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 2016.

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

Economies around the world appear to be relatively resilient, with data signalling that in many countries, economic activities are expanding at a faster pace than was previously believed. Most commentators believe that the policies of president-elect Donald Trump will encourage further strength in the US economy, which could spread to other countries. There is, however, some concern that he may impose measures that could dampen global trade.

There was a significant shift in investor sentiment during the final quarter of 2016. In late summer, investors had begun to question widely held assumptions that interest rates, economic growth and inflation would all stay low and this process accelerated towards the end of the year, following the US election result.

In the UK, the performance of many multinational companies continued to be supported by further falls in the value of the pound relative to the US dollar. Furthermore, sharp rallies in the prices of oil and metals benefited the producers of such commodities, while banks were boosted by an improved outlook for the financial sector.

In the US, a widely anticipated quarter-point US interest rate increase took place in December, with three more upward moves from the Federal Reserve now expected in 2017.

Elsewhere, other central banks hinted that their asset-purchase programmes may be reaching completion, with support for their economies shifting to tax cuts and more public spending.

Equities (or shares)

The UK stockmarket sustained its strong recovery from its temporary Brexit-induced weakness, with the FTSE 100 Index finishing 2016 at an all-time high.

US stockmarkets hit several record highs. Shares were boosted by the surprise presidential election result, in anticipation of possible moves to cut taxes, reduce regulation and increase infrastructure spending.

The Italian stockmarket delivered the highest return in Europe, rallying strongly after the constitutional reform referendum.

Japanese investor sentiment was boosted by the Bank of Japan keeping its asset-purchase programme unchanged, suggesting that the economy is stabilising.

Emerging markets were mixed. While markets such as Russia and Brazil were positively influenced by the rally in commodity prices, others came under pressure from the perception that a stronger US dollar could lead to withdrawals of money from previously higher yielding areas.

Elesewhere, Hong-Kong investors became concerned about reported attempts by the Chinese government to curb speculation in the country’s stockmarket. On the other hand, the resource-rich Australian stockmarket benefited from the rally in commodity prices. 

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

Sentiment towards bonds weakened and some gains from earlier in the year were offset as yields moved higher. UK government bonds in particular were negatively affected by a pick-up in inflation expectations due to higher import costs following the sharp drop in sterling since the UK’s referendum on membership of the Europe Union (EU).

Given their greater sensitivity to movements in interest rates, longer-dated UK government bonds underperformed those bonds with a shorter repayment period.

Global bonds reacted negatively as investors weighed how US government debt and inflation might increase if the Trump administration implements big infrastructure spending and tax-cutting policies. The Organization of the Petroleum Exporting Countries (OPEC) agreement to lower oil output added to the negative sentiment. 

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

After a fall in capital values (the price that would have been paid for land or property if it had been purchased when it was evaluated) in the third quarter, UK commercial property has been surprisingly resilient recently. Following a small increase in October, capital values grew by 0.5% in November. Post Brexit referendum, the industrial sector outperformed other sectors, with values supported by a lack of good-quality property.

Capital values fell between January and the end of November 2016; however, the total return for All UK commercial property was overall, positive in 2016. While the UK commercial property market appears to have stabilised, several risks remain, including Brexit negotiations. The stance therefore is one of caution, as events in 2017 may put capital values under pressure again. 

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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