Many financial experts and commentators believe that the coming year will see increased investment in equities at the expense of bonds.
Given the volatility that has characterised markets in recent years, investors have tended towards bonds in the hope of securing a stable investment income.
However with returns from fixed interest investments struggling to outpace rising inflation, equity investment is becoming an increasingly attractive option.
Bank of America Merrill Lynch believe that 2013 will be characterised by ‘the great rotation’ as the recent dominance of fixed interest investments gives way to equities.
The use of quantitative easing by the Federal Reserve, Bank of England and other central banks was responsible for a period of high liquidity that provided a good environment for bonds. Merrill Lynch believes that we are now moving into a low liquidity, high growth period in which the focus will turn towards equities.
These convictions are reinforced by the fact that we are also moving into an inflationary environment.
Bonds will typically pay out an income at a fixed rate of interest and therefore a rise in inflation will see this return eroded. The Consumer Price Index is currently at 2.7 per cent and a level of inflation between one per cent and four per cent is seen as conducive to equity investment.
According to The Investment Management Association the last part of 2012 was characterised by bumper sales for equity funds. Whereas the first eight months of 2012 saw most investors placing their money into bond funds, the final four months of the year saw a shift in favour of equities. This trend has continued into 2013 and is largely due to the fact that many of the fears that acted as a drag on markets last year have now subsided.
The abatement of fears about conditions in Europe is welcome but the situation in the º£½ÇÊÓƵ remains fairly bleak. However this should not deter investment in º£½ÇÊÓƵ companies.
In contrast to the incessant torrent of bad news about the economy, the FTSE 100 has performed very well in the early part of 2013.
This is principally because the British companies which comprise the index have significant amounts of international exposure.
Some companies derive over 75 per cent of their revenues from abroad, giving them security against the tumult of the º£½ÇÊÓƵ economy.
FTSE 100 equity yields could increase to an estimated 3.37 per cent before the end of the year. This compares well to Government bonds and ISAs, currently offering interest rates of around two per cent. It is not unrealistic to assume that the Consumer Prices Index will have increased to three per cent by the summer and so equities will be a viable option for those looking to inflation proof their portfolios.
Henk-Jan Rikkerink is the head of European Equity Research at Fidelity and believes that the choice between fixed interest and equity income is a ‘no brainer’. Many stocks are now paying out more than the bonds issued by the same company making equities the best option for those in pursuit of yields.
Mr Rikkerink believes that there is a number of high quality, safe companies suitable for investment.
He is particularly keen on consumer goods and pharmaceutical companies along with the US tech sector – he points to Microsoft as a ‘strong cash rich company that offers the prospect of attractive dividend growth’.
Conversations about the pursuit of dividends always seem to revolve around the big name blue chip companies and this is justifiable given their track record.
However, it can make the selection of a diverse portfolio of income generating investments difficult. Stephen Message of Old Mutual believes that medium sized companies can also provide interesting opportunities.
Mr Message gives the examples of the pub group Greene King and broadband provider Talk Talk. In the wake of the financial crisis businesses are avoiding the accumulation of debt and have excess capital on their balance sheets.
This can be paid out to investors in the form of dividends and The Old Mutual fund manager believes that this will continue over the coming year.
A move towards equity investment looks set to be one of the major trends in 2013.
Inflationary pressures mean that fixed interest bonds can no longer be relied upon to provide income as they have been in recent years. Equity income in the form of dividends is therefore a viable alternative for investors with the appropriate attitude to risk.
* Trevor Law is a director with Merito Financial Services, chartered financial planners, based in Solihull.
* E-mail: tilaw@meritofs.com
