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Spanner in the works?

America celebrated Independence Day last week but should UK investors still be wary of its market?

Fearns: Investors can rightly feel a bit concerned over whether it is the best place for their hard-earned cash but can they afford to ignore the opportunities that lie within one of the world’s biggest economies? Some companies are trading on good valuations and have strong balance sheets, robust cash flows, fantastic brands and products that are sought after globally. Remember, it is not necessarily about investing in an economy but the good companies within it, so finding a good stockpicking fund manager is key. In the short term, you would not necessarily pile your cash into the US right now. However, taking a longer-term view, it almost always leads the way into recovery, at least in the developed world, so should remain a solid part of anyone’s portfolio.

McDermott: After the sub-prime crisis, investors in the US have some new problems. The one looming largest is the soaring oil price. Inflation is also putting a strain on the economy and markets are suffering in consequence. Currency also remains a risk. However, the US remains the most entrepreneurial market in the world and there will always be opportunities.

I believe that equity returns will get back to their historical levels but not for some time. For that reason, I will not be dipping my toe into this notoriously efficient market for some time yet.

Dampier: The trouble with the US market is that there are few good, consistent fund managers who have done well there. This is why I believe it has been an unloved sector for such a long time with UK investors. However, with the dollar still very weak against the pound and at least two managers, Tom Walker at Martin Currie and Felix Wintle at Neptune, having done well in the area, perhaps this is changing.

At the same time, the credit crunch has exacerbated the shift of wealth from West to East. The US is hardly down and out but client portfolios should shift more eastwards, in my view.

The consumer price index recently breached 3 per cent again and Bank of England governor Mervyn King has predicted that it may hit 4 per cent this year. Where is the best place to invest in an inflationary environment?

Fearns: There are different ways of looking at this. One is to think short term and find investment products with defensive qualities. The other is to set a long-term strategy and stick to it to generate a positive return over the long term, thus beating inflation.

The most obvious products are the National Savings index-linked certificates which are linked to the retail prices index and have a guaranteed interest rate on top, currently 1 per cent on both three and five-year terms. Moving to equities, there is some debate about the best place to invest but certain themes are emerging, such as commodities, infrastructure, utilities and tobacco. Emerging regions are likely to fare better, as despite inflation being a global affair, the massive changes that are happening in those regions, such as urbanisation and more active consumerism, mean their GDPs are able to stay strong and continue growing.

McDermott: It might seem obvious but one of the best ways to tackle rising inflation is to invest in utilities. These are the companies that benefit from rising energy prices. To hedge against the rising oil price, investors could use an exchange traded fund to track the price of oil. However, this is an inherently risky strategy. A far safer bet is to look to funds that invest in companies that provide infrastructure and services to the oil supply chain. These companies will continue to function well, even if the inflated oil price takes a dip.

Gold has always been a natural hedge inflation as it tends to move in the opposite direction to equities. In the last six months while inflation has been gathering pace, the gold price has risen but remains volatile.

Dampier: This is a very difficult question right now. Other than index-linked gilts which look a little pricy and National Savings index-linked certificates, the usual methods of insulating yourself against inflation would be real assets such as property and equities.

Unfortunately, we are now going through a period of deleveraging which is going to last for at least two or three years. This means that the housing market will be a disaster with falls of over 25 per cent. The stockmarket is already racing to beat the housing market. Equities do work but only over the longer term. The stockmarket over 15 years to get over 1970s’ inflation. There is no easy answer. You cannot put everything into gold but I believe that sterling will fall further, so perhaps Swiss francs would be a good idea.

BlackRock managing director Alex Hoctor-Duncan recently predicted the demise of some absolute return funds because of the high number of new entrants. Are some funds taking unnecessary risks to stand out in a crowded sector?

Fearns: There are lots of new entrants to the absolute return fund space and some are very likely to disappear through natural selection, as a result of inexperienced management, missing targets and failing to achieve critical mass. The funds have broad investment powers available to them through Ucits III regulations, meaning there are more tools to help grow and protect assets but also, if not used properly, more tools to create losses.

However, most companies bringing absolute return funds to market have the necessary experience in running these sorts of portfolios. They are making use of the tools available to them within the regulatory environment and working within their risk budgets, so overall it would probably be unfair to say they are taking too much risk to stand out from the crowd.

McDermott: It appears that the absolute return sector is the rock that investors are clinging to for safety in our present climate of wild volatility but investors must exercise caution. Many investment houses will rush into this sector in the hope of redirecting outflows from flagship UK funds that have struggled recently. The quality of absolute return funds varies greatly and investors need to be aware of the levels of risk needed to deliver the desired outcome. Some have bond strategies, others use equities. The absolute return products that will deliver are likely to be those where the fund manager has depth of experience in all techniques. We consider BlackRock alpha to be the benchmark in terms of quality absolute return products.

Dampier: The problem with the absolute return sector is that there is a mass of funds with very different objectives. Like all the Investment Management Association sectors, you do need to look under the bonnet but perhaps more so in this sector. It is my view that many intermediaries are not doing enough work before they put their clients into these funds. The vast majority are unproven over a market cycle so it is really early days to see how they will react. The answer in the end will be to put three or four of these funds together as they do not perform in exactly the same way. This is just the same way as you might buy three or four UK funds to represent your UK weighting. I am sure some will fall by the wayside and my own preference has been what I call the long/short funds headed by BlackRock. However, new launches are coming, with Cazenove being next. This new breed of retail hedge funds looks likely to take the lion’s share of the sector.

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