Looking through the short-term noise, the challenges of 2022 should give way to longer-term opportunity. Read on to get ahead of key trends for 2023.
Edward Allen, Private Clients Investment Director at Tyndall Investment Management, explains his approach to low-risk investing, which aims at delivering the best possible returns despite difficult conditions.
Investors can often prefer to be quite cautious about the level of investment risk they are willing to assume. This might be because they are new to investing serious sums in a portfolio and are testing the waters or it risk-aversion be more of a character trait, and there is certainly nothing wrong in that. It is also the case that investors sometimes want or need to dial down their risk exposure because they have a significant call on their wealth coming up (like purchasing a property) and so won’t have time to recoup any losses or simply because they have no retired and need to carefully husband their savings so that they are sure to last.
Low-risk investing is therefore something most, although not all, wealth managers cater for very well. However, investors need to be aware that at times the economic environment, and in particular prevailing inflation trends, do not lend themselves to too much risk aversion – meaning being too cautious could be costly indeed.
Today, even after fairly sizable increases in the interest rates achievable on cash (1% is now offered at some banks) and bonds (the 10-year UK bond now yields 1.9% whilst the 2-year yields 1.6%), investors locking in these returns still end up woefully behind the headline “CPI” inflation rate of 7.0%
Back in the good old days, low-risk investing meant putting your money into a mixture of cash and bonds and taking a 5% yield to the bank. You might not have come out with much return above inflation after tax, but it was certainly an acceptable return to many.
Today, even after fairly sizable increases in the interest rates achievable on cash (1% is now offered at some banks) and bonds (the 10-year UK bond now yields 1.9% whilst the 2-year yields 1.6%), investors locking in these returns still end up woefully behind the headline “CPI” inflation rate of 7.0%. We expect this inflation rate to fall over the coming months, but I still think that the returns achieved by those cash and bond investments will be sharply negative after factoring in inflation.
So, what to do? Is the low-risk investor doomed to negative real returns?
The fact that I am prepared to write this article suggests not; indeed, I feel that investors have access to a useful palette of lower-risk investments today, perhaps more so than ever before. However, the disclaimer is writ large: Low Risk Is Not The Same As No Risk. Capital is at risk with any investment, and this article should not be construed as investment advice. Each of the areas I will touch on have attributable risks, and the potential to decline in value. A combination of risks may help diversify away the risk of loss, but it remains likely that this portfolio will have periods of significant negative returns.
My “low risk” portfolio has a target return of 5-10% in nominal terms, which gives us half a chance of beating inflation after fees and costs. Each constituent part should contribute either to capital stability or to returns and should have a demonstrable current earnings yield.
Each constituent part should contribute either to capital stability or to returns and should have a demonstrable current earnings yield
It holds roughly a quarter in liquidity, fixed interest (usually inflation linked), and gold, targeting a nominal return of 3%. This is the “safest” part of the portfolio, with limited scope for return but equally limited downside. The gold holding provides protection in certain markets.
The next quarter of the portfolio is in infrastructure and property, where I aim for high single-digit returns through dividend yield (say 5%) and some capital return.
The next quarter is in multi-asset funds and to a very limited extent, hedge funds. This is real “mind your eye” territory as returns from hedge funds can vary significantly, and do not necessarily protect you when equity markets fall.
Finally, the most contentious quarter: equity. Here I am specifically looking for stocks or sectors which give me an earning yield in my target return range, say 8% or more, and although I don’t mind if those earnings don’t grow that much, we must be confident in the underlying businesses. Examples in the UK which meet the earnings yield target are housebuilders, insurers, and resources companies, although clearly all have significant risks to their earnings depending on how the economic picture develops.
Here I am specifically looking for stocks or sectors which give me an earning yield in my target return range, say 8% or more, and although I don’t mind if those earnings don’t grow that much, we must be confident in the underlying businesses
This combination of asset classes and risk factors gives me an intellectually coherent portfolio for clients who seek a safer harbour than that provided by equity or bond markets. I make no comment as to whether or not now is the time for low-risk investing, and would urge a re-read of my disclaimer above, but I believe that opportunities exist for inflation+ returns for the patient low-risk investor.