Like the credit crunch and the dotcom crash before it, bubbles emerge when the demand for an asset class inflates share prices far and beyond their true value. As soon as confidence in this valuation evaporates a frantic sell-off brings the whole house of cards tumbling down.
, the manager of the Ruffer Investment Company
says that such a scenario could play out in equity income stocks
. The FE Alpha Manager believes an environment of low-growth, low interest rates and high inflation are creating an insatiable appetite for defensive dividend payers. While investors’ can ride the wave to take advantage of the upside, Russell warns they need to get out before the party ends.
Here FE Trustnet looks at four other asset classes that provide a yield – and one that could be a good hedge should the bubble burst.
Russell has gone for inflation-linked bonds to combat the growing bubble. He believes that high levels of indebtedness in the UK will encourage the Bank of England to pursue a policy of currency devaluation leading to inflation as high as 9 per cent.
Index-linkers shield investors from this rise because the bonds’ cashflows are adjusted to compensate and ensure owners receive a real return.
The best-performing Index-Linked Gilt
fund over the long-term has been Newton Index Linked
, FE data shows. It has returned 116.27 per cent over the last decade compared to 101.76 per cent from the average fund in the sector. It is also top quartile over one, three and five years.
With yields on UK government bonds at all time lows, another alternative could be inflation-linked corporate bonds. This is a relatively immature market with the majority of issues coming from utilities companies and sectors where goods and services are pegged to inflation.
Infrastructure funds are a good alternative income provider for investors. Building new infrastructure, or replace ageing systems, takes a lot of investment – much of which comes from private investors. What is appealing about infrastructure investment is that it is largely independent of, and therefore uncorrelated to, the whims of the stock market.
An additional advantage if you believe that inflation is on the rise, is that earnings are often pegged to the consumer price index. Train companies, for instance, often increase prices in line with inflation plus a certain amount.
Most funds with exposure to the UK infrastructure sector sit in the closed-ended universe because projects require a finite and fixed level of funding and cannot be at the mercy of outflows.
John Laing Infrastructure
is popular among discretionary fund managers. Our data shows that it has returned 7.32 per cent over the last year compared to 2.16 per cent from the IT Infrastructure
It’s currently yielding 5.5 per cent. Like all five portfolios in its sector, the trust is currently trading on a premium – in its case, 7 per cent.
Traditional bond funds are the most obvious choice for investors looking for an alternative to equities for income. However, unless you are prepared to take a gamble in the junk bond market, bonds are yielding less than equities at the moment.
The upside is that having the extra diversification could protect your portfolio if the equity income bubble does indeed come into fruition.
Performance of sectors over 5yrs
Source: FE Analytics
The market crash which accompanied the 2008 financial crisis was characterised by a dramatic fixed income rally. Our data shows that the average Global Bond fund made 19.28 per cent in 2008 while the average UK Equity Income
fund lost 28.54 per cent.
Property has been a traditional hedge against falls in other assets and inflation because investors can get an uncorrelated yield via the rent paid to them by the tenants. There has never been greater demand for prime London property because wealthy investors see it as a good store of value in volatile markets.
Unfortunately, there are no open or closed-ended funds that give investors direct exposure to AAA tenants and CPI plus leases. It seems the only way to access this corner of the market is to buy-up swathes of high-end London property your self – something that few will have the fire power to be able to do.
There are, however, some decent options in the IMA Property
sector which have yields in excess of the FTSE. One specialist portfolio that might be of interest is the Freehold Income Trust
. The £156m portfolio attempts to provide a secure and stable return primarily by acquiring freehold ground rents, which offer both income stream and capital growth. It’s currently yielding around 4.3 per cent.
It has an unbroken track record of positive returns over 18 calendar years and has consistently out-performed cash, gilts and inflation over these periods. In a recent FE Trustnet
study, it was crowned the best risk/return fund of the decade
, thanks to its high Sharpe ratio over the period.
The fund’s status as an unregulated collective investment scheme (UCIS) means that it is out of reach of most IFA firms, since the FSA does not look on favourably at its poor liquidity. However, it can be accessed direct.
Whilst the shiny metal does not provide a yield like equity income, a dramatic fall in equity prices generally coincides with strong performance for safe-haven assets like gold.
In 2008 the gold spot price made a massive 46.1 per cent and provided double digit returns in the following three years. This has led to the commodity being one of the most successful investments of the last decade.
Investors can get access to the gold price via an exchange traded fund such as ETFS Physical Gold