Massacres seldom last forever in markets. But there is one that has endured for eight years and is set to intensify this week: the slaughter of savings rates. Ahead of the Bank of England’s MPC meeting, cheers are sounding for a further cut in rates from the current 0.5 per cent to 0.25 per cent. Some predict a cut to zero further ahead.
All good news for borrowers: loans will be cheaper for companies and for all those with a mortgage. Given the widespread fears of economic slowdown in the wake of the Brexit vote, this should help to boost confidence.
But the alter ego of this is yet another fall in returns for savers. Interest rates on bank and building society deposit accounts are already at near-zero levels – the yield on an “Everyday” savings account at the Halifax is just 0.5 per cent. Meanwhile, the yield on ten-year gilts has fallen below 1 per cent for the first time to hit 0.85 per cent last week – its lowest level ever. For long-dated gilts the yield is just 1.5 per cent.
This massacre of savings yields is wreaking havoc for pension funds – particularly for those in defined benefit company pension schemes. According to pension consultancy Mercer, the pension deficits of UK FTSE 350 companies – the gap between pension fund assets and the amount required to fulfil their premises of retirement income to members – has now yawned out to a record £119 billion, up by £21bn since May. This debacle has been intensified by advice from pension regulators that such funds should be wholly invested in gilts or fixed-interest savings in the name of minimising risk.
But there’s nothing “absolutely safe” in investment markets. Fixed-interest savings are vulnerable to a return of inflation. And an upward spike in inflation now looks likely after the fall in the value of the pound over the past two weeks.
There is escape – though it does involve risk. Over the past eight years the FTSE 100 has risen by some 78 per cent, not including dividend income. With dividends re-invested, that return is substantially compounded (though past returns cannot be taken as a guide to the future). And regulators argue greater certainty is needed so actuaries can make more accurate calculations as to the amount of pension fund contribution required to meet liabilities.
But such certainty comes at a price. The fact is that pension funds and their members would have done better in terms of capital appreciation and dividend income accumulation over periods of ten, 20 and 30 years with a balanced portfolio comprising equities and property as well as gilts and fixed interest.
The instant market reaction of the Brexit vote was a sharp fall across the board. Housebuilding, commercial property, financials and consumer-facing stocks were among the worst to suffer. But the market has since rallied strongly. The FTSE 100 now stands some 4 per cent above the level just before the vote. The FTSE 250 Index is still trailing, but joined in the rally last week. This by no means signals the end of market troubles. But when the central bank drops loud hints about cutting interest rates, with further quantitative easing also cited as an option and the Chancellor talks of cuts in corporation tax, investors have had second thoughts about Brexit consequentials.
Now add to this the dividend appeal of many household name companies when interest rate cuts on government stock have tumbled yet again and it is not hard to see why bargain hunters have emerged. Last Friday saw shares in housebuilders rallying strongly. Taylor Wimpey (yield on forecast earnings 7.8 per cent), climbed 7.7 per cent to 131.5p. Berkeley (forecast yield 7.6 per cent), rose 7.2 per cent to 2491p, and Barratt Developments (6.9 per cent) gained 6.9 per cent to 373.2p. Oil giants such as BP (7.2 per cent) and Royal Dutch Shell (7 per cent) also came in for support.
What of the traumas that have beset commercial property funds? It’s looking nasty: trading across much of the open-ended £25 billion commercial property fund sector has been suspended – investors can neither put money into funds, nor take it out.
But those prepared to take a long-term view – and commercial property should always be considered as a medium to long-term investment – could opt for closed-end investment trusts which do not face a redemption problem. Standard Life Investments’ Property Income Trust is yielding 5.6 per cent and F&C Commercial Property 5.3 per cent – both worthwhile considering in a self-invested pension portfolio. Target to beat: a mere 0.8 per cent return on ten-year gilts.