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 June 2018.

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.

Overview

The second quarter was an eventful period, with several bouts of volatility in stockmarkets. Politics was on many investors’ minds, with elections in Italy, Russia and Turkey.

In the UK, uncertainty over Brexit continued. Investors were also preoccupied by weaker economic data out of Europe and Japan, and escalating tension between the US and several of its trading partners following the imposition of trade tariffs. Despite the volatility, most stockmarkets rose over the quarter. Notable exceptions included emerging markets such as Brazil, Chile and Turkey.

In terms of sectors, cyclical areas such as technology and energy were in favour, while others, such as financials and industrials, lagged. In fixed income, government bond markets were broadly unchanged over the quarter.

Equities (or shares)

The UK stockmarket made impressive gains over the quarter. Both the FTSE 100 Index (comprising large, mainly multinational companies) and the FTSE 250 Index (made up of mid-cap, more domestically orientated companies) reached all-time highs. Performance was driven by a fall in sterling – which boosted the earnings of companies that generate profits overseas – alongside some prominent merger & acquisition activity, including Sainsbury’s proposed merger with Asda.

Share prices advanced despite some business leaders warning on the lack of clarity over the terms of EU exit. Economic growth was also disappointing with the gross domestic product barely increasing in the first quarter, according to the Office of National Statistics. Unsurprisingly, given the economic uncertainty, the Bank of England left interest rates unchanged.

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.

Fixed interest

UK government bonds (gilts) were broadly unchanged over the quarter, although this masks occasional volatility. For example, in May, when political turmoil in Italy struck, gilts rallied along with debt issued by other countries perceived as safe-haven assets. It had been widely anticipated that the Bank of England would raise interest rates during the quarter; however, disappointing gross domestic product data – growth fell to its lowest rate in five years – and ongoing uncertainty over Brexit appear to have held back the pace of expansion.

Some investors now expect interest rates to be raised in August. Index-linked gilts were broadly unchanged over the quarter against a backdrop where inflation continued to trend lower.

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.

Property

UK commercial property generated a reasonably strong total return in the first half of 2018. However, gains are somewhat smaller than for the same period in 2017. Capital value and rental value growth continue to be strongest in Industrials, whereas capital values fell in the Retail sector, reflecting the challenging trading environment for stores.

Looking ahead, UK commercial property is expected to generate a mid-single-digit total return in 2018, with rental income representing a significant proportion of returns. The investor market remains healthy, buoyed by overseas demand, following the decline in sterling. Within the market, investors are attracted to quality assets that display resilience, provide increasing rental income, and have the ability to adapt to an evolving economy.

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.

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