This year's investment story will be equities mixed with bonds because people will be more interested in avoiding losses than taking on risk to back winners, says Phil Wagstaff, managing director UK retail M&G.
And despite fears of a bond bubble, the continued risk of deflation means that increasing the proportion of an average investor’s portfolio exposed to pre-determined returns may not be the big risk some believe it is, adds Jim Leaviss, M&G head of retail fixed income.
"It’s a question of inflation," says Leaviss.
Given the remaining risk of deflation, it is unlikely that, for example, the Federal Reserve will raise interest rates in the US anytime soon because of the fear of repeating the mistake made in Japan in the 1990s.
Then, the government introduced a sales tax right at the time the first signs of economic recovery appeared, effectively stalling the economy for another decade.
Bearing in mind inflation is the real danger for bondholders, M&G’s view is that the deflationary risk means it is still a good investment to increase exposure to fixed income.
In fact, the house view is that despite increasing sales of bond products, most investors, particularly at the higher end of the age spectrum, do not have enough bonds in their portfolios, providing the income required per amount of risk taken on.
Bonds remain a promise of return in a low inflation environment, says Leaviss.
Low inflation is also positive for those looking for dividend income from equities, says Richard Hughes, M&G Dividend fund manager.
Faster inflation boosts headline figures, but in real terms is not good for dividend yields he says.
With the FTSE 100 index returning a yield of 3.5% compared to the FTSE 250 yield of 2.5%, it is a good time to look towards big cap UK companies paying dividends, he adds.
Issues such as how Lloyds TSB will grow fast enough in future to sustain its current yield do exist, but generally the dividend is a "reliable beast", which should keep growing at an annual rate of between 3% to 5%, Hughes says.
"History tells you you can rely on UK plc to deliver dividends," he says.
David Fancourt, manager of the £1bn M&G High Yield Bond fund warns that investors face a challenge in avoiding bonds from companies being propped up by high levels of liquidity in the market.
The problem is the extra money sloshing around the system is enabling companies to remain solvent, where in tighter times they might have gone to the wall.
This is not to say there are many Parmalat’s around. The spectacular downfall of the Italian milk products company is more a case of direct fraud on a grand scale, which even managed to con analysts at credit ratings agencies – at least for a time.IFAonline
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