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Rob Kyprianou: The prospects for gilts - beyond the rhetoric
Two investment heavyweights appeared to disagree about whether UK gilts really rest on a 'bed of nitroglycerine'. But look beyond the public rhetoric to understand what is really going on.
Rob Kyprianou is one of Britain's foremost economic and investment experts. His 32 year career in finance included spells at Citibank, Salomon Brothers and Axa Investment Managers where he was Global Head of Fixed Income. He also served on the Bank of England's Fixed Income Committee. Rob is currently on a walking challenge to raise money towards a cure for MS. More details here: http://1000miles4hope.com.
If Warren Buffett is the Sage of Omaha, Bill Gross is the Guru of Orange County to veterans of the fixed income markets. Called ‘the nation's most prominent bond investor’ by the New York Times, he co-founded the bond powerhouse Pacific Investment Management (PIMCO) in 1971, and currently manages PIMCO's Total Return fund, the world's largest bond fund.
His ‘Investment Outlook’ is akin to Buffett’s ‘Shareholder Letters’ in which, with personal anecdotes and striking historical references, they distribute pearls of investment wisdom to a devoted audience, often laced with memorable sound bites. Bill’s latest monthly Investment Outlook has certainly produced several sound bites for investors here in the UK. He describes the UK as a member of ‘The Ring of Fire’, countries that will experience an ‘escalation of government debt, which in turn slows economic growth and .......lowers returns on investment and financial assets’.
Greece, Spain, Italy and Ireland are our colleagues in this fiery hell which, for good measure, includes the US and Japan. However, Gross reserves for the UK government fixed income market (gilts) the special commendation of ’a must to avoid’ (Pimco underlining), lying, as Mr Gross claims, on a ‘bed of nitro-glycerine’ - or, more precisely, an explosion (my words) of Government debt issuance as the UK struggles with ballooning public financial deficits. For good measure, Gross rounds on sterling, concluding that ‘High debt with the potential to devalue present high risks for bond investors’.
Faced with such a devastating attack from a fixed income heavyweight, who would dare speak up for our maligned lady? Enter stage right M&G’s Richard Woolnough. Richard can claim to be one of our very own heavyweights in fixed income investing in the UK. He manages a range of bond funds at M&G and I certainly have been so impressed with his excellent track record that he safeguards the largest portion of my SIPP in his Optimal Income and Corporate bond funds – as they say, after your life, you can give no higher accolade to someone than to trust them with your money.
Richard agrees that ‘there is justifiable scepticism that markets will not be able to absorb the forthcoming huge government debt issuance once the Bank of England stops providing life support to the gilt market when it ends the quantitative easing program’. But he goes on to remind us that the ‘UK’s total outstanding gross debt stands at 68.7% of GDP, which compares favourably with the USA (84.8%) and Germany (78.7%)’. And while we are at it, instead of sterling being our Achilles heel, Richard argues that ‘by having a flexible currency and control over domestic interest rates, the UK is arguably in as good a position as anyone to grow our way out of our debt problem’. In short, a little local difficulty rather than ‘a must avoid’ – take that Mr Gross!
So what is the private investor to make of it all, especially on something as important as the outlook for the gilts market, the bedrock for many of our pension funds and ISAs?
As an investor myself for many years, I know how important it is to look beyond this public rhetoric and understand what is really going on behind the scene. When we do so we find that there is in reality little difference in their views. Bill is well known for backing his company’s investment positions with public statements. Most recently he netted $1.7 billion (£968 million) in profit for his funds after betting against ailing US mortgage giants Fannie Mae and Freddie Mac. Mr Gross was an ardent critic of the two mortgage firms which eventually came under government control as a result of continued uncertainty over their financial standing.
For Richard, as a fund manager of a suite of bond funds, it is important that investors do not lose faith completely in gilts which might lead to large scale outflows from bond mutual funds. However, in Richard’s own end of year ‘Monthly Fund Review’ for his Optimal Income fund we learn that the fund holds a very low weighting of 5.7% in government bonds. Furthermore, he has a derivative overlay comprising a short position in 10 year gilts in the belief that yields will rise. In the Review Richard argues that ‘The huge supply of government bonds that are likely to be issued to fund government borrowing over the next couple of years will put upward pressure on yields’ – do as I do, not as I say!
So there is in reality a shared view on the direction of gilt yields among our two commentators – one expresses it loudly and extremely, hoping that by doing so the market will respond to his views; the other expresses it cautiously so as not to damage the underlying book of business which he manages.
And what about Sterling? Bill is a US dollar based investor and the returns he earns in dollars will depend also on the performance of sterling. A weak currency means less reward and more risk and therefore a reason to stay away. Richard is a sterling-based investor and is not worried about currency losses but rather takes comfort from the fact that – unlike Greece – the weakness of our currency may help the UK manage its way out of low growth and high debt. This is the elephant syndrome – your description of how an elephant looks depends on which end you are looking at – either way, it is still an elephant.
So it seems that there is not such a conundrum for the private investor – both experts believe gilt yields will rise under a weight of high government debt. In this context, the Bank of England’s decision this week to hold off on further quantitative easing could be the first real serious test – continue to hold off locking in your annuity or topping up your ISA bond fund with gilts just a little longer.
Rob is walking 1000 Miles in 2010 to raise £100,000 for MS Research. You can find more details here: http://1000miles4hope.com.
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by Income Investor on Mar 11, 2014 at 07:47