Cash in with risk for reward

The Life: With interest rates likely to rise, advisers are recommending investors check out equities

US and European equities are a good choice for investors looking for other options. Above, traders at the Frankfurt Stock Exchange.

Investors around the world have had to put up with scant returns on cash deposits since the global financial crisis, with any proceeds eaten away by inflation.

But after the European Central Bank (ECB) announced a small increase in interest rates this month - and signalled further hikes - investors are asking how to position their portfolios in this changing environment.

Rates globally are expected to rise this year, with the US a notable exception, according to analysts.

"It's certainly something we have not seen in recent memory so when the ECB raised rates it was quite a significant event," said Khurram Jafree, the head of investment advisory for the Middle East and North Africa at Barclays Wealth.

He says the 25 basis-point increase to 1.25 per cent is a "good news, bad news thing" because it signals a pick-up in corporate health and activity, but consumers on variable mortgage rates will have their spending power diminished.

"There are also other risks for investors, the higher oil price, aggravated by supply constraints and unrest, as well as sovereign debt worries," Mr Jafree said. "So alongside the prospect of higher rates you have these lurking in the background."

Tom Elliott, a strategist at JP Morgan Asset Management in London, predicts ECB interest rates to end the year at 1.75 per cent, the UK to increase from 0.5 to 1 per cent, and the US to remain unchanged.

With this backdrop in mind, Dan Dowding, a portfolio manager at Killik & Co in Dubai says UAE investors should reduce the long-dated bond exposure in their portfolio. This will help reduce the sensitivity to interest rate changes.

Investors should also look at inflation-linked bonds in the US and Europe because rate increases reflect high levels of inflation in these regions.

Mr Jafree agrees. "If you must stay in bonds then try to reduce the maturity of those so they are less sensitive to interest rate risk," he says.

The latest Friends Provident International (FPI) Investor Attitudes Report shows investor confidence continues to improve, but investors still favour little risk, opting to leave their money in cash and gold.

But experts actually recommend taking on a little more risk and investing in equities, rather than cash deposits, which will continue to offer relatively low rates of return.

Mr Jafree recommends increasing exposure to US and European equities, excluding the UK, despite sovereign debt worries in much of Europe.

The companies on the European and US indices have high exposure to the growth markets in Asia and South America, but come at cheaper valuations, Mr Jafree says. "It's about being clever in how you get exposure."

Companies in Germany are exporting a lot of goods and the major companies are healthy.

The UK is not favoured as a market because rate increases are expected to come at the same time as the government's austerity package, which could have an effect on corporate earnings.

Mr Elliott recommends investing in the major companies in Europe that have strong cash flow and can pay a dividend. That way investors can move from cash, which will still earn little even as rates go up, and into equities offering an income.

"We recommend blue-chip companies for the income and they will provide protection against inflation," he says.