Market update and investment risks
The following reflects the general views of Prudential Portfolio Management Group Ltd and should not be taken as recommendation or advice as how any specific market is likely to perform.
These views are as at the end of December 2017.
The value of investments can go down as well as up. Investors could get back less than they put in.
Please remember that past performance is not a reliable indication of the future performance.
Quarter 4 2017 was positive for most stockmarkets, many of which rose to all-time highs, while others reached their highest levels for many years. Investor sentiment was boosted by better economic data and robust company earnings. Among the markets to reach record highs were the UK, US, Hong Kong and Indonesia, thus helping the global equity (company shares) index to reach its own record. Over the quarter, sterling rose against several currencies, including the US dollar and Japanese yen, which reduced the gains from assets in those countries for UK investors. Many of the best-performing markets were in the Far East, including Japan, Singapore and China, although South Africa also enjoyed a notable rally. By contrast, shares in mainland Europe and Latin America lagged.
Central bankers are now considering the withdrawal of emergency measures, such as record low interest rates and asset purchases, to curb any rise in inflation. For example, interest rates were increased in both the UK and US while the European Central Bank is scaling back its asset purchase programme. For the moment, however, inflation remains generally subdued. In currency markets, sterling and the euro strengthened modestly relative to the US dollar and Japanese yen. The price of oil rallied during the quarter, helped by an agreement among oil-producing countries to restrict production.
Equities (or shares)
Despite a continued lack of certainty over the UK's withdrawal from the European Union and a reduction in the levels of economic activity expected in the coming years, UK shares had a positive quarter. UK companies seem to be making good levels of profits and some economic signals, such as employment, are encouraging.
In the US the S&P 500 Index hit a series of record highs, along with other market indices. In Europe the strongest performers included Austria and Germany, while Italy and Spain lagged. Italian assets are coming under pressure from concern about the country’s election in March 2018. Miners and consumer-related companies performed well, while telecom companies and banks were weak.
The Japanese stockmarket was the leading performer globally during the final quarter of 2017, rising to levels not seen for at least 20 years. The performance of emerging markets was generally positive during the fourth quarter, led by Africa and Asia, although several South American markets suffered declines.
What do you mean by Equities?
- Equities are commonly known as "shares". When a fund buys a company share, it is investing in a company and, in exchange, receives a share of the ownership of that company. Shares give two potential investment benefits:
- share prices may increase as the value of the company increases.
- companies may pay dividends - regular payments made to shareholders based on how well the company is doing.
What are the general risks of this type of asset?
- Over the longer-term, equities are considered to offer greater growth potential than many other asset types. However, the value of any investment can go down as well as up, either over the short or longer term and so there is a higher risk of losing your original capital than investing in fixed interest securities (see below).
- The financial results of other companies and general stock market and economic conditions can all affect a company's share price, and consequently the value of any fund investing in that company.
The governor of the Bank of England increased the rate of interest by 0.25% in November, the first rise in borrowing charges for more than 10 years. He said that the change was required to combat inflation, despite the ongoing uncertainty over Brexit. Inflation in the UK hit a five-year high in November, which helped the performance of index-linked government bonds.
Most international bond markets rallied in price during the quarter, as central banks remained broadly supportive, despite moving gradually towards the withdrawal of policy measures designed to boost economic activity. The Federal Reserve raised US interest rates again, while policymakers in Europe are to scale back the asset purchases that have kept interest rates at historically low rates.
What do you mean by Fixed Interest?
- Fixed interest securities, more commonly known as "bonds", are loans issued by companies or by governments in order to raise money.
- Bonds issued by companies are called Corporate Bonds, those issued by the UK government are often called Gilts or UK Government bonds and those issued by the US government are called Treasury Bonds.
- In effect all bonds are IOUs that promise to pay you a sum on a specified date and pay a fixed rate of interest along the way.
- Index-linked securities are similar but the interest payments and redemption value are normally increased by a price index e.g. for UK government index-linked securities, interest payments and redemption value are increased in line with the UK Retail Price Index.
What are the general risks of this type of asset
- On the whole, investing in Government or Corporate Bonds is seen as lower-risk than investing in equities. To date, no UK government has ever failed to pay back money owed to investors. But with Corporate Bonds there is a risk that the company may not be able to repay its loan or that it may default on its interest payments.
- Corporate and Government bonds are sensitive to interest rate trends. An increase in interest rates is likely to reduce their value, and hence the value of any fund investing in them.
UK commercial property looks on course to have delivered a solid double digit return over 2017. This was due to solid capital value growth, in particular from Industrials. While growth in capital values in Offices and Retail has lagged, both sectors have nevertheless been able to avoid the worst excesses of negative 'Brexit' sentiment.
The overall resilience of UK commercial property is encouraging, and is due in part to buying by overseas investors following the decline in sterling. Looking ahead to 2018, it is expected that income will once again dominate returns, with investors attracted to those assets that display resilience, international appeal and the ability to adapt to an evolving economy in a low-growth environment.
What do you mean by Property?
- For our funds we would mean commercial property investment. This generally means the fund is sharing in the returns from the ownership of some buildings (for example, offices and shopping centres).
- The value of the property may increase and tenants may pay rent to the owners of the building.
What are the general risks of this type of asset
- Property can be difficult to buy and sell quickly. Fund managers may have to delay withdrawal of money by customers from a property fund until they can sell some of the buildings the fund invests in.
- The actual value of a property is what someone is prepared to pay for it - an actual sale value. As sales are infrequent, interim valuations are based on a valuer's opinion and may be revised up or down from time to time. This can affect the value of a fund invested in commercial property, with the value possibly fluctuating significantly and could result in an investor not getting back the amount they originally invested.
- This leads to a number of risks for funds investing in property:
- Cash could remain uninvested as property assets can be difficult to buy, leading to lower returns than expected.
- The value of the fund may be reduced if a large number of withdrawals are requested and it is necessary for properties to be sold at reduced prices.
- There may be delays removing your money from the fund if property cannot be sold.
- Property fund valuations may be revised periodically, upwards or downwards.
- Rental income is not guaranteed. Defaulted rent and unoccupied properties could reduce returns.
- If the size of the fund falls significantly, the fund may have to hold fewer properties, and this reduced diversification may lead to an increase in risk.