InvestmentsMar 29 2012

International stardom

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To shed some light on the prospects for equity income funds today, it is perhaps worth reviewing these in the context of market behaviour in the current political and economic environment.

Encouragingly, equity markets have entered 2012 on a strong footing. The optimism that accompanied a more positive economic outlook has seen an easing in the demand for perceived safe havens; while equity markets have enjoyed the increased attention. In March, the S&P 500 surpassed the 1400 mark, a feat not achieved since 2008, and the Dax burst through the 7000 mark.

The macro picture has been helped more recently by a moderate improvement, or at least stabilisation, in economic data, and central banks worldwide are providing support through accommodative monetary policies.

In Europe, the central bank has taken the immediate funding pressures off the table by issuing unlimited discounted three-year loans through its long-term refinancing operation. Although these recent moves fall short of addressing issues of sovereign insolvency and cannot serve to disentangle the region’s political complexities, quantitative easing ‘European style’ is at least providing a more stable platform and should allow for more constructive negotiations towards greater political and fiscal stability in the region.

Across the pond, the US Federal Reserve commented that rates would likely remain low through to late 2014, while there are signs of tempering inflation in China.

These factors support a more constructive macro view in the near-to-medium term, and should prove positive for risk assets globally in 2012; but what does this all mean for investors on the hunt for yield?

Real interest rates have plummeted with authorities flooding the markets through loose monetary policies in an effort to stimulate the economy. With the prospect of negative returns on cash and the highest quality sovereign bonds offering either negative short-term yields or low single digit 10-year yields, the burgeoning demand for income is being met with short supply.

As investors flocked to the perceived safety of government bonds during 2011, yields at the end of the year on 10-year US treasuries and 10-year German bunds hit 1.9 per cent and 1.8 per cent respectively – falling a good way short of the guaranteed rates of return on life insurance products (offering average annual yields of approximately 2.8 per cent), and leaving corporate pension funds delivering annual rates of return grossly shy of the, rather optimistic, forecasted long-term rate of return of 8 per cent a year. Yet fund flows in 2011 continued to show a preference for fixed income assets.