Until recently, the Bank of England had been looking upwards since last raising the official interest rate in November 2017. It sent messages for months that a ‘gradual, limited’ rise in interest rates would be needed to stop inflation rising above its 2% target and this led LIBOR (London Inter-bank Offered Rate) rates to edge up as the markets anticipated another hike.
Floating Rate Notes (FRNs) – bonds that have short durations and reset their coupon as rates move – were in great demand during this period. We took a similar view, with FRNs in the Fund (which benefited from the re-setting of rates each quarter with LIBOR moving upwards towards the next interest rate rise) peaking at 45% of our holdings by March 2019. Of course, we do not buy FRNs for the sake of it – it has to be for the right reason and driven more by a name or its rating and the relevance of this strengthened as it became apparent that further rises were going to be on hold. Since then we have seen economic conditions falter further in the UK with Brexit uncertainty dragging on and a disruptive no-deal Brexit at the end of October seeming more likely given the new Prime Minister Boris Johnson’s stance. Consequently, markets now are pricing in rate cuts over the next 12 months and this can be seen in 5--year gilt yields of 0.40% as of August 1st.
FRNs still play an important role in the Fund by way of duration and exposure to otherwise rare names – currently making up 33% of our holdings. However, we have changed the Fund’s emphasis in recent months by reinvesting FRN maturities into select highly liquid 1-year fixed rate bonds to lock in returns that adequately reward the term and counterparty risk. A prime example is a lesser-known gem – Aareal Bank’s fixed rate covered June 2020 bond. This German covered bond is rated Aaa yet yields more than a FRN or commercial paper for an unsecured counterparty and was bought with the added-benefit of consulting with our internal credit research team.
Source: Bloomberg at 01/08/2019
The LF Canlife Sterling Liquidity Fund is designed to provide institutional investors with a high degree of capital security and daily liquidity with the ultimate aim of delivering enhanced returns relative to short-term bank deposits. It stands out within Canada Life Asset Management’s well-rounded product range because of its day-to-day active management strategies as well as its AAAf/S1 rating from Fitch Ratings.
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