Ceasefire Drives Bond Market Rally

Despite the Straits of Hormuz remaining shut for much of the quarter, markets were prepared to ‘look through’ the inflationary risks, taking the ceasefire as an indication that despite their posturing, both the US and Iran had little appetite for further escalation.

While yields fell as the market priced fewer rate hikes in the coming months, the disruption caused by the US/Iran war means that the likely direction for rates remains up. This supports our decision to keep the overall duration of the portfolio short, falling slightly to 2.6 years over the quarter.

Short Duration and Enhanced Credit Quality 

That fall in duration was the result of a continued increase in our exposure to AAA rated Floating Rate Notes (FRN). The stability of FRNs allows the fund to weather the volatility in the Gilt market as rate expectations shift with news flow, as well as enabling us to benefit from the higher coupons should rates stay higher for longer. Furthermore, the spreads at which corporate bonds trade above Gilts remain at their tightest level since the outbreak of the Global Financial Crisis. The AAA-rating of FRNs gives us further protection should we see a widening of credit spreads, maybe in the event of a stock market correction. 

Whether such a correction may happen is impossible to predict – perhaps it has already started. But the issuance of $25bn of debt each by SpaceX and Nvidia in June is noteworthy. While the various issues were oversubscribed multiple times, their subsequent price action suggests the bond market is growing more doubtful of the AI build-out than equity investors.

Banking and Defence Lead Equity Returns

The rate environment was a positive for the fund’s bank equities, Barclays and Standard Chartered, the latter’s share price also recovering from a sharp fall at the end of May over concerns that new regulations would restrict mainland Chinese people from opening accounts in Hong Kong. The fears were overblown but like so often in the current environment, the knee-jerk reaction was sizeable, if short-lived.

There was a similar response to the news that the German government had cancelled a frigate contract from Rheinmetall, a new equity position in the fund. Within a fortnight the share price had recovered much of its fall, and while we expect the market to be more circumspect in the short-term, we see good value over the longer term as defence spending increases throughout Europe.
Conclusion

Geopolitical risk continues to put pressure on inflation while equity market exuberance over the build-out of AI is being treated with scepticism by bond markets. Tenax aims to provide a measure of protection for investors whether direct or within a model portfolio, hence the fund’s cautious stance with short duration in the fixed income allocation, an increase in the allocation to AAA rated FRNs, and an equity allocation well below the permitted 35%. 
 

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