AT their most recent meeting the Bank of England’s monetary policy committee surrendered their unanimity on keeping rates as they are, voting 7-2 in favour of no change, rather than the preceding three years of 9-0 landslides, writes Nick Williams, an Assistant Director at Brewin Dolphin in Newcastle.

Obviously, if you take it in isolation, 7-2 is still pretty convincing. Even Arsene Wenger would struggle to spin that as a close run affair. But it did send a message that the average attitude amongst the monetary cardinals is drifting towards a tightening of policy.

Leaving aside the ‘when’ and ‘how much’, rising rates, by way of economic lore, is negative for the prices of conventional bonds, by which I mean loans made by investors to companies who, as a thank you, commit to returning a regular income until the bond matures, whereupon they jolly well promise to pay every penny back.

These types of investments are a staple of the lower risk portion of an investor’s portfolio. Depending on your goal and risk tolerance you may have a large proportion of your invested wealth in these assets. Sensibly, you would be considering the alternatives ahead of the rate rises.

Where possible, you would try and replicate their risk and return characteristics. One asset class seems to fit the bill more closely than others: infrastructure. Specifically I mean the several infrastructure investment trusts listed on the London market which have become popular during the low interest rate environment. They generally yield 5 per cent or so, exhibit price volatility lower than equity income funds and also some classes of bond (mainly higher risk ones), and the long term nature of the underlying projects provide the stable cash flows needed to support these 5% yields. In many cases these cash flows can rise with inflation too, in contrast to the fixed income payments offered by bonds.

But we aren’t talking like-for-like in terms of risk here.

There is the mere fact that the performance of the underlying portfolio of assets might be stellar but because these trusts are listed on the stock market then they could be dragged down in a general fall. Also, due to their popularity, many have share prices significantly higher than the value of the underlying assets. Were they to fall out of favour then share prices may creep back towards net asset values. This might happen because better returns on cash make the 5 per cent yields less attractive, so it cannot be said that these investments are completely interest rate-proof either.

The question is, do you need an alternative? You can stick with bond-like investments but still take steps towards partially mitigating interest rate risk. Floating rate securities, for example, have their income returns tied to a particular measure of interest rates, such as LIBOR. The investor can thus benefit from rising rates. Another alternative are absolute return bond funds, which are hedge fund-type structures where the manager aims to provide positive returns whatever the economic weather.

Or, you could stay with conventional bonds. There are funds which invest in bonds that aren’t particularly sensitive to changes in rates: low-duration bond funds. A broad-brush approach may also be sensible which can be achieved by investing in a fund where the manager has a very wide mandate: strategic bond funds. Managers of these funds have the flexibility to be nimble, and jump around to the better quality areas of the bond market at any given time.

In actual fact, the central tenet of investing is to have a portfolio of assets which isn’t generally dependent on one economic outcome, so why not mix it up and have a diverse blend. The lower risk end of the spectrum offers more variety than you’d think.

We do have a tendency to be rather feast or famine about asset classes, too. Bonds aren’t in a portfolio to provide double digit growth year on year. Hopefully they maintain their value and pay an acceptable level of secure income, whilst acting as a shield against a turbulent equity market.

Frame the prospect of an annual loss of, say, 1 per cent on your bonds in the context of a bear market in shares where losses can be significantly higher and it doesn’t seem so bad. Income yields can still mean that your return is a positive one, at least on this part of your portfolio. Diversification is key to long term investing.

nicholas.williams@brewin.co.uk

Nick Williams is an Assistant Director at Brewin Dolphin and offers advice on a wide range of financial services to private clients, trusts, charities and pension funds.

Past performance is not an indication of future performance. The value of any investment and any income can fall and you may get back less than you invested. No investment is suitable for all people and should you have any doubts you should consult an authorised financial adviser.

The information contained in this article has been taken from public sources and is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. The opinions expressed in this article are not necessarily the views held throughout Brewin Dolphin Ltd. No Director, representative or employee of Brewin Dolphin Ltd accepts liability for any direct or consequential loss arising from the use of this document or its contents.