Marriott, the Income Specialists share their view on the various asset classes, both locally and offshore.

Over the past five years retired investors have weathered a storm of negative real cash interest rates and historically low property and bond yields globally. Fortunately, this environment is starting to return to “normal” with interest rates and yields beginning to rise, albeit at a gradual pace.

The driving force behind this normalisation process is the same driving force that resulted in the current low-yielding environment – the US economy. The US contributes approximately 22% to global Gross Domestic Product (GDP) making it the biggest economy in the world by some distance. Consequently, changes in the economic conditions of this region have major repercussions for the rest of the world.

It is therefore unsurprising that a crisis in the US sub-prime housing market proved to be the catalyst for the 2008 global recession. The severity of the recession was such that it necessitated extraordinarily accommodative monetary policy in order to revive economic activity. This included quantitative easing (QE) in the economies worst affected. Five years later, these measures are only now starting to yield the desired results.

It is becoming increasingly apparent that the foundation for a protracted period of sustainable economic growth is now in place in the US. This is evident in the fact that QE is being tapered and will likely come to an end by September 2014 as illustrated in the chart below. The next step in the normalisation process will be for the US Federal Reserve to begin raising interest rates. Although the timing and extent of the increases remain in question, the direction is clear.

A combination of the end of QE and rising interest rates in the world’s biggest economy will likely continue to exert upward pressure on bond and property yields globally. This, in time, will create an environment more conducive to meeting the income needs of investors.

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Our expectations for the various asset classes, both locally and offshore, are outlined below.

Local asset classes: paying a high price for an income stream

• SA Cash: With inflation above the 3 to 6% target band, the SA Reserve Bank is likely to continue increasing interest rates despite faltering economic growth.
• SA Bonds: Upward pressure on the yields of SA government bonds is likely to continue due to a combination of rising inflation and a rapidly deteriorating fiscal position. Exacerbating this is monetary policy normalisation in the US.
• SA Property: Due to the high correlation between property and bond yields, exposure to this asset class should be minimised.
• SA Equity: In a subdued and uncertain economic environment, investors will be best served by companies with track records demonstrating an ability to grow their profits and dividends, irrespective of interest rate or business cycles.

International asset classes: attractive yields still on offer

• International Cash: Interest rates in the first world are likely to rise as monetary policy in these regions starts to normalise on the back of improving economic conditions.
• International Bonds: US, UK and Euro-Zone 10-year fixed-interest bond yields remain well below historic averages, presenting investors with capital risk.
• International Real Estate Investment Trusts: International real estate continues to offer investors acceptable yields with inflation-hedged income growth prospects.
• Direct UK Commercial Real Estate: Direct A grade real estate in the UK is offering investors exceptional yields.
• International Equity: The investment case for offshore equities remains compelling due to a combination of attractive dividend yields and improving economic conditions.

The duration of the current low-yielding environment has far exceeded the expectations of most market participants; nevertheless, it remains unsustainable. The recovery of the US economy in the years ahead is likely to prove the catalyst for higher yields and an environment more favourable to meeting the income needs of investors.

Investments in offshore markets continue to offer investors the best prospects for acceptable real returns. The yields of first-world mega-cap stocks and direct UK commercial real estate are particularly attractive. Domestically, income yields are low and capital risk is high.