Capital Gearing ramps up UK 'linkers' despite fiscal crisis concerns

The defensive trust has significantly increased its exposure to UK index-linked bonds as it says investors face 'unappealing' choices.

Capital Gearing (CGT ) has warned investors face ‘unappealing choices’ in both bonds and equities as the investment trust ramps up exposure to UK index-linked gilts despite concerns over a fiscal crisis.

Interim results from the £816m defensive trust confirmed bond returns were ‘muted’ in the six months to end of September, with tailwinds in inflation-linked bonds – which make up 39% of the portfolio – offset by headwinds.

However, this hasn’t deterred manager Peter Spiller from stocking up on UK debt. Improving yields encouraged Spiller to make the biggest portfolio change in the period, increasing allocation to UK ‘linkers’ from 5% to 20%, which was funded by reducing exposure to TIPS and recycling risk asset sales.

‘Our US inflation-linked bonds (TIPS) profited from falling yields that were offset by the weakening dollar,’ said Spiller.

‘Our UK inflation-linked bonds profited from strong inflation accruals that were partly offset by a steepening yield curve.’

Spiller, who runs the trust with Alastair Laing and Christopher Clothier, said despite the increased exposure to UK government debt, his chief concern is the ‘fiscal position of developed market governments, in particular France, the US and UK’ meaning they all have ‘lots of bonds to sell’.

The UK’s position is ‘probably more precarious’ given ‘few need to own UK government debt’.

‘Bond markets have woken up to this. Yield curves have steepened dramatically as investors assess these risks and the higher returns needed to entice new buyers to buy the ever-greater supply of government bonds,’ said Spiller.

However, equity investors have ‘shrugged this off’, with the S&P 500 having only ever been more expensive for less than 1% of its history.

‘When it comes to long-term prospective returns, starting valuations really matter. If history is a guide then investors in the US can expect real returns of less than 1% per annum over the next 10 years,’ he said.

The valuations are set against a backdrop of ‘high and rising’ macroeconomic risks, including tariffs and the artificial intelligence (AI) boom.

Spiller is expecting the returns from the latter ‘will disappoint’ as vast capex spending is not as fruitful as anticipated.

‘We are left with a world of unappealing choices. US equities are very expensive and much of the relative better value of other equity markets has, through good performance, been eroded,’ he said.

‘Bonds offer, on a long-term view, good value but are very vulnerable to fiscal crises in the near term.’

Infrastructure spat

The wealth-preservation trust has continued to hit its target of growing investors’ wealth ahead of inflation, racking up a 3.4% net asset value (NAV) total return in the six months to end of September, ahead of the 2.1% consumer price index inflation rate.

Spiller said the majority of returns came from the ‘risk asset portfolio’, thanks to a strong rebound in equities following post-liberation day weakness. Notable returns came from emerging markets and Japan, with the former being a ‘standout performer’ with returns in excess of 30%.

Spiller said the large holding in Aberdeen Asian Focus (AAS ) bond converted into equity in May ‘just in time to enjoy an extraordinary few months of performance’.

The alternative portfolio was also a driver of the outperformance, with infrastructure trusts enjoying a strong period, which Spiller said was ‘a welcome return to form after a difficult couple of years’.

The largest contributors were International Public Partnerships (INPP ), 3i Infrastructure (3IN ), and HICL Infrastructure (HICL ), all of which are top 10 holdings.

HICL, which is currently the ninth largest holding at 1.3% of the portfolio, has come under scrutiny from CG Asset Management this week after it announced it will merge with Renewables Infrastructure Group (TRIG ) to create a £5.3m mega trust.

The manager did not pull any punches in an open letter to the trust, stating it was ‘appalled’ by the plan and said it was ‘an exceptionally poor transaction for HICL’ that would be ‘value destructive’.

The ‘risk assets’ part of the portfolio, of which infrastructure is part, was reduced over the six months from 29% to 26% as Spiller said he was ‘concerned about extremely stretched equity valuations, particularly in the US, and increasingly speculative investor behaviour’.