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 June 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

Prime Minister Theresa May called a snap election in June in a surprise move designed to give her an increased majority ahead of Brexit negotiations. Instead, the UK electorate responded by wiping out the slim majority she had commanded before the election.

US President Donald Trump continued to struggle in his attempts to reform taxation and healthcare, and has yet to be able to boost infrastructure spending. Nevertheless, the Federal Reserve (Fed) increased interest rates again, citing economic strength as the reason, and stockmarkets reached record highs.

In Europe the election of business friendly Emmanuel Macron as the president of France prompted rallies in equities and the euro. The results of regional elections in Germany were also positively received. The strength of the euro boosted the returns from European assets to UK investors.

Economic indicators, such as employment statistics, manufacturing activity and company profits, seem to indicate that the global economy is recovering steadily. However, recent data from the US were somewhat disappointing, although not bad enough to stop the Fed raising interest rates for the fourth time in the current cycle. Inflation remains fairly benign across many countries, notably the US, with the exception being the UK, where prices are rising at the fastest rate since 2013. Towards the end of the quarter, central bank commentators appeared to signal that the era of very low interest rates was coming to an end.

Equities (or shares)

The general improvement in economic data appeared to be reflected in higher demand for company shares (equities) and many stockmarkets delivered robust returns.

In the UK, despite uncertainty over the political situation and how talks with Europe will proceed, share prices continued to rise. Both the FTSE 100 Index and the more domestically oriented FTSE 250 Index reached record highs.

US stockmarkets enjoyed a strong quarter, led by technology companies with the technology-dominated Nasdaq Index outperforming the broader stockmarket.

Among the best performers in Europe were the stockmarkets of France and Italy, as well as the banking sector. On the other hand, the continued fall in the oil price kept the energy sector under pressure.

Japan enjoyed a positive quarter, with the weakness of the Yen boosting demand for shares of the exporters that dominate the economy. Technology was the best-performing industry.

A number of Asian and emerging markets benefited from an increase in investors’ appetite for risk. The Chinese stockmarket rose strongly when the country’s shares gained entry to a widely followed emerging markets index.

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

In the UK, government bond (gilt) prices fell during the quarter. While the governor of the Bank of England appears set against raising interest rates, the most recent monetary committee minutes revealed that some policymakers feel higher rates might soon be needed to combat inflation.

The reduction in political risk in Europe resulted in weaker demand, and in turn, lower prices, for government bonds from the likes of France and Germany, although the strength of the euro meant that they registered positive returns in sterling terms. Similarly, US Treasuries were adversely affected by the Fed’s decision to raise US interest rates by 0.25%.

During the quarter, bonds issued by companies performed better than those issued by governments, supported by investors’ desire for income.

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 second quarter, despite the outcome of the general election and continued uncertainty surrounding ‘Brexit’. Total returns from the asset class are being driven 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 buying by overseas investors following the decline in sterling.

Capital growth is currently strongest in offices and industrials – with the latter supported by firm demand for national distribution and smaller warehouses close to towns. Capital value increases in the retail sector, however, were subdued. The retail sector is also seeing little in the way of rental growth, while rental growth is strongest in the industrial sector.

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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