The outcome of the General Election is due tomorrow morning, and, assuming a hung parliament does not complicate things, UK investors should have an indication of how the next five years will shape up – but how could the gilt market be affected?
Cunningham, manager of Newton’s Index Linked Gilt and Long Gilt funds, believes that for investors holding short-duration UK government bonds, Conservative frugality is a far better prospect than Labour expenditure.
“A Conservative-led government would be most beneficial for gilts, at least in the short term,” he said. “Austerity will continue – albeit at a slightly slower pace than the past five years – and public finances should be in surplus before the end of the next parliament.
“This would mean lower gilt issuance than under Labour’s plans, and also, because fiscal policy will be somewhat tighter, monetary policy may be kept looser for a while longer. This would help keep short-dated gilt yields down.
“In the short term, gilts may remain better supported, shorter maturity ones at least, as supply will be limited and uncertainty in other domestic asset classes may be even greater.”
However Cunningham issued a caveat, highlighting the danger posed by a possible in-out referendum on the UK’s EU membership, the impact of which would be felt further down the line.
He explained: “In the medium term, a referendum on EU membership could cause uncertainty and a steeper gilt curve, at least temporarily, even if ultimately it is likely that Britain would vote to stay in the EU.
“This scenario would inject uncertainty, hit confidence and deter investment, which could put back the need for rate increases by a Monetary Policy Committee perhaps faced by a weaker growth outlook.”
Taking up a position
In line with this view, Cunningham has recently reduced the duration on his gilt exposure, having been neutral at the turn of the year.
“In the gilt funds, we moved from one to 1.5 years shorter than the benchmarks to 1.5 to two years shorter,” he said. “But we have begun to close some of this gap after the sharp sell-off in the last few days, going back to one to 1.5 years shorter than benchmark.”
Cunningham has also altered his sterling-denominated bond holdings in preparation for expected currency market volatility.
“We moved to about half of the benchmark’s 7% sterling exposure,” he explained. “On the euro side, although we are longer-duration than the benchmark, allocation in percentage terms is approximately the same as the benchmark at 26%, but we own a higher proportion of longer-dated bonds.
“In our absolute return bond fund [Newton Global Dynamic Bond] we have cut sterling duration in half since year end, from 0.7 years to 0.37 years, and tripled euro duration from 0.4 years to 1.25 years.”
