Can your investments survive a global crisis?
The world seems to be reeling from one upheaval after another: Australian flooding, a devastating earthquake in New Zealand, quickly followed by catastrophe in Japan and political instability in North Africa and the Middle East. All that comes on top of massive debt crises in the US and Europe.
These upheavals can be catastrophic for those who are directly involved, but the shockwaves will have crashed into your portfolio too. So how do you prevent lasting damage to your investments?
What can I do about it?
Justin Modray, founder of personal finance website Candidmoney, says altering investments in the light of global upheaval is something of a gamble in itself.
"The way in which markets react seems as unpredictable as the turmoil," he says. "Global events might not make that much difference to markets over the longer term but they almost always increase short-term volatility. Common sense says that in times of uncertainty safe-haven investments such as gold and government bonds, especially US Treasury bonds, tend to be in demand, which should push up their price. And this did happen after events in Japan, although both started to fall back again soon afterwards."
Peter McGahan, managing director of Worldwide Financial Planning, says the rules on how to respond to natural disaster - in other words switching to fixed interest when times are bad - have been rewritten in recent years.
"In days gone by it was easy to know where to move your assets, but this has changed since the banking crisis," he says. "It has become less obvious where to run because you don't know whether a government will use quantitative easing." Quantitative easing means a government buys its own country's bonds to put money into the economy, as has been happening in the US and UK – a move that can impact prices and yields on bonds.
Bonds become popular when there is stockmarket uncertainty, but they have already had a good run over the past couple of years. Danny Cox, head of advice at Hargreaves Lansdown, says: "I'd be nervous about gilts and investment-grade (lower-risk) corporate bonds at the moment. Yields are being kept down because interest rates are low, but there are signs rates might go up later in the year, and this will push up yields and lower capital values. Index-linked gilts are a good hedge, although they are overpriced right now."
Will unrest in the Middle East affect my portfolio?
Yes, in short, through soaring oil prices. Social upheaval has pushed oil prices to a recent record high, with a barrel priced at over $120 on 4 April, up from $95 in December last year. As the conflict in Libya continues, potentially restricting oil supplies, the price will remain high.
A high oil price works in favour of certain companies – like BP or Royal Shell - but against others, such as retailers who have seen their fuel costs rocket. Absorbing the indirect cost of such conflicts hits their profits.
What about gold?
Global disasters also affect the price of other commodities, such as gold, which has also leapt to a record $1,526 an ounce (as of 25 May 2011), up from $1,180 a year earlier. The metal is often considered a safe haven when stockmarkets teeter.
Many UK investors have piled into commodity funds, with some exposure to gold and other precious metals, over the past three years. One of the most popular is BlackRock Gold & General, which has broad exposure through a variety of commodity-linked shares. The fund has risen in value by 110% over five years and 25% in one year.
Cox says it might well rise further but adds: "Investors need to know it is not a one-way bet. It fell back a lot during the banking crisis in 2008. Since its value has risen substantially, now might be the time to check if you have too much exposure. Commodities should not make up more than about 2% to 3% of a portfolio."
Darius McDermott, managing director of Chelsea Financial Services, says gold might rise further in the near term, and suggests investors wanting exposure could consider a fund such as Investec Gold.
"The price of gold is seasonal; experts say the price tends to rise in the summer – it's the peak of the Indian wedding season, when there's a high demand for gold," he says.
However, Modray warns: "If market volatility scares you, then by all means shift a little towards gold and fixed interest, but these assets are by no means immune from volatility so you should tread carefully. Absolute return funds [designed to produce a positive return even in falling markets] might also appeal, although far too many have yet to deliver what's on the tin, so don't assume they'll always work."
What should I avoid?
Experts warn that the top places to flee are 'overheated' investments - for example, emerging markets, some hard commodity investments such as gold, and overpriced fixed-interest funds. But they are divided about the potential of global emerging markets, which until recently, were the darling of UK retail investors, outselling all other sectors in the last quarter of 2010, according to figures from the Investment Management Association.
Some fear they have reached their peak, with key countries like Brazil at risk of overheating and all of them under pressure from high inflation.
Among the advisers who believe it is time to get out is McDermott. He says: "Emerging markets have been sensational for 10 years, except for the three months at the height of the 2008 financial crisis. But when everyone's talking about emerging markets, maybe that's the time to take some profits. Someone who sold emerging markets three or four months ago and then invested in the US would be looking very clever now."
What about the eurozone debt crisis?
The debt crisis engulfing countries such as Ireland, Portugal and Greece have made government bonds issued by these countries look pretty unappetising. Moreover, although while there is uncertainty, there will always be demand for quality fixed-income, inflation is lurking and central banks will raise rates to deal with it, making fixed-interest assets less attractive.
Darren Ruane, senior bond strategist at Rensburg Sheppards Investment Management, believes equities are currently better value than bonds and that this will only increase if inflation takes off. "There are better risk-adjusted returns from equities than bonds at the moment," he says.
That said, investors wanting to spread their risks (especially those within a few years of needing to draw an income from a pension fund) are advised to consider using certain types of bond to balance their portfolio. McDermott recommends strategic bond funds, which although not immune to the European debt crisis, have the flexibility to adapt to risks.
Should we be scared?
While the global crises may be causing anxiety for some investors, the consensus is there is no need to be excessively frightened. Indeed, for the bold and fleet of foot there are juicy opportunities.
Japan is a daring bet for those wanting to cash in on upheaval and lower stockmarket prices, for example, and many fund managers quickly increased their exposure immediately post-earthquake to cash in on the bounce-back. But whether the Japanese market is a long-term winner remains uncertain. In fact, some believe the Japanese stockmarket will simply never take off.
Overall, Cox says the wisest move for investors, especially those with long-term goals such as pension savings, is not to panic. "The FTSE has bounced back and is over 6,000 today (4 April). Plus, when markets fall, regular investors do well because they are buying more units of a fund for the same contribution."
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
A term applied to raw materials (gold, oil) and foodstuffs (wheat, pork bellies) traded on exchanges throughout the world. Since no one really wants to transport all those heavy materials, what is actually traded are commodities futures contracts or options. These are agreements to buy or sell at an agreed price on a specific date. Because commodity prices are volatile, investing in futures is certainly not for the casual investor.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Absolute return funds
Absolute return funds aim to deliver a positive (or ‘absolute’) return every year regardless of what happens in the stockmarket. Unlike traditional funds, they can take bets on shares falling, as well as rising. This is not to say they can’t fall in value; they do. However, over the years, they should have less volatile performance than traditional funds.