MANAGING MY RETIREMENT

Six tips to help defend your investments against turbulent markets

  • 15 June 2020
  • 10 mins
  • Frequent and sharp ups and downs in investment values can make us nervous

  • These six tips could help defend your investment portfolio

  • Focus on your longer-term goals rather than daily changes in value

As an investor, you might be worried about a range of challenges. Global economic growth has been slowing since late 2018. But just as a preliminary US-China trade deal was being signed, and as the UK and the European Union started to discuss their future trading relationship, the Covid-19 pandemic has undermined the potential for further gains in the near term.

In this briefing we provide six tips that investors could consider taking in anticipation of unpredictable times.

Tip 1 - Be defensive not cyclical

The values of many types of investment has been rising and falling rapidly, and sometimes quite sharply, since the summer of 2018. Initially triggered by the US-China trade dispute, the uncertainty over the UK’s exit from the European Union added to investors’ concerns.

The Covid-19 pandemic has added to these uncertainties.

The more uncertainty there is, the harder it is for you to know what, when or where to invest. But when uncertainty is lower, it’s less difficult to project the potential outcome of your investment decisions. And that applies to a huge number of investors.

However, there are some businesses whose sales and earnings are not so reliant on the economic cycle. These are known as defensive companies and they tend to make products or services that are essential to consumers. Defensive firms tend to have long histories of surviving economic downturns because their products are likely to be purchased whether the economy is booming or in a recession. Their more economically sensitive peers are called ‘cyclical companies’ or ‘cyclicals’

Defensive companies tend to make products or services that are essential to consumers

With any investment you should bear in mind that past performance is not a reliable indicator of future results. The value of investments and the income from them can fall as well as rise and is not guaranteed, and you might not get back your initial investment.

Tip 2 - Consider bonds with low risk ratings

You might also consider defensive opportunities in the bond markets.

A bond is an investment in which an investor lends money to an issuer. The issuer can be a government institution or a company. Bonds usually have a fixed lifespan during which the issuer usually pays the investor an annual interest payment. At the end of the loan period the issuer also returns the amount initially borrowed.

The lower the level of risk associated with the bond, the less the issuer has to pay to attract investors to buy its bonds.

Consider a large company operating in a growing market with low total levels of debt, and frequent and stable cash-flows. Bonds issued by that company could be perceived to be relatively low risk. If you held such a bond, you would probably find it fairly easy to sell it if you wanted to. In other words, you’re less likely to be stuck with something that you don’t want or that is rapidly losing value.

Government bonds can also provide a relatively defensive investment opportunity. But it will depend which government is issuing the bonds, and that brings us on to the consideration of geographical variations.

Consider defensive opportunities in the bond markets.

Tip 3 - Stay out of troubled countries

At present, there is a considerable difference in the perceived risk associated with a 10-year bond issued by the Argentine government and an equivalent one issued by the UK government.

The higher the risk associated with a bond, the higher the yield that it tends to pay in order to compensate investors for that risk. In late October 2019, the yield on the 10-year UK government bond was around 0.7%. The Argentine equivalent was around 44.0%. [1]

This is because the UK has the world’s fifth-largest economy and is a stable, liberal democracy based on the rule of law. By contrast, Argentina had lost its economic-reforming president for a populist leadership that included a former president under investigation on suspicion of having accepted bribes.

That 43.9% return might have appeared attractive, but it reflected the higher risk of investing. In fact, the new president has since suspended all historical bond repayments while the government attempts to restructure Argentina’s US$100bn debt pile. Bondholders fear they could lose much of their investment. [2] To date, Argentina has defaulted on its debts eight times [3].

If we’re considering how we can reduce our exposure to potential sharp movements in prices, maybe we should focus our investments on regions and economies that are more stable.

Focus investments on regions and economies that are more stable.

Tip 4 - Don't put all your eggs in one basket

You might think that it would make sense just to focus on low-risk rated bonds. But that would leave you vulnerable to a sudden change in bond prices.

For example, with a preliminary US-China trade agreement, the start of UK-EU trade negotiations, and at some time an end to the Covid-19 pandemic, global economic growth could recover quite sharply.

That, in turn, would attract investors to cyclical stocks and out of bonds. If your portfolio only held low-risk bonds, their values would be likely to fall if the broad community of investors sold bonds to buy stocks that have the potential to deliver higher long-term gains.

Don't out all your eggs in one basket.

Creating a mix of investments that don’t all move up or down at the same time can help to reduce this concentration risk as it is known. In short, don’t put all your eggs in one basket but have a mixture of investments appropriate to your objectives and capacity to accept short-term losses. These don’t have to be limited to stocks and bonds.

The respective asset classes are represented in this chart by the FTSE All Share Total Return Index, the Bloomberg Barclays UK Government All Bonds Total Return Index, and the Morningstar Diversified Alternative Total Return Index.

Tip 5 - Investigate other asset classes

Traditionally when stock prices rise in general, bond prices tend to fall. This is because the majority of stocks carry a higher level of risk and potential return. When investors are confident they tend to favour equities, and when they are concerned they tend to favour bonds.

So if you’re an investor who expects trouble ahead, you’d be more likely to increase the number of bonds you hold and decrease the stocks as that would reduce your risk levels. By the same token, as prospects improve, you’re more likely to want a larger proportion of stocks as they tend to carry greater potential for returns alongside their higher risk levels. In short, the movement of stocks and bonds are correlated: when one goes up, the other tends to go down. So why not consider other assets that are not correlated so strongly to stocks and bonds?

Such investments can include property (investment funds as well as physical property), and other alternatives including a group of investments referred to as “absolute return”.

When stocks go up, bonds tend to go down and vice versa.

Tip 6 – Keep a long-term focus

Finally, and perhaps most significantly, be patient. That investment warning that you’ve probably heard dozens of times is there for a reason: investment returns can go down as well as up and cannot be guaranteed. However, the longer you are prepared to leave your money invested, the better your chances of earning a positive return.

We prefer an investment horizon of around 10 years or more because we believe it enables you to take less notice of the short-term ups and downs that take place on a daily basis. What’s more, our analysis shows that this 10-year time line has historically delivered a positive return 99% of the time. [4]

We drew this conclusion from looking at the 10-year returns on the FTSE All Share Index between December 1985 and December 1995, January 1986 and January 1996, and so on up to 31 March 2010 and 31 March 2020.

That’s a total of 183 individual 10-year periods. Of these, only three failed to deliver a positive performance. The average return over all of those periods was 140%.

A 10-year timeline has historically delivered positive returns 99% of the time for the FTSE All Share Index.

Conclusion

By holding a long-term perspective and retaining a diverse mix of more defensive and lower-risk rated investments, you can reduce the likelihood that your portfolio will be subject to rapid changes in its overall value. However, the precise mix of assets most appropriate for you will depend on your unique circumstances and needs.

Important information

Any views expressed are our in-house views as at the time of publishing.

This content may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.

Fees and charges apply

Sources:

[1] Bloomberg accessed on 24 April 2020

[2] https://www.ft.com/content/308a7cf8-3626-11ea-a6d3-9a26f8c3cba4

[3] https://www.telegraph.co.uk/business/2020/02/09/argentina-threatened-default-just-months-new-leftist-presidency/

[4] Bloomberg and Schroders Personal Wealth as at 31 March 2020, data sourced on 21 April 2020

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