The boost from fixed interest funds is likely to decline over coming years, investment manager CCLA has predicted.
The analysis followed Room 151’s Treasury Investment Survey which revealed that 5% of local authorities had holdings in fixed interest investments.
John Kelly, client director at CCLA, warned local authorities using fixed interest funds to support income flows in the current ultra-low interest rate environment need to be aware the income boost these assets provide may only be temporary and is likely to decline substantially in the next few years.
At present, fixed interest funds are able to provide investors with income yields far above those available on cash deposits because their portfolios hold high coupon bonds which were issued in the past when prevailing interest rates were materially higher than they are today.
He said: “The problem is that these bonds have fixed lives. Many are already old and all are moving ever closer to maturity.
“When they expire, as most will in the next couple of years, it will not be possible to replace the income, putting pressure on the distributions they can pay their investors.
He added: “Bond fund managers can try to delay income cuts, but only by increasing portfolio risks – something treasury investors may not be comfortable with.
“However, even a shift to higher risk profiles only puts off the cuts, it doesn’t avoid them. Potentially they will be severe, some funds may have to halve the income they pay their investors.”
Kelly advised treasury teams to contact their fund
managers and ask how they intend to meet the challenge.
In reality, he said, it is not possible to avoid some fall in income, but early
planning could prevent an income shock and allow authorities to mitigate
the impact on receipts.
Also speaking to Room 151 at the recent Local Authority Treasurers Investment Forum, Mike Jensen, director of investment at Lancashire County Council, said s151 officers should get specialist knowledge from people who understood the products properly.
“The best yield on UK gilts at the moment is 94 basis points. You need to upskill your team or get an external manager to give you advice. You won’t get market advice from treasury advisers. Have people who know what they are doing or access to people with the knowledge.”
Jensen added that simply abandoning investment tools could also mean losing out: “Low yield is not the same as low return. If you’re going to get a high return, you either take a higher degree of market risk or maturity risk.”
He added: “You could look at the things like the bonds issued by Oxford and Cambridge universities or you could look at sovereign state supra-national bonds. German government bond yield is negative at minus-14 basis points but the return year to date is nearer 15%.”
