Market update and investment risks

The following reflects the general views of our Treasury & Investment Office (T&IO) and should not be taken as a recommendation or advice as how any specific market is likely to perform.

These views are as at the end of June 2019.

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 likelihood of a US interest rate cut this year increased as Jay Powell, chairman of the US Federal Reserve, said the central bank would “act as appropriate to sustain the expansion”. Powell warned that US businesses were becoming more concerned about trade tension, resulting in a drop in business confidence. The US economy added fewer jobs than expected in May (the latest month for which data was available at the time of writing) and year-on-year rises in average earnings also missed expectations. Meanwhile, in Japan, the economy is “worsening” for the first time in six years, according to one of the government’s main indicators (an index of economic conditions). The last time the Cabinet Office used the bottom grade to describe the economy was in 2013. The outlook for Germany’s economy also worsened, with the country’s central bank cutting its forecast for 2019 GDP growth to below 1%, blaming lacklustre exports.

Equities (or shares)

UK stockmarkets rose during the second quarter, with rallies in April and June overcoming marked weakness in May. Investors reacted to both global and local factors, with the accommodative stance of the US Federal Reserve, and most of the world’s other central banks, being the most supportive influence. President Trump’s threat to increase tariffs on Chinese products endangered economic growth and caused shares to fall sharply before hopes of lower US interest rates, as well as some reconciliation on trade, led to strong recovery. Brexit negotiations were extended to the end of October, which initially helped the domestically focused FTSE 250. However, the greater likelihood of the new Prime Minister pushing for a ‘no deal’ exit resulted in the more international FTSE 100 finishing the period ahead.

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 further positive returns in the second quarter of 2019 as the prospect of renewed stimulus from the world’s central banks provided a supportive backdrop for fixed income markets. While gilts suffered weakness in April, these assets recovered strongly the following month as resurfacing trade war tensions and concerns about slowing global growth helped drive demand for traditional safe haven assets. 10-year gilt yields ended the quarter at around 0.8%, from around 1.0% at the start of the quarter. UK corporate bonds also delivered steady returns over the period, notwithstanding periods of volatility in UK credit markets amid ongoing political uncertainty.

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 recorded a small positive total return in April and May 2019 according to property consultant CBRE (June data was not available at the time of writing.) However, the overall positive return masks a divergence between Offices and Industrial (where capital values have increased every month so far this year) and Retail (where capital values are falling). In the Retail sector, profitability is being squeezed by structural changes in the way we shop, and even well-known brands are suffering. This has resulted in some having to employ Company Voluntary Agreements to manage their rental commitments. This decline in rental values has driven a fall in capital values. Nevertheless, we expect UK commercial property overall to generate modest returns over the next five years, with rental income representing a significant proportion of returns.

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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