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Our views 22 June 2021

JP's Journal: The importance of trust

5 min read

Trust is really important. It underpins so much of what we do. I was reflecting on this listening to the latest revelations by Dominic Cummings about his time advising the Prime Minister. What struck me, perhaps surprisingly, was not what was said but the fact that it has been published.

Frankly, I am not really concerned about Boris Johnson’s language, but I do think that publicly airing conversations that were deemed to be private is bad for government. Prime Ministers, like leaders generally, need to be able to discuss things with colleagues without fearing that unpalatable ideas are leaked or published. This may seem against the spirit of openness – but in reality the opposite is true. For leadership to work colleagues have to trust one another. If this breaks down discussions become limited, lateral thought is discouraged and cliques are formed. Perhaps both the Prime Minister and Dominic Cummings will recognise that trust, once lost, is very difficult to get back.

Trust is one reason that I favour focused teams. I consider teams of 6-10 to be ideal for idea discussion, collaboration and team ethos. Over my years in fund management I have worked in such teams and have frequently come up against the argument that this approach is inferior to larger teams, with more resources spread across the globe. What the ‘Big is Beautiful’ concept fails to accept is that, rather than benefitting from economies of scale, larger teams suffer from diseconomies, reflected in silo mentalities, bureaucracy, and internal friction. I don’t think it is a coincidence that the best performance is generally to be found outside the largest fund management businesses.

Trust is also important in markets. ‘My word is my bond’ was the mantra drilled into me on day one at Royal London. But this also applies to central banks and this trust is now being tested. For the last thirty years investors have trusted the Fed and other central banks to do the right thing with regards to inflation. What this means is that the present debate about whether the current global inflation uptick is transitory is much more important than it may seem. If investors lose faith in the word of central banks (e.g. inflation targets) things will get tougher for markets and a lot of goodwill built up over a long period of time will have been squandered.

Cash, government bonds and currencies

UK CPI rose to 2.1% in May. There are three components largely behind the rise in inflation: clothing and footwear, transport (petrol and diesel prices) and recreation and culture (mostly from computer game and music downloads). Looking at the other components there are some echoes of the kind of reopening effects we’ve seen in the US. The upward surprise will be treated as temporary by the Bank of England – which had already warned on energy prices. Later in the week there was a pull-back in UK Retail Sales, after very strong data in April. This does not mean that consumer activity as a whole fell – given that there was a substantial services reopening in the second half of May.

In the US the Fed released new forecast which showed that the median rates projection of members was 0.6% in 2023 – this equates to two rate rises, when the same forecast in March showed expectations of no rate rises, reflecting a slight rise in the 2023 inflation forecast. The message remained, however, that current high inflation rates were transitory and that longer-term inflation expectations had moved into a range broadly consistent with the inflation target. In the Fed’s opinion, the labour market and how it fares in the coming months will be the key to how monetary policy evolves.

In currency markets sterling dipped against a stronger US dollar market. Cash rates remained low with little movement in most markets.

Despite inflation data there was a move lower in implied inflation in all markets. 10-year UK yields moved to 0.75% whilst longer dated US yields moved back to the level last seen in mid-February.

Credit

Things remained stable in credit markets with both investment grade and high yield spreads towards their respective YTD lows.

Longer dated credit has recovered from the March and April sell-off in government bonds although we still prefer short and medium-dated bonds in our investment grade portfolios.

The prospect of a bid for Morrisons from private equity reinforces our view that covenant protection is really important. With the UK equity market appearing cheap on valuation grounds we can expect more interest in sterling assets from leveraged buyers. Good news for equity holders, but not for debt.

 

Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are the author’s own and do not constitute investment advice.