Investment Comment: Investing in a low interest climate

THE BANK of England’s decision to link interest rates to unemployment was widely expected. Accordingly, interest rates could remain at all-time lows until at least the middle of 2016. So what does this mean for investors?

Savers will be the worst hit by the pledge of three more years of low interest rates. So they should focus on trying to get a yield which beats inflation. There is very little value to be gained by holding your money in cash for more than one year.

Instead, savers should consider higher-yielding alternatives. Low interest rates, loose monetary policy, and greater certainty should be good for shares, for example. Consumers and companies have more certainty on the future, so can now make the big investments they had been avoiding, which will feed through to economic growth. In particular, we could see equity income continue to perform as savers and investors continue to struggle for income options.

The JO Hambro UK Equity Income fund offers an above inflation yield of 4.15 per cent and has a bias towards more economically-sensitive areas. Its managers favour areas where they believe the attention of investors is much lower, such as bus and rail, and telecommunications firms. This fund should do well if growth continues to improve and interest rates remain low.

Residential property has already benefited from the Help to Buy plans announced in this year’s Budget. But any concrete guidance on official rates staying low until 2016 will be of particular interest to property buyers, especially those seeking a mortgage. Certainty of low interest rates means people can more confidently take out a bigger mortgage, and should help stimulate the property market.

However, buyers should be wary of borrowing too much at such low interest rates: what is affordable now becomes much more expensive when interest rates rise. And investing directly in residential property requires a lot of skill and specific knowledge.

Property is a big investment and highly illiquid. Not only is it difficult to sell, but investors cannot sell a portion of their investment – they either sell the lot or none at all. Property investors should be wary of headline income rates, as these often ignore maintenance costs, mortgage costs and vacancy fees.

Alternatively, investors can buy shares in companies which will benefit from the growth in residential property prices, such as house builders or materials companies. Paul Spencer, manager of the Franklin UK Mid CAP, currently favours sectors including housing, financial services and industrials. The fund currently has 7.58 per cent in house builders.

Traditionally, gold has acted as a hedge against inflation, so has been sensitive to indications on whether the US Federal Reserve is going to taper quantitative easing (the precious metal is priced in dollars). Inflation fears may have receded, but longer term inflation is likely to reappear. Investors can access gold through Exchange Traded Funds – like Source Physical Gold ETC – or through an investment fund.

Sebastian Lyon, manager of Troy Trojan fund, has exposure to gold and gold mining equities; inflation-linked government bonds in the UK and US; and cash. He still believes in the case for gold, despite the recent drop in price. He took the fall as an opportunity to add to his holding. He thinks the ultimate debasement of paper money through inflation and QE means there is a place for gold in a portfolio.

Giving guidance on when interest rates are likely to rise should help to keep government bond yields at their low levels, and reduce volatility in the bond market. Gilts do not look attractive at current levels, although corporate bonds are offering rates of 4 to 5 per cent, which will appeal to investors who are getting less than 1 per cent returns on cash.

Jupiter Strategic Bond Fund, managed by Ariel Bezalel, has the freedom to invest across the fixed-interest spectrum, from traditional government and corporate bonds to higher risk high yield bonds that behave more like shares. The fund can also invest overseas, potentially benefiting from currency movements and falling bond prices.

Adrian Lowcock is senior investment manager at Hargreaves Lansdown.