Fund manager’s response

DWS Investments is a great believer in the case for a focus on income, and the designer of this portfolio certainly shares that view. We expect competition from Asia to keep downward pressure on corporate profits globally, effectively exporting deflation to the developed economies. This indicates that inflation looks set to remain low over the longer term, pointing to sustainably low interest rates and therefore meagre returns from cash on deposit. The lessons of the past tell us that in this environment, the prospects for rapid capital appreciation are limited and that income-producing assets will remain highly prized. At DWS, we also believe that the low-growth environment increases the need for diversification, because with investors now focused on whether growth is sustainable, a better-than-expected economic performance boosts shares and causes bonds to sell off (and vice versa). What better reason to combine the two asset classes in a portfolio? This negative correlation between equities and bonds has other important implications, namely that equity market rallies are likely to be harder to sustain. If bonds sell off when equities rally, shares as an asset class begin to look expensive much more quickly than they did during the 1980s and 1990s. Then, equities and bonds were positively correlated, benefiting from good news in the form of falling inflation. This move from a positive to negative correlation is important to understand when considering portfolio construction. This portfolio focuses on corporate bonds and income-driven UK equity strategies, which is fundamentally in keeping with our beliefs. My only concern would be that the client should diversify through even more asset types; for example, commercial property has proved itself an excellent source of income, delivering 6-8% a year. Although I am a bond fund manager, even I struggle to disregard global stockmarkets entirely. Asia is establishing itself as the new driver of global growth and I would be keen for the client not to miss out on this. To counterbalance the extra volatility that this would introduce, perhaps a little exposure to unhedged gold producers would be appropriate, which would of course diversify this portfolio even further.