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 September 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.
An escalating trade war between the US and China was very much at the forefront of investors’ minds during the third quarter of 2018. Despite the prospects of import duties being applied to a significant volume of products both from China into the US and vice versa, so far at least, economic growth in both countries remains resilient. On the other hand, the Eurozone disappointed and the economy within the single currency area expanded at a slower rate than in the first quarter of 2018. During the quarter, monetary policy was tightened in the US and UK (interest rates were raised by a quarter point in both countries). In contrast, central banks in Japan and the Eurozone remain committed to maintaining loose monetary policies for the time being.
Overall, most stockmarkets recorded strong gains over the quarter, with the US and Japan standing out. Corporate profitability remains resilient in both countries and quarterly results were well received by investors. However, performance in Europe was mixed. For example, the share prices of some car manufacturers fell on fears that an escalating trade war could impact the export of automobiles, while banking shares fell on worries over their exposure to the Turkish economy.
Equities (or shares)
It was a disappointing quarter for UK company shares, with the stockmarket one of the worst performers globally. The US stockmarket enjoyed a stellar quarter, with both the S&P 500 Index, which contains many of the country’s largest companies, and the technology heavy NASDAQ composite reaching all-time highs.
The performance of European stockmarkets was disappointing in the third quarter of 2018, with company shares facing several headwinds. Japanese shares made solid gains, performing particularly well in September.
Stockmarkets in Asia Pacific ex Japan declined over the quarter as the fears of a global trade war hit investor risk appetite. Emerging market stocks were under pressure as a crisis in Turkey, fears of a global trade war and a rising US dollar dampened investor sentiment.
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.
UK gilts declined over the third quarter of 2018 as higher-than-expected inflation readings and some robust economic data helped push 10-year yields above 1.6% for the first time since February 2018. The Bank of England raised interest rates from 0.5% to 0.75%. UK corporate bonds held up relatively well with Index-linked gilts outperformed conventional gilts.
Higher interest rates and strengthening inflation weighed on the performance of global bond markets during the quarter. The Federal Reserve raised interest rates to counter upward trends in inflation. Consequently, the bellwether 10-year US Treasury yield rose and closed above 3.0%. Other key factors also dampened sentiment in bond markets. In Europe, these included assessing the implications of an anti-establishment party holding a strong presence in Italy’s newly formed coalition government.
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.
So far this year, UK commercial property has generated a reasonably strong total return; however, gains are more modest compared to the same period in 2017. Capital value and rental value growth continue to be strongest in Industrials, driven by demand for well-located fulfilment centres and smaller distribution units. Conversely, capital values continue to fall in the retail sector.
Looking ahead, we expect UK commercial property to generate mid-single digit returns over the medium term, 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.