Pension lifestyling fund investors – a subset of gilt investors, these investors are particularly at risk as they will probably never have made an active choice to invest in bonds. As these investors approach their stated retirement date, they are automatically shifted from equities into long dated government bonds. The idea is to hedge annuity rates, which move in line with bond yields. Of course, since the pension freedoms were introduced, very few people now buy an annuity. But these lifestyling programmes, potentially set in train 20 to 30 years ago, are still robotically moving people into gilt funds nonetheless. Any falls sustained in the value of these funds should be offset by rising annuity rates. But then, that’s not much use if you’re not buying an annuity.
Corporate bonds – Unlike gilts, corporate bonds (both investment grade and high yield) carry a higher interest rate, which helps cushion the impact of price falls emanating from fears of tighter monetary policy. They also tend to be shorter dated, which means they are less sensitive to interest rate rises. Being loans to companies rather than governments, they also experience some upward pressure on prices from an improving economy, because the accompanying earnings growth should in theory make it easier for companies to service their debt. In a rising interest rate scenario, these ‘riskier’ bond funds should therefore fare better than ‘safer’ gilt funds, but they still might still struggle to post positive returns, particularly after tax and charges.
Gold investors – higher interest rates aren’t good for gold because it pays no income. That’s much less of an issue when rates are close to zero, and so the opportunity cost of holding an asset with no yield is virtually nil. As interest rates rise, that cost becomes heavier to bear, and cash and bonds become more attractive as safe havens. Investors may still turn to gold though, if they buy into the idea that it’s a hedge against inflation.
Moneymarket funds – these cash-like funds saw £1.6 billion of inflows last August, which is more than they see in most years. Most of that can probably be accounted for by cautious multi-asset funds fleeing bonds, and in the short term we may see more money heading into moneymarket funds as such investors seek sanctuary from rising rates. Higher rates should lead to higher yields in the moneymarket sector, but like cash, the ascent is likely to be painfully slow compared to the rate of inflation.
Absolute return funds – rising interest rates are a double edged sword for absolute return funds. These funds tend to hold large sums of cash to offset derivative positions, and so higher rates will feed through into more interest flowing through into returns. However, the target return for many funds is based on cash rates, so higher rates will mean many absolute return funds have a higher hurdle to clear to beat their benchmarks, and potentially collect the performance fees which are common in the sector.
