UK - Schemes should steer clear of UK government bonds if they want to maintain the real value of their capital and secure a positive real income, AXA Investment Managers warns.
Fixed income chief investment officer Chris Iggo (pictured) said the prevailing wisdom in the UK seems to be that higher inflation is better than higher interest rates - even though consumer price inflation is more than twice the level of the mid-point of the official inflation target range.
Iggo said he believed it is "very likely" inflation will continue to rise in the next few months as the impact of higher taxes and duties impact on prices.
He said: "No-one should touch UK government bonds if their prime motivation was to maintain the real value of their capital and secure a positive real income. Measured against February's inflation rate, the entire gilt market yield curve is negative in real terms."
Iggo added: "The holders of gilts do so because they either have to (banks for liquidity purposes) or because they aren't particularly worried about UK inflation (foreign central bank reserve managers).
"If policy and the general body economique is concerned with stimulating as high a level of nominal growth as possible then a nominal asset with low yields is just not very attractive. Except if you are the government planning to issue a gross £169bn amount of gilts in the coming fiscal year at coupons that are below the rate of inflation."
Despite this, Iggo said a time will come when raising rates is the right thing to do - even if it is longer into the recovery than in previous cycles and may require more evidence of the persistence of inflation.
He said: "It is very likely to mean that when that time comes, market yields will have already risen and when central banks pull the trigger, there will be an even bigger adjustment in bond markets."
But he added until that time comes, investors should think carefully about their fixed income strategies.
He said: "Until the outlook changes materially - i.e. there is evidence of inflation coming back down or growth slowing - I will continue to argue that the best strategies in fixed income are to be in short duration strategies, to access credit spread even in the high yield space which is starting to look a bit expensive, and to seek inflation protection though index linked."
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