Holden & Partners Quarterly Investment Views: Q2 2019 Outlook

With all inflation-linked securities, value is determined based on ‘breakeven’ inflation rates: the spread (difference) between the yield on an inflation-linked bond and that on an ordinary fixed rate bond. This difference represents an expectation of future inflation rates which is ‘priced-in’ to the market; the higher the differential, the higher future inflation is expected to be. In such an environment, assets aiming to provide returns above the rate of inflation can protect, and increase, investors’ future purchasing power and therefore constitute valuable additions to a diversified portfolio.

Index-linked bonds tend to outperform when market inflation expectations (as suggested by the breakeven inflation rate) are too low, and the actual inflation rate over the life of the bond is higher than the breakeven rate. The ideal environment for these assets is therefore one in which inflation forecasts rise unexpectedly, but interest rates remain relatively low due to economic fragility. Such an environment manifested itself in the UK in the latter half of 2016 in the aftermath of the Brexit referendum, as fears grew that the withdrawal from the EU would result in stagflation (high inflation and low growth).

Higher interest rates can result in a fall in the capital value of fixed income assets, regardless of their inflation protection characteristics, so this should be borne in mind when selecting exposure to the asset class. In the current environment, investors should generally favour short-dated index-linked bonds which are less sensitive to interest rate risk and therefore less susceptible to capital losses.

At present, global index-linked government bonds tend to offer better value than those in the UK. This is because a sustained increase in inflation is likely to be driven by an acceleration in wage growth and this seems more imminent in the US due to the tightness of the labour market. Inflation expectations have increased to reflect this thinking, but there is still the possibility for upward increases in the US inflation outlook. It coincides with a period when relatively soft economic data and pauses in the Federal Reserve’s rate-hiking programme are likely to keep interest rates contained, therefore presenting an environment in which inflation-linked sovereign debt could outperform. The managers of the Aberdeen Standard Global Index Linked Bond fund, which the H&P investment team use, have conviction in this view and hold a large position in US TIPS (Treasury Inflation-Protected Securities) accordingly.

Nonetheless, there are some opportunities within the asset class in the UK due to the uncertainty surrounding the EU Withdrawal Agreement. Although an extension to the Brexit deadline meant that the UK avoided leaving the EU without a deal at the end of March, and both the main parties state that they are committed resolving the current stalemate, there is no guarantee that a compromise will be found before November. A ‘hard’ Brexit would likely result in an inflationary environment in which index-linked bonds would thrive, so we continue to advocate holding a position in inflation-linked gilts to protect against this risk and dampen news-related volatility. High quality inflation-linked corporate bonds, such as those owned by the M&G UK Inflation Linked Corporate Bond fund, provide superior yields to their government equivalents (in order to compensate investors for taking on a small degree of credit risk) and therefore provide an attractive risk-reward profile, particularly in the event of further Brexit instability.

To summarise, inflation-linked bonds are included within a portfolio to:

Maintain inflation protection:

  • Inflation-linked bonds complement other fixed income securities by offering protection against inflation risk (which erodes purchasing power).
  • The prices of inflation-linked bonds respond to changes in real interest rates, instead of nominal rates, thereby providing protection against unexpected inflation as their coupon and principal value adjust accordingly.
  • The IL bond market is a high quality, liquid asset class.

Provide diversification:

  • The positive, but low, correlation of inflation-linked bonds compared to nominal bonds can be a diversifier in portfolios. The periods of lowest correlation often coincide with times of economic uncertainty and market stress, when diversification is of most use value.
  • Traditional asset classes such as stocks and bonds can be adversely affected by periods of persistent inflation, as their cashflows do not increase in line with prices. Inflation-linked bonds, with their explicit link to changes in the inflation rate, are an effective way to achieve real returns without substantially increasing risk.

Content of the articles featured in this publication is for your general information and use only and is not intended to address your particular requirements. They should not be relied upon in their entirety and shall not be deemed to be, or constitute, advice. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No individual or company should act upon such information without receiving appropriate professional advice after a thorough examination of their particular situation. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles. Thresholds, percentage rates and tax legislation may change in subsequent finance acts.


 

I have been a customer of Holden & Partners since its inception. During this time, no matter what the state of the financial climate, I have always found that their advice has been balanced and fair. They have a good understanding of everyone’s individual circumstances and produced tailored strategies to match these needs and expectations.

Duncan B, NHS consultant

I’ve always received high quality, personable advice at a time of my convenience. My adviser has often travelled to my home in order to provide very personal service. The advice given is clear and unambiguous. The risks of different types of investment have been clearly discussed to allow me to make an appropriate decision on the nature of my investment portfolio. This has been of great importance when considering the available investment options for my forthcoming retirement. I have always considered that Holden & Partners is very client centred and they have my best interests at heart. I have been with Holden & Partners since 1996 and have recommended them to friends and colleagues on many occasions.

Michael, Surgeon

Holden & Partners manage our company pension scheme with a totally professional and dedicated approach. They have worked with us over a number of years, and are able to explain the potential ‘minefield’ that is pensions, to make it perfectly accessible for the staff.

Jeremy, Print Management Partner

Holden & Partners offer everything I want from financial advisers. They are highly efficient, independent and trustworthy. They understand their clients and give them a great service. The peace of mind they offer me is invaluable in allowing me to get on with my work and family life.

Peter, director of publishing company

Holden & Partners provide me with a friendly, efficient and personalised service that has been tailored over time to meet my changing needs and priorities. I value their ability to always be one step ahead and lead me seamlessly through the maze of paperwork.

Helen, former Investment Banker

Holden & Partners clearly ‘read’ our financial needs and requirements very well. Most of our queries will have been well anticipated. Where changes of mind are offered, we get practical reasons, not excuses. And outside review periods we have the sense that the vigilance continues on our behalf.

Chris, professional copy-writer

On retirement after 40 years of salaried employment, I interviewed several financial advisers, amongst whom Mark Dodd of Holden & Partners was the nicest and seemingly the most understanding of my investment needs and priorities. Since then my wife and I have had regular (c.6-monthly) meetings with him in order to check and, when necessary, adjust the holdings in our portfolio. This has been very helpful and provided a comforting sense of confidence and security. I have recommended Holden & Partners to others and will certainly continue to do so.

Patrick, retired university professor

It’s easy to feel powerless in the face of global trends such as climate change and environmental destruction. But I feel I regain power as a consumer and a citizen by thinking about where I spend my money and to whom I entrust my savings. I chose Holden and Partners because they were recommended to me and because of their strong track record in ethical investments. It has proven to be a wise choice. Their advisors listened carefully to my needs and created an investment strategy and portfolio that has met and indeed continues to exceed my expectations. The culture of a company also matters to me, I have found their advisors to be well informed and financially shrewd but also easy to speak to and engage with. Many of us find it difficult to trust institutions and organisations these days, but I do trust Holden and Partners to make the right decisions on my behalf.
I would have no hesitation in recommending them to others.

Patrick, Advertising and Marketing Consultant

Read all our testimonials

Contact us

Whether it’s a question about your personal finances or how you can invest your wealth more ethically, we are here to help. Call us on 020 7812 1460, email info@holden-partners.co.uk or complete the form: