What is driving investment decisions at present?

Bond and equity valuations are stretched at the moment, with bonds currently yielding 6.9% and the JSE All Share Index on a 3% dividend yield.

Bond yields are driven by inflationary expectations as well as the supply of bonds. Many commentators are looking to a rise in inflation. Bill Gross, co-chief investment officer of Pimco, noted that: "An authentic debt crisis - which the world is now experiencing - can only be ultimately cured in two ways: default on it; or print more money in order to inflate it away." The gold price, which acts as an interesting proxy for inflationary expectations, is also pointing to a hike. As quantitative easing began in 2008/9, the gold price started rising from around USD900/oz to almost USD1900/oz in 2011, before settling around USD1750 in 2012.

The supply of bonds has exploded

At the same time, the supply of bonds has exploded. We have witnessed gross central government debt as a percentage of GDP for the advanced economies rise to the highest level in over 100 years, a trend that has been echoed in South Africa.

On the equity front, yields are driven by dividend growth fundamentals. The Nielson Q2 2012 Online Consumer Survey reveals that global consumer confidence is declining as the euro zone crisis continues to deteriorate, US job growth remains weak and China's 2012 GDP forecasts are revised downwards. In fact, more than half (57%) of global respondents believe that they are in recession and half of those say that it will continue for another year.

Clearly, we are not experiencing an environment conducive to galloping equity or bond markets, yet investors are favouring these asset classes over others. In the 15 months to June 2012, R44 billion flowed out of money market funds and R47 billion was added to balanced funds, which represents a significant change in investor behaviour and a greater adoption of risk.

But why would investors be prepared to up the ante? Locally, no asset classes are producing high, or even average, levels of income and the environment is poor so the demand cannot be driven by valuations or by the fundamentals.

Exceptionally low interest rates

Marriott believes that the major driver of this trend is the exceptionally low prevailing interest rates internationally. The local investment trend is a reflection of the international flows and SA bonds have been a beneficiary of this movement too. With global investors hunting for yield, there has been a consequent massive flow of funds into SA bonds from foreign investors. Over the period 1993 to 2008, the SA bond market witnessed a nett R36 billion outflow of foreign capital. In the subsequent period from 2009 to 2012, there has been a nett inflow of R126 billion.

However, we are concerned that, at 4.5%, the yield on a balanced fund comprising 60% equities and 40% bonds is at its lowest level in 40 years and well below the historic average of 7.1%. Added to this, the key elements within them - bonds and equities - are fundamentally weak.

Marriott urges investors to consider carefully before withdrawing assets from the money market, particularly those who require income from their investments. By switching into a more volatile asset class, particularly at a stage when yields are low, investors may be taking on excessive capital risk. We would guard against assuming such risk and recommend that investors err on the side of caution.

Better options

There are better options for those investors who require income. High-quality companies with the ability to produce reliable, growing dividends in difficult economic conditions, both locally and offshore offer a far more appetising option. Interestingly, we have seen fewer investors externalising assets this year: flows into offshore equities from South Africa are down 20% this year compared to last year. With a yield of 3.9%, higher than the average yield of 3.1% and the SA equity market yield of 3%, combined with good quality dividends, offshore equities present an attractive investment possibility.

With a solid offshore dividend yield, investors would do well to maximise their offshore equity exposure. They should opt for equities in defensive industries, for example those supplying household necessities with solid brands. Some examples of global companies which have shown steady dividend growth over time, through all market conditions, include Proctor and Gamble, BAT, Kellogg, Nestle, Unilever and Johnson & Johnson. Closer to home, the types of counters that display these investment characteristics include: Mr Price, SAB, Standard Bank, Tiger Brands, Spar and Clicks.

There are also creative solutions for investors seeking income. At Marriott, we have found a blend of high-yielding investments to maximise income and minimising capital loss. These instruments include high-yielding equities, inflation-linked bonds, preference shares, corporate debt, structured NCDs in addition to cash and fixed deposits.

In conclusion, we have noticed a shift out of money market funds, a move that is being driven by the low interest rate environment in which all economies find themselves. While we understand the rationale behind this trend, it is not necessarily the best move that investors can make as this means they are assuming higher risk. We would urge them to exercise caution when making investment decisions.