Investor Chronicle #1 – The Uncertain World

Dear Reader

Welcome to our first article on matters that affect us all, planner and client alike.

As financial planners it is incumbent upon us to focus on what lies ahead, whether it be impending changes to legislation, global economic developments, or the human life cycle in general. In Consequence, with only the certainty of death to depend upon for all things future, we must continually review, interpret and anticipate those courses of action we believe represent the greatest probability of best outcome for you, our clients. We call this ongoing scenario analysis.

With this in mind, we offer our thoughts on the current demise of Fixed Interest Investments, i.e. Government and Corporate Bonds, and the impact this should have on our views and portfolio construction.

Traditionally a balanced portfolio might apply a mix of growth and defensive assets on a 60/40 basis, i.e. 60% Equities and 40% Bonds (Fixed Interest). The purpose of FI is to provide a low level of regular income and a “safe haven“ for when growth markets are stressed.

We must now consider that aged 60/40 model as broken, for the interventions of Covid fighting governments have severely fractured global supply chains and led to record levels of peacetime borrowing. Such events are not without impact. The direction of government led economies in a high debt world with weakened revenues will now rely heavily on Central Banks maintaining very low interest rates for several years to come. Furthermore, with base rates already at historical lows, pre-covid “normalisation” expectations have moved beyond view. In addition, with no interest rate lever available to manoeuvre economies, inflation control becomes somewhat challenging. The jury is out on whether this spells an end to more than 20 years of low global inflation, but indicators are there.

The sharp “V” shape of this pandemic recession means that global macro growth forecasts can, for the present, remain largely unchanged. However there now exists an acute challenge in sovereign fixed income markets (Government Bonds), traditionally the mainstay anchor point of many portfolios. So, with a perceived normalisation of base rates now at least three years away (and possibly longer), what does this mean for portfolio construction? …

Essentially we believe the search for income (dividends) must now inevitably flow from fixed interest (Sovereign Bonds in particular) toward equities and perhaps even to the global private equity market (which is now larger than the entire UK stock market). This suggests an inevitability in accepting higher capital risks to generate income, so we will watch these developments with interest.

There is no doubt however that mindsets must now retreat from the traditional acceptance that Sovereign Bonds represent a sensible low risk asset. In the present fiscal environment, they do not.

In closing, I would add that a truly global investment diversification now appears more attractive than ever, as we contemplate a reduction to sovereign debt and fixed interest exposure in client portfolios.

Steve Myers MLIBF DipFA