Overview
“In the short run, the direction of interest rates drives the bond markets, but in the long run, it is the starting yield that really matters.” – Silverdale Funds Global Investor Call 2023
Strong economic data prompted the markets to slash the 2024 potential interest rate cuts from circa 1.80% to just 0.85%, providing a window of opportunity for a strategic allocation to fixed income at the prevailing elevated yields.
Sticky services inflation led by shelter
US January CPI at 3.1% YoY (est. 2.9%) and Core CPI at 3.9% (est. 3.7%) overshot the consensus estimates.
Figure 1: US CPI (6-months annualized)
As detailed in previous Silverdale Commentaries, Shelter consists of over 33% of CPI; while rising interest rates have cooled housing demand which reflects in both housing prices and rentals, there is a lag before it gets reflected in Shelter CPI.
Figure 2: US CPI YoY: Shelter vs. All Items less Shelter
In Jan 2024, core services (ex-Shelter) showed an uptick, while the prices of energy and core goods declined. As detailed earlier, the final descent of inflation towards the 2% target would be bumpy, providing an alpha generation opportunity for active investors.
- Source: Bloomberg, Alliance Bernstein, Feb 2024
- Source: Bureau of Labor Statistics, Feb 2024
Labour market remains robust
Non-farm payroll increased by 353k in the US for Jan 2024 against an estimate of 185k, which spooked the market. However, today US companies are hiring less than before the pandemic
Figure 3: US Job Hirings (in Mn). There is consistent drop in job hires, with nearly all the jobs the US economy is adding being part-time
Historically, unemployment rate spikes after the first Fed rate cut, as depicted in Figure-4.
Figure 4: Unemployment rate at the time of first Fed rate cut
Hence, the job data should be read with caution.
Time in market over timing the market
From an economic perspective, a difference in a few months and/or a few cuts won’t materially affect Fed’s interest rate trajectory. Hence, rather than timing the market, and lose out on current elevated yields, it would better to focus on the big picture, capitalize on the Fed pause, and grab the opportunity to lock-in the prevailing elevated yields.
Empirically, when the economy is strong and the Fed is hiking interest rates, risk assets outperform, as economy slows down, the Fed pauses and starts rate cuts, fixed income asset class outperforms. Interest rate pause provides a window of opportunity for strategic re-orientation of portfolio.
The current elevated yields provide a compelling opportunity for income-seeking investors while protecting against potential downside because even in case of further 0.50%-1% rate hikes (or credit spread widening) the investors’ return would be positive for the year with (additional) benefit from pull-to-par over the bond lifetime.
- Source: Vontobel, Feb 2024
- Source: DB Research, Jan 2024
Figure 5: Yields and forward returns regression:
YTW versus 5-year annualised return
For instance, Silverdale Fixed Maturity Fund 2023, was launched in September’20, with target returns of circa 7% p.a. It matured on 24 November’23, delivering +23.70% (that is, XIRR of 7%) despite adverse market conditions of pandemic 2020 and turbulent 2022 with Bloomberg Global Aggregate Index declining by -17%.
Furthermore, there is a mountain of cash of circa US$ 9 trillion lying globally in money market funds waiting to be re-allocated. With interest rate cuts, this cash will leave the money market funds with a lag; hence, investors may be well-served to get ahead of the expected reallocation.
- Source: RBC, Bluebay, Feb 2024
Figure 6: Cash leaves money market funds with a lag
February 2024 Performance
For February 2024, the Bloomberg Emerging Markets Asia Total Return Index returned 1.1% and the Bloomberg EM USD Corp and Quasi 1-3Yr Index rose 0.4%. In comparison, the Silverdale Bond Fund NAV increased by 1.3%, and the NAV for various Silverdale Fixed Maturity Funds increased between 0.6% to 1.9%.
Figure 7: Silverdale Funds performance since Nov’23 (Fed Pivot)
The flagship Silverdale Bond Fund remains well-positioned to take advantage of the prevailing high carry offered by high-quality bonds, holding 77% Investment Grade bonds, with a duration of 2.0 years, yet offers a leveraged YTM of 9.3%, pointing to higher potential returns.
The investors who prefer higher assurance of returns versus potential capital gains, would do well to lock-in the current prevailing high yields through fixed tenure funds.
Thank you for your unwavering support.
DISCLAIMER
THIS COMMENTARY IS AN INTEGRAL PART OF AND SHOULD BE READ ALONG WITH THE FUND FACTSHEET FOR FEBRUARY 2024. This document is written for the benefit of and is being communicated exclusively to Accredited Investors or Institutional Investors as defined under the Securities and Futures Act (Cap. 289) of Singapore. The above commentary does not provide a complete analysis of every material fact regarding the market, industry, security, portfolio, or any Silverdale fund. It is not a recommendation to buy or sell any security nor an investment advice. The portfolio holdings, opinions and information may change without notice and the actual results may differ from the said opinions and estimates. The contents of this document, including any narrative, does not constitute an offer to sell or a solicitation of any offer to buy the units or any Sub-Fund or class of the Silverdale Fund VCC (the “Fund”) or any of the funds managed or advised by Silverdale Capital Pte Ltd., and is strictly for educational purpose only. The distribution of the shares of the Fund may be restricted in certain jurisdictions. It is the responsibility of the person or persons in possession of this communication to inform themselves of, and to observe all such restrictions, all applicable laws, and regulations of the relevant jurisdiction, including of any applicable legal requirements, exchange control regulations and taxes in the countries of their respective citizenship, residence, and domicile. Any subscription for units or shares must be made solely based on the Fund’s private placement memorandum, applicable class supplement) and Subscription Documents (together “the Offering Documents”). Past performance is not an indicator of future performance. The Fund uses leverage and invests in financial derivative instruments. Please refer to the Offering Documents for Risk Factors. Nothing in this document is intended to constitute legal, tax, securities or investment advice or opinion regarding the appropriateness of any investment, or a solicitation for any product or service. Please seek opinion from an independent professional adviser before taking any decision based on this document.
- Source: Guggenheim, Feb 2024
- Source: Bloomberg, Silverdale Capital, Feb 2024