SORBUS debt positioning: still ‘safety first’

The collapse of Silicon Valley Bank (SVB) and the recent forced takeover of Credit Suisse by UBS are a function of rising interest rates and bad decisions. There will be other banks suffering from the same dynamic.

We have no exposure as investors to either institution and indeed have clear rules over which institutions to avoid. We will not buy assets backed by banks that have investment banks attached because of their propensity to explode. Why juggle with a landmine?

In addition, small banks making flaky loans to one highly volatile sector (SVB) are not credible financial institutions. Generally as policy we steer clear of anything racy in the sector.

Over the last 12 months, there has been a significant shift in central bank monetary policy throughout the developed world in response to inflation, about which we have written several times.

UK treasuries or gilts, are the only asset class that can be considered ‘risk free’, that is if you hold to maturity (or redemption) you are guaranteed by the government to get your money back. However during their life they can fluctuate to a surprisingly large degree. The FTSE UK conventional gilt index, which is the broad market index that captures all UK gilts (of short and long-dated maturities) returned -23.7% in 2022 (source: Bloomberg). This is an extraordinary loss of value in what was regarded as a “safe” asset.

Usually with fixed income securities the longer the time until they mature the higher the yield, but you expose yourself to these price movements. Our strategy in debt investments over the last three years has been that the slightly higher yield from longer dated gilts was insufficient to compensate for the additional risk.

As prices of fixed interest and other debt assets fell the potential for attractive investment opportunities arose, however it is important to distinguish between something falling in price and being cheap. While the premium corporate debt buyers’ received (above government debt) rose, alongside the premium for buying longer dated assets. they remain considerably below what we consider good value. We did not and do not believe there was/is sufficient potential reward for taking this additional risk and so persisted with only buying ultra short duration sovereign debt.

For some years now we have used the highest quality short duration global sovereign debt, index-linked gilts (which give a measure of protection against rising inflation) and floating rate asset backed securities, which pay increasing distributions as interest rates rise. Across the entire asset class we have predominantly invested in short duration securities to insulate our clients against price volatility during a period where it was well-signposted by central banks that interest rates would rise (which generally means bond prices fall).

The steep price falls in corporate debt and longer duration fixed interest assets over the last few months, and increasingly last week, mean that they look substantially better value than they were, but still not sufficiently good value to compensate for the risks. We will maintain our “safety first” strategy for now.