Why do US interest rates and inflation forecasts affect bond yields? Cherry Reynard explains the workings of a confusing asset class.
At the end of 2017, the IA Europe ex UK sector was the place to be. Having shaken off the rising nationalist threat, shiny new leaders such as Emmanuel Macron looked set to take Europe into a new era. This year, in contrast, has reminded investors that Europe is still, well, Europe: mired in political problems, with growth slowing. The performance of European stock markets has reflected that weakness.
With interest rates at record lows, infrastructure trusts looked like the perfect solution. Paying an income of around 5 per cent plus, from a portfolio of government-backed assets such as hospitals and schools, they were a good option in an income-thirsty world. The trouble is, everyone else realised it too. The trusts moved to double-digit premiums and started to look unappealingly expensive.
Reliable income is still an elusive commodity. Interest rates may have moved higher, but savings accounts still don’t beat inflation. This seems to leave investors with an unexciting choice: the stock market, bonds or commercial property, all of which have had lengthy bull runs and are potentially unstable. Structured products, in contrast, remain widely overlooked.
If history is any guide, we may be nearing the end of a strong run in stock and bond markets. At more than 3,450 days, the bull market run in equities is already the longest in history and bond markets have started to roll over. There are sound reasons for this: interest rates are rising, valuations are high and the geopolitical environment is increasingly uncertain.
As interest rates rise and quantitative easing is withdrawn, stock and bond markets look set to lose an important support mechanism. Share prices may make further progress, but they are swimming against the tide. In this environment, fund investors may well be looking for an alternative to equity and bond funds, such as targeted absolute return funds.
Fund management companies have an inherent conflict of interest, though few like to admit it. The sales teams and shareholders want them to grow funds as large as possible, because that creates higher fees and delivers higher profits. However, it is clear that this is not always in the interests of those who invest in their funds. There are too many examples of funds that have grown very large, only to see performance slip, to write it off as coincidence.
When property investment delivered giddy returns, it was worth the hassle of awkward tenants, slimy estate agents, or fickle buyers and sellers. However, as the housing market has slowed and those returns have ebbed, the allure of bricks and mortar has waned. Dealing with builders has little appeal for low or negative returns.
Just as stock markets are showing new and uncomfortable volatility, private equity is going through a purple patch. Private equity managers around the world have raised around $1 trillion (£742 billion), currently sitting on the sidelines and ready to invest.
A chunk of that money is heading towards the unloved UK market. Inbound merger and acquisition activity into the UK market amounted to $67 billion in the first quarter of 2018, up from $11 billion in the previous quarter.
Despite trade war posturing and tit-for-tat tariff impositions, China-focused funds still look sound like long-term investments.