Derby District & Law Society (D& DLS) magazine - April 2010
In my previous article I considered two well known asset classes, namely Cash and Fixed Interest investments and their place in a balanced portfolio (for more details see page 16 of the February 2010 D & DLS Bulletin).
As considered in the January edition most people invest their hard earned monies into asset backed ‘real’ investments because historically they have been the only way to ensure that the purchasing power of your money exceeds the rate of inflation by a meaningful amount over the long term.
If either you, or your clients, have realised that they either want or need to invest in a balanced spread of investments to have the potential for better performance than simply leaving the monies in deposit based arrangements – what investments are available?
There are a bewildering array of different types of investments available and all manner of terminology and different tax structures that can sometimes ‘muddy’ the picture. However, whatever investment or ‘tax wrapper’ that is proposed to you, the most important factor to focus on is:-
What is the underlying investment that is being made? The reason that this is so important is that this is what will enable you to identify the nature of the Risk involved and it is the underlying investment that will drive the ultimate performance of the investment. Any tax benefits should be secondary, as you should never let the tax tail wag the investment dog – particularly as you don’t pay tax on losses!
In this article I am going to provide a brief description of some more of the different asset classes available, namely Stocks and Shares, Commercial Property and Alternative Investments, as well as their uses in a portfolio.
Equities – Stocks and Shares
The safest type of Equities are traditionally shares in companies with strong balance sheets, steady profits that pay good dividends and that have historically increased their dividends over time. There are currently very high yields available from some companies. Over the long term, as detailed earlier, Equities have performed very well, better than most other asset classes, although this is at the cost of greater fluctuations in capital value.
Some companies are classed as ‘growth stocks’ in that they do not pay any, or only small dividends, but investors still purchase the shares, as they believe that the companies will increase their profits quickly, which should result in a share price increase.
The market tries to anticipate the earnings and profits of companies on the stock market. One of the main drivers of Equity performance is whether earnings and profits rise or fall by more or less than the market is already anticipating. If the earnings and profits of companies do not increase by as much as the market is anticipating, then share prices could fall. Conversely if profits increase by more than the market anticipates, share prices could rise further. The market is also likely to be sensitive to other key indicators going forward, such as unemployment figures.
A balanced Equity portfolio would usually have holdings outside of just the UK, including those in European, American and other international markets.
The FTSE 100, which measures the price of the top 100 shares in the UK, stood at 3,400 in March 2003. In the middle to last quarter of 2007 it was over 6,800. During March 2009 it fell as low as 3,512, which is only 3% higher than six years earlier (this was deemed to be an excessive low point driven by the fear of the second gulf war). As at 19 March 2010 the FTSE 100 is 5,650 a rise of 60% in just over twelve months. This demonstrates the recent extreme volatility of the markets and the extreme downsides of anyone encashing after the market has fallen (i.e. they would have missed out on the ‘bounce’ and crystallised their losses).
This is a broad asset class including offices, retail, industrial units, hotels etc. The income is received in the form of rent and as rents and the values of the underlying land increase, so do the values of the properties.
There are two main types of property funds, those that invest directly into properties and those that invest into property shares (REIT funds).
This asset class has fallen in value quite heavily over the last two years, more so than residential property. The main negative aspects for Commercial Property values going forward are the sheer volumes of debt that needs to be renewed over the next few years and if the economy suffers a ‘double dip’ and falls into another recession (after having just exited the last one), there could be an increase in empty properties and in the average time that they are left empty.
It appears as though the high income yields available from Commercial Property are finally tempting investors back into this asset class again and we are seeing increases in capital values. We are currently more negative about Residential Property than Commercial Property.
Despite the bad press, property is still a good asset class to hold for the long term as it provides diversification to a portfolio and is likely to be a more stable asset class than Equities with returns in excess of those available from deposit accounts, although it will be more volatile than cash.
There are lots of alternative investments that people use to further diversify their portfolio. These include gold and other commodities, hedge funds, private equity, foreign exchange, life settlement funds and timber etc. Typically, alternative strategies would only form a small percentage of an overall portfolio, depending on the investor’s objectives and risk profile.
Commodities have performed particularly well over the last seven or eight years. Some believe that we are in a super cycle and due to the demand from emerging economies, such as India and China and the time it takes to increase mining capacity and produce more commodities, commodity prices still have a long way to rise.
Others feel that any short-term increases in commodity prices will not last and the current prices are unsustainable, particularly given the current slowdown.
A sensible overall plan
Professional Financial Centre (East Midlands) Ltd has successfully helped many clients to put a sensible financial plan into place that will last them for the rest of their lives. When looking at the huge choice of investments available we are able to prove that we only have your interests at heart. We do not have any vested interest in choosing one particular product or course of action over another. As changes happen, we review our clients’ plans, adjusting them to meet changing economic circumstances and family needs. If you want to challenge us to do the same for you or your clients, you will not be disappointed. If you simply want a second opinion, our view on your existing holdings, or have a general query about financial matters, please call us.