Capability Brown

Our March Ask the Investment Team client call explored the challenges presented by low interest rates and rising inflation. This should be a concern for anyone with cash savings as inflation is eroding the spending power of their capital. What are the options for those looking to protect their savings?

This month’s investment experts were:

  • Stuart Newey, Head of Banking
  • Alan Higgins, Head of Portfolio Management and Construction
  • Mary Haly, Senior Portfolio Manager

The call was hosted by Paul Sarosy, Head of Client Investment Management.

As with our previous Ask the Investment Team calls, it was an informative and wide ranging discussion. The following is a summary of the main points.

 

Don’t miss out on our next Ask the Investment Team call in April. Contact your Coutts Wealth Manager or Private Banker to find out how you can dial in and put your own questions to the investment team.

Paul Sarosy: Before we take questions from our clients, could I ask you all to summarise the key opportunities you see in markets at this point in time?

Alan Higgins: The good news is that inflation is relatively low; the bad news is that interest rates are close to zero and even negative in some currencies. In the short term, inflation is edging up, with the Retail Price Index (RPI) approaching 3%. Meanwhile, the Bank of England is unlikely to raise rates any time soon. Therefore, our message to clients with cash is don’t wait for higher rates.

Mary Haly: For those able and willing to move out of cash in the search for inflation-beating returns, Coutts offers a range of discretionary investment portfolios. These strategies have performed well over the past few years with the most defensive delivering an average annual return in the high single digits and the more adventurous in the mid-teens.

Stuart Newey: If you had held £100,000 in a high-street savings account for the past five years, you would be around £6,500 to £7,000 worse off in purchasing terms owing to the impact of inflation. This calculation illustrates how cash is not without risk. Short-term government bond markets are not much better with one-year deposits below 1% in many countries and even negative in countries like Germany and Switzerland.

Could we see lower inflation, or even deflation, if sterling rises?

Alan Higgins: Sterling is bearing the brunt of Brexit concerns and would have to rise substantially to make an impact on inflation, which is unlikely given the level of commodity prices and global economic growth. A sharp rise in the value of the pound would subdue price increases but we expect modest inflation over many years with RPI around 2% to 3%.

Equity valuations are seen by some as very high. The Shiller price/earnings (PE) ratio shows that they have only been higher twice previously – before the 1929 and dot.com crashes. Are we witnessing another stock market bubble?

Mary Haly: Some equity markets are more expensive than others. The US is trading on a PE ratio of about 29 times but this measure was as high as 40 times in 1999. There is a division between this expensive US market and more fairly valued markets across the rest of the world. We prefer the UK, Europe and Japan because we believe they offer better value, and do not believe they are in a bubble. The performance of the US market this year will largely depend on whether companies can meet their earnings growth forecasts.

For those sitting on cash who are older and might not have a 10-year view, what are the alternatives for above-inflation returns?

Stuart Newey: Cash ISAs will continue as a mainstream form of saving in the UK thanks to the Chancellor’s favourable tax treatment. But I think it is sensible to have a  balanced view about how much cash you should hold. Doing nothing may not prove to be a wise choice depending on your individual circumstances.

Alan Higgins: Conventional wisdom suggests that as investors grow older, their portfolios should emphasise government bonds, which are less risky than equities. But bond yields are so low today and there is no magic solution. Alternatives include peer-to-peer lending, which comes with risks, and buy-to-let property, which is heavily taxed. I would lean towards defensive portfolios that have less volatility.

Mary Haly: Our defensive portfolios comprise around 50% fixed income, 25% equities and 25% other asset classes, including property. The fixed income portion is divided between government bonds, investment grade credit and high yield. One area we particularly like is bonds issued by financial institutions, which we believe can offer attractive yields. 

How does Coutts think a ‘hard’ Brexit would affect foreign exchange rates, interest rates, inflation and equity markets?

Alan Higgins: A hard Brexit is a possible outcome but not necessarily one we believe will happen. Even if it does, life will continue and UK businesses will continue to trade with the Continent. If negotiations become acrimonious then financial markets could suffer periods of volatility as they react to the news, which could create buying opportunities. For example, markets recovered quickly following Donald Trump’s unexpected election victory last year.

Mary Haly: We realise our clients are worried about Brexit. Yet UK economic growth has been stronger than many expected. Notably, manufacturers are benefiting from a weaker pound and enjoying increased demand from overseas. There are likely to be both positive and negative factors as the negotiations progress.

Stuart Newey: Alan and Mary have discussed the investment potential of Brexit, but if you look at banking, Europe is driving innovation in the industry and the UK is at the forefront of that, and I don’t think Brexit will affect this. There is regulation in the UK arriving next year that means all banks have to ‘open up’ to third party banking apps, so you won’t need to use your bank’s app to access your account. That’s happening in the UK and the rest of Europe will soon follow suit. We’ll continue to see innovation with companies such as Amazon blurring the lines between financial services and other sectors, and this will happen regardless of what happens with Brexit. 

Could sterling fall further owing to ongoing uncertainty surrounding Brexit?

Alan Higgins: The pound could fall further in the short term but is likely to rise over the longer term. When we look at past performance, sterling tends to revert to its mean relative to purchasing power parity and inflation-adjusted value. Markets are putting downward pressure on sterling but the UK economy is performing well and was the fastest growing out of all G7 countries last year. It would take a lot to depress sterling further but it may stay low if the EU imposes new trade tariffs on UK exports.

How could this year’s European elections affect portfolios?

Mary Haly: Politics tends to have a short-term impact on markets and the underlying economy drives them over the long term. This year’s elections are likely to have some implications but we don’t believe they will last long. France is the key one this year. My understanding is that Marine Le Pen will go out in the second round but it’s difficult to predict. We need to focus on looking after clients’ money and what factors might have a longer-term impact on returns.

Paul Sarosy: Last year, it took the markets two weeks to rebound after the Brexit referendum result and just two days to recover from the vote for Trump. After Italy’s referendum on political reform, it took two minutes to recover. Ultimately as an investor, it’s important to be patient and remain focused on the fundamentals.

IMPORTANT INFORMATION

This webpage is produced by Coutts for information purposes only and for the sole use of the recipient and may not be reproduced in part or full without the prior permission of Coutts.

The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment.

Past performance should not be taken as a guide to future performance.

In the case of some investments, they may be illiquid and there may be no recognised market for them and it may therefore be difficult for you to deal in them or obtain reliable information about their value or the extent of the risks to which they are exposed. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down. Investments in emerging markets are subject to certain special risks, which include, for example, a certain degree of political instability, relatively unpredictable financial market trends and economic growth patterns, a financial market that is still in the development stage and a weak economy.

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