a little bit about that. That's not to say they couldn't go further up, but from a three-month to six-month perspective, we still feel that there are attractive returns to be had from a diversified portfolio.
But the real gain, I think, is to be able to think five years out. That's where the current industrial revolution we're living through will have a chance to really affect corporate profits. All those things, by lending to companies and owning companies, that's how you are going to benefit from the industrial revolution that we're currently living through that with generative AI.
CF And it's reminding yourself, isn't it, as to why you're investing that you are in it for the long term.
WH: Absolutely. Very difficult, but that's the trick.
Great. Thank you both. Thank you very much. Hopefully you found that useful. Now we'll be back again, as Will said, in the beginning of next year.
But in the meantime, you can stay abreast with everything that's going on and hear from Will and Chris and our other internal experts here at Barclays weekly on our podcast, Word on the Street. So if you haven't listened to that yet it's available on all the main podcast platforms.
But for today, that's it from me. Thank you. Bye.
