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Equities to outperform bonds and deliver the best rewards in 2011

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Equity-based investment and to a lesser extent commercial property are likely to be the key drivers for UK investors and a better bet than government bonds going forward into 2011, predicts HFM Columbus’ investment director Rob Pemberton.

While bond investors have enjoyed returns of around ten per cent so far this year, Pemberton thinks the days of continuing high returns for this asset class are numbered.

“The current return on gilts is very low and there is limited upside potential but the prospect of significant downside risk,” he says.

“If the UK Government’s CPI inflation target of two per cent has any credibility, then a yield of three per cent for ten year gilts is less than investors accepted in the past whilst a yield of 1.6 per cent for five year paper implies an actual loss in real terms,” adds Pemberton. “I would prefer to have an exposure to fixed interest through corporate bond and strategic bond funds rather then government bonds.”

Pemberton believes that the formerly strong recovery in the commercial property sector has stalled in the past quarter.

“The IPD UK All Property index has enjoyed 12 per cent growth so far this year, but our concern is that this recovery has been too rapid and is not reflecting the current realities of the UK property market.

“Rental growth remains negative, which is unusual when prices are rising, illustrating that price rises are based on liquidity and investor asset allocation rather than on supportive economic fundamentals. Vacancy rates continue to climb,” he adds.

“The majority of returns from property as an asset class are from its stable income stream and we would expect this attribute to be resumed in the coming years after the roller-coaster in capital values over the last five years.”

Property traditionally offers an excess yield over gilts to account for illiquidity. The current yield on the IPD UK All Property Index is 7.5 per cent with a much higher pick-up over gilts than average, though Pemberton says this is probably a reflection of the very poor value in gilts rather than necessarily meaning that property is cheap.

“The outlook for prime property with blue chip tenants, excellent locations, long leases and strong covenants is still good – but investors should be aware there is a lot of secondary and tertiary property for which the outlook continues to be dire,” he says.

European-based equities could well be the place to be in 2011, predicts Pemberton.

“The Euro has rebounded 15 per cent against the US dollar since plumbing the depths in June 2010, whilst the European Bank stress tests, though somewhat flawed and unconvincing, were at least another step forward. Thus far, the southern European nations appear to be taking their harsh debt-reduction medicine more readily than envisaged.

“In Germany, Q2 GDP growth was the strongest for 20 years and unemployment is falling back to pre-crisis levels. These growth numbers are exceptional and unlikely to be repeated but Europe is surprising on the upside economically whereas the US has been surprising on the downside.

“Germany and France are both trading on around 11x estimated 2010 earnings and 9.5x 2011 whilst European forward dividend yields are four per cent, well above their 20 year average.

“Let’s not forget that major problems remain in Europe, principally sovereign debt risk in the periphery, but economic data is surprising on the upside and valuations are undemanding. It’s not an area to be overweight, but some exposure is recommended,” says Pemberton.
 

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