INVESTMENT COMMENTARY

April 24, 2011

Our Investment Director, Peter Heckingbottom, provides up-to-date comment on financial markets and investment issues/strategy.

In my September 2010 review, I noted that:

• stock market volatility in 2010 had been high
• interest rates were remaining low despite some members of the Monetary Policy Committee (MPC) indicating that they would like to see rate rises
• corporate profits were robust
• equity markets offered good value (as measured by dividend yields in particular)
• there were strong messages from respected investors about good future returns from equity markets
• there are key reasons why emerging markets have outperformed developed markets and that this pattern could continue in the future
• my messages were becoming quite repetitive

As I review the above list today, I feel I have very little new to add.  We continue to see volatility in markets; the MPC is still divided about interest rate policy etc.

What is now becoming very apparent is the impact of inflation on real incomes of individuals living in the UK.  Consumer Price Inflation rose to 4.4% in February 2011 and Retail Price Index rose to 5.5% [Source: Capital Economics 22 March 2011].  There is anecdotal evidence that the majority of the retired population experience higher rates than either of these figures.

Against the above backdrop, retail investors can currently secure about 3% credit interest on the best instant access accounts [Source: Moneysupermarket 22.3.2011].  After basic rate tax, an investor would receive a net return of just 2.4% and would lose 3.1% in real terms over just 12 months.  50% taxpayers would lose 4% in real terms.

Capital Economics are continuing to predict low interest rates for the foreseeable future.  This is reinforced by real questions about the potential impact of increasing interest rates to fight inflation.  These questions arise because inflation appears to be sourced from rising food and commodity prices (especially oil), the rise in VAT and the “reverse China effect” (i.e. rising manufacturing costs in China leading to rises in the prices of imported goods).  Whilst the rise in VAT is likely to come out of future inflation figures, any rise in interest rates is not likely to have any effect on these other factors.

So, our central view currently is that retaining large amounts of cash in bank and building societies (even those with competitive interest rates), is not a sensible strategy (for anything other than an emergency or contingency fund).  Anyone in this position seems destined to lose money in real terms for the foreseeable future.

The main alternatives available today for such investors are “real assets” (including equities and property) and debt-based assets (fixed interest and bonds).

For investors prepared to take a risk with their investments and who wish to consider equity (stock-market) investing, I would cite an example as Invesco Perpetual’s High Income fund.  The yield on this fund is currently 4% and, unlike a bank or building society account, both the capital and income have the potential to increase over time.  Investors are aware that income and capital values can fall as well as rise.  Finally, due to the current UK tax rules, all tax-payers are better off by investing in a fund which produces dividends than they are in bank accounts.  There are many such funds available and investors should seek professional advice from a Pearson Jones consultant before making any investment decisions.

For more risk-averse investors, the debt market may offer less volatile short-term capital values and higher initial yields.  M&G’s Optimal Income fund is currently paying a yield of 4.6%.  Unlike the Invesco fund, there is less opportunity for future capital growth but the yield is currently about one and a half times better than the best interest rate available in the retail market.  (There is no tax advantage of investing in fixed interest funds over bank accounts for all UK tax-payers).  [Income yields sourced from Trustnet 22.3.2011].

The above funds are quoted purely as examples and no clients should act on these facts without the benefit of independent financial advice.  Wrapping either of the above investments in ISAs or other tax-privileged investments clearly produces even better net returns.

Predicting the short-term future is folly.  What we know from history is that markets tend to perform in cycles.  Investors in 1969 would have seen 13 years where equity markets delivered (on average) negative real returns of about 1.8% p.a.  Investors in 1982 would have seen 18 years of positive real returns of 13.6% p.a.  Investors in 2000 would have seen 10 years of negative real returns of 1.2% p.a.  [Source: Schroders February 2011].  It is time to see some positive returns from equity markets.

To plan finances sensibly, clients and Pearson Jones’ Consultants must make educated assumptions for the future.  To provide a basis for this, the following “House View” should prove useful.

Past performance is no guide to the future and no statement in this commentary constitutes any form of individual advice or guarantee.  The value of investments can fall as well as rise.

Information in this document represents a consensus of views from various sources including those of Pearson Jones plc.  Readers should not act on the comments made in this document without the benefit of Independent Financial Advice from a Pearson Jones Consultant.

PETER HECKINGBOTTOM FCIB APFS
Chartered Financial Planner
Deputy Managing Director & Investment Director