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In the mix

There has been much debate among economists and fund managers about the short-term direction of UK interest rates this year, with the hawks in the ascendency back in the early summer when a 25-basispoint rise in May was seen as pretty much a foregone conclusion. However, just three months on and we learn that the US plans to keep rates close to zero until the middle of 2013 while the latest Bank of England inflation report seems to suggest that the monetary policy committee will not be increasing the cost of money any time soon.

The result of this will be that savers, who have had to endure bank rate at 0.5 per cent for well over two years now, will either have to accept the purchasing power of their cash deposits will continue to be eroded in real terms or will have to seek out alternative higher-yielding assets, all of which carry their own set of risks.

Traditionally, the first port of call for the more risk-averse investor would have been the UK government bond market. However, like cash, conventional gilts are currently producing a negative real return and while inflation will probably fall next year, it is likely to creep higher over the next few months and, by the bank’s own admission, will likely remain above its 2 per cent price target for the next 12 months. Against this backdrop, it is hard to see UK government bonds offering any fundamental long-term value although they have clearly proved to be a very useful port in a storm during the recent rout in world stockmarkets.

Corporate bonds remain popular with investors and there is no doubt that they have produced excellent returns over the last two decades. However, like gilts, we believe this asset class has seen its best days. Having said that, corporate balance sheets are generally in pretty good shape and credit continues to look attractive relative to both cash and gilts. Our prefer-ence is for a mixture of investment-grade and high yield although we have been taking profits over the last few months in the latter, with prices a little frothy.

UK commercial property appears to have become the forgotten asset class over the last few years and perhaps this is not surprising, given the dramatic falls seen in all areas of the market during the credit crunch. However, while capital values are likely to stay in the doldrums for some time, commercial property once again looks attractive from an income perspective. Unfortunately, accessing this asset class via open-ended funds remains unappealing in our view, with yields being diluted by high cash weightings.

Gaining exposure via investment trusts on the other hand results in a significantly higher yield although investors going down this route have to accept that price movements in these vehicles are going to be considerably more volatile than their open-ended equivalents.
Given the latest bout of extreme volatility in stockmarkets and the highly uncertain macro backdrop, there will probably be little appetite for equities at the current time. However, falling prices of course result in higher yields and I believe that from a fundamental valua-tion standpoint, stocks look highly attrac-tive on a medium-term view and certainly more appealing than the bond markets.

David Hambidge is investment director of pooled funds at Premier Asset Management


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