This page contains a Flash digital edition of a book.
Cash crash T

2012 Q4(b)

November 0.4 August

0.3 here are many

uncertainties in today’s economic and investing environment, but it is certain that interest rates will remain at current levels at least for this year. I believe it is likely

that UK interest rates will remain low for the foreseeable future, and indeed the anecdotal evidence is that the rates being offered by many major UK banks are beginning to fall, heaping more pressure on investors who rely on their bank savings. If the current low rates do persist, they also pose big dangers for fiduciaries that are entrusted with managing the wealth of others. It is likely that not only will the return on such assets be negligible, but there will also be a loss of the real value of such funds, as inflation will remain relatively high. Consequently, the maintenance of a (conservative) cash- only or cash-heavy investment strategy could lead to problems in later years for trustees and fiduciaries. Advisors should be actively looking for ways to improve the returns from cash or, alternatively, look to invest that cash to at least maintain its purchasing power.

The interest rate outlook Current consensus is that the UK base rate will remain at or close to its current level throughout this year and the next, and that any increase thereafter will be moderate and gradual. The table below is from the Bank of England’s November 2012 Quarterly Inflation Report.


The conclusion that must be drawn from the term structure of UK money market rates is that UK cash rates are likely to remain very low in absolute terms and negative in real terms for another three years, at least. With the UK economy enduring a technical second recession and 2013 GDP growth anticipated to be no more than 1 per cent, expectations for the timing of any potential increase in UK base rates are being pushed further into the future.

How long can rates remain so low? There is a striking similarity between the interest rate environment since 2007 and that following theWall Street crash of 1929 (see graph, opposite). In both cases interest rates quickly fell

below 1 per cent. They have fallen from 5.5 per cent at the beginning of the financial crisis in 2007 to virtually zero currently in theUS. In 1932 rateswent below 1 per cent but didn’t rise above 1 per cent again until 1948. Indeed,over this period inflation remained relatively high and cash investors would have lost over 38 per cent of the nominal value of their capital if they remained in cash. Many believe an increasing reliance on

unconventional monetary policy and a lack of a clear path to sustainable fiscal policy raises the long-term risk, particularly of rising inflation. The current expectation is for Consumer Prices Index inflation to remain at 2 per cent until 2015, although Retail Prices Index (RPI) will be higher. One thing is certain: the more cash portfolios hold, the greater the loss

Conditioning path for bank rate implied by forward market interest rates(a) Per cent


Q1 Q2 Q3 Q4 0.4 0.3 0.3 0.3

0.3 0.2 0.2 0.2 2014

Q1 Q2 Q3 Q4 0.3 0.4 0.4 0.5

0.2 0.2 0.3 0.3 2015

Q1 Q2 Q3 Q4 0.5 0.6 0.7 0.8

0.4 0.5 0.6

(a) The data points consist of 15-working-day averages of one-day forward rates to 9 November 2012 and 1 August 2012 respectively. The curves are based on overnight index swap rates. (b) The November figure for the fourth quarter of 2012 is an average of realised spot rates up to 9 November, and forward rates thereafter.


will be in real terms for investors. It is my view, therefore, that investors should begin to tilt their portfolios towards real assets such as index- linked gilts, commodities, property, infrastructure and higher-yielding (but lowly leveraged) equities. This will entail accepting higher short-term investment risk, but over the long term will offer greater investment protection. So where should investors focus

their attention? Gilts

The Bank of England has been active in its pursuit of non-conventional monetary policy, undertaking two additional programmes of quantitative easing since last October despite UK inflation having stayed stubbornly above its 2 per cent target rate sinceNovember2009. Gilt yields have consequently reached unprecedented lows. I expect that the current policy of ‘yield repression’ (the deliberate forcing of yields lower than would otherwise be the case) will be with us for some time yet. Once this policy ceases, however, there

is potential for a strong upward move in yields. Gilts are expensive (2 per cent for ten years and 3 per cent for 30 years), but quantitative easing is likely to remain supportive for some time. Eventually, yields are likely to rise and return closer to long-term averages. The current ten-year UK gilt is yielding 2.09per cent,having hit a low of 1.43per cent inAugust2012. While gilts undoubtedly offer solid risk management and diversification benefits in a multi-asset portfolio, there is better value in the corporate bond market. Yields in the corporate bond market currently varyfrom2.9 per cent forAAA paper to 4.4per centonBBBissuers. In turn, these reflect higher yields of 0.8 per cent and 3.18 per cent over the comparable UK gilts. The spreads relative to gilts have also narrowed in considerably over the past 12 months, reflecting the continued demand for such instruments from yield-hungry investors and the general improvement in global sentiment. In fact, the lower down the credit spectrum one


Page 1  |  Page 2  |  Page 3  |  Page 4  |  Page 5  |  Page 6  |  Page 7  |  Page 8  |  Page 9  |  Page 10  |  Page 11  |  Page 12  |  Page 13  |  Page 14  |  Page 15  |  Page 16  |  Page 17  |  Page 18  |  Page 19  |  Page 20  |  Page 21  |  Page 22  |  Page 23  |  Page 24  |  Page 25  |  Page 26  |  Page 27  |  Page 28  |  Page 29  |  Page 30  |  Page 31  |  Page 32  |  Page 33  |  Page 34  |  Page 35  |  Page 36  |  Page 37  |  Page 38  |  Page 39  |  Page 40  |  Page 41  |  Page 42  |  Page 43  |  Page 44  |  Page 45  |  Page 46  |  Page 47  |  Page 48  |  Page 49  |  Page 50  |  Page 51  |  Page 52  |  Page 53  |  Page 54  |  Page 55  |  Page 56  |  Page 57  |  Page 58  |  Page 59  |  Page 60  |  Page 61  |  Page 62  |  Page 63  |  Page 64  |  Page 65  |  Page 66  |  Page 67  |  Page 68  |  Page 69  |  Page 70  |  Page 71  |  Page 72  |  Page 73  |  Page 74  |  Page 75  |  Page 76  |  Page 77  |  Page 78  |  Page 79  |  Page 80  |  Page 81  |  Page 82  |  Page 83  |  Page 84