Equities or fixed interest – which way to turn during the credit crisis

The recent volatility in the Footsie and the extent of the fall out from the sub-prime mortgage market in the US have created an uncertainty, which may prompt some investors to take advantage of the credit crisis and also to seek some shelter from falling equity prices.

Fixed interest and cash offer safer option than equities, and the current climate is throwing up opportunities for the former.

Mark Dampier, head of research at Hargreaves Lansdown, says: “Fixed interest is beginning to look quite interesting at the moment, partly because it lacked any value ten or twelve months ago until the credit crisis. Investment grade corporate bonds don’t look half bad when you consider they are offering something up to 6% when interest rates in the UK look as if they might fall by close to 1%.”

Paul Craig, manager of funds of investment trusts at New Star Asset Management, says: “The levels we have seen corporate bonds spiking to has clearly made them an attractive looking asset class. And going forward, as we continue to see volatility, the factoring in of more downsize risk from a higher level of default will continue to make them a attractive asset class compared to equities.”

Jim Tennant, head of investment trusts at Gartmore, says: “At present there is some compelling value in corporate bonds, particularly in the lower grade issues, but I would expect this to correct as the credit crisis abates.”

Tennant acknowledges the opportunities but highlights that the fact that any short to medium-term gains will still not change the underlying view that long-term investment in equities offers a better return.

James Maltin, investment director at Rathbone Investment Management, believes that cash is definitely safer but says there will come at time when the markets turn and equities recover quite strongly.

And he refers to Barclays’ recent equity/ gilt study, which showed that over any twenty-year period the worst returns from equities are still better than those from bonds or cash.

“It’s only over the past ten-year period in which equities have underperformed and only the third time in the stock market’s history that that has happened.

“Statistically one would expect there will be some considerable reversion to the mean, which means equities will now in the next decade outperform bonds and cash,” he says.

Another drawback to increasing your exposure to fixed interest and cash is the smaller choice of funds in the investment trust universe.

Craig and Dampier say that an investor would actually have more choice from the unit trust sector to get this kind of exposure.

However, for those investors who are not sure whether they should be considering a safer option / better return, Maltin reminds us that: “One of the benefits of effectively allocating funds to investment trust managers is that within the portfolio themselves, they have the flexibility to raise cash and effectively reduce gearing, which means you don’t have to sell your holding.”

1 March 2008