When I wrote here a few weeks ago about the end of bond bubble I said that the things that might bring the 30-year bull run to its final end wouldn't happen "in the immediate" future.
That was because I was worried that inflationary pressures were already embedded in the UK and would soon come out in the wage numbers a trigger for the Bank of England to start raising interest rates. The wages bit is clearly happening now.
The Office for National Statistics told us last year that pay for those who have stayed in regular full-time work since the financial crisis has been doing just fine their wages have been rising at 4% a year. But this week, after a year of rising employment, came news that average weekly pay for all employees rose by 2.7% in the three months to April.
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Add in last month's dip into deflation, and that means the average rise in real wages was 2.8%, with pay in construction, wholesale, retail, and hotels and restaurants rising the most. That's the largest rise in eight years, and a move that should be putting us on the alert over inflation and interest rates.
But not everyone is convinced that we need to worry yet: May's Consumer Prices Index came in positive but only just at 0.1%, so our low-inflation era isn't definitively at an end yet.
And not everyone is convinced that the BoE's rate-setting Monetary Policy Committee will act when it is time to worry. As Peter Warburton of Halkin Research puts it: "the MPC has grown so used to sitting on its hands every month that there is a real danger that the circulation to its button-finger has been cut off".
Still, let's assume that the MPC is doing what we would all be doing in their situation. They'll be justifying their super-low interest-rate policy (everyone else is doing it, and the financial world would have blown up without it) and feeling mildly panicky about how to get out of it (if we stop now, the financial world really will blow up) while knowing that they have to have a go at getting out of it (we can't actually let inflation get real traction in the economy again). The odds are that, just like the Federal Reserve is expected to, they'll give in and have a go pretty soon. Then what? What should you worry about?
The answer is every single asset class and sector that has boomed on the back of low interest rates.
I could fill many columns with this one (several with house-prices alone), but earlier this week my eye was caught by a statistic on funds in the targeted absolute return' sector funds that aim to make a positive return for you every year, regardless of market shenanigans.
In April, the sector saw its highest inflows ever, taking £530m in a month. This is about all sorts of things, including the marketing brilliance of Standard Life's £25bn Global Absolute Return Strategies (GARS) fund, plus the arrival of full pension freedoms. Pre-retirement, you might think of market falls as being no real bother history tells you prices usually come back. But if you are hoping to drawdown constantly for your living costs, the idea of never losing money seems pretty good.
However, the main driver behind the sector which was more or less invented in 2008 has been super-low interest rates. Investors haven't been able to get the regular absolute returns they want on cash and have been nervous of riskier-sounding investments (standalone equities, perhaps) so a product that sounds like it offers a fabulous mix of the two has been seen as just the job.
But wait. Absolute return funds aren't quite the low-risk sleep-at-night investments some seem to think. It is tough to generalise about how they invest like hedge funds, they can do pretty much whatever they want in their search for positive returns. However, as Brian Dennehy of Fund Expert pointed out in a recent note, one way to see how much risk you are taking is to see how much money you are making. Too much and your fund could be taking on more risk than it should and "what goes up must come down".
One example is the Odey Absolute Return Fund, which is six times more volatile than the sector as a whole. Most absolute return funds, regardless of how much risk they look like they are taking, are incredibly complicated. I have been having a look at the full list of holdings in the GARS fund. The last available one on the website is from 2013 (perhaps Standard Life's new chief executive can arrange to have it updated) it is 65 pages long in a very tiny font.
Obviously, when you have £25bn to spend you need to buy a lot of stuff and, of course, if you have an ongoing charge of over 1.5% you want to look like you are working for the money. But I suspect the list would come as something of a surprise to anyone who thinks they have a "cash-plus-a-bit" fund. It is also, like most of the absolute return funds I have looked at, fairly bond heavy, which won't help returns as interest rates rise.
I dare say the managers at GARS know what they are doing, but not everyone will. This is an inexperienced sector which is why not many more than half of the funds in it have five-year records, and presumably why, as Dennehy notes, only eight of the 39 funds that do have a five-year record have managed to produce consistently positive returns.
So even in the stunningly benign environment of the past six years the sector has failed to deliver absolute returns. What happens when it is tested in an environment of rising interest rates? I remain to be convinced it will pass that test.
If absolute returns are really what you want and you think that interest rates might soon rise, you should remember this: a bull market in all asset prices, such as the one we have seen over the past few years in our super-low interest rate environment, is really the same thing as a bear market in cash. If rates rise, we might all begin to wonder if cash is really such a bad thing. After all, it does at least guarantee absolute nominal returns.
This article was first published in the Financial Times
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