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Riskless Rather Than Risk Off

7 March 2017 by Mark Holman

We have come to that point again when the risk-off portions of fixed income portfolios may well present us with much unwanted mark-to-market risk. The US market has rapidly responded to the various Fed Governor comments that a rates hike next week is now firmly on the cards, and that the pace of hiking in 2017 will be far more meaningful compared to the previous two years. US Treasury yields have backed up to the top of their recent ranges, but we feel it would not take much to push them into new territory.

In the UK, gilts had a very strong performance in February on the back of Carney acknowledging some remaining slack in the economy, as a consequence yields moved back to levels last seen in October 2016, with 5-year yields at a mere 0.59%; basically pricing in no change in rates for the foreseeable future. From an investable perspective Europe’s core is becoming an ever decreasing sector, with the forthcoming French elections having created a small but worrying possibility of redenomination risk hanging over OATs. In addition, the market is facing collateral shortages which have taken short-dated Bunds close to the lowest yields ever recorded.

With these current valuations and the Fed in hike mode, risk-off is certainly not risk-free, and with correlations feeling vulnerable to a period of decoupling we think they carry some mark-to-market risk here. Consequently, in the short term, we are positioning the traditionally risk-off sections of our portfolios into securities that are as close to risk-free as we can. This essentially means ultra-short government bonds and cash. One exception to this are Australian Government bonds, where we currently see no change in rates from the central bank this year, and as such we are willing to go out to 4-years since there is still a reasonably positive yield curve as a consequence of its correlation to US Treasuries.

Having said this, as we formulate our views and potential actions that we might take ahead of the French elections, we do still firmly believe that traditional risk-off will perform strongly should there be a far right victory in France, so our move to “riskless rather than risk-off” is a short term decision and we remain prepared to be nimble.




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