Search for yield will end in tears

Dan Jones

How should we react to the prospect of higher UK interest rates disappearing over the horizon? We’ve been here many times before, but today a rate hike looks as far away as it ever did – not before 2020, by some forecasts.

This looks like good news for the investment industry’s marketing departments. The hunt for income will remain just as voracious as it has been over the past seven years, and appetising yields will be the order of the day again.

I wonder, however, whether this latest postponement could prove to be rather ill-timed – whatever your view on just how well the economy would deal with higher borrowing costs.

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Consider the outlook from an investment perspective. Mainstream sovereign bond yields are still unattractive. Some of the perennial UK equity income staples, by contrast, are offering juicy dividend yields – fund managers, however, are rightly wary of just how sustainable these are.

In this environment, it seems likely that alternative ways to generate income will continue to attract plenty of interest. So far, many of these esoteric products have proved more than capable of meeting their lofty return targets. But it must be asked: is there a sustainability question here, too?

We also know that an era of easy monetary policy has led to the prices of all manner of assets being bid up. The start of a rate-rise cycle, had it come this year, may just have helped cool down that process.

It may also have encouraged investors not to venture too far off the beaten track when it comes to their pursuit of income.

Warnings of this kind have been around for as long as rates have been low. The problem is they’re easier to ignore when returns are good.

There are signs those same returns are now faltering, however. I’m thinking in particular of the alternative debt funds which have struggled in recent months, though they are far from the only products to be suffering in more difficult market conditions.

The wider point is it’s not so much faltering performance that should worry yield-hungry investors as the possibility that capital may also be at risk.

Few of the alternative income vehicles to have sprung up in recent years have been tested by a more difficult investment backdrop. I’d look closely at the assumptions which underpin their ability to deliver these attractive yields.

A reach for yield always ends in tears, and I’m not sure even the latest ‘new normal’ environment of ultra-low rates will be enough to help – not now we’re entering another phase of the investment cycle, at least.

Dan Jones is editor of Investment Adviser