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 2017.

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

Data appears to signal that economic activity is picking up around the world, with many forecasts for growth being revised upwards. This has been accompanied by a rise in inflation, with the pace of price increases at the highest level for many years.

While political events, such as the UK’s first steps on the road to Brexit, approaching elections in Europe and President Trump’s attempts to meet campaign promises dominated headlines, economic data continued to improve. Investors were encouraged by higher company profits and some significant takeover activity, prompting several major stockmarket indices to hit all-time highs, notably in the US and UK. For much of the quarter, sentiment was supported by hopes that President Trump would introduce policies designed to stimulate growth, such as lower taxes, even though the prospect of such moves faded later.

At the end of the quarter, the UK government signed Article 50, beginning the two-year process of leaving the European Union (EU). The prospect of protracted negotiations weighed on the pound, which boosted the value of the many multinational companies represented in the FTSE 100, pushing the index to record highs.

In the US, the country’s central bank decided to raise the official interest rate by another 0.25%, citing the strength of the economy, with two more upward moves expected in 2017.

Equities (or shares)

During the quarter, the UK FTSE 250 Index hit record highs and outperformed the FTSE 100. Shares in smaller companies rallied as well, beating their larger counterparts.

The expectation that President Trump would introduce policies designed to stimulate economic activity enabled stockmarket indices in the US to hit successive record highs.

Although there was plenty of uncertainty surrounding financial markets in Europe, mainly due to political events, continued strength in the economy led investors to drive share prices higher.

Despite a sustained recovery in the country’s economic outlook, Japanese shares lagged most of the world’s stockmarkets, particularly in local currency terms. Elsewhere, shares in the Asia Pacific region were among the best performers during the quarter, again helped by a decline in the US dollar.

In Emerging Markets the US dollar losing ground to most other currencies was helpful for company shares during the first quarter of 2017. The Argentinian stockmarket rallied in sterling terms. A decline in the oil price weighed on the Russian stockmarket, which is heavily reliant on natural resources.

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

During the first quarter of the new year, UK government bonds (gilts) delivered positive returns following losses in late 2016 and at the beginning of 2017. This initial weakness was in response to a pick-up in inflation expectations resulting from higher import costs.

While credit spreads on UK corporate bonds were little changed overall, the decline in government bond yields meant that these assets also posted higher returns over the three months.

Core government bonds (principally those issued by the UK, US and Germany) continued to come under pressure at the start of 2017. This was in response to ongoing fears of rising inflation, partly fuelled by the prospect of a strengthening US economy, and the potential effects of oil price increases.

Corporate bonds in US dollars, euro and sterling delivered positive returns over the quarter.

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 has enjoyed a solid start to 2017, which follows on from the recovery seen in the fourth quarter of 2016. Total returns from the asset class are being propelled by both growth in capital values and stable rental income. The overall resilience of UK commercial property is encouraging, and is due in part to increased purchasing by overseas investors following the decline in sterling.

The industrial sector continues to see both the strongest capital and rental value growth. Demand is being driven by retailers for smaller warehouses close to towns, while larger ‘sheds’ are required for regional and national distribution. Within the industrial and office sectors, rental value growth is strongest in the South East.

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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