Ask the Coutts Investment Team
Finding value in a world of rising inflation and interest rates
Ask the Investment Team, January 2017
As the extended period of low rates and inflation gradually begins to ease, we invited veteran bond investor Ian Spreadbury of Fidelity International to join us on our monthly Ask the Investment Team call to consider the challenges ahead. Also on the call from Coutts were Alan Higgins, Head of Portfolio Management and Construction and Alistair Jex, Senior Portfolio Manager.
As ever it was a lively and stimulating discussion covering a lot of ground in a short time. Subjects discussed included:
- Which areas of the bond markets look appealing – and which to avoid
- Opportunities for equity investors in today’s highly valued markets
- The prospects for a recovery in sterling
The main points from the discussion are summarised below.
Don’t miss out on our next Ask the Investment Team Call. In February, we’ll be considering the world of real estate following the launch of our latest quarterly Real Estate Perspective. Watch out for your invitation, or contact your private banker to secure your chance to ask our investment experts about the property market in 2017.
We’ve seen a lot of talk about rate rises coming this year particularly from the US. Against this backdrop, where do you see the opportunities for bond investors in the coming months?
Ian Spreadbury: I think there’s value in investment-grade (higher quality) corporate bonds (also known as ‘credits’). In the UK, we’re seeing yields of 2.75-3% as against gilt yields at 1.25-1.5%, and some good-quality credits are even offering double the yield on gilts. Longer-term bonds are even offering rates as high as 6%. In government markets, US Treasuries are yielding a percent or so higher than gilts (UK government bonds) and there is a little bit of value in emerging market bonds.
It is a challenge to find value in bonds but there is till value out there. And if you’ve got the reach and the global coverage there are still quite a few opportunities in international bonds markets.
And what about the opposite? What are you afraid of, what do you want to stay clear of?
Ian Spreadbury: I am concerned about systemic risk from a couple of areas. The first is debt. There’s so much debt in the system that the global economy is like a highly leveraged business, making it very sensitive to changes in global interest rate expectations. I believe the way to hedge against this risk is to focus on high-quality credits.
The second factor is global demographics. The proportion of over-60s in the global population is not only increasing but accelerating. In simple terms, as these people drop out of the work force they aren’t being replaced, and that is an increasingly significant headwind to global growth.
Another important factor is global inequality – the fact that the wealthy have a much bigger share of income and assets than they ever did before. The wealthy spend less, proportionately, than poorer people and this is a headwind for global growth.
Looking at specific sectors, I know Alan is positive on financials and I think that maybe in the short run that might be right. But in broader terms I’m still a bit cautious because I feel that while capital levels are higher than they were, in actual terms against actual assets they’re still pretty low. I still have a reasonable allocation in the Fidelity Moneybuilder Income Fund but I’m a bit cautious generally.
Based on a number of metrics equity markets appear to be at over-bought levels. Where do you see opportunities?
Alan Higgins: If you look at the UK, it’s somewhat extended, but I will point out that the dividend yield for the FTSE 100 is still close to 4.5%; as a pure income stream that still looks very attractive. The US equity market is of course somewhat over-valued. They’re high-quality companies, but there’s a big price to pay. In contrast we see a lot of value in markets like Japan and Europe and some sector plays as well.
Alistair Jex: Europe and Japan are obvious stand out names. Towards the end of last year, after the US election, we did see a sharp rally in value trades, for example in European equities, which didn’t perform particularly well through 2016. It wasn’t really until the year-end that we started to see an upturn. We saw a similar story in Japan, with the value plays leaving it until late in the year before starting to outperform very strongly.
At a sector level, we saw a value opportunity in healthcare stocks just prior to the US election. Valuations in the healthcare sector came close to 25-year lows relative to the wider market before the election and one of the themes in the current world – alluded to by Ian earlier – is an aging population. That will require healthcare solutions into the future.
Where do you see sterling headed in the short or medium term?
Alan Higgins: Currency’s difficult. We want to be longer term in currency, as it’s very difficult to get short-term trends right. So yes it was weaker after Theresa May’s interviews about the shape of Brexit last week, but one of our investment principles is value and being contrarian. Looking at sterling today in terms of real effective exchange rates or purchasing power parity we see real value.
Ian Spreadbury: I’m broadly in Alan’s camp. I think it’s incredibly difficult to get currencies consistently right and the volatility can be horrendous. I think I share the view that sterling is probably okay at these levels. It’s dropped a long way already and may drop a little further. We’ve still got the decision to trigger Article 50 in March and that might mark the bottom in sterling.
What effect will a sterling recovery have on asset values?
Alistair Jex: In the near term we think that the under-performance of sterling will last for a little while yet. What we have done in our portfolios where we’ve seen gains made in international markets, is to start switching some of those funds to sterling. Recently, for example, we switched share classes in a European fund from a euro-based, pure European exposed version into a sterling-hedged version, locking in some of those currency gains. So we’re trying to capture the performance of those assets but eliminate the currency risk from here.
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