Nearly all investors have been "Gilt-y" of being drawn to the tax-free returns offered by short-dated UK government gilts—and I'll admit, I'm no exception. To understand the recent obsession with these instruments, it's important to revisit the economic backdrop that made them so appealing.
The global pandemic disrupted economic norms in unprecedented ways. In a short span we transitioned from zero interest rates, and negative oil futures prices to an inverted yield curve, multi-decade high interest rates, and rampant inflation. Amid this upheaval, a compelling opportunity emerged for investors: a wave of recently issued gilts with sub-1% coupons now trading at yields-to-maturity (YTM) of 5% or higher
For clients with excess cash, this presented a compelling alternative to taxable savings accounts. Additionally, for those holding amounts above the FSCS protection limit of £85,000, gilts provided the added benefit of mitigating the credit risk associated with keeping large sums in the bank. Before long, these ‘cash proxies' started appearing in multi-asset portfolios. A 5% risk-free rate forced wealth managers to reevaluate the attractiveness of nearly every asset in their portfolio . The additional yield pick-up from investment-grade and high-yield bonds no longer made sense after factoring in taxes. Alternative allocations, often filled with funds that had over-promised and under-delivered, became even harder to justify. Perhaps for the first time in decades, serious questions arose about whether future equity returns would adequately compensate investors for taking on additional risk over cash. With most investors long term equity returns assumptions sitting between 7-8% gross of fees and tax, did it make sense if cash is offering 5%?
Not only did certain asset classes lose their appeal, but the entire 60/40 multi-asset proposition offered by DFMs came under scrutiny. A medium-risk mandate, typically expected to deliver around 6–7% gross, saw its attractiveness diminish when accounting costs and taxes relative to short dated gilts. This challenge was compounded by a wave of articles proclaiming the death of the "60/40" portfolio, following the painful experience of multi-asset investors in 2022.
Fortunately, the anticipated demise of the 60/40 portfolio didn't materialise. The ARC Steady Growth PCI benchmark delivered 12.2% over 1 year to end of Sept 2024. On a longer-term basis is it wise for clients to stay in cash? Clients primarily seek out the help of investment managers to help them grow their assets over the long term ahead of inflation usually to meet their retirement spending requirements. Unfortunately, cash returns have had a terrible track record of staying ahead of inflation. The total inflation adjusted returns of cash over the last 30 years is 0.07%! Minus 30 years of fees and it's likely that client is going to have a much more frugal retirement then they had originally planned. In stark contrast, equities delivered a 482% inflation-adjusted return over 30 years. There is also the concern that investors who endured the pain of rising rates and falling bond prices in 2021 and 2022 have since shortened duration, effectively locking in a permanent loss of capital. As a result, they may miss out on the recovery in bond prices that could occur as rates normalise.
Bloomberg: Solactive US Large Cap Index, Bloomberg US Treasury, Effective Federal Funds Rate. US CPI. 31/10/1994 to 31/10/2024.
Clients need exposure to equities to achieve their long-term objectives. However, an all-equity portfolio is likely to exceed the risk tolerance of many investors. Including long-duration bonds can help mitigate significant drawdowns during recessions and reduce overall portfolio volatility. Furthermore, to prepare for periods when equity and bond correlations rise, it makes sense to include an allocation to alternatives for added diversification.
Join me as we delve into the opportunities within equities, bonds, and alternative asset classes to build a portfolio aimed at achieving superior long-term, inflation-adjusted returns compared to short-dated gilts. This content is brought to you by Atlantic House, by clicking either "Fixed Income", "Equities" or "Alternatives" you agree to the data protection statement below.
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