July 2022

Most of us will be familiar with the concept of regular investing, through pension saving for retirement. Each month, contributions are deducted from salary or earnings and under a Defined Contribution arrangement, are invested into a stock market fund. The monetary contribution buys a number of units based on the prevailing price of the fund on the day the contribution is received by the pension provider. At each monthly contribution point, the number of shares the contribution buys is different, as the price of the units will fluctuate from month to month.

When markets are buoyant, and performing well, the monthly contribution is likely to buy less shares, as the price of the fund is likely to be higher. Conversely, when markets are under pressure, the monthly contribution is likely to buy a greater number of shares as the price will be lower. By saving regularly and investing at different entry points, this provides the benefit of “Pound Cost Averaging”, which is an effective way of smoothing out the peaks and troughs that markets experience over a period of time.

Under a pension arrangement, or any other regular saving approach, regular savings of this manner are often the only way that an individual can effectively save over the longer term. As the regular savings are deducted from salary, this leads to a disciplined saving regime month after month. But what if the investor has a lump sum to invest? Should regular savings still be employed, or should the investment be made in a single transaction? This is a more complex decision, where a series of factors need to be considered before reaching a decision.

Don’t try and time the investment

Conventional investment wisdom would dictate that investors should maximise the time that investments are held, and therefore the simple answer would be that a rational investor would make a lump sum investment at the earliest opportunity in order for the investment to begin working for them. In periods when markets are stable or rising, this is often sound advice, as not being invested comes with an opportunity cost.

Missing out on just a few of the best performing days that investment markets have witnessed can have a dramatic impact on long term performance. For example, the annualised return achieved on an investment made in 1990, invested in the S&P500 index of US Equities, would fall from 10.4% per annum to 7.7% per annum if just the 10 best days, when markets gained the most, were missed. This is, perhaps, the best illustration of the importance of being invested in markets, and staying invested for the long term, rather than trying to time the entry point into an investment position.

A phased approach

When markets are more volatile, however, a case can be made to drip feed the investment in over a number of months. When a lump sum investment is split into a number of smaller investments that are made over a period of time, this is known as “Phasing”. A phased investment approach effectively converts the lump sum investment into a series of smaller amounts, which are then invested over a period of months. The investment is normally established so that the same amount is invested at each point in the phasing process, and as prices and values will be different from month to month, each purchase buys a different number of shares in a fund or series of funds, thus smoothing the entry into markets.

Phasing can work in an investor’s favour, if markets fall during the phasing process. At each investment point, the phased investment would buy a greater number of shares if prices are falling, leading to a better outcome than if the lump sum was invested in a single transaction. On the other hand, rising markets will mean that each phased purchase will buy less shares, if prices are rising, leading to a worse outcome than would be the case using a single purchase point.

An individual decision

Other factors need to be considered when deciding on whether to invest a lump sum immediately, or phase an investment over a series of smaller transactions. For example, investment experience is an important consideration. If an investor is making a lump sum investment for the first time, drip feeding funds in over a period of time can be helpful in reassuring a nervous investor.

The opportunity cost of not investing in a single lump sum also needs to be considered. If funds are held in cash during a phasing process, and are not invested, the cash funds are likely to earn a negligible rate of interest, and if the investor is seeking to generate income from the investments, the income stream will take longer to develop, as only a small investment would be made initially.

Lastly, the size of the investment, in relation to value of an individual’s wealth, may also be a contributory factor in the decision making process. If a large lump sum is being invested, the investor may be more keen to invest over a number of months, rather than investing in a single transaction.

Deciding on an appropriate strategy for entry into an investment position is an area where independent advice from a professional can add significant value. At FAS, we employ Phasing where appropriate and always consider an individual’s circumstances in a holistic manner when advising whether to invest a lump sum using a phased approach or not. As each individual’s needs and objectives are different, we take the time to talk to our clients about risk and volatility, enabling clients to reach a decision with which they are comfortable.

If you would like to discuss the benefits and drawbacks of phasing with one of our experienced advisers, 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 circumstance.

Since March 2020, investors have been exposed to volatile market conditions, with markets falling heavily at the height of the Covid-19 pandemic, only to be followed by a rapid recovery, and then weaker market conditions again this year, due to higher inflation and the conflict in Ukraine. Whilst volatile conditions lead to opportunities, there are a range of funds that aim to generate profit irrespective of whether markets are positive or weak.

These funds are known as Absolute Return funds, and as the name suggests, they aim to generate positive returns in all market conditions, by adopting a different strategy than is used in more traditional investment funds that tend to invest in a single type of asset (e.g. Equities or Corporate Bonds) or a mix of asset classes.

Absolute Return funds often use “long” and “short” strategies, and are designed to make money from shares in companies that go down as well as up, thus aiming to  deliver a positive return for investors regardless of whether the market is rising or falling. They also aim to achieve returns that are smoother, reducing some of the volatility that has been so apparent for investors over recent years. This is also reflected in the choice of benchmark, or performance measure, used by Absolute Return funds, which is more often a return based on cash, or inflation, plus a percentage margin, rather than broader market movements.

A combination of strategies

The primary feature of Absolute Return funds is that the fund manager is not usually constrained by investing the fund in a rigid asset allocation, and has the flexibility to choose where the fund is invested across a range of different asset classes and strategies. In many Absolute Return funds, the manager will look to employ strategies that hold both “long” and “short” positions.

“Long” strategies are traditional investments into assets that the fund manager believes will rise in value over time and involves buying and holding the shares of companies or other assets. A “short” position can be adopted on any investment that the manager believes will fare less well, or fall in value. These positions make use of derivatives, which are complex financial instruments that typically allow the manager to sell shares they do not own, with the aim of buying them back at a lower price to make a profit.

In addition to these strategies, Absolute Return funds also invest in other assets depending on market conditions. Some use cash and short dated loans/bonds as a way of protecting the portfolio in more difficult market conditions, and use alternative assets and commodities as hedging tools.

What is the attraction?

Looking at historic returns from the sector, it is clear that a well managed Absolute Return fund can limit volatility and risk, whilst achieving good returns over the medium to longer term. The fact that the fund manager is not limited by strict guidelines can help tailor the portfolio to match the underlying and expected conditions more closely than when the fund manager is constrained by the fund guidelines. This flexibility can also mean that a strong performing Absolute Return fund can aim to deliver returns when other asset classes struggle.

And the drawbacks?

This type of investment is more heavily dependent on the skill set of the manager or management team than perhaps any other type of investment. As the investment strategies used often involve derivatives, these can amplify performance in both directions, and lead to greater losses if the wrong asset is held at the wrong time.

In addition, Absolute Return funds tend to be expensive in terms of their annual charges, and some funds charge a performance fee, which is charged in addition to the standard fund charge when certain performance targets are reached.

In addition to the added complexity of Absolute Return funds, in certain circumstances, positions taken within an Absolute Return fund can be less easily realisable than mainstream assets, which could lead to delays or difficulties if investors wish to sell or encash their investment.

Does flexibility translate into returns?

Absolute Return funds started becoming more popular immediately after the financial crisis of 2008, and by 2015, they represented the most popular type of fund by volume of sales. However, this popularity has waned over recent years, with outflows of £3bn from the sector seen during 2021.

Performance across the sector has been mixed. A number of funds have shown consistently strong performance over a range of different market conditions, and merit consideration. In a diverse sector, however, there have been a number of funds that have performed less well, with a wide divergence of returns seen over the medium term.

Given this variance in performance, increased due diligence is required when considering Absolute Return funds, and careful analysis of the strategy, track record of performance of the management team, and risks, is key to making the right selection within the sector. At FAS, we maintain a limited exposure within our portfolios to a small, select group of Absolute Return funds that we feel have good prospects for outperformance over the medium to longer term. However, we use these funds where appropriate as part of a much wider, diversified portfolio of assets.

If you would like to discuss Absolute Return funds or would like to review your portfolio strategy with one of our experienced advisers, 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 circumstance.

Anyone heading off abroad at the moment will be facing the prospect of the Pound not stretching as far, as Sterling continues to weaken when compared to other global currencies. The implications of a weak Pound go much further than making holidays more expensive as it has a major impact on the UK economic outlook and for investors in UK assets.

Interest rates are key

Whether a currency is strong or weak against a basket of other currencies, and notably the US Dollar depends on a number of factors. The prevailing interest rate, and expected interest rates in the medium term, can help promote a strong currency, as investors will be more keen to hold cash in a currency where interest rates are higher than in a currency with lower interest rates.

The Bank of England, whilst raising interest rates on five occasions since December 2021 are still lagging behind the US and Canada, with the US Base Rate standing at 1.75% and the Canadian Base Rate at 1.50%, compared to 1.25% in the UK. However, the Base Rate is still some way above the Eurozone, where Base Rates are effectively still at zero. Interestingly, the Euro has been just as weak against the Dollar as Sterling, and is close to reaching parity with the US Dollar.

The importance of stability

Financial stability is another important consideration, as investors would, unsurprisingly, be more willing to hold reserves in a country that has sound economic prospects and good governance. It is quite evident the political turmoil and uncertainty we have seen over recent months has impacted on Sterling’s performance. Looking at the longer term, Sterling has been on a broadly downward trajectory against the Dollar ever since the Brexit vote was announced in 2016, and given the uncertainty that was introduced by the vote to leave the EU, again, it is perhaps not a surprise that Sterling has found itself on the backfoot.

Inflationary pressure

Lastly, levels of inflation that exist in the location where reserves are held is also important, as higher levels of inflation can hinder real returns achieved on deposits. Inflation in the UK is also higher than most other developed nations, with the Consumer Price Inflation (CPI) measuring 9.1% in May and standing higher than both the US and Eurozone, at 8.6%.

The higher levels of inflation are, to some extent, not only a disincentive to holding Sterling, but a direct result of Sterling’s weakness. The UK has a negative trade balance, in that it imports significantly more than it exports. Imported goods that are priced in Dollars can potentially cost more when passed on to end consumers, once the Dollar price is converted to Sterling.

The impact on the UK economy

Considering these factors, there is plenty of evidence that confirms why Sterling is under pressure at the current time. But how does this impact on UK businesses, and in turn on the prospects for investors in UK assets?

We have already alluded to the fact that importing goods in Dollars will become more expensive as Sterling weakens. Businesses have a choice whether to absorb these higher costs, at a risk to their margin, or pass on the cost increases, which runs the potential risk that customers may turn to alternatives or simply reduce or stop buying the product altogether. This is the reason why we favour funds that invest in businesses with strong market share, good cash flow and brand loyalty, that can look to pass on increased costs without affecting their market position.

Sterling weakness can provide a positive impact on companies that earn a good proportion of their income from outside of the UK. Within the FTSE100, around three quarters of revenue earned by the largest UK companies are generated overseas, and once these earnings are converted back into Sterling, a falling Pound can amplify the profits of these companies. This effect is less prominent in mid-sized companies, and in particular, far less apparent in smaller companies, that tend to be more domestically focused. For those companies that primarily export their goods, a weak Pound is a barrier to profits, as goods and services priced in Sterling can look more expensive to overseas buyers.

Should investors be concerned about currency risk?

We live in a global economy, and it is only correct that investors should look to hold a diversified investment portfolio, with assets spread across the globe. As we have commented in previous articles, the UK market is relatively tiny compared to the influence of the US, and by simply focusing on UK positions, many of the World’s largest and by definition successful companies will be out of reach. That does, of course, lead to currency risk.

As we have seen over the course of this year, Sterling’s weakness has helped overseas investments held in UK funds. The S&P500 index of leading US shares is down over 17% over the year to date in Dollar terms, but due to Sterling’s weakness, the fall is just 8% when converted back to local currency.

The reverse effect would, of course, be apparent in periods when Sterling strengthens. In these conditions, one option is to blend funds that aim to hedge their portfolio against currency movements.

Where next for Sterling?

The Pound has drifted down a slippery slope this year, due to higher inflation, political upheaval and weak economic prospects. Given our expectations for the coming months, it is difficult to see the position changing significantly in the short term.

If you would like to review your portfolio to consider aspects such as currency risk with one of our experienced advisers, 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 circumstance.

Making sure an investment portfolio has sufficient diversification can help mitigate risk, and one way that a portfolio can effectively be diversified is to allocate funds globally. By investing funds across a range of different geographic areas of the world, the impact on the overall portfolio, if a particular region suffers a downturn, is reduced.

Investing in a global investment fund may be a sensible way of obtaining this diversification, and you may be forgiven for thinking that such a fund would invest a reasonable proportion of the portfolio in each region. The reality is that a significant proportion of the portfolio, perhaps up to two-thirds, is highly likely to be invested in the US market. The MSCI World Index, perhaps the most recognised global market index which comprises the largest 1,540 global companies from 23 developed nations, allocates 68.3% to the US market, with the next largest component being Japan at just 6.2% and the UK at a mere 4.4%.

Size that can’t be ignored

The reason US markets command such a weight in global indices is a result of the sheer size of the largest components of the US S&P500 and Nasdaq indices. The relative size of companies value on the market is calculated by multiplying the number of shares in issue by the price of each share, and is known as the market capitalisation (or market cap). Currently, US tech giant Apple and Saudi energy company Saudi Aramco are swapping places as the largest global stock by market cap, with both companies valued at over $2 trillion. To put this in perspective, both companies are individually over 10 times bigger than Shell, which is the largest component in the FTSE100 index of leading UK shares.

Of the remaining 8 companies in the top 10 global stocks ranked by market cap, 7 are based in the US, with Chinese conglomerate Tencent being the only other non-US company to feature in the top 10.

To reinforce the scale of these mega cap stocks, it was interesting to note that at one point in 2020, the market cap of Apple was bigger than the combined market cap of all 100 constituents of the FTSE100, and whilst Apple shares have fallen back this year, the value of the company continues to stand just below the combined market cap of the UK index.

Given the sheer magnitude of the largest US stocks, active managers of Global Equities funds would have to make a very bold decision to ignore the largest positions, as doing so would be increasing the chance that the fund would perform very differently from the market as a whole.

When America sneezes

It is clear to see the dominance of US companies in global terms, and why US stocks really can’t be ignored when considering geographic asset allocation within a portfolio. But this doesn’t necessarily explain why the fortunes of the US economy are key to how global markets perform.

Whilst the origins of the saying are open to debate, the phrase “when America sneezes, the world catches a cold” is often used to describe the influence the US economy has over the rest of the world. Perhaps the most striking example would be the Great Depression in the 1930s, which started following the infamous Wall Street Crash of 1929.

Despite only being home to less than 5% of the world’s population, according to the World Bank, the total Global Gross Domestic Product in 2020 was $84.5 trillion, with the US contributing almost $21 trillion or 25% of the world’s economic output. Any shift in performance of the US economy, by virtue of the global marketplace, will therefore have a disproportionate impact on the economic prospects for many other countries.

The confidence of US consumers will have a truly global impact, as it is the most important export destination for one fifth of countries around the world. Increasing US consumer confidence can lift the fortunes of many trading partners through an increase in demand for imported goods, and this is why the prospects for Emerging Markets are, in particular, linked to the performance of the US economy.

Another key reason is the importance of the US Dollar, which is the most commonly used currency both in trade, and also financial markets. The Dollar is seen by many as the world’s reserve currency, and according to the International Monetary Fund, just under 60% of Global central banks reserves are held in US Dollars. Monetary policy decisions by the Federal Reserve, the US central bank, are so carefully watched due to the impact these can have on the strength of the US Dollar, which in turn affects the financial stability of countries that rely on Dollar reserves.

Finally, global commodity markets are intrinsically linked to US economic prospects. As the US is the largest producer, and consumer, of both Oil and Gas, the output from US production of energy supplies, and the demand for those supplies around the world, will weigh on global commodity prices.

The US is key to the global economy

As these factors demonstrate, the US economy and stock market have a defining role to play in the fortunes of the global economy, and in our opinion, any portfolio strategy should have exposure to the US as part of a global approach.

We see many investment portfolios managed by others that are too focused on UK stocks and funds, and significantly underweight in their allocation to US Equities. Since 2016, this would have led to underperformance as UK Equities have consistently lagged US stocks over this period. Whilst we advocate good exposure to the UK within any strategy, given the importance of holding domestically focused positions, not having a sufficient allocation to the US means missing out on the prospects for the world’s largest firms, and the most influential economy.

If you would like to discuss the geographic diversification in your investment portfolio 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.