Unorthodox monetary policy was initially envisaged as a short-term measure. However, there is now reluctant acceptance that this has become orthodox policy, with even negative interest rates introduced in some regions and potentially on the horizon in others.
Focusing on the UK, there has never been a longer period of consistent rates going back to the beginning of the 20th century – with the exception of the period when rates were at 2 per cent between the 1930s (which included the Great Depression) to the early 1950s.
Incidentally the average UK base rate since the turn of the last century is 5.44 per cent, which may surprise some. To put this environment into perspective, 10-year gilts currently yield around 1.4 per cent, and the long-run risk-free rate and UK base rates are at 0.5 per cent.
This environment was unthinkable pre-GFC and, even in the following years, was considered an aberration that would quickly reverse.
Unfortunately, I am among those to have been proved wrong on rate expectations, although I do take some solace from the fact that my rate-predicting powers are similar to those of the Monetary Policy Committee.
Pre-GFC, a 5 per cent yield on a balanced income-orientated portfolio was relatively straightforward – today gaining a yield of 3 per cent takes some work. The problem arises in the form of retail and some institutional clients being wedded to a portfolio yield of 5 per cent.
This is understandable, given what was historically produced pre-GFC. But to put it into perspective, a 5 per cent yield is ten times that of UK base rates. Should we be providing a yield of 50 per cent if base rates ever reach 5 per cent?
The previous environment no longer exists and therefore neither does the yield. Many clients will have budgeted for a 5 per cent yield and are consequently disappointed that this return is unavailable. So what can be done for our clients?
Unfortunately, few of the options are palatable – increase the level of risk, retire later and build up a larger portfolio, or take income from capital, which can lead to permanent impairment.
I concede there are now more income-orientated products; there are even Japanese equity income funds.
But few equity income asset classes yield above 3.5 per cent on a consistent basis – the UK currently does so, but the outlook for the stocks making up the yield for the market is challenging.
Despite there being some interesting opportunities in the closed-ended space, there is still a dearth of innovative income funds.
This is particularly true within the alternative space being provided by our friends on the manufacturing side of our community. That this is the case leads me to the view that there is no simple solution.
This therefore leaves those of us in the wealth management space needing to educate clients that 3 per cent is the new 5 per cent.
James Calder is research director at City Asset Management
