In the three months to the end of September, our fund marginally outperformed the UK market, with both rising by a little over 1%.
There was, however, an important distinction between our performance and that of the wider market. We remained fully hedged throughout the quarter, meaning that our positive return was generated by the relative outperformance of our high-quality equity portfolio rather than exposure to the direction of the market itself. We regard this as a particularly encouraging result, reflecting the contribution from stock selection while limiting exposure to broader market movements.
As already mentioned, we have now been fully hedged for an unusually long period. There are several reasons for this. Equity valuations remain elevated, although this is hardly a new development. More recently, however, a series of increasingly concerning risks has emerged, many of which show little sign of resolution and, in our view, may not be fully reflected in equity market valuations.
The situation in the Middle East remains unresolved. It could improve, but equally there is scope for further deterioration. Closer to home, the UK government faces an important Budget against a difficult economic and political backdrop. The new Prime Minister may find himself confronting many of the same challenges that undermined his predecessor. There is considerable ambition for new policies and spending commitments, but seemingly little political appetite for meaningful spending restraint. This raises the prospect of either disappointing policy outcomes or further increases in taxation and borrowing.
More broadly, we are concerned that the cumulative burden of taxation and regulation across the UK and much of Europe is constraining economic growth. Reviving growth is increasingly important, yet much of the existing policy framework appears to make that objective harder to achieve. Without a meaningful change in direction, the risk of further economic disappointment or political instability seems considerable.
These concerns are increasingly reflected in bond markets. One of the more striking developments this year has been the rise in long-term government bond yields. In the UK, the 30-year gilt yield has risen from around 5.0% in early spring to approximately 5.9%. Similar pressures have been evident in parts of Continental Europe and the United States.
In the US, stronger economic activity may help explain some of the increase in long-term interest rates. The same argument is less convincing in the UK and Europe, where growth remains weak. This suggests that bond investors may be becoming increasingly concerned about the scale of government deficits, the accumulation of public debt and the apparent difficulty politicians face in bringing public finances under control.
Historically, governments have often struggled to address persistent fiscal imbalances without the pressure of a crisis. We are not suggesting that such an outcome is inevitable, but the direction of bond markets is becoming harder to ignore.
From a shorter-term perspective, we are also surprised by the relatively limited response of equity markets to rising bond yields. Higher long-term interest rates would normally be expected to put downward pressure on equity valuations, particularly when those valuations are already elevated. So far, any adjustment has been relatively modest.
One possible explanation is that equity investors regard some of the current pressures as temporary, particularly those associated with the conflict in the Middle East. However, there is little indication of an imminent resolution, and the longer uncertainty persists, the greater the possibility that elevated bond yields become a more enduring feature of the investment landscape. Should equity investors begin to price in a prolonged period of higher interest rates, a more meaningful market adjustment could follow.
Looking ahead to the fourth quarter, there may nevertheless be an opportunity to remove our hedge. Markets are no longer as overbought as they were earlier in the year, and the passing of the UK Budget and US midterm elections could remove some of the uncertainty currently weighing on sentiment. This may create conditions for a year-end rally.
We will continue to monitor developments closely, particularly in bond markets, and will adjust our hedging position when our assessment of the balance between risk and potential reward becomes more favourable.
As always, thank you for your continued support.