In addition to pure equity investment, we also look for a blend of assets – covering equities, bonds and alternative investments. This has the dual objective of achieving a return at the same time as dampening the high levels of volatility associated with investing solely in stocks. The non-equity portion of a portfolio has in recent years followed a particular trend of falling interest rates. This has seen lower income returns which have been more than offset by capital appreciation. Now, however, investors buying Sovereign bonds are being locked into flat or negative real returns (if held to maturity), and so this month we are looking at alternative approaches to protecting portfolios in what is still undoubtedly a deeply challenging economic backdrop.
The UK 10-Year Gilt (government bond) yield was 0.16% at the end of June. If held until maturity, investors can expect a total return of just under 2% over 10-years. Given the Bank of England’s inflation target, the real return is likely to be negative after only one year. It does raise the question as to why investors would settle for these returns. In our view, there is still some merit in holding government bonds in a portfolio – but for short periods of time on a tactical basis – when equity markets are volatile.
We are constantly exploring and investing in alternative options that we hope will help provide the diversification and return profile that a traditional defensive area, such as Sovereign bonds, once gave. In our portfolio construction we would expect to include in the asset mix inflation-linked bonds as an alternative to the conventional bonds discussed above, with added protection should inflation trends accelerate . Gold is another useful asset that we have talked about in recent months. Absolute return funds – that look to derive returns from the market in various ways – can often be a useful tool in portfolios but require monitoring. They may perform well during periods of market stress and be steady in fair-weather conditions. Overall, with the International Monetary Fund continuing to lower its economic forecast for the year, we intend to continue our cautious portfolio positioning over the summer employing some of the strategies described above.
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