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Will commodities come a cropper?

Last month saw the launch of yet another commodities fund, this time from Investec, and another agriculture fund, from Barings. Is the rapid increase in the number of funds in these areas an indication that there is a soft commodities bubble or is there still a convincing argument for long-term investment?

Patel: I would not be surprised if there was some softening in the commodities sector as prices have been driven up sharply in a short period of time but I believe this would be a short-term situation and the long-term case for commodities is very much intact.

We are still in the early years of a commodity super cycle and the supply and demand dynamics should be supportive of the sector over the longer term.

It is worth noting that the launch of the Investec fund is well timed as it is pretty much a commodities hedge fund and should weather the storm if commodities were to weaken.

Thomson: I think there is some mileage still to go with commodities funds as long as demand for these assets exceed supply and prices continue to rise.

However, this is a more specialised investment area so it is crucial that one chooses an experienced fund manager who understands not only the commodities markets but also the wider socio-economic environment. This may be a niche market but agricultural commodities tend to be noncorrelated to other asset classes and should act as a useful diversifier in bigger portfolios. They may not necessarily be suitable for the smaller investor with more limited funds.

Davidson: Much of the recent bull market has been on the back of returns from basic materials, so these areas of investment are catching investors’ eyes as they are producing returns or potential returns. Investors feel that the conventional areas are not yielding the expected growth. Investors need to understand the areas and realise they are not a substitute for core areas of investment but OK for a percentage dependent on the risk tolerance of the client.

We have all seen fads come and go. It is good to have choice but the percentage in these funds of a portfolio should be limited.

Last week, Bradford & Bingley revealed higher than expected mortgage arrears. When do you see the end of credit crunch bad news?

Patel: We are not out of the woods yet and there may be more pain to come before the outlook becomes rosier. Bradford & Bingley is seeking to raise more capital than originally planned as their mortgage arrears have risen sharply.

The Bank of England is in a bit of a pickle. On the one hand, interest rates need to be lowered to ease the problems for mortgagepayers. On the other hand, it needs to raise rates to keep inflation in check. It is a Catch 22 situation and I really do not know when we will start to see the light at the end of the tunnel.

Thomson: Although some market commentators indicate that we are in the final stages of the credit crunch, the effects will remain with us probably for a number of years to come.

The severity of market corrections and the improved prospects of positive returns will depend on whether the Western economies move into a deeper recession than is currently predicted. It will probably take a year or two for lenders to fully untangle the sub prime liabilities and identify the true damage.

It may be that the losses have been over estimated but, then again, it may be that some losses have yet to be identified or crystallised. The effects of the credit crunch could last much longer before the true cost of poor lending practices is flushed out of the financial system. Davidson: This the $1m question. If we knew, we could make a lot of money. This is a difficult call as the experts do not agree. Our advice is to tread with caution. Even if companies are steadier, market sentiment can affect values. For investors, we recommend pooled funds rather than individual shares in, say, bank stocks as at least the investment is spread.

Does Norwich Union’s move back to monthly valuations for its commercial property funds mean that investor confidence has turned a corner for property investment?

Patel: I would be careful about plunging back into the property market just yet. We are not past the worst. If the economy continues to weaken and unemployment rises, this could present a major obstacle for the property market.

It is good news to see that Norwich Union has moved back to monthly valuations. It suggests that redemptions from its funds are at more manageable levels but we cannot rule out a further deterioration in the economy. We will have to wait and see how things pan out with the property market but I do not believe it is a buying opportunity yet.

Thomson: We think that the corner has not yet been turned but the bottom of the market is getting nearer. They need to have accurate valuations and a reasonable cash holding to meet redemption demand and there are signs that some money is trickling back into the sector but we think it is unlikely that the sector will bounce back strongly in the short term.

As a portfolio diversifier, property has its place, but at this stage we would be cautious about jumping back in with both feet. However, some Reits and property investment trusts standing with discounts of 40 per cent to net asset value do look tempting.

Davidson: Not necessarily. It means that the asset switching out of the sector has now stabilised, not necessarily meaning confidence has returned. Property funds produce yields as well as potential capital growth so there is some return which must filter through.

Property funds are not all alike so we are using them selectively. Some are faring better than others, so it is a question of picking the fund rather than being gung-ho on property as a sector.

Recent business figures from the Association of British Insurers show sales of investment bonds are down by 30 per cent year on year. Are you surprised by the sharp drop in demand?

Patel: Investment bonds no longer have the appeal they used to have under the new tax changes. It is therefore not surprising that sales of investment bonds have been dwindling, especially when funds held in Isas and Sipps, for example, can offer far better compounded long-term returns once the income and capital gains tax benefits have been taken into consideration. Investment bonds can have an appeal in some special circumstances but these should be considered on a case by case basis.

Thomson: We are not surprised at all, as advisers are now beginning to wake up to the fact that unit trusts tend to be more tax-efficient, transparent and betterperforming for most UK-based investors than the insurance-policy-based alternatives.

The capital gains tax changes have added some impetus to the flight away from investment bonds, as have the FSA’s treating customers fairly principles, but bonds still have a place in portfolio and taxation planning, so they are not dead yet.

They will find their natural level based on their own merits rather than being distorted by financial marketing and incentives, and they will probably attract the bigger investment sums, although sales numbers may be lower in future.

Davidson: No. It is clear that bonds have lost many of their advantages following the changes last Budget. Even though there was a flurry when there was opposition to the changes, wise advisers have used bonds with caution in recent times.

A lot of bonds were probably written historically with a link to with-profits funds which are now very out of fashion so this will also have affected bond sales.

We would expect the trend to continue and then level off as the market finds its natural level in the light of changes.

Has the falling value of the pound made investment in European equity funds a more attractive option?

Patel: Betting on currency is highly speculative and you are likely to get it wrong more often than not. The strong euro has proven beneficial for UK investors over the past year but do not forget it can work the other way too.

When it comes to investing in Europe, I believe the focus should be on investing with good quality fund managers, with solid track records. As currencies move in and out of favour over time, investors should look to benefit from the stockpicking skills of the manager rather than get bogged down by where the pound or euro are heading.

Thomson: The falling value of sterling has made investing in European equity funds more attractive, especially for growth investors, but we think sterling still has some way to fall before levelling out. European income funds may not be quite so attractive as the currencyrisk will directly affect the income being paid on a constant basis.

We think it is best to consider whether investing in the European sector is the correct strategy in the first place rather than basing investment decisions on currency movements. Perhaps we should be asking whether we should have so much invested in the UK rather than going global?

Davidson: European funds have seen something of a boom given the strong euro. We would usually recommend that a client has exposure to Europe as a core established international area. How long will the euro’s strength last? It is difficult to say but there may be further strengthening.

How hard will it be for Architas, Axa’s new multi-manager offering, to differentiate itself from the crowd of existing multi-manager offerings?

Patel: I feel the multi-manager market has become saturated in recent years but the good thing with this new venture is that Richard Philbin is a reputable manager and well known in the industry so I do not see why he will not be successful at raising assets.

It would be good to see a different offering, making them niche players in their own right. It could mean they look to make greater use of the wider investment powers under Ucits III or use more specialist funds in their underlying portfolios.

Thomson: Multi-manager offerings have been popping up all over the place trying to capture the growth in this sector so Architas will have a job on its hands to have its head poke above the crowd.

The reputation of the fund management house will be important, as will be the fund managers themselves, who will need to convince advisers why they are different and how they will provide superior returns, less risk or better consistency.

Advisers are becoming increasingly sophisticated and more cynical when researching funds these days. I do not envy Axa’s task as its investment track record has not been especially sparkling of late.

Davidson: Until recently, I would have said very little chance, as it was a relatively stable area. However, in the past year or so, there has been so much fund manager movement that they now stand a chance. Leading players in this field, Gartmore, Cazenove, Fidelity and indeed F&C – where Mr Philbin, Architas CIO has come from – have all seen changes to management.

The two areas that it could distinguish itself are the investment powers within its funds and launching a fund outside the familiar active, balanced or cautious sectors that most multi-managers operate in. I would envisage the second of these two options to be the easier for Architas.

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