From the monthly archives: October 2016
We are pleased to present below all posts archived in 'October 2016'. If you still can't find what you are looking for, try using the search box.
Market cap based passive investment strategies are supported by theory and appear to function well in many equity markets. They also appear to work for fixed income markets but here their track records are shorter and not so well supported by logic. The market cap approach directs flows towards the largest borrowers who are not necessarily those best positioned to honour their obligations.
A further issue is that the technical aspects of the way bonds are priced can have profound implications for the risk characteristics of the indices. The impact of the secular fall in interest rates has impacted prices of longer dated gilts far more than those with a shorter time to maturity. Gilts are typically issued around the par price of 100. Today, there are two high coupon long dated gilt bonds which are priced at over 200. As a result, the weighting of these two issues in the index is approximately twice that of when they were originally issued. Falling bond yields pushes out the average duration of the index (ceteris paribus).
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Investors this year should be as happy as a guest on the Jeremy Kyle Show, who has just found out that they are not the father. Unfortunately, the returns have not come about through corporate performance, rather a continued compression in yields as discounts rates fall ever lower. By some accounts, discount rates are now as low as they have been in the last 5,000 years. Since the credit crisis we have been in unchartered economic waters and we are now even moving off the known map for many financial markets. This leaves us totally reliant on valuation metrics to act as our compass and liquidity analysis as our sextant. Equity valuations can be justified only in relation to bonds, unfortunately we are struggling to see any way to defend bond valuations. The relaxed nature of the recent market run has left us uneasy and sensing that market participants are becoming complacent.
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