CIO's Year End Letter 2025

Naisbitt King Asset Management is a corporate bond specialist with many years’ experience of successfully running actively managed global fixed interest portfolios for clients. Unlike most bond fund managers, we currently do not hold any sovereign debt. This is not because we think sovereign bonds are in any way dubious but because we believe returns on corporate debt, using careful study and research, allows us to give the portfolios a superior risk reward performance.  

We put a lot of thought into sectorial choice; our preferred investment areas currently include industrials, consumer staples and communications but, and for some time now, our most favoured sector is financials, more specifically the sub-debt of significant global banks and insurance companies. This has proven to be particularly rewarding for both capital and income return. This area of Additional Tier 1 (AT1) and Contingent Convertibles (CoCo’s) subordinated bonds, which rank below senior debt level, is used by financial companies to raise capital for growth, for acquisitions or to shore up their capital reserves. Many of these junior bank debt securities are still rated at investment grade levels.  

Our portfolios have always held a limited amount of sub-investment grade bonds to enhance yield and performance. This year however, with the continued heightened global tensions, we have become more cautious and therefore dropped the percentage held further.

Earlier last year we became concerned with portfolio reinvestment risk, whereby maturing bonds redeem into a lower yielding market. Reinvestment risk is the danger that an investor won’t be able to reinvest the principal from a maturing investment at the same favourable income rates received previously, therefore reducing future income and returns. We therefore sold many short-dated holdings to purchase longer dated bonds maturing in a few years’ time.

One sector we have also closely monitored over the last few years is the tech area including AI stocks. The share price of companies in this sector, particularly the so-called Magnificent 7, were hitting ever higher levels. We felt we should not ignore this ever stronger and more powerful sector. However, the problem for this segment is that the debt of these companies is trading at expensive levels, with many launching their bonds at the long end of the market, which did not suit our portfolio duration objectives.  Whilst we liked the sector, we felt it was one to closely monitor, rather than invest in at this time.    

An important aspect of any portfolio construction is duration. Over the last 3 years the difference in yield of the 10-year US Treasury bond to the 30-year bond has increased by over 32bps creating a steep yield curve. However, while it would have been easy for us to move a portfolio to longer dated bonds, thereby increasing yields, but we resisted.  Indeed, last year the US Treasury yield curve continued to steepen, which would have caused increasing losses to the portfolios. In fact, all portfolios have comparatively short durations, which has really protected them from that ever-steepening government yield curve.

Benchmarks

To properly measure the performance of the portfolios we pay close attention to our choice of benchmark; used as a reference point to measure and evaluate an investment portfolio's performance. Areas such as currency, securities, durations and sectors should be equivalent and as realistic as possible. We like to be consistent so once chosen we rarely change our benchmark, thereby giving an accurate comparison over time. Currently, the benchmark we use for all portfolios is the market bellwether, the Bloomberg US Aggregate Total Return Value Unhedged USD. We also compare the portfolios to other market leading fixed income fund indexes such as the Pimco Total Return Fund. I am pleased to report all the portfolios we run have beaten these benchmarks.  

Shadow banks

We believe the running of global fixed income portfolios is not about the avoidance of risk but more the management of risk. The collapse of US companies First Brands and Tricolor Holdings earlier in the year, costing private credit over $12bn, has caused great concern about the so-called shadow banking sector. The IMF has recently warned there are increasing dangers that the $3 trillion private credit market, run by non-bank lenders such as investment funds, pension funds and insurance companies, often known as ‘shadow ’, banks. These have become deep routed in the financial system. Jamie Dimon, CEO of J P Morgan, has recently been reported as saying "When you see one cockroach, there's probably more," referring to these bankruptcies.

A major problem is that these shadow banks are not bound by the same regulations and capital requirements as traditional lenders. While this has helped the private credit market grow significantly it leaves them vulnerable to trillions of dollars of bad loans and credit lines. The Governor of the Bank of England, Andrew Bailey, has now written to his counterparts across the G20 to warn of the mismatch between rising asset prices and weak global economic growth. Major US investors including Morgan Stanley and BlackRock have reportedly tried to pull money from a Jefferies-backed fund in recent days as panic about the crisis spread. A portfolio of private credit loans managed by Blackrock has performed so poorly that the money manager has waived some management fees – a real rarity in the credit world. Besides their bad debts, a significant drawback for investors of private credit funds is often liquidity, which can mean it could be hard for them to sell their holdings if things start to go wrong. In fact, to prevent a private credit fund suffering from investors selling, they might try to delay or even block redemptions making a bad situation even worse. We have never had exposure to private credit. On 4th December the Bank of England announced it was launching its first ever stress test of the private credit industry. This follows the UK’s seven largest lenders passing the BOE’s latest stress test. We have no exposure to this sector of the market.

Liquidity

Naisbitt King Asset Management has always been keenly aware of the problems of lack of liquidity and possible company failures in the bond market. To counter these potential challenges, we only hold debt in well rated global companies and significant financial organisations. Part of our investment research process excludes illiquid bonds by requiring a minimum issuance size of an individual bond. Through our research and studies, we take great care to only invest in notably strong companies.

Forward to 2026

With the continuing war in Ukraine, the ever-changing Trump tariffs, the Israeli-Hamas war, global inflation still proving sticky and now the Venezuelan situation, making investment choices difficult, we will continue to hold broadly the same investment views into 2026 – at least for the start of the year. Our overarching view, that we have held for some time, is that government bank rates with be reduced over time. The problem has been that, while rates have indeed fallen, it has been at a lot slower pace than envisaged. Whilst acknowledging Japan has just raised its rates to a 30-year high and the ECB is expected to hold its current 2% rate all this year, the rest of the world seems to be on a downward trajectory. After cutting in December, it seems likely that the BOE will cut at least one more time this year. In the US, it is more likely that there will be more rate cuts, with some forecasting a near 3% rate by the end of the year, from the 3.5% to 3.75% rate today. Since US interest rates are likely to decline further, we believe the yield curve is likely to remain steep. Therefore, we will maintain our current portfolio durations.

As I said before, last year was successful for us with all our actively managed portfolios beating their benchmarks and comparison indexes. The prospects for fixed income portfolios next year look strong, but not without the usual global challenges. However, with rate cuts, robust corporate fundamentals and the continuing investment enthusiasm for the fixed income market leading us to believe corporate bond portfolios will continue to give excellent capital and income returns throughout this year. Current yields look very attractive versus equities where the return prospect is low because of high valuations. It's a particularly exciting time for total return funds fixed interest funds for this year and beyond.

The international bond market is set to remain appealing from both a technical and fundamental viewpoint. We believe that market risks need an actively managed approach, combining diverse portfolio construction with robust risk management and the flexibility to adjust evolving market conditions. Amid the ongoing volatility in the global economic outlook, we will continue to invest in the debt of high-quality companies with compelling yields and excellent potential performance. Going forward we will maintain a high-quality investment stance which will allow us to have the ability to go on the offensive when opportunities open up this year and beyond.

Trevor Cooper FCISI

Chief investment Officer

Naisbitt King Asset Management