Redmayne-Bentley Investment Column: Tulips, technology and Tesco – what to do with fixed interest in your portfolio
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ONE of the risks highlighted for 2011 is that of over-inflated prices of fixed interest securities coming crashing back down as the bubble bursts. Economic bubbles are not new: in the 1600s the Tulip Bubble (or Dutch Tulip Mania) saw the price of a single tulip bulb rise to astronomical levels – reportedly more than ten times the average annual salary of a skilled craftsman – until demand dropped and prices plummeted back to their original level within about six months. In 2000 we saw the bursting of the technology bubble, as prices of technology companies reverted to the norm after a year during which they had deviated from their intrinsic value into the realms of hype and speculation. Fixed interest investments are those such as corporate bonds, which pay a fixed rate or ‘coupon’ until an agreed date in the future when they redeem, or pay back a fixed capital sum. Money has flowed into the asset class as investors sought new sources of income when interest rates fell. The extra demand sharply pushes up prices, but if interest rates rise – as is widely expected to happen in 2011 – investors will start selling bonds quickly pushing prices back down. Investors are therefore left with a dilemma: how to maintain the required income levels without risking being caught with a dud tulip. The first point to note is that the impact of an interest rate rise on bond prices will act like a reverse ripple effect, in that an interest rate rise now will have more of an effect on bonds that redeem further into the future than it will on bonds that are due to redeem in the next few years. So move your bond investments to shorter-dated issues which are not as volatile. The next step is to look at esoteric fixed interest investments such as callable bonds or convertible preference shares. These carry more risk than traditional corporate bonds and the terms and benefits may vary, so they may not be suitable for everyone. The Co-Operative has a bond which is undated, and as mentioned above this would usually imply greater volatility. However, this particular bond is callable in 2014 i.e. it can be redeemed on this date at the company’s discretion. With expectations that inflation and interest rates will rise further, it is likely that it will be called making it shorter dated. At the current price it offers a yield to call in the region of nine per cent, a significant premium over traditional short-dated fixed interest investments. Alternatively, Leeds-based Premier Farnell has a convertible preference share which gives investors the right to convert into the ordinary shares in the company. It also pays a fixed dividend and in 2016 will redeem at a fixed price, which is at a significant premium to the current price. The conversion terms mean this course of action is not currently worthwhile, however you can still benefit from the fixed dividend and the capital gain on the price to redemption, in a similar manner to a bond. The next option is to look for a ‘fixed income proxy’ – something that pays a healthy, steady income stream from a stable source. We are moving here more towards equities, so the risk profile is a little higher again. Infrastructure Funds invest in PFI and PPP schemes such as hospitals, bridges and toll roads. The income streams and therefore dividends are often government-backed, providing more security and stability than many equities. There are several infrastructure funds out there, with yields in the region of five to six per cent. The different funds vary based on whether they are involved in the riskier construction stages, and whether they invest in projects just in the UK and Europe or into emerging markets and your appetite for risk will determine which one is right for you. The final option is a rare one, but one that is available right now: that is to buy a corporate bond when it is first issued, so you are not paying inflated prices and you should get back what you originally invested. Tesco Bank is launching a 5.2% bond that will redeem in August 2018. Investors can buy this at £1 (minimum investment £2000) and Tesco Bank aims to pay back £1 on redemption in 2018. In the meantime investors will benefit from a fixed rate of interest of 5.2 per cent paid in half-yearly instalments. The deadline for applications is close of business on Thursday 17th February, although it may close earlier if demand is very high, so you need to take action now if you are interested. Full details, including the prospectus and instructions on how to apply are available at www.redmayne.co.uk/tescobond/desk . If you would like further details on how our investment managers can construct a portfolio to meet your or your clients’ needs please email your enquiry to g.mitchell@redmayne.co.uk Please note the details above are for information only and do not constitute a recommendation to buy. You should consult an adviser as to the suitability of any investment for your own personal circumstances. |
