Wealth Manager - the site for professional investment managers

Register to get unlimited access to Citywire’s fund manager database. Registration is free and only takes a minute.

Beware: the impending ‘debt trap’ is upon us

Beware: the impending ‘debt trap’ is upon us

Investors are taking heed of the Bank for International Settlements’ (BIS) warning of an impending ‘debt trap’.

The global clearing bank says the trap has been caused by a persistent easing bias among policymakers, which has embedded instability into the system.

The scenario presents investors with two key questions. First, what do policy makers do now? Second, if there is a debt trap, what does this mean from an asset allocation perspective?

The BIS argues that persistently loose monetary policies have lulled governments into a false sense of security, delaying necessary consolidation – which has created a risk that instability could entrench itself in the system. A downward bias in interest rates and an upward bias in debt levels makes it very difficult to raise rates without damaging the economy, equating to a debt trap.

Aberdeen Asset Management’s Bruce Stout, who manages the Murray International trust and Aberdeen World Equity fund, says the trap has been created due to ‘the misguided experiment that is quantitative easing (QE)’.

‘They have failed to deliver what they wanted, which was inflation to inflate debt away. All they have done is layer debt on existing debt,’ Stout said, highlighting a debt-to-GDP ratio of 350% in the US.

While the prospect of rate rises could strangle any recovery, in his view a more worrying prospect is talk of further government intervention to reduce debt levels in the form of wealth taxes, higher corporation taxes and even debt write-offs.

He is concerned this could simply compound mistakes that have already been made.

‘The most difficult aspect of the whole picture is that the 10-year bond, probably the most important instrument in the world is the wrong price,’ he said. ‘Not having an accurate price means everything else is mispriced. It is being priced according to some mechanism, but we don’t know what it is.’

His concerns are echoed by Ian Brady, CIO of OakTree Wealth Management, who agrees with the BIS’s warning. The UK’s failure to rebalance its economy poses a key risk in the face of rising rates, he said. ‘I actually think this is why productivity in the UK has not been great. So many zombie companies have been kept alive.’

While QE has continued to power a bull market in equities, he expects this momentum to continue in the near term but warns of a 33% probability of an ‘upside melt-up’, where markets are driven upwards on momentum rather than improvements to the economy. He anticipates this could be to the tune of 15-20% over the next three to six months.

Against this potential backdrop, he has scaled back bond exposure and let cash in portfolios drift up to 10-15%, dependent on the client’s risk profile.

Leave a comment!

Please sign in or register to comment. It is free to register and only takes a minute or two.
Citywire TV
Brewin's Gutteridge: Yuan direction

Brewin's Gutteridge: Yuan direction

This week Brewin Dolphin's research head chats to Fidelity Asian Investment Directors Jenny Lee and Gary Monaghan about the big changes in China.

Play On the Road Challenge: horsing around on the polo pitch

On the Road Challenge: horsing around on the polo pitch

Libby Ashby takes to the polo pitch with Stuart Leigh-Davies from Redmayne-Bentley for an 'On the Road' challenge.

Brewin's Gutteridge: where Miton's Godber sees value

Brewin's Gutteridge: where Miton's Godber sees value

This week Brewin Dolphin's research head talks to George Godber, co-lead fund manager of the Miton UK Value Opportunities fund, about value investing.

Your Business: Cover Star Club

Profile: what tempted Brewin's Glasgow team over to Rathbones?

Profile: what tempted Brewin's Glasgow team over to Rathbones?

Rathbones’ Glasgow office has only been open for three months but the team, led by Angus Kerr, has already attracted new clients

Wealth Manager on Twitter