On 23 July ( see review here), we raised the issue about the potential dangers in Fixed Interest as an Asset Class stating that it was similar to a game of “kerplunk” where , in the absence of deflation and “Turning Japanese” it was only a matter of time until the last few straws of “safe haven” status from falling Equity markets were removed.

Date 23 July

  • Ftse 100  5,510 ( Curr  5,838)
  • Bund 10yr  145.59 ( Curr 141.31)
  • Eur Yield 10yr 1.17% (Curr 1.56)

As you can see, that was exactly the day when Bunds, a proxy for 10 yr Fixed Interest, peaked at just over 146.00 in price terms which equates to a Yield of  1.17%

Equity Markets-Ftse 100 (Daily Chart)

 

Ftse 100 Rally

Yield Curve Analysis-Eur 10 Yr Yields

Yield 10 yr Bunds-Aug 19 2012

As the positive sentiment in Equity markets has noticbly returned in the last 3 weeks, we will take a closer look at the Fixed Interest Markets and reflect on the changing face of International Yield Curves …

 

Yield Curves- 17 Aug 2012

and by how much (bp’s) ?

For those of you less familiar with Fixed Interest, the main deterioration in Price or rising Yields has occurred at the back  end of EUR and USA Curves where 10 yr  yields have risen almost +28 bps compared to UK +11bps,  and Jpy +3bps.

Note : the markets fear of inflation in 30yr (US +30bps, Eur +23bps Vs UK +6bps)

To be clear, rising yields mean falling prices and a trade off between securing income and increasing the risk to your capital.

Take a close look and find out more…….

Conclusion – Know your Duration and Investment Objectives

The search for Yield in Fixed Interest sometimes encourages people to move up the Curve ( increases duration exposure) but importantly this ALSO increases risk as you are exposed to more market events or shocks over time. Now, if you have an asset with a 10 yr life that is matched by a 10 yr liability the reality is that you don’t care.

However, if as is the case with many investors you have long term capital requirements and short term income demands you better beware!!

Increasingly, because of the low yield environment, equities are providing investors with an Income (Dividend) solution which can appear attractive compared to fixed interest alternatives in an upward or sideways trending Equity market. However, if you asked investors that might have adopted this strategy at the start of 2008 only to see a Capital loss of circa 40% they may have a different view.

At the moment all of our asset class trend analysis is reverting to benchmark with a bias towards overweight positions in equities. Are we going to see a situation where the yield curves adjust significantly causing capital losses in fixed interest?

It is time to do your homework for your portfolio(s) and ensure that your clients’ investments are designed to meet their personal objectives. Allocating assets to equities for long term income and to fixed interest for short term capital preservation may not be effective.

It is important now to keep an eye on the respective volatility of each asset class as we proceed.

 

 

 

 

 

Keith Reid
Keith Reid
Keith’s training as an accountant and auditor has emphasized the importance of evidence in all good decision making process. The ability to monitor management processes effectively is a key to making the most of business opportunities. Both Keith and Gerry believe that this priority for capital preservation is the common principle that sets the framework for any sound investment strategy or business model.