BLOG: The conundrum facing cautious investors
With central banks from the US to Japan pumping the global economy with unprecedented levels of easy money, leading stock market indices are once again testing multi-year highs despite last week’s wobble on the back of poor economic data from China and fears that the US might reduce the extent of its money printing later this year.
While indices scaling new heights is clearly welcome news for equity investors, those of a more cautious disposition are starved of options as a result of central bank monetary policy distorting valuations across a number of asset classes (but notably bonds).
Interest rates on cash remain at record low levels (and negative in real-terms once above trend inflation is factored in) and aggressive central bank buying of bonds has driven yields below fair value. While bond valuations could well remain propped up at current levels for some time, there will eventually come a point when the markets start to factor in an end to quantitative easing by the US Federal Reserve, so the risks of capital losses are real and growing and the Day of Judgment for bonds is getting closer.
The high yield end of the bond market has also seen yields squeezed as investors have been shunted up the risk spectrum in search of returns. Yet the prospects for capital returns here are diminishing and a nagging concern is that much of the recent new issuance has been of poorer quality as businesses starved of bank financing have sought to access the credit markets.
For investors wanting to stick with bonds, we favour funds with flexible mandates, a bias towards short-duration (to mitigate the risks of any changes in the yield curve) and a tool kit to manage interest rate and credit risk. TwentyFour Dynamic Bond fund (5.9% yield) is one such example.
And while some may be tempted by the yields on offer from commercial property funds, we are cautious about the potential refinancing challenges facing the sector given the continued focus of banks on strengthening their own capital. If you are going to invest in commercial property funds then we suggest sticking with those that have bias to London and the South East. We rate the Henderson UK Property fund, currently yielding 4.5%, which has 68% invested in the South East of England and 23% in cash.
In theory, absolute return funds should help fill the void and it should be noted that the Absolute Return UK sector was the best-selling IMA sector in terms of net sales in March. Yet the challenge here is finding funds that manage to deliver on their aspirations and that have strategies that investors can understand when they lift the bonnet. Two we rate highly are Insight Absolute Insight and Standard Life Global Absolute Return Strategies. While both funds should deliver inflation-beating capital returns at low volatility, neither is suited to investors needing to draw an income.
Likewise, two multi-asset funds we rate which aim to combined both capital growth and capital preservation are the Trojan Fund, which has had a record of steady returns with low volatility, and the Artemis Strategic Assets fund which invests across equities, bonds, cash, currencies and commodities.
The challenge is particularly acute for cautious investing wishing to draw an income as this is not a feature of any of the absolute return or multi-asset funds mentioned above.
In our view it is abundantly clear that there are no easy-options for the cautious investor. And that includes staying put in cash where inflation will nibble away at it.