An independent professional's take on the latest news and trends in global financial markets

The “most dangerous investment environment ever”

These are the latest comments on the implications of the drastic policy measures being adopted by central banks in a so far unsuccessful attempt to stimulate their economies. They come from one of the most successful managers of a “real return” fund in the UK. Iain Stewart has been running the Newton Real Return fund since its launch in 2004, with only one small down year (2011). Anyone interested in capital preservation in the current uncertain climate is likely to find much that resonates here. The full story can be found here (source: FE Trustnet).

“Fixing the price of government bonds is a very risky policy as it can lead to mis-allocated capital. I would say now is the most dangerous environment I have ever seen. It feels nice when stock prices just keep going up, but if anything, those assets are being pushed up by policy. It may be an uncomfortable thought, but we need to keep reminding ourselves that the reason we are all bathing in an ocean of liquidity some five years on from the financial crisis is that we have, to date, failed to lay to rest the legacies of the last cycle. The problem is that forcing mature, ageing economies to grow through monetary easing is recreating the distortions and excesses which caused the crisis in the first place”.

“There is also a risk that the policy of continuous monetary accommodation may itself be becoming part of the problem. Low-to-zero interest rates do seem to sap the vitality of economies while at the same time inflating expectations and valuations of financial assets. The growing disconnect between expectations and reality could ultimately set the scene for the next crisis. Although the trajectory of risk-asset markets may well continue upward for now, there is a high probability that further problems will emerge”.

“How I see this fund is as a long-term savings plan; especially in a world of a lot of volatility, protecting capital is a very important part of generating returns. In the past when markets were healthier, you could basically use passive investing and hop on the returns, but now it is different. We hold around 60 per cent in equities at the moment, with a heavy bias towards non-cyclical areas such as healthcare, tobacco and utilities. We hold around 10 to 11 per cent in corporate debt, but it is at the higher-risk end as it is sub-investment grade”.

“I think people are broadly right when they say there is no value in bonds. You are getting very low levels of yield from government bonds. Though they can be quite useful from a risk-management point of view, central bank intervention has made them more risky. If you have a 10-year government bond with 7 per cent duration, if interest rates were to move by 1 per cent, investors would lose a lot. If yields were to increase then it would be a dangerous environment. That won’t happen yet as there is too much debt; however, the risk is out there.”

“I guess the popular view is that quantitative easing seems to be working in the US, with some saying they may make fewer asset purchases and then we would see a normalisation in interest rates in the near future – I don’t believe that. I think the numbers in the US are quite soft. I think the central banks are absolutely desperate to keep interest rates low for a very long time in order to pay off the huge amounts of debt in the system and I also think they will keep interest rates below inflation”.

So do I. The great monetary policy experiment goes on, for want in the main of any better ideas.



Written by Jonathan Davis

April 23, 2013 at 3:06 PM