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Sunday, November 6, 2011

UK Inflation Imfact bond yields and pension funds

UK Inflation Imfact bond yields and pension funds : With inflation at a 20-year high, UK real bond yields at record lows and equity markets down over the year, the opportunities for investors are few and far between. But some managers are optimistic that inflation may hold a silver lining for equities.

According to data from a UBS Investment Research report “What are pension funds doing?”, published this month, the spread between 10-year UK government real bond yields and UK dividend yields is at one of its highest levels in 26 years, with dividend yields returning more than four percentage points more than gilt yield

The immediate future for gilt yields is poor. The latest UK Office for National Statistics inflation figures put both the consumer price index and retail price index above 5% in September, levels last seen in June 1991. As of October 6, UK real bond yields reached a low of 0.06%.

According to Paul Mumford, senior fund manager at Cavendish Asset Management, this may be a boon for equities managers. He said: “With inflation now running at over 5% – eroding the capital value of bonds – equities are rendered yet more attractive compared with fixed-income assets, which currently are struggling to provide investors with decent income.”

The reasoning behind Mumford’s hypothesis is the benefit of inflationary spikes. He said: “Supply sectors are able to use inflationary periods to push through legitimate price rises which would be difficult to justify – yet perhaps no less necessary – in an environment of low inflation. And once these price rises are in place, they are less likely to be reversed once volatility subsides.”

Equity managers are in need of good news. According to data from UBS, UK pension plans held, on average, more than 80% in equities in 1992. This had fallen to less than 50% by 2011. Conversely, pension funds have increased their allocation to bonds from 7% in 1989 to 35% today. William Dinning, head of investment strategy and economics at Kames Capital, formerly Aegon Asset Management, said: “The flip side of that is because we have got a very sluggish economy, and because we have got significant policy focus on a big chunk of the stock market, there is a concern for future earnings and dividend growth.”

Karen Olney, strategist at UBS and author of the paper, said that there had been some movement into equities, “but although they see value in equities, pension funds are waiting for a solution to the sovereign debt crisis before they allocate”. For many investors, though, it remains a case of minimising losses, rather than spotting profit-making opportunities.

Dinning added: “While a dividend yield of 4% is attractive, relative to a dividend inflation of 5%, I am not sure.” For the latest updates on the stock market, visit Stock Market Today For the latest updates PRESS CTR + D or visit Stock Market news Today

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