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What Does the Interest Rate Cut Mean for Your Portfolio?

The Bank of England has cut interest rates to 0.25% - the first move in more than seven years. What does it mean for your investments?

Emma Wall 4 August, 2016 | 2:15PM
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Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Dan Kemp, for Morningstar Investment Management.

Hi, Dan.

Dan Kemp: Hi, Emma.

Wall: So, we've just had an announcement from the Bank of England. They have cut rates to 0.25%. They've issued some QE and there is a new sort of funding for lending scheme. I thought we perhaps could go through the asset classes and see what it really means for investors, starting with bonds. $60 billion gilt purchase to come and a $10 corporate bond purchase as well in order to help boost asset classes.

Kemp: Yes. So, this is a heroic attempt by the Bank of England to make some of the most expensive asset classes in the world even more expensive. And all it's really going to do is bring forward future returns to the present. We hate to see investors pay too much for returns and really what you're seeing an encouragement of that unfortunately from the Bank this afternoon.

Wall: And this of course means that yields will drop and we've heard from the Bank of England the forecast for inflation by the end of 2017, 2.5%. So, it means for a lot of bond holders negative real rate of return?

Kemp: Well, that's exactly what we're expecting and that's the worry that you really are losing money almost in nominal terms now but certainly in real terms by holding these assets. So, our argument will be that in many cases investors are paying far too much for the safety blanket of feeling they own a low-risk investment. In reality, risk is a function of price and they need to be thinking about how much they are paying for these negative returns.

Wall: Does this mean bonds entirely are off the table or just means that gilts are less attractive?

Kemp: Well, gilts and investment-grade bonds are all pretty expensive, but it's important to say that they may have a place in the portfolio. They still act as a hedge to short-term volatility for equity holdings which may look more attractive. So, they still may have a place but don't expect them to deliver a positive real return. You're not going to get that from bonds at the current price.

Wall: Let's have a look at equities then. FTSE 100 has gone up slightly between 1% to 2% led by Aviva, Standard Chartered, Kingfisher. So, those financials and indeed, housebuilders have taken a bit of bashing since Brexit. What does this mean for equity returns?

Kemp: Well, I think it is a general feeling of relief that the Bank is doing something. The question is, how efficacious the latest policy is going to be? And really, we would worry not a jot about what's happening over the next couple of days as this news syncs in, but really what's happening over the long term.

And over the long term, the moves we've seen today are not going to make much of a difference to returns. There are some equity markets that look good value. We still think the U.K. looks pretty good value and certainly, elements of the European markets, like financials, look attractive. But generally, asset prices, including equity prices, across the globe are still pretty high.

Wall: I think the most important thing to bear in mind is here at Morningstar we are an advocate long-term investing. We're not speculators. Having said that, even over the long term investors should expect more muted returns from their portfolio, shouldn't they, although try to ignore all this noise?

Kemp: Well, that's exactly right. So, the general level of returns has fallen as prices have risen. And so, we're not going to get the sort of returns we would think over the next 10 years that you've had over the last 10 years and so investors need to be thinking carefully about that. But at the same time, look for pockets of value. They will emerge. They are still there and that can add to returns. But overall, we just need to see this latest effort by the Bank of England as just pulling forward future returns to today which ultimately is unhelpful for the long-term investor.

Wall: Dan, thank you very much.

Kemp: You're welcome.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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Emma Wall  is former Senior International Editor for Morningstar