Most UK investment managers have spent the past week pinned to their screens, watching the impact on their funds of the UK market turmoil. But a British investment house executive spent the week poolside in Dubai, worrying about his hotel bill.
“I watched my vacation get more expensive by the day,” he said. But his own worries about the upheaval in the pound have been overwhelmed by the scale of the financial crisis gripping London. “It’s really one where we probably won’t see something like this again in our careers.”
Although the pound and government bonds rebounded after a huge £65bn intervention by the Bank of England, the market turmoil following Prime Minister Liz Truss’ ‘mini’ budget will inflict pain sustainable, according to wealth managers.
They expect further pressure on living standards, with damage from higher energy bills, even higher inflation and increased borrowing costs, especially on mortgages.
“It will hit households in terms of inflation, higher interest rates and a tougher mortgage market. . . and a push out of the point at which inflation peaks,” says Richard Flax, chief investment officer at digital wealth manager Moneyfarm.
While some daring investors like to spot opportunities in a sell-off, the cloud of uncertainty that already hangs over the markets from the war in Ukraine, energy prices, inflation and economic distress does not only darkened.
“There’s a lot of nervousness,” says Alexandra Loydon, director of partner engagement and advisory at St James’s Place, the UK’s largest wealth manager.
She spent the week talking to SJP’s army of 4,600 financial advisers, who answer questions from 800,000 clients. She says, “It’s hard to offer certainty and reassurance in such uncertain markets, but encouraging the right behavior is really important . . . don’t start moving assets and stay invested.
How do wealth managers assess what happened in the markets this week?
While the fall of the pound sterling grabbed the headlines after Chancellor Kwasi Kwarteng’s speech, the drama that erupted midweek in Britain’s public debt was arguably much more significant for finance professionals and investors. ordinary savers.
UK sovereign bonds, known as gilts, saw some of their biggest moves. “What we’ve seen is sort of a crisis of confidence in both the gilt market and the pound,” says Peter Spiller, director of investment trust Capital Gearing.
Duncan MacInnes, chief investment officer at Ruffer, says gilts have seen “absolutely wild swings for a world’s premier sovereign bond market.”
The BoE stepped in after falling prices posed a serious threat to pension funds by using special strategies known as liability-driven investing (LDI) to manage risk.
The yield – the interest rate that rises when prices fall – on Britain’s 30-year gilt, which hit a 20-year high of more than 5% on Wednesday, fell to 3.85% on Friday morning.
The intervention leaves the BoE torn between a promise to raise interest rates to fight inflation and an emergency money-printing operation. Professional investors are still betting on further central bank rate hikes. “At this point, they’ve only added to the confusion,” MacInnes says.
Will mortgage fears fuel the cost of living crisis?
Public debt markets are important for households because they establish the basis for mortgages and other personal borrowings.
Loydon said customers were starting to grapple with the impending “massive impact” of the rate hike and asking questions.
The average standard variable mortgage rate, which had already hit its highest level in a decade – above 5% – at the start of the month, could now reach 6%.
The turmoil has made it difficult for vendors to price new fixed-term deals, with thousands of products pulled. Around 600,000 fixed-rate mortgages will expire by the end of the year, with 1.8 million to be renewed next year, according to UK Finance.
The government-imposed cap on energy prices has somewhat mitigated the immediate cost-of-living crisis, limiting the maximum expected inflation rate over the next few months to around 10%. But utility bills continue to rise and, with Truss’ economic plans likely to increase government borrowing, the upward pressure on inflation could last longer.
While many wealthy households who are the wealth managers’ clientele will benefit from the end of the top 45% tax rate on incomes over £150,000 a year and a reversal of the tax increase on dividends, these gains, for many mortgage holders, be offset by higher interest rates.
Rachel Winter, partner at wealth manager Killik & Co, says mortgages have “replaced energy bills as the number one fear in the UK. . . You have almost taken away the benefit of giving people a lower tax rate.
Meanwhile, wealth managers say clients often underestimate the impact of moves in the pound. While the pound had recovered most of its lost ground on Friday – trading at around $1.12 to the US dollar, from a low of $1.03 – it is still widely seen as fragile. Much depends on the government’s reaction to the approach of the announcement of its budget plan in November.
“A devaluation of the pound is inflationary and means the cost of living squeeze will get worse,” says Edward Park, chief investment officer at Brooks Macdonald.
What should I do with my wallet?
The good news for many savers is that global investments can provide protection against the UK turmoil. In particular, if the British pound weakens, overseas assets are worth more in British pound terms.
“If you’re a sterling-based investor with a well-diversified portfolio, a weak sterling helps,” says Janet Mui, head of market analysis at wealth manager Brewin Dolphin.
Wealth advisors have been inundated with questions from clients: whether they should buy sterling or gilts at current prices, or reduce their sterling holdings in case the currency drops to new.
Experts strongly advise individuals not to make any sudden moves. “It’s the old advice: if you’re going to panic, panic first. If you haven’t panicked yet, it’s probably a little too late,” MacInnes says.
But the uncertainty in the UK highlights the importance of diversifying outside the domestic market. A majority of UK retail investors have allocated more than a quarter of their portfolio to UK equities, according to a Quilter survey last year, despite the country making up just 4% of the MSCI World index.
The UK’s FTSE 100 index itself brings global exposure, as its companies derive 80% of their revenue from overseas. This gives exposure to foreign currencies, but it still limits choice for companies, particularly because the UK market is energy and mining heavy and tech light.
Wealth managers say their clients are also concerned that higher borrowing costs threaten property prices. “For the past few decades, property has been something you can live in and doubles as a diversified investment portfolio,” says William Hobbs, chief investment officer at Barclays Wealth & Investments. The market crisis has challenged the assumption that house prices would steadily rise, he argues.
“That’s why you need to have diversified exposure to the global economy, not just to a particular street in the UK.”
Capital Economics predicts bluntly: “A recession and a sharp drop in house prices seem inevitable.”
Meanwhile, investors should be wary of investing in highly leveraged companies as borrowing costs are rising rapidly. “Debt is the source of trouble, whether you’re an individual, a company or a country,” says Christopher Rossbach, managing partner at J Stern & Co. He recommends looking at corporate balance sheets.
Gold, the traditional safe haven, has done well as a hedge against sterling, rising around 16% over the past 12 months. But it’s down in dollar terms, suggesting there might be better ways to hedge. “I would be very suspicious of anyone who tells you that whatever the question, gold is the answer,” says Hobbs.
Gold also does not earn income, so it becomes less attractive as interest rates rise. Although bonds have fallen dramatically this year and the UK gilt market has been in turmoil this week, in the longer term the rise in yields is starting to entice investors back into debt securities.
“We have a lot of clients who I think hold too much cash,” says Winter. “It is now possible to have a fairly diversified portfolio of fairly senior corporate bonds with a yield of around 6%.”
Savers who want to hold cash, despite the threat of inflation, are advised to find the best rates, as banks vary and many high street lenders have mediocre offers.
The return of decent interest rates on deposits and bonds means a big change for savers. MacInnes says, “It’s a profound shift in the investing landscape that has come out of nowhere over the past six months.”