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 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

As the quarter progressed, investors became increasingly concerned about the outlook for the world economy. The perception was that the combination of a trade war between the US and China and tighter monetary policy could stifle growth. During the quarter, the US Federal Reserve (Fed) increased interest rates by a quarter of a point and the European Central Bank (ECB) confirmed it was scaling back its monetary stimulus. On the other hand, the Bank of Japan continued with its policy of quantitative easing. In commodity markets, the oil price fell on the expectation of weaker demand and a sense that planned output cuts by major producers were insufficient to allay concerns about oversupply. Meanwhile, in currency markets, the yen strengthened on the back of its perceived safe-haven status, while sterling weakened over fears over a ‘hard Brexit’.

Equities (or shares)

In common with other stockmarkets around the world, UK shares suffered major falls during the quarter. Little progress was made over the form of the UK’s withdrawal from the European Union, and this weighed on the pound. In the past, pound weakness supported the exporting companies that make up a large proportion of the FTSE 100 Index, but the significant weakness in the oil price in the fourth quarter led to lower share prices for energy companies. 

Still, the FTSE 100 did outperform the more domestically focused FTSE 250, whose members are seen as more exposed to a ‘hard’ Brexit. In addition to Brexit, investor sentiment was dented by higher US interest rates, trade tension between the US and China and signs of slowing global economic growth.

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 (over 10 years), 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 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) delivered positive returns in the final quarter of 2018 as ongoing Brexit uncertainty coupled with fears of a slowing global economy helped support demand for traditional safe haven assets.  As widely expected, the Bank of England kept interest rates unchanged at 0.75%, with policymakers warning that UK growth would likely slow in the final quarter of 2018. It proved to be a more challenging period for UK corporate bonds as the general downturn in sentiment held back returns.

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 delivered a solid performance in 2018; however, the overall return was somewhat lower than last year. Nevertheless, UK commercial property was one of the few asset classes to close out 2018 in positive territory. Growth in capital and rental value continue to be strongest in Industrials, driven by demand for well-located fulfilment centres and smaller distribution units. Conversely, capital values in the Retail sector fell in every quarter, reflecting the challenging trading environment.

Looking ahead, we expect UK commercial property to generate mid-single-digit returns over the medium term (5 to 10 years), 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 can 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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