Lower for longer: an age old problem

Ed Monk
Ed Monk
Fidelity Personal Investing7 March 2018

There are a number of well-known ‘super trends’ that underpin broad assumptions about the type of investment that will flourish in decades ahead.

One, for example, is that more than a hundred years of globalisation has created inequalities that will soon need to be addressed, with developed societies altering social policy to the benefit of domestic consumers and industries that employ home-grown workers.

Another is that the technological developments will dramatically change manufacturing, transport and day-to-day living. The rise of robots and the so-called ‘internet of things’ will render traditional industries redundant and create whole new ones at the same time.

Perhaps the most widely cited super trend is the rising age profile of the human population. Improvements in diet, medicine and sanitation mean there are simply fewer things that are likely to kill us, while falling birth rates in developed societies mean we are entering a world with a far higher proportion of older people in it.

It’s said that this demographic change will drive demand for companies that serve the needs of older people - medical services, perhaps, or robots to help perform domestic tasks - but there was evidence this week that the effects of the change are already being felt in a far more direct way in financial markets.

A working paper from the Bank of Japan, by Nao Sudo and Yasutaka Takizuka, examined the relationship between real interest rates - the rate after inflation is accounted for - and population ageing in Japan. The origin of the paper is important because Japan has front-run the rest of the world in population ageing. It has been living for decades with the trend that is becoming apparent in places like the US and UK only now.

The headline conclusion of the paper was that the rising age profile of Japan had driven real interest rates significantly lower - meaning inflation and returns on investments were driven lower, too.

Put another way, Japan getting older meant returns getting lower. In fact, of the 6.4 percentage point fall in real interest rates in Japan over the past 50 years, 2.7 percentage points is accounted for by the effects of population ageing, the paper said.

Why? Firstly, economies become less productive as they age, with relatively fewer working age people having to support more older people. Secondly, older people tend not to spend as much, meaning less activity in the economy. Finally, older people need to stash money in income producing assets to fund their old age. This means demand for Government bonds rises, pushing prices higher and yields lower.  

And the BoJ paper suggested that this effect, while unlikely to be unwound any time soon, won’t get worse from here because the demographic shift has largely played out in Japan.

Overall, it supports the case that ‘lower for longer’ is the new-normal for developed economies. If correct, that means lower bond yields and sustained demand for income producing assets - notwithstanding the short-term fluctuations to prices that are always a feature of markets.

In that environment, it is companies that can be depended upon to produce reliable dividend income that are the most attractive. Our Select 50 list of favoured funds include a number that perform this job.

The Fidelity Enhanced Income Fund. This fund builds on the underlying dividend offered by its already high-yielding shares by selling the option to buy some of its shares to other investors. The premium it earns by doing this results in a yield of more than 6% currently, although this is not guaranteed.

The JOHCM UK Equity Income Fund. This is a more ‘vanilla’ income fund but still currently offers a yield of more than 4%, although also not guaranteed.

Important Information

The value of investments and the income from them can go down as well as up, so you may not get back what you invest. Select 50 is not a personal recommendation to buy funds. The Fidelity Enhanced Income Fund uses financial derivative instruments for investment purposes, which may expose the fund to a higher degree of risk and can cause investments to experience larger than average price fluctuations. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.