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Investing in a Zero-rate World

The key question is whether interest rates will remain positive. How do you manage a money market fund in these conditions?

For some time now, the Bank of England (BoE) has been exploring the possibility of taking their base rate into negative territory. While the BoE Monetary Policy Committee debates the pros and cons of further rate moves and quantitative easing, the markets have already taken them at their word and are pricing in further cuts in the base rate.

Very short deposits still have a positive return, with the Sterling Overnight Index Average (SONIA) and 3-month LIBOR rates holding steady at around +0.05%, but we are already seeing negative yields in the bond and short-term money markets. Gilts are pricing negative rates out to six-year maturities. At the shorter end, last week's UK treasury bill auction saw only £50m of the £1.75bn issuance sold at zero yield. Furthermore, certificates of deposit and commercial paper issued by some banks are pricing negative yields out to 12 months. This clearly limits the investment opportunities for money market funds seeking to maintain positive returns.

The COVID-19 pandemic has ensured that rates will remain lower for much longer. The key question is no longer when interest rates will go up, but whether they will remain positive. In this scenario, you might expect that rational investors would shun money markets in favour of equities, corporate bonds, property or commodities.

Bear in mind, however, that all these sectors have experienced volatility this year. In a volatile world, money market funds can provide a degree of stability for all or part of a portfolio while also achieving a yield.

How is the LF Canlife Sterling Liquidity Fund finding yield in a zero-rate world?

Our first priority remains the provision of sufficient levels of liquidity. We have kept our overnight deposits above 11% over the past quarter, and they currently stand at 12.4%. Quality is also a key factor in the makeup of the fund. With treasury bills falling into negative yields, we have focused on sovereign, supranational and agency (SSA) bonds and covered bonds, with the result that 31% of the LF Canlife Sterling Liquidity Fund’s assets were AAA rated at 30th September 2020.

We firmly believe there can be no compromise for liquidity and quality. In fact, there is no need to compromise, as these terms are not mutually exclusive to yield.

Whilst ensuring our high levels of overnight and one-week liquidity, we have been able to maintain the Fund’s weighted average maturity at around 75 days by looking for additional yield in selected high-quality, longer-dated fixed income bonds, such as Bank of Nova Scotia’s covered September 2021 bond - which we bought at an average yield of 0.35%.

We have previously bought floating rate notes (FRNs) in anticipation of increasing rates, and we can still add FRNs today where we believe the spread over the reference rate (SONIA or 3-month LIBOR) will provide a beneficial return, even if the BoE lending base rate and the respective reference rates do turn negative. For example, the Fund holds Toronto Dominion’s covered June 2022 FRN. This issue was bought at a spread of 35bps over SONIA, which is equivalent to 0.40% for an AAA rated asset.

The markets always present challenges to fund managers. At the moment the challenges are certainly multiplying, but there still are opportunities out there. We simply have to work that little bit harder on behalf of our clients to deliver yield without compromising on liquidity and quality.

 

Important information

Past performance is not a guide to future performance. The value of investments may fall as well as rise and investors may not get back the amount invested. Income from investments may fluctuate.

The information contained in this document is provided for use by investment professionals and is not for onward distribution to, or to be relied upon by, retail investors. No guarantee, warranty or representation (express or implied) is given as to the document’s accuracy or completeness. The views expressed in this document are those of the fund manager at the time of publication and should not be taken as advice, a forecast or a recommendation to buy or sell securities. These views are subject to change at any time without notice. This document is issued for information only by Canada Life Asset Management. This document does not constitute a direct offer to anyone, or a solicitation by anyone, to subscribe for shares or buy units in fund(s). Subscription for shares and buying units in the fund(s) must only be made on the basis of the latest Prospectus and the Key Investor Information Document (KIID) available at www.canadalifeassetmanagement.co.uk.

Canada Life Asset Management is the brand for investment management activities undertaken by Canada Life Asset Management Limited, Canada Life Limited and Canada Life European Real Estate Limited. Canada Life Asset Management Limited (no. 03846821), Canada Life Limited (no.00973271) and Canada Life European Real Estate Limited (no. 03846823) are all registered in England and the registered office for all three entities is Canada Life Place, Potters Bar, Hertfordshire EN6 5BA. Canada Life Asset Management Limited is authorised and regulated by the Financial Conduct Authority. Canada Life Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.

This fund is a UCITS scheme and a standard variable net asset value (VNAV) money market fund (MMF). The MMF is not a guaranteed investment, nor does it receive external support to guarantee its liquidity. Unlike bank deposits, investment in MMFs can fluctuate and investors’ capital is at risk.

 

CLI01719 Expiry 31/03/2021