Barclays Capital expects a slow death for shares

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The Independent Online

Shares will be slowly "extinguished" as a major form of investment as UK pension funds dump equities in favour of higher-performing bonds, a leading City bank has forecast.

Barclays Capital said a shift out of equities was underway as fund managers coped with longer life expectancy and new pension regulations.

Its latest annual research into returns on financial assets since 1899 found that corporate bonds earned the best return of all assets both last year and over the whole of the last decade.

Stock investment slumped almost 14 per cent last year taking the drop over the last two years to 21 per cent, the worst since 1973-74. In contrast, corporate bonds bucked the volatile market conditions of 2001 to give the highest return of 6 per cent.

Mark Capleton, director of UK strategy for Barclays Capital, said: "Institutional investment is undergoing a secular asset allocation shift away from equities into bonds, and this is particularly true for pension funds."

Mr Capleton said low inflation and longer life expectations had prompted fund managers to switch out of high-risk, low-income assets such as equities into lower risk but high-income products such as gilts and corporate bonds. "If we are right in our discussion overall we will see an extinguishing of equity in the UK," he said, although he did not think shares would disappear completely.

The factors behind this trend include the Minimum Funding Requirement, the controversial FRS 17 accounting rule on how companies account for pension losses, and an ageing population adding to the costs of running a final salary pension scheme.

On top of the pressure from fund managers he believed equities would be phased out as:

* shares were "retired" through management buy-outs and companies going private;

* the number of new offerings fell due to poor market conditions and cheap bond financing;

* cash takeovers of companies resulted in equity disappearing.

Barclays Capital said demand would be met by extra gilt supply, PFI investment and "old economy" companies lowering their cost of capital by restructuring their balance sheets and issuing bonds to investors switching out of equities. "We believe that this sort of balance sheet restructuring will become popular in the UK as economic activity picks-up," Mr Capleton said.

The details of the Barclays Capital gilt-equity study, which has been published every year since 1956, showed the average real annual return from corporate debt exceeded that from shares by 1 per cent over the last 10 years. In stark contrast, investors suffered a negative return of 13.8 per cent from equities, and gains of only 4.8 per cent from cash and 0.6 per cent from Government bonds, better known as gilts.

The bank said it was surprised at the "stellar" performance of corporate bonds, especially as 2001 was widely seen as a year of mounting worry over the corporate sector.

The slump in equity prices was the worst in real terms since 1990 and in nominal terms was the sharpest fall since the oil crisis of 1974.

In cash terms, £100 invested in 1990 would have grown, accounting for inflation, to £288 from corporate bonds £264 for shares and £246 for gilts.

These results were achieved against the background of a fall in inflation last year to its lowest level since 1959. Earlier this week Sir Edward George, the Governor of the Bank of England, warned investors would have to adapt to lower levels of returns if the UK was entering a permanent era of low inflation.

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