The balance between the search for yield and risk appetite

It is common knowledge that low interest rates and the availability of government funds to banks have hit savers hard. During a period when people who were worried about volatile markets placed their faith in cash, they have been disappointed by deposit rates. The consensus is that low rates are here to stay for a few years more. RBS is forecasting a rise in base rates in Q4 2016, while PWC doesn’t expect gilt yields to rise above 3% until 2014 and over 4% two years later.

In the traditional fund market, the IMA reports that the best-selling funds in 2013 have been Pan Asia (ex Japan) and other emerging markets and UK equity income. Investors appear to be willing to put more risk on the table to generate yield and growth.

Corporate bond funds are not as popular as they were this time last year, perhaps because yields remain low and central bank policy has resulted in narrowing funding spreads for banks.

In the UK retail structured investments market, there is a similar trend. Last year, around two-thirds of sales reported on the website were capital-protected solutions, with the remaining one-third being non capital protected. By contrast, in the year to date, the position has been reversed, with two-thirds of structured investments putting capital at risk.

This trend towards putting capital at risk has been replicated on a smaller scale in Europe, which has seen increases from 50% to 60%, and globally, from 60% to 65%.

The primary drivers include the combination of low interest rates and tight credit spreads that is making the terms on capital-protected products less attractive, as has been well documented in this blog.
I recall seeing similar trends when I was at Coutts in the early “noughties”. UK clients investing in high-yielding sterling placed more of their money in capital-protected deposits. In contrast, customers across the globe holding low-yielding US dollars tended to invest in higher-risk equity reverse-convertible bonds and dual-currency strategies.
Low rates are not the only explanation. Equity markets have generated better returns recently and are more appealing to investors.

No doubt some scribblers will allege that this pattern shows structured investments are more risky. However, as I highlighted above, our markets are simply reflecting the trends in the underlying cash and investment markets.

I have spoken to a number of pensioners recently about life in general and the low interest rate environment in particular. It is perhaps surprising how many know about quantitative easing but then again no. The real point is that while low interest rates may be benefiting the wider economy, they are hurting savers, some of whom are taking on more risk to generate income.

This is one of the consequences of the current monetary policy that politicians and central bankers should take into account when making decisions. It would be a concern if encouraging people to spend their way out of recession is also causing them to take on greater risk.

The challenge for the investment industry as a whole, traditional funds and structured investments alike is to ensure the right product is reaching the right client to mitigate future risks.

There is also a challenge for the Financial Conduct Authority. Its chief executive, Martin Wheatley, has made addressing investor behaviour a priority for his organisation. The question for the regulators is how do you ensure that retail clients balance their need for income against their appetite for risk? This may be a conversation they want to share with the Bank of England when they are discussing monetary policy!

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