Most British investment managers have spent the past week taped to their screens, watching the impact of the UK market turmoil on their finances. But one British Finance House executive spent the week poolside in Dubai, worried about his hotel bill.
“I was watching my vacation get more expensive day by day,” he said. But his concerns about the turmoil in the pound overshadowed the scope of the financial crisis gripping London. “That’s really maybe we’ll never see something like this again in our professional lives.”
Although the pound and government bonds rebounded from lows after a massive £65 billion intervention from the Bank of England, the market turmoil that followed Prime Minister Liz Truss’s “mini” budget will lead to lasting suffering, according to wealth managers.
They expect more pressure on living standards, with damage from higher energy bills, increased inflation and increased borrowing costs, especially on mortgages.
It will hit families in terms of inflation, higher interest rates and a more difficult mortgage market. . . And pushing away from the point where inflation peaks, says Richard Flax, chief investment officer at Moneyfarm, digital wealth manager.
While some aggressive investors would like to spot opportunities in the sell-off, the cloud of uncertainty already hanging over the markets from the Ukraine war, energy prices, inflation and economic distress has only darkened.
“There’s a lot of tension,” says Alexandra Loydon, director of partner engagement and advisory at St James’s Place, the UK’s largest wealth manager.
She spent the week consulting with SJP’s army of 4,600 financial advisors, who answer questions from 800,000 clients. “It’s hard to provide certainty and reassurance in such unstable markets, but encouraging the right behavior is really important… Don’t start moving assets and keep investing,” she says.
How do wealth managers assess what happened in the markets this week?
While the drop in sterling grabbed the headlines after Chancellor Kwasi Quarting’s speech, the drama that erupted in the middle of the week in the British government’s debt was arguably far more important to financial professionals and ordinary savers.
UK sovereign bonds, known as sovereign bonds, have seen some of the sharpest moves ever. “What we’ve seen is a kind of crisis of confidence in both the gold and sterling market,” says Peter Spiller, fund manager at Capital Grange.
Duncan McCains, chief investment officer at Ruffer, says gold bonds have experienced “very wild volatility for the first world sovereign bond market.”
The Bank of England stepped in after falling rates posed a serious threat to pension funds using special strategies known as liability-driven investments (LDIs) to manage risk.
The yield – the interest rate that rises when prices fall – on UK 30-year Treasuries, which on Wednesday touched a 20-year high of more than 5 per cent, fell to 3.85 per cent on Friday morning.
The intervention leaves the Bank of England torn between a promise to raise interest rates to fight inflation and an emergency operation to print money. Professional investors are still betting on further rate hikes from the central bank. “At this point, they added to the confusion,” McKins says.
Are mortgage fears fueling the cost of living crisis?
Government debt markets are important to homeowners because they establish a baseline for mortgages and other personal borrowing.
Loydon said clients are starting to grapple with the impending “massive impact” of higher interest rates and are asking questions.
The standard variable average rate for mortgages, which already rose to a decade high – above 5 per cent – earlier in the month, could now rise to 6 per cent.
The turmoil has made it difficult for service providers to price new, fixed-term deals, with thousands of products pulled. About 600,000 fixed-rate mortgage deals will expire by the end of the year, with 1.8 million deals to renew next year, according to UK Finance.
The government-imposed energy price cap has somewhat mitigated the direct cost of living crisis, limiting the maximum inflation rate expected in the coming months to around 10 per cent. But utility bills are still rising, Truss’ economic plans are likely to expand public borrowing, and upward pressure on inflation may continue for much longer.
While many well-to-do families that make up the wealth managers client base would benefit from the top end of the 45 per cent rate of income tax on earnings over £150,000 a year, and from reversing the tax increase on dividends, those gains would benefit, for many Mortgage holders, higher interest rates will outweigh.
Rachel Winter, partner at Killik & Co wealth management, says that mortgages have “replaced energy bills as feared the former in the UK . . . they have almost taken away the advantage of giving people a lower tax rate”.
Meanwhile, wealth managers say clients often underestimate the impact of pound moves. And while sterling regained most of the gains it lost by Friday – trading at around $1.12 per US dollar, up from a low of $1.03 – it is still widely seen as fragile. Much depends on the government’s reaction in the run-up to the announcement of its fiscal plan scheduled for November.
“The devaluation of the pound is inflationary and means that cost-of-living pressures are only going to get worse,” says Edward Park, chief investment officer at Brooks MacDonald.
What should I do with my wallet?
The good news for many savers is that global investments can provide protection from the turmoil in the UK. In particular, if sterling weakens, assets abroad are worth more in terms of sterling.
“If you are a sterling-based investor with a well-diversified portfolio, a weak sterling is beneficial,” says Janet Moy, head of market analysis at wealth manager Brewin Dolphin.
Wealth advisors are inundated with questions from clients: they want to know if they want to buy sterling or gold at current prices, or reduce sterling holdings in case the currency drops again.
Experts strongly advise individuals not to make any sudden movements. “It’s the old advice: If you’re going to panic, panic first. If you haven’t panicked yet, it’s probably too late,” MacInnes says.
But the uncertainty in the UK underscores the importance of diversifying away from the domestic market. The majority of UK retail investors dedicate more than a quarter of their investment portfolio to British stocks, according to a survey by Quilter last year, even though the country makes up just 4 per cent of the MSCI World Index.
Britain’s FTSE 100 index itself brings global exposure, with its companies generating 80 percent of their revenue overseas. This gives exposure to foreign exchange but still limits the choice of companies, especially as the UK market is heavy on energy and mining and light on technology.
Wealth managers say their clients are also concerned that rising borrowing costs are threatening home prices. “Over the past few decades, real estate has been something you can live in and double as a diversified investment portfolio,” says William Hobbs, chief investment officer at Barclays Wealth and Investments. The market crisis has cast doubt on the assumption that house prices will rise steadily, he argues.
“That’s why you need diversified exposure to the global economy, not just a specific street in the UK.”
Capital Economics bluntly predicts: “Recession and a significant fall in home prices seem inevitable.”
In the meantime, investors need to be careful about investing in companies that carry a lot of debt, because borrowing costs are rising rapidly. Says Christopher Rosbach, Managing Partner at J Stern & Co. He recommends examining corporate balance sheets: “Debt is the reason you get into trouble, whether you’re an individual, a company, or a country.”
Gold, the traditional safe haven, has done well as a hedge in terms of sterling, rising about 16 per cent in the past 12 months. But it has fallen in dollar terms, suggesting there may be better ways to hedge. “I would be very wary of those who tell you that whatever the question is, gold is the answer,” Hobbs says.
Gold also does not pay any income, so it becomes less attractive as interest rates rise. Although bonds have fallen significantly this year and the UK gold market has fallen this week, higher long-term yields are starting to make investors look again at debt instruments.
“We have a lot of clients who, in my opinion, have a lot of money,” Winter says. “It is now possible to have a very diversified portfolio of very large corporate bonds with a yield of around 6 percent.”
Savers who want to keep cash, despite the risk of inflation, are advised to find the best rates, since banks vary and many lenders on the street have bad offers.
The return of decent interest rates on deposits and bonds represents a major turnaround for savers. “This is a profound change in the investment landscape that has come out of nowhere in the past six months,” says MacInnes.