In this episode, I answer a listener question about playing catch-up on retirement savings. If you’ve left it late to save for your future, you’re going to want to hear my answer.
I also speak to Curtis Evans, Investment Director and Head of Fixed Income Product Management at Fidelity International, to get his outlook on interest rates and fixed income investments.
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Personal finance news
-The construction company Carillion has announced it will go into liquidation, with up to 43,000 jobs at risk. Talks between the business, its lenders and the government failed to secure the financial support needed to save the UK’s second largest construction firm.
-Price inflation, as measured by the Consumer Prices Index, slipped back to 3% in December from 3.1% a month earlier. The modest fall in inflation was largely the result of cheaper air fares.
-Customers of the supermarket chain Tesco have expressed dissatisfaction with changes to the retailer’s Clubcard rewards scheme. A new simplified scheme will result in some customers gaining less from their accumulated points.
-New research from GoCompare Money has found that Brits are hiding a collective £13bn worth of secret personal debt from their friends, families and even their partners. The study from the comparison site found that 40% of UK adults had some form of personal debt (excluding mortgages), owing £6,131, on average.
-House sellers in London are cutting their asking prices by the largest amount since the global financial crisis, according to property website Rightmove. The impact of higher purchase taxes on expensive homes and the Brexit vote is hurting demand from foreign buyers and raising the prospect of job losses in the City.
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Useful links
–Don’t Stop Me Know by Vassos Alexander
–When: The Scientific Secrets of Perfect Timing by Daniel H. Pink
Curtis Evans interview transcript
Martin: Well welcome back Curtis Evans from Fidelity. We’re talking again about fixed interest and we’re just saying before we started recording, it was nearly a year ago we last spoke. How much has changed in the world of fixed income in that past year?
Curtis: Well, surprisingly not that much really, I think at that time we were talking a bit about the bond bubble and lots of investors were concerned that bond yields will rise. But last year actually fixed income returns were pretty good. We didn’t see the disaster scenario that many had thought might occur.
Martin: What has changed in the last year is we’ve had an interest rate rise in the UK. Do you think that rates will rise further in 2018?
Curtis: We can’t see them lifting rates this year. I think it will be quite a precarious position the Bank of England will be in. The challenge that they’re facing is Brexit uncertainty. And it’s starting to trickle through economic data now. I think it’s particularly the housing market. So, if you look at some of the housing market surveys they’re really starting to come off their four to five years lows. And that’s typically a great leading indicator of the UK economy. So I think faced with some softening in economic growth I think the Bank Of England will stay on the sidelines.
What could tip them in balance of lifting rates is if inflation stays high. Currently it’s above 3% but our forecast is that next year it will definitely fall closer to 2% or end the year around there. And so we think that will be enough for the Bank Of England to stay cautious and not move rates.
Martin: And of course, we had an interest rate rise in November. It went back up to 0.5% from it’s post Brexit low to 0.25%. Did that rate rise in November have any impact on bond yields and capital values or was it priced in already?
Curtis: It was well priced in advance. And actually gilts performed positively both in November and December. As we start 2018 we have seen a little bit of weakness in the gilt market. We’ve seen yields pop a little bit higher. But that’s really been a mirror reflection of the strength in equity. So when equities are doing very well such as the S&P and the Footsie, you typically see gilts do pretty poorly. So that’s what’s happened you today.
Martin: And assuming that interest rates do rise in the medium term, maybe not this year, but the following year and the years afterwards. What changes should investors make to their portfolios to position themselves ready for those rate rises?
Curtis: Yeah, I think there’s lots of strategies that investors can employ. I think firstly, you can reduce the interest rate sensitivity of your portfolio by holding fewer say, government bonds that have a direct link to changes in rates. Secondly, I would certainly think a good strategy is using corporate bonds. You tend to see corporate bonds outperform government bonds when rates are rising. And you get that additional yield or that spread by holding corporate bonds. So that gives you a bit of extra cushion. And we’d also be suggesting that investors can access global markets much more than they may have done so in the past because you tend to find each economic cycle, each country has slight variations. So when one country is lifting interest rates, you might not be seeing the same sorts of rate increases in others. So I would be certainly advocating spreading the risk, using some of the foreign markets such as the dollar market, even the euro market at times in addition to the sterling bond market.
Martin: And what about the duration of bond holdings? Is there anything investors can do in that front to reduce sensitivity to rate rises?
Curtis: Yeah, you can reduce the duration of a portfolio, this is a technical concept. And that reduces your sensitivity to rising rates. The problem with simply taking duration out of a bond portfolio though is it leaves you with a cash like return, which is very low. And it makes your portfolio very sensitive to risky assets because the only thing left is the credit spread. And you tend to find that the credit spread is quite linked to sentiment in the equity market. So we’d be suggesting to investors to not just simply take duration out of a portfolio, use some of the other asset classes. Also, things like the inflation linked market we think makes sense. So by substituting some conventional government bonds for inflation linked bonds, you reduce your sensitivity to rising interest rates to some extent. And that’s because rising interest rates is normally synonymous with rising inflation. So you get some protection there by holding inflation linked bonds.
Martin: And what do the portfolios look like at Fidelity at the moment in respect of fixed income holdings? What steps have the asset managers there taken to protect capital values from rising interest rates?
Curtis: Yeah, interestingly when we look at our portfolios and we look at the risk in portfolios, our concerns are more about credit risk rather than actual interest rate risk and the threat of rising interest rates. And that’s because when you go into the credit market today that additional yield or that spread is very low historically. So there’s not much room for error, particularly in something like the high yield market. If you were to see an economy enter a session, you’d see the faults increase and the spread you’re getting paid today simply probably isn’t enough reward for that scenario.
So most of our portfolio are positioned quite defensively within the credit area. So we’ve got a preference for higher quality corporate bonds, so investment grade rated as opposed to junk bonds or high yield securities. We’re trying to use a lot more width in funds as well. So accessing some of the emerging markets, which have economic cycles that are very different to the developed side.
And then on the interest rate side, we are a little bit cautious. We have trimmed some of the duration in our funds but we’re really trying to diversify the sources of the duration. So to capitalise on economic cycles not being perfectly correlated. And also I mentioned the inflation link area. That certainly in most of our unconstrained or our more flexible bond products, it’s normal that they’d have anywhere from 5 to 20% in inflation linked bonds at this point.
Martin: So for a cautious investor that’s looking maybe for income. Are there alternatives to fixed income if you’re worried the interest rates are going up? Or should it be a case of sticking with the asset class but taking some of those steps you’ve described to protect your capital?
Curtis: I certainly would suggest still sticking with the asset class ’cause I think it’s got an important role to play of giving you the income and it’s a very defensive source of income. But, if you are to see more drastic rises in interest rates that should normally be a great environment for growth. And as such a good environment for equities. So it’s quite common that investors at this point in the cycle, they’re a bit overweight equities, underweight fixed income. I think that can make a lot of sense. If you’re trying to find other, more defensive asset classes, it’s hard to find things better than government bonds, because government bonds tend to outperform when equity markets come unstuck. Your other alternatives are things like gold, things like property, things like currencies even. And actually I think in this sort of world where there’s a lot of leverage, there’s a lot of uncertainty, we’re late in the cycle, I think just generally diversifying and spreading risk makes a lot of sense. So even capitalising on some of those other asset classes I mentioned.
Martin: Curtis, thanks for your time.
Curtis: Thanks a lot.
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