Ups & downs
5 Jan 10
Interest rates, tax hikes, the property slump and the spectre of a double dip recession have placed added pressure on making solid investment decisions. CA Magazine’s panel of experts give their views on which direction to take
How are advisers helping their clients to prepare for expected tax increases, including a top tax rate of 50p? What sort of investment decisions will they need to be making as a result and should we be concerned about any other likely tax hikes for the well off?
SANDY CROSS: The cumulative effect of the changes announced in the 2009 Budget will see taxes increase, particularly for those with higher incomes. For example: someone with a constant income of £250,000 will see his or her tax bill shoot up by about £13,600 between this tax year and 2011/12.
The other major change alters the traditional tax efficiency of pension contributions for people with a higher income. From April 2011, people with an income of £180,000 or more will receive basic rate tax relief only on pension contributions. This is a major departure from the current position where people get tax relief at their highest marginal rate [see also Ian Harper, page 26].
It’s unfortunate that further complex changes have been introduced to the pension and tax rules but it is important that you consider the impact it will have on your future. If your income is below £150,000, pension planning can continue as before. There is even an argument that it should be accelerated, if income may exceed £150,000 in future. If your income is above £150,000, seeking independent financial advice is essential.
JOSS MITCHELL: Income should always be protected in the most tax efficient way possible. Simple tax planning includes, where appropriate, allocating income-producing assets between spouses to ensure that full advantage is taken of lower tax bands and individual allowances.
When investing, it is now generally more attractive to focus on vehicles that provide capital gains over income. However, we would caution against overly complex schemes as the Inland Revenue will be focusing on this area and both income and capital gains tax rates obviously remain subject to change.
ALASTAIR MACKENZIE: While there remains a disparity between the income tax and capital gains tax rates, we will continue to advise clients and structure portfolios to focus on investments that offer capital returns, and should there be a spending requirement that needs funding, that this be achieved by a series of cash flows derived from capital returns rather than from income distributions –interest and/or dividends. Beyond this, we would encourage clients to utilise the range of tax efficient wrappers that are available, including ISAs [individual savings accounts], offshore bonds, enterprise investment schemes, venture capital trusts, maximum investment plans and, within limits, pensions.
Have cautious investors already missed out on the stock market rally? What are the chances that we are heading for a “double dip” recession in the UK?
MARTIN SMITH: Global stock markets have recovered significantly since their lows in March this year. However, we would never advise anyone to invest in the hope of gaining a significant return over the short term. We believe investors should focus on long-term goals and objectives. No one can accurately predict the movements of the stock market, therefore, regardless of whether the stock market is headed for a “double dip” or a slower recovery, investors should continue to plan for the long term.
SCOTT WYLIE: Despite the sharp increases we have seen, with low interest rates at present and an improving economic environment, there will still be opportunities for cautious investors to make money. While they may wish to underweight equities, which may be volatile, or trade sideways from here, we feel there is still value to be found in corporate bonds, index linked gilts and commercial property, all of which we believe will deliver positive returns over the course of this year.
MACKENZIE: Continued strength from current levels will depend on future trends in profits and valuations, and there is reason to be cautiously optimistic on both counts in our view. We see three key supports to this case for equities: a vigorous recovery in quoted sector profits; a friendly interest rate environment; and undemanding valuations, underpinning rising profits.
Of course, it is extremely unlikely that equities will rise in a straight line from here. At some stage, the pending rise in long-term interest rates, even as short-term rates remain low, may unsettle investors’ nerves and reduce equities’ apparent yield attractions.
GRAEME LIND: Cautious investors should have invested all through this period. It is not about calling the bottom or the top of the market. If you had stayed fully invested over the past 20 years, your return would be 7.4 per cent, but if you had missed out on the best 20 days, it would be only 3.9 per cent.
In the long term, equities will continue to be the best asset class, but performance throughout the 1980s and 1990s is clouding judgement about what a “normal return” should look like.
CROSS: Interest rates remain exceptionally low and this has undoubtedly prompted investors holding large cash positions to invest in higher yielding assets. With many economic statistics showing an encouraging recovery from the depths of recession earlier in the year, there seems little on the immediate horizon to unsettle investors’ appetite for risk assets.
Consumer spending remains a key area of uncertainty, but even here, there have been tentative signs of improvement.
Government finances remain the main focus of investors’ concerns.
The extent and pace of these measures may yet unsettle equity investors, and as a result it is our expectation that volatility will be a feature of capital markets for some time. It remains important, therefore, that any investment strategy focused on risk assets has an ability to control periods of downward market volatility.
JUSTIN URQUHART STEWART: The question for this year will be – what happens when the economic stimulants are withdrawn, quite probably later in the year? Pull back too early and the economic recovery could fall back and shares look significantly overvalued – too late and we could see a bout of very unpleasant inflation. If you are investing on a five-year time frame and you are spread across the globe and across all the asset classes, then cautious investors can still invest, but not so heavily in the equity market – say only 25 per cent globally.
SCOTT MURRAY: The global financial crisis has had a silver lining in the sense that stimulus packages around the world have been directed at boosting the environmental economy. This recession has given the governments of the world the opportunity to create a green economy.
In 2009, governments around the world responded to the economic crisis by committing $2.8 trillion to a global stimulus package. Fifteen percent of this – $430bn – is earmarked for green infrastructure.
Property has been through a severe slump, but is it now time to think about getting back in? If so, what would be the best route for an individual investor?
URQUHART STEWART: Commercial property is still going to have a difficult time, but among the debris there may still be value. However, investors must remember that cheap does not necessarily mean good value; it will depend on the property’s ability to retain paying tenants and provide a yield. If you can find a portfolio with recovery potential this is a good time to get back in.
For residential property the picture is still being clouded by the lack of volume. Low levels of lending, lack of supply and weak confidence will all contribute to a flat market. Add to this the unwinding of the buy-to-let madness and there will be further losses to come here.
MACKENZIE: The UK property market underwent an unprecedentedly rapid decline over a two-year period from June 2007. Total returns again turned positive in August of this year accompanied by a stabilisation in yields at just below 8 per cent, which in historical terms looks high versus yields on gilts and corporate bonds. However, while prime yields are now starting to contract, there remains ongoing softness in off-prime assets, which may be compromised by location, tenant quality or lease length.
BRYAN JOHNSTON: Property cycles are notorious and this looks no different to its predecessors. The building of new commercial property has ground to a standstill, which means that, at some point over the next three or four years, rental incomes will have to rise as a buyers’ market moves the other way.
There are undoubtedly opportunities at present for prospective tenants, but it is also likely that, as the property market stabilises, some of the banks will attempt to unwind their exposure, dampening down commercial property prices in the nearer-term.
LIND: Property is a great example of when tactical calling doesn’t work. Many investors were suckered into a higher percentage of holding in property than they should have had.
We think property is reasonably attractively priced, especially prime buildings with existing blue chip tenants. But it’s hard to call when you should get in or out. Collective investments such as unit trusts, or OEICs [open-ended investment companies] can invest in a spread of properties. It’s important to beware of vehicles that are actually stock market funds as much as they are property funds – that could leave you overexposed to equities.
SMITH: A number of investment managers have moved back into the property market due to the comparatively attractive yields available, but there are still a number of property funds that remain suspended due to lack of liquidity, highlighting the risk of investing in a single asset class.
With interest rates remaining at historically low levels, returns on cash deposits are also low. What are the alternatives for investors looking for an income, but where security of assets is the primary concern?
JOHNSTON: Cash is likely to remain of little appeal to income-seeking investors for some time. After tax, and today’s even moderate rates of inflation, the purchasing value of both a cash deposit principal and its income yield is falling. There are alternatives, including: UK Treasury issues, although they have rallied strongly and now look fairly fully valued; corporate bond funds; and corporate bonds themselves.
There are also a number of equities with substantial yields, especially smaller issues, which might imply a higher degree of risk but are supported by solid balance sheets and a misunderstood business model. It is essential that advice be sought.
LIND: We see many people in the market taking on more risk than is appropriate. For example, there are “cautious managed funds” that can be up to 80 per cent equities! Defensive clients should have an exposure to all the main asset classes, but the percentages will depend on their appetite for risk. If you wanted no risk at all, national savings would be an option. Top end corporate bonds are worth looking at, and individual investors can access these through collective investment vehicles that invest in bonds.
Ethical investors now have a wider and diverse range of companies and funds to invest in, for income and capital growth.
These companies and funds are at the heart of an ethical strategy that will provide solutions for the world’s greatest challenges. While ethical funds can deliver excellent income prospects, investors will also be investing in securing the existence of future generations.
MITCHELL: If the last year has shown us anything, it is that “cash alternatives” are not cash. As high street savings rates decline, investors naturally look for alternatives, but there is no magic solution. Enhanced yields can be achieved, but only by taking on some element of risk, however small. This may not be appropriate for investors where the security of assets is all.
For investors who are prepared to move up the risk curve in search of increased returns, we suggest high-quality corporate bonds and capital protected structured products.
URQUHART STEWART: This has been an especially difficult aspect for those with little choice in this area, including trusts and charities.
The answer is to address this with a very cautious and broadly spread portfolio with a measured and managed low volatility and a greater predictability of lower but potentially steadier returns.
This could be made up of a low level of equities (12 per cent), a greater proportion of a blend of global corporate and government bonds, including index linked, along with property, cash, commodities and other alternatives.
WYLIE: Index linked gilts should perform strongly when inflation does return. Corporate bonds are looking very good value at present. While there is a risk of default, investing in a fund of these bonds reduces that risk. Property, too, is yielding 8 per cent in many cases.