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 March 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 first quarter began strongly for most stockmarkets; many reached record highs before falling sharply, seemingly on concern about US inflation. The US Federal Reserve (Fed) raised interest rates in late March by a quarter point to 1.75%. The Japanese yen, sterling and the euro all strengthened relative to the US dollar. The price of oil rallied during the quarter.

Sterling's strength against several currencies reduced the returns from those countries to UK investors. Demand for assets perceived as `safe havens', such as gold and the Japanese yen, increased. Improving economic data and the likelihood that central bankers will soon reduce their asset purchases weighed on government bonds, although they later benefited from being seen as less risky than company shares.

Late in the first quarter of 2018, a potential global trade war dominated the headlines. President Trump imposed tariffs on various imports into the US, and China, the main target, vowed to retaliate. Economic data was generally positive, with measures of activity revised upwards in the US, Japan and the Eurozone. The UK proved an exception as growth was revised downwards, albeit remaining positive. Corporate earnings showed healthy growth and, on the whole, inflation remains muted.

Equities (or shares)

UK shares were among the weakest during the quarter. Investors had to contend with continued uncertainty over the UK's withdrawal from the European Union and a potential reduction in the levels of economic activity. The stronger pound was also seen as negative for multinational companies.

US stockmarkets reached record highs. However things changed rapidly when investors decided that an increase in wage growth could signal higher inflation, prompting faster Fed interest rate hikes. European stockmarkets suffered their worst quarter for two years. Share prices started the quarter strongly before succumbing to fears about higher US interest rates, a potential trade war and sharp falls in the share prices of technology groups.

Having reached its highest level for 26 years in January, the Japanese stockmarket fell back very sharply during the rest of the quarter. Performance of emerging markets was negative overall during the quarter. While Africa, Asia and the Middle East declined, Latin America rallied. Brazil led the way, helped by the economy recovering from recession.

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

The Bank of England left UK interest rates unchanged at their latest meeting. However the prospect of higher interest rates weighed on the prices of 5-10 years government bonds, which underperformed those with a longer time before repayment, making the returns from UK government bonds (gilts) almost flat over the quarter. Index-linked gilts were also broadly unchanged as UK inflation declined from the peak hit in late 2017.

The Federal Reserve raised US interest rates. Emerging market bonds performed well, while bonds from peripheral Europe, including Portugal and Spain, also rose in price. As risk aversion built up later in the period, government bonds benefited from their safe haven status, bonds issued by Japan and Germany returned to low, or negative, levels. Corporate bonds underperformed government bonds.

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 made a steady start to 2018, although the pace of expansion was somewhat slower than in the final quarter of 2017. Capital value growth was strongest in Industrials, which was also the only sector to see a meaningful increase in rental values. Meanwhile, Retail capital value growth lagged the broader market. Looking ahead, UK commercial property is expected to generate a mid-single-digit total return in 2018, of which rental income would represent a significant proportion. The investor market remains healthy, buoyed by overseas demand following the decline in sterling. Within the market, investors are attracted to those assets that display resilience, international appeal and 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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