June 2022

A common theme underpinning all investments, the notion of risk and reward, is a general trade off that affects almost anything from which a return can be generated. Anytime you invest money, there is a risk, whether large or small, that you might not get all of your money back, or in the worst case scenario, that the investment may fail. For bearing that risk, you expect to receive a return that compensates you for potential losses. In theory, the higher the risk the greater return you should receive for holding the investment, whereas if lower levels of risk are taken, lower returns should be expected.

This definition is, of course, simplistic; however, over a period of time, an investor should rightly receive greater compensation for taking greater risk. If this was not the case, why would an investor choose an investment where higher levels of risk were inherent, if they could expect to receive a similar return from an investment that displayed lower levels of risk? This introduces the notion of risk adjusted returns, whereby the return achieved by the investment over time is considered in conjunction with the level of risk experienced.

Assessing investment risk

Assessing the risk of any investment relies on subjective assessment of the potential for the investment to fail, amidst a whole host of other factors. For example, placing money in a UK deposit account carries low levels of investment risk. The nominal value of the deposit cannot fall in value, and if the bank or building society were to fail, then assuming the deposit meets the qualifying criteria, the deposit of up to £85,000 would be protected by the Financial Services Compensation Scheme. However, other risks, such as inflation risk, need to be carefully considered to assess the potential “real” return of the funds held in savings, which is expressed as the return less the then prevailing rate of inflation.

Examples of other risks that investors need to consider are liquidity risk, which is the risk that you will not be able to access your money quickly and easily at a time of your choosing, and currency risk, which applies when investments in foreign assets are made, which exposes the investor to the risk of losing money due to movements in the exchange rate.

By undertaking a similar assessment of the risks associated with each asset class, investors can make a judgement as to the level of risk that applies to each investment and by reviewing long term historic returns and projected returns, can begin to assess the balance between risk and reward that applies to any asset class.

Time horizon is also key

The length of time an investor is willing to invest for is also a key risk factor. Given that economic growth (and therefore market performance) is generally cyclical in nature, investing for less than the medium to long term (which we would normally express as being a period five years or more) would introduce Time Horizon risk, whereby the point at which an investment is bought and sold may be less likely to produce a positive outcome.

When investors look beyond asset classes to individual investments, volatility measures are used to determine how much the price of an individual investment will move up or down over time. If an asset rises and falls considerably, it is seen as displaying high levels of volatility. On the other hand, if the price of an asset is relatively stable and predictable, then this is seen as being low volatility.

Volatility measures are also useful when considering the risks associated with broad market conditions. The widely reported Chicago Board Options Exchange Volatility Index (or “VIX” for short) measures the expected volatility of the S&P500 index of leading US shares and can be a helpful indicator of how much markets are likely to move, in either direction, over the next trading periods.

Deviation from the average

The most common way to measure volatility is through standard deviation. This measures how much the returns of an investment move away (or deviate) from average returns. More volatile investments deviate further and more frequently from their average return, whereas less volatile investments are more likely to track the long term average returns more closely.

The value of investments with very high levels of volatility tends to be dependent on overall market confidence, and sentiment towards riskier assets can be weak during periods of economic uncertainty. In periods when market confidence is lower, investments displaying lower levels of volatility may be less likely to experience poor performance.

When we construct investment portfolios, volatility is a key component we consider when determining which assets are included in the portfolio, and the percentage of the portfolio that is allocated to that position. As each investment has its own volatility measure, when these are combined within a portfolio of different assets, an overall portfolio risk can be determined. The portfolio volatility measure can then be compared to the volatility displayed by similar portfolios, or to recognised benchmarks, to determine whether the strategy is of lower or higher volatility than its peers.

Review your risk adjusted return

Risk is always a key component of our research and analysis when we assess investments, and as explored above, risk can come in many guises, all of which need to be considered. We use advanced technical tools to review volatility and standard deviations of investments with the aim of achieving returns that are commensurate with the level of risk being taken. We often come across investment portfolios managed by other fund managers that carry substantial levels of volatility and risk, that the investor is unwittingly exposed to. 

If you are concerned about risk levels within your portfolio, then please get in touch with one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

Inflation is the key

Following a very positive year in 2021, investment markets have faced significant challenges over the first six months of this year. Inflationary pressure, that was starting to build following the emergency monetary policies employed by Central Banks at the start of the pandemic, has rapidly increased due to higher energy costs, and increases in the price of food and oil. Much of this is due to the Russian invasion of Ukraine, and the combined impact of sanctions on Russian supplies of energy and lack of exports from Ukraine. Further pressure has been exerted by supply chains, which were damaged by the pandemic, failing to keep up with increased demand, and further lockdowns in China, which have exacerbated the supply side constraints.

To combat higher inflation, central banks in the US and UK have increased interest rates over the course of the year. It is the job of Central Banks to try and navigate a course that reduces inflation (the anticipated consequence of the base rate increases) whilst avoiding recession, which may well arise as consumer confidence falters amidst the higher costs of living. Global economic growth was strong in the second half of last year as economies emerged from the pandemic; however growth is slowing in many Western economies once again, with recession a real possibility in the UK, US and Eurozone.

The latest round of base rate increases saw the Federal Reserve increase rates by 0.75% and the Bank of England by 0.25%. Since December 2021, the Federal Reserve has now increased rates by 1.5% and the Bank of England by 1.15%, and further substantive rate increases are anticipated over coming months.

Bear Market in Equities

Global Equities markets have struggled amidst the higher inflation and slower growth. US markets have already moved into correction territory, with falls in the S&P500 and Nasdaq of over 20%. Despite the market reaction, corporate earnings have continued to hold up well in many sectors, and companies with strong balance sheets and cash flow should be able to navigate through these conditions effectively.

Bond markets have not provided a safe haven, with yields increasing over recent months in anticipation of higher interest rates and persistent inflation. Bond markets have now, in our opinion, priced in much of the expected monetary policy decisions, and now offer investors much better value than they did at the start of the year.

What should investors expect over coming months

Given the weak performance seen so far this year, investors are questioning what they may expect to see during the second half of the year. It is important to bear in mind that stock markets are a discounting mechanism, and as such, have factored in the expected course of interest rates and slowdown in economic growth. The forward guidance provided by central banks, in particular the Federal Reserve, has outlined the expected path of interest rates that we expect to see as we head through the remainder of the year. Without any further surprises seen from economic data over coming months, it is likely that the rate hike cycle may begin to slow as we move towards the end of the year.

It is evident that higher volatility will persist during the remainder of 2022; however, we contend that price action over the course of recent months has already discounted higher interest rates and slower growth to come, and market participants are looking beyond this period, when inflation begins to gravitate back towards stated targets, and central banks can ease off the brake pedal.

In any given market, opportunities will present themselves. We are watching the so-called “Price Earnings Ratio” of the S&P500 index of US shares, which measures the stock price relative to earnings for each component in the index. The forward Price Earnings Ratio now stands below 16, compared to the 10 year average for the index of 16.9 and 25 year average of 16.3. Assuming earnings hold up reasonably well over coming months, equities markets – by this measure at least – offer value over the medium term.

The importance of staying invested

In these difficult conditions, it is important to remember the advantage of staying invested and the risks inherent in trying to time an exit and re-entry to an invested position. Trying to trade these conditions is certainly not advisable for any long term investor. Take the example of an investor in the S&P500 index from March 1990 to April 2022, who would have achieved a return of 10.4% per annum over this period, with all income reinvested. However, by missing the 10 best days over this period, this return would fall to 7.7% per annum, and missing the 30 best days would see the return fall to just 4.5% per annum. It is interesting to note that the 10 best performing days all occurred in 2008-9 and 2020, when markets recovered sharply from heavy falls.

A better second half?

The first half of 2022 has seen investment markets struggle, and whilst it is apparent that the volatile and weak conditions may persist over the near term, we are starting to see real value emerge in a number of areas, including Equities and Bonds.

If you wish to discuss your investments and how they are positioned in these conditions, then please get in touch with one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.

The private rental sector has grown significantly over recent years, with over 4.5m tenants now renting from private landlords in the UK. Propertymark  – the professional body for the lettings industry – reported in April that their agents continue to see strong demand, with 10 new registrants for each available property to rent in their member’s branches. In light of the increased demand, it would, perhaps, be easy to conclude that buying a property to let would be a good decision at the current time; however, tenants’ requirements are also shifting, and with many now working from home on a part or full time basis, having the right property, in the right location, is key.

Introducing our Taxation of Property brochure

Whether you are looking to buy, sell, or rent a property a thorough understanding of the tax implications is essential. For up-to-date information and expert advice please access our latest Taxation of Property brochure here.

Growth about to stall?

Landlords have enjoyed the benefits of house price growth in addition to rental income over recent years. Despite the effects of the pandemic that were felt across much of the wider economy, house prices have continued to climb (although the Stamp Duty holiday which ran until 30^th June 2021 certainly gave prices a helping hand).

Recent surveys and reports have, however, suggested that price growth may finally be slowing. The Office for National Statistics reported annualised house price growth slowed from 11.3% to 9.8% in March, although behind the headline numbers, the rate of growth is variable depending on location. For example, annual price growth in London is only 4.8%, compared to the East Midlands region, where growth has exceeded 12% over the last year.

Given the economic shock of higher inflation and consecutive interest rate increases, it is highly likely that this downward trend will continue, and may well accelerate, as higher costs of living and increased borrowing costs limit affordability for house buyers.

Potential changes in legislation

There have been increasing calls for further legislation of the private rental sector, which may well have cost implications for landlords over coming years.

Legislation may be introduced by the end of 2022 to prevent landlords from evicting tenants without giving a specific reason. This could lead to serious implications,  as under the proposed legislation, the likely route to remove tenants would be through the court system or specialist tribunals. One option to protect landlords may be to consider asking for several months’ rent paid upfront or for a guarantor to be provided.

A compulsory energy performance certificate rating of ‘C’ has been proposed, for new tenancies by December 2025, and on all rented properties by December 2028. This could be a major issue for landlords with older properties, as the cost of remedial works may make the financial decision to continue letting an older property unviable. As ever, the proposed legislation is subject to change and carrying out expensive improvement work is not recommended until definite rules are in place.

New rules for holiday lets

Holiday lets have become increasingly popular, in particular given the boom in UK holidays seen during the pandemic. However, if you are a second homeowner with a holiday let, you have a year to ensure you won’t be caught by the closure of a tax loophole used by some to avoid council tax bills on their holiday homes.

Currently, those with second homes in England can avoid paying council tax and can access small business rates relief if they state they are planning to use their property as a holiday let.

Until now, homeowners have not had to provide any evidence that this home has in fact been rented out to holidaymakers, allowing some to gain a tax advantage, despite the property being occupied solely or primarily for private use and standing empty for much of the year.

From April 2023 new rules stipulate that holiday rentals must have been let for a minimum of 70 days in the previous year to qualify for the council tax exemption and small business rates. In addition the property must be available to let for 140 days a year. Property owners will have to provide letting receipts and details of where the property is advertised to holidaymakers, e.g. online or via brochures. Those that fail to let out their property for the required period will have to pay council tax the following year.

Business rates are paid to the local authority. Like council tax, the amount paid will depend on the ‘rateable value’ of the business property. However, as many holiday lets are effectively small-scale businesses, many will qualify for small business rate relief, which will effectively mean no charge at all. Government figures show that around 65,000 holiday lets in England are liable for business rates, but around 97% have rateable values of up to £12,000. If the rateable value is less than £12,000 then there will be no business rates to pay. These rates are also reduced, on a sliding scale, if the rateable value is between £12,000 and £15,000.

Landlords running commercial holiday let businesses, which encourage tourism and provide jobs and local revenue across the country, will, however, not be penalised.

A more balanced decision?

The property rental market has been buoyant for some time, although we feel the decision to take on a new rental property is more finely balanced than it has been for some time. With a slowing economy, higher interest rates and inflation, and legislative changes proceeding through Parliament, landlords have plenty to consider. It could be the case that other forms of investment, such as a diversified investment portfolio of equities and fixed interest securities could produce an attractive income yield to match rental income, in a more tax efficient manner, and without the potential legislative headaches.

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstances.