There’s a lot in the news at the moment about gilts and pensions and we wanted to share our thoughts on this. There’s two things in play here:

1. The impact of interest rates on fixed income (gilts and corporate bonds)
2. The impact of falling gilt values on defined benefit pensions

The blog is all about the impact of interest rates on fixed income values. You can read all about impact of falling gilt values on define benefit pensions HERE.

The Impact of interest rates on fixed Income assets

There are two distinct parts to our portfolios. There’s the stocks and shares part and there’s the fixed income part. Each is designed to play a very different role in your long term investing journey.

You might recall us referring to a ‘red line’ and a ‘blue line’ during our meetings. The red line is the stocks and shares part of the portfolio. The blue line is the fixed income part.

The Red Line

The equity (stocks and shares) part of our portfolios is for generating long-term returns. But this comes at a price – short-term volatility.  These holdings are higher risk (in the short-term) and therefore typically produce higher long-term returns.

The Blue Line

The Fixed Income portion of our portfolios is designed to reduce volatility.  It isn’t as risky (its short-term volatility is lower) and so it doesn’t produce as high returns as equity over the long-term. With lower short-term volatility it does reduce the overall risk of a portfolio.

Our portfolios range from 100% in equities to 100% in Fixed Income.  The mix of equities and fixed income determines the overall portfolio risk, which in turn is dependent on your attitude to investment risk, capacity for loss (your ability to absorb any market downturns), time horizon and circumstances/goals & objectives.

Due to the nature of equities and how they behave, they can fluctuate significantly over the short term.  This is something that we are all familiar with, especially with recent events such as Covid and the recent Russian invasion of Ukraine.  Previous events include the 2008 credit crunch and the 1999 dot com bubble.  All of these events impacted the market substantially at the time but the market subsequently recovered.

So what is currently happening?

The fixed income part of our portfolios is adversely affected by increasing interest rates. When interest rates rise the value of fixed income assets has to fall. This is inevitable and the risk  cannot be diversified away (without selling the fixed income).

So with increasing interest rates there are four choices investors face with their fixed income holdings

1. Sell fixed income holding to cash. But with inflation high (currently 10%) the cash will lose vale. A guaranteed loss.
2. Reduce the risk. This means buying more fixed income which will magnify the impact of future interest rate rises.
3. Increase the equity exposure. Buying more equity will inevitably increase the risk of the portfolio.
4. Do nothing. This will maintain the long term portfolio risk that was appropriate for your goals.

What are we going to do about it?

When we experience some market turbulence with equities, our general stance is to ‘sit tight and wait’.  Our approach to investing is that we cannot time or beat the market so when this situation arises, we need to be patient and we will eventually be rewarded for that.

Selling when markets are low means that you essentially ‘lock in losses’.  Currently, everything is just a paper loss but by pressing the nuclear button, we then make that a real monetary loss which is what we aim to avoid.

So for most people the right thing to do is sit tight and ride out the storm. But in the current high inflation and increasing interest rate environment, we could facing this uncertainty for some time.

Be rest assured that we are monitoring this closely and are in the process of reviewing our options.