Leading investment firm highlights interest rate threat to fixed rate investments

By David Lamb

A couple of days after I wrote my last blog, highlighting my concerns about fixed rate investments, I found a very interesting article written by Giulio Renzi-Ricci of Vanguard Asset Management Limited – one of the world’s largest investment companies and a leader in passive investments.

Giulio is concerned that the correlation between fixed interest and equities have converged to such an extent that bonds can no longer be relied on to perform their primary role as an anchor in times of market stress.

He goes on to say that there is worry that portfolios are too heavily exposed to duration risk (longer term bonds) which will mean they could be vulnerable if interest rates increase.

Another issue Vanguard has identified is that the rock bottom yields are compromising the function of bonds as portfolio diversifiers. They analysed the distribution of UK bond returns when UK equity returns were negative between January 2003 and November 2020 and looked at two scenarios: when 10-year gilt yields were greater than or equal to 1%, and when 10-year yields were below 1%.

When equities fell, government bonds provided higher returns than corporate bonds and cash. Because of this, government bonds can be good ‘shock absorbers’.

There is also concern that, if interest rates rise, the returns from equities could also turn negative (it will be more expensive for companies to borrow money to fund their growth, for example).

Portfolios with high fixed interest and equity holdings could be hit twice. Giulio concludes by asking if interest rates increase because economic activity is recovering and earnings growth is also increasing?

Would equity prices move up or down?

This would depend upon the relative forces associated with earnings growth or rates growth. Higher interest rates do not necessarily mean negative equity returns. Central banks are unlikely to start increasing interest rates unless they are reasonably confident in the economic recovery. If so, expect a positive impact on equity returns.

This brings us back to my last blog: take action!

We strongly recommend that you review your investment portfolios (including your pensions) to determine how much fixed interest your portfolios hold and seek advice as to how you can minimise the threat to your wealth if inflation and interest rates increase in the capital value of your fixed interest investments falls.

Lamb Financial is here to help.

The information contained in this article is provided for information purposes only and is based on the opinion of Lamb Financial and does not constitute financial advice or a suggestion to a suitable investment strategy. You should seek independent financial advice in regard to your own personal circumstances before embarking on any course of action.

Lamb Financial is a trading style of Lamb and Associates Independent Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority. FCA number 782092.