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After the gold rush

Our panel consider the prospects for investing in gold, the possibility of a bond bubble and IMA fund sector changes

The panel

Darius McDermott managing director, Chelsea Financial Services
Adrian Lowcock senior investment adviser, Bestinvest
Dennis Hall managing director, Yellowtail Financial Planning

The price of gold is now above $1,300 an ounce. Do you think it will it go much higher?

McDermott: The drivers are there for it to go higher. They can only get so much of it out the ground and demand is outstripping it.
A lot of the demand is coming from investment purposes as opposed to jewellery. The big buyers of it are central banks. India and China have started to make big inroads into gold, as opposed to just buying dollars. If China starts throwing money at an asset, it will have plenty of people looking at it.

Historically, gold has also been a good hedge against inflation and although $1,300 represents an all-time high on a basic price, on an inflation-adjusted price it is way below what it could be.

Lowcock: The US dollar is weak and that is in expectation of quantitative easing. If the currency continues to weaken, we will see gold continue to move higher but we may get to the point that the expectation of QE is so high that unless it happens, and unless it happens at the levels expected, you could easily see it come down.

The other problem is you could end up in a currency battle and currency wars. That would be unappealing to equities. Lots of QE and everyone devaluing their currencies would drive gold up as a safer haven. Will it go higher? It is difficult to see. But the pressure is with the currency weakening and it would not take much for that to come off if expectations are not met.

Hall: It can go higher, clearly. It is emotion that is driving the price rather than investment fundamentals. Gold does not produce dividends. It has some industrial use as well as decorative use but there is no change to those markets so people are buying it on sentiment over inflation or they want to get some value because they are not sure what currencies are doing. I do not think it is on sound investment principles that the price is going up.

Over the last few weeks, there been a lot of talk about whether there is or is not a danger of a bond bubble developing. What is your opinion?

McDermott: Different managers have differing views. Richard Woolnough put out a note saying no bond bubble but when I asked this question of FC, they said certain sectors of investment-grade are looking expensive but others, such as financials, still had some value.
It is a bit of a mixed answer. I do not think it is as straightforward as yes there is a bubble or no there is not. We prefer strategic bond funds, which give the managers more power and more opportunities to avoid the expensive parts of the market.

Lowcock: It is not so much whether there is a bond bubble, it is whether they are particularly attractive at the moment.
From an investor’s point of view, would you really want 3 per cent for 10-year gilts? It is not particularly attractive. Whether or not we are in a bond bubble, would you want that return? If we have further quantitative easing , you have the added risk of higher inflation down the line and then 3 per cent will look very unattractive. With inflation at 3.1 per cent, you are trading very close to inflation at the moment. You could easily be losing money in real terms in those bonds.

Hall: At the moment, people are heading for safety and they are prepared to pay a bit for that. There is potential for a bubble to build but it depends on the bonds being purchased.

If you hold them to maturity you are not making a loss. It is when people try and sell out partway through and have paid too much for something and interest rates change, then, yes, you could end up buying something you cannot offload without making a loss but if they are held to maturity, that should not be a problem.

McDermott: There are two sectors that most need looking at. In UK all companies, there are 320 or 330 funds with 10 to 12 sub-sectors – ethical funds, small-cap funds, mid-cap funds, large-cap funds, value funds, all cap fundss etc.

Is it fair to compare a FTSE 100 tracker with something like Legal & General alpha, which has a recovery/small-cap mandate? I would suggest not. Is it fair to compare F&C stewardship growth to Old Mutual mid cap? No.

The other sector which bothers me is cautious managed. The only restrictions on cautious managed are a certain bond and equity ratio. A lot of people deal with the equity part and the bond part quite differently.

A decent number of funds in the cautious managed sector underperformed the FTSE 100, which was down by 29.8 per cent in 2008. Anything which underperforms the UK benchmark while being cautious is of concern.

Lowcock: Two of the more difficult areas are the balanced managed and the cautious managed sectors. It is not so much what they say but how they are interpreted by clients.

Balanced managed offers a range of assets with a maximum equity exposure of 60 to 85 per cent. Eighty-five per cent in equities is a lot. You could really, really have a lot of risk in there. It is the same with the cautious managed sector.

But what you have in terms of the assets is not necessarily the issue, it may also be things like what is the volatility. Cautious managed, balanced managed and active managed need fleshed out to let investors know what they mean. They are fine for B2B and professionals but when it comes down to talking to clients, they do not know what they necessarily mean.

Hall: Some of the terminology surrounding some sectors needs addressing. With the cautious sector and the balanced sector, there can be issues if there is an overweighting in one place or another. An investor, rather than their adviser, might be looking at the balanced sector and expecting it to be a balanced fund or a cautious fund and expecting it to have a much lower equity component than it actually does.
In addition, with Ucits III, you have got funds which are called one thing but the underlying assets, the derivatives they may be using, may change the shape of the fund completely.


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