Colchester Global Government Bond A (ETL0409AU) Report & Performance

The fund returned 0.17% (gross of fees) over the month, outperforming the benchmark which returned -0.36%. Bond selection added 0.42% to relative returns and currency selection added 0.11%. The top three positive bond contributors to relative returns were the overweight positions in Colombia and Mexico and the underweight position in United States. The top three positive currency contributors to relative returns were the short positions in United States Dollars and Thai Baht and the long position in Colombian Peso.

The second quarter got off to an uncertain start, as investors worried about the health of the US banking system after a number of regional bank failures in March and the emergency takeover of Credit Suisse fueled concerns in Europe. As concerns over banks eased, markets had the US debt ceiling negotiations to contend with but this issue was resolved, at least for now. The macroeconomic backdrop over the quarter continues to centre on inflation and monetary policy. Despite headline inflation rates generally falling, core inflation remains ‘sticky’ leading central bankers in the US, the Eurozone, and the UK to continue to raise interest rates. Against this backdrop, the FTSE World Government Bond Index returned -0.4% in US dollar hedged terms whilst the unhedged return for the index fared worse at -1.8% over the quarter given the strengthening of the US dollar against currencies like the Japanese yen.

Despite the banking sector turmoil and the debt ceiling deliberations, the US economy continues to expand, at least for now. Whilst headline inflation has dropped rapidly to 4% in May, core inflation remained stubbornly high at 5.3%. Given this environment of elevated inflation and resilient growth the Federal Reserve hiked rates by 25bps in May before pausing in June for the first time in over a year. Indications are that the Fed will push rates higher again in the coming months and bond yields rose over the quarter. The US Treasury market returned a negative -1.4% over the period and the Colchester global bond programme remains underweight.

As in the US, headline inflation in the Eurozone in May fell to its lowest level since the beginning of the war in Ukraine, down from 7% in April to 6.1%. Of concern to policymakers at the ECB however is the rate of core inflation, excluding the impact of food and energy, which stood at 5.4% in June, only slightly below the rate at the end of the first quarter. The ECB increased its policy rate by 25bps in both May and June bringing their deposit rate up to 3.5% – its highest level in 22 years. Notwithstanding this, Eurozone government bonds held steady over the quarter with German bonds recording a modest negative performance of -0.4% and Italian bonds generating a positive 0.9% over the quarter. In contrast, the UK was amongst the worst performing bond markets over the quarter with a negative return of -6.2%, as inflation surprised to the upside several times. The Bank of England surprised markets somewhat with a 50bps rate hike in June whilst remaining hawkish as inflation stands at 8.7% in May, the highest amongst the G7 economies.

Turning to Asia, Japan’s CPI dropped back to its March level of 3.2% in May and the economy recorded strong growth for Q1 of 1.6% annualised. This backdrop coupled with the unchanged policy of the Bank of Japan, led the government bond market to a positive return of 0.5%. The Singaporean bond market generated the same return over the quarter and remains a significant overweight in the Colchester global bond programme. In contrast, the Australian bond market sold off over the quarter, returning -4.0%. This comes amidst the Reserve Bank decision to restart interest rate increases after a pause in April. Moreover, Australia is set to raise the minimum wage by 5.75% on the back of soaring living costs, a decision that risks further stoking inflation.

On the currency markets the US dollar recovered strongly on the back of resilient economic data, particularly relative to other developed markets. The Japanese yen was the worst performing currency over the quarter, depreciating by over 7% against the US dollar. The Swedish krona and Norwegian krone also recorded negative returns of -4.0% and -2.2% respectively over the same period, but the British pound gained 2.8%. Latin American currencies fared even better however with the Colombian and Mexican peso rising 11.6% and 5.3% respectively, benefiting our overweight position in both.

The fund returned -0.11% over the month, outperforming the benchmark which returned -0.59%. Bond selection added 0.45% to relative returns and currency selection added 0.02%. The top three positive bond contributors to relative returns were the overweight positions in Colombia and Indonesia and the underweight position in United States. The top three positive currency contributors to relative returns were the long positions in Colombian Peso and Mexican Peso and the short position in Euro.

The month of May continued to be dominated by the ongoing US debt ceiling negotiations as we approached the critical deadline when the US would “run out of money” and financial markets fearing the possibility of a technical default. Meanwhile global headline inflation continues to fall but ‘sticky’ core inflation remains a concern to policymakers globally as both the Federal Reserve and the ECB raised policy rates this month. Against this backdrop, the FTSE World Government Bond Index returned negative 0.4% in US dollar hedged terms whilst the unhedged return for the index fared worse at -2.2% over the month given the strengthening of the US dollar. In the US, the political stand-off between the White House and Republicans in Congress came to an end when the Senate approved the deal to lift the debt ceiling until after the 2024 presidential election. Whilst this allayed fears that the US was on the brink of an unprecedented default, Fitch took the decision to keep the US credit rating on negative watch. On a positive note, US inflation continued its downtrend reaching 4.9% in April. The US bond market returned a negative 1.2% in May and the Colchester global bond programme remains underweight the US bond market.

The fund returned -1.01% (gross of fees) over the month, outperforming the benchmark which returned -2.19%. Bond selection added 1.05% to relative returns and currency selection added 0.13%. The top three positive bond contributors to relative returns were the underweight positions in Europe, United States and Japan. The top three positive currency contributors to relative returns were the long positions in Japanese Yen and Korean Won and the short position in United States Dollars. 2022 was a tumultuous year for financial markets as rampant inflation hit multidecade highs across the globe.

This backdrop forced central banks into aggressive tightening of monetary policy, paving the way for negative returns in both equities and sovereign bonds. The FTSE World Government Bond Index returned -12.9% over the year in US dollar-hedged terms, whilst the USD unhedged version of the index returned -18.3%, as US dollar strength persisted for much of the year before reversing in the last quarter. This reversal in the past three months fuelled a positive return to round out the year, with the WGBI returning 3.8% in USD unhedged terms. In the US, headline inflation continued its downtrend, falling from 7.7% in October to 7.1% in November. Subsequently, the Federal Reserve reduced the pace of policy tightening from 75bps to 50bps in December, whilst maintaining that further hikes were warranted in 2023.

The Treasury market returned -0.7% over the month, bringing the annual return to -12.6%. The Colchester global bond programme remains underweight US Treasuries although exposure has been increased as yields backed up this year. Returns from Canadian bonds were similar, posting -1.5% over the month and ending the year at -10.3%. As Mexico’s inflation continued to show signs of slowing down from its peak of 8.7% in August, Banxico followed regional peers and raised interest rates by 50bps to 10.5%. Mexico’s bond market returned 1.6% over the month, finishing the year with a positive return of 1%. We continue to hold a significant overweight to Mexican government bonds on account of the relatively attractive valuation and robust monetary policy framework.

The fund returned 2.73% (gross of fees) over the month, outperforming the benchmark which returned 1.98%. Bond selection added 0.57% to relative returns and currency selection added 0.18%. The top three positive bond contributors to relative returns were the overweight positions in Mexico, Indonesia and Poland. The top three positive currency contributors to relative returns were the long positions in Japanese Yen and Korean Won and the short position in United States Dollars.

The performance of global bond markets was generally positive in November as investor sentiment continued to improve following a lower inflation print in the US, with market participants viewing this as a strong signal that the Fed will slow the pace of rate hikes. The FTSE World Government Bond Index returned 2.1% in US dollar-hedged terms, whilst the unhedged version of the index returned 4.5% as the US dollar weakened and erased some of its gains from earlier in the year. In the US, the Federal Reserve once again raised its target range for the policy rate by 75bps in November. The target is now 3.75%-4.00%, although Chair Powell signalled that the Fed will likely slow the pace of rate rises with a “downshift” to a 0.5% increase at the next meeting. He did warn however that the US central bank has a long way to go in its fight against inflation and the Fed would act accordingly until price pressures have slowed to a level more in line with the 2% target. Encouragingly, headline inflation reduced from 8.2% the previous month to 7.7% in October, continuing the downward trend for the second half of 2022.

The Treasury market returned 2.6% over the month as yields declined. The Colchester global bond programme remains underweight US Treasuries. Elsewhere, returns in Canada were similar, posting 2.4% over the month as we remain broadly flat the market relative to the index. Mexico’s bond market was up 3.5% on the month as Banxico followed regional peers and raised interest rates to 10%.

We continue to hold a significant overweight to Mexican government bonds on account of the relatively attractive valuation. In Colombia, the central bank hiked rates to 11%, whilst the new President’s fiscal reform was approved. The local Colombian government bond market rallied 4.5%.

The fund returned -0.15% over the month, outperforming the benchmark which returned -0.39%. Bond selection added 0.20% to relative returns and currency selection added 0.04%. The top three positive bond contributors to relative returns were the underweight positions in United States and United Kingdom and the overweight position in Singapore. The top three positive currency contributors to relative returns were the long positions in Norwegian Krone and British Pound and the short position in Swiss Franc. Investor sentiment improved somewhat in October, fuelling a rally in risk assets with the markets beginning to debate whether or not the pace of monetary tightening from global central banks may be slowing. Inflation remains a key concern and US CPI declined slightly in September to 8.2%. Meanwhile in Europe, although inflation pushed higher, unseasonably warm weather has allowed gas reserves to remain high and put downward pressure on wholesale gas prices which had been extremely elevated.

Meanwhile, the political angst in the UK has also abated with the installation of a new Prime Minister providing some respite to markets. Global government bonds experienced mixed fortunes in October with the FTSE World Government Bond Index returning -0.4% in US dollar hedged terms. The unhedged version of the index performed similarly, at -0.5%. Despite a dearth of economic data in the US in October, Treasury yields continued to push higher, with the 10-year Treasury yield pushing through 4% for the first time since before the global financial crisis in 2008. The return of the US bond market was -1.4% underperforming most of the other major markets. Our prospective real yield valuation has risen with the rise in nominal yields, and is now well into positive territory at around 1.0%, meaningfully above cyclical lows of -1.5%. The Global Bond programme has held an active underweight to the US market for some time, but we have reduced the scale of this underweight exposure somewhat in response to shifting valuations. Meanwhile, over the borders in both Mexico and Canada, local bond markets fared better, returning – 0.1% and -0.9% respectfully.

The fund returned -3.16% over the month, outperforming the benchmark which returned -3.41%. Bond selection added 0.50% to relative returns, while currency selection detracted -0.24%.

The top three positive bond contributors to relative returns were the underweight positions in United States, Europe and United Kingdom. The top three currency detractors from relative returns were the short positions in United States Dollars, Swiss Franc and Euro.

The third quarter has been characterised by the ongoing tightening of monetary policy by major central banks in response to elevated levels of inflation. This backdrop translated into volatility across financial markets, with both global equities and global bonds declining. As yields moved higher, the FTSE World Government Bond Index returned -3.1% in September and -3.8% over the quarter in US dollar hedged terms. The US dollar continued its upward trajectory this quarter, leading to a more negative unhedged index return of -7.6%. Much of this selloff occurred in September where the unhedged index declined -5.1%. In the US, the Federal Reserve raised its target rate by another 75bps in its September meeting. This brings the cumulative year to date increase to a substantial 3% and in delivering its policy decision, the Fed also signalled that more rate hikes will be needed to lower inflation to target.

The rate of inflation has fallen slightly for the second consecutive month to 8.3% in August from 8.5% the previous month. However, this was somewhat higher than expected and continued to put upward pressure on bond yields. The Treasury market fell -3.4% during September and posted -4.5% for the quarter. The Colchester global bond programme remains underweight in US Treasuries relative to other markets in the opportunity set, although real yield valuations in the US have improved somewhat.