Investors have endured a torrid few days. The pound has never been lower against the US dollar, the cost of Government borrowing has soared, and stock markets are beleaguered by dramatic volatility.
Most investors will need a strong stomach to look at the value of their portfolio this weekend. (In fact, not looking could be a good plan.) An index of the UK’s 350 biggest companies is down about 12 per cent this year alone, while global stock markets have fallen close to 25 per cent.
Most investors were already nursing losses this year, even before the events of last week took hold, thanks to the war in Ukraine, soaring inflation and the ongoing global recovery from the pandemic.
Adrift: Most investors will need a strong stomach to look at the value of their portfolio
But things got much worse in the wake of Chancellor Kwasi Kwarteng’s mini-Budget and the Bank of England’s muted response to soaring inflation. Things got so bad that the Bank of England had to step in to buy up to £65billion of government bonds to restore financial stability.
So what – if anything – should investors be doing? And is it really as bad as all that?
The impact is bad – but not awful
Most investors have a well-balanced, diversified portfolio. This means that severe turbulence in one country, currency or sector should not have a toppling effect overall.
So, for example, if you have a number of investments in UK companies and priced in pounds, the falls these have experienced will be partly offset by the gains made by investments in others that earn profits in US dollars.
Philip Dragoumis, director at Thera Wealth Management, explains: ‘UK companies make up less than 4 per cent of an index of the biggest companies around the world. This means that 96 per cent of an equity portfolio is automatically invested in other currencies, and therefore benefits from any fall in sterling.’
What about UK investments?
Many UK investors have what is known as a home bias – in other words a high proportion of UK companies in their portfolios.
Even for these investors, it is not all bad news.
Smaller companies are hurting the most from the fall in sterling. That is because they are most likely to buy materials from overseas in dollars and euros, but earn their profits in pounds. Therefore their costs are higher but their profits lower.
The FTSE 250, an index of 250 small and medium sized UK-listed companies, is down 29 per cent so far this year. Firms including ASOS, TUI, Taylor Wimpey, Persimmon and Barratt Developments have seen particularly sharp falls in the last few days.
However, the picture is a lot brighter for large UK businesses. The FTSE 100 index of the biggest UK firms fell just under two per cent last week and is down around 8 per cent so far this year. That is because 71 per cent of the revenues generated by these companies come from outside the UK and so are more likely to be earned in dollars rather than pounds.
Victoria Scholar, head of investment at investing platform Interactive Investor, says: ‘We have seen painful volatility for investors in the pound but the FTSE 100 has been relatively resilient.
‘London-listed exporters such as Diageo and Coca-Cola enjoy a currency advantage when sterling slides, as UK exports priced in pounds become cheaper and more competitive on the global market.’
Bad news for bonds as falls continue
The value of bonds has been dropping this year – and falls have accelerated in recent days. Bonds are essentially debt that is issued by companies or governments. While interest rates were low, bonds paying a yield of one or two per cent looked like reasonable value and investors were happy to pay for them. But as inflation has risen, this level of income has been less attractive and so the value of bonds has fallen.
If investors think that the debt that a company or government issues is as safe as houses, they are likely to lend to them at low interest rates. But when there is so much as a hint of doubt about their ability to pay the debt, the cost of borrowing rises. That has also been feeding into the rising yields on bonds. Yields move in the opposite direction to bond prices.
All this matters to investors because most diversified portfolios contain a mixture of shares and bonds. The theory is that they tend to behave differently, so that if shares start to fall you have some protection in the form of bonds. However, it has not been working out that way this year. Shares are falling – and so are bonds.
James Norton, head of financial planners at fund manager Vanguard, says: ‘This is clearly very unsettling for investors, particularly those approaching retirement, but importantly the fundamental diversifying benefits of bonds still exist over the long term.
‘And it is really important that investors do focus on the long term. There is no doubt that 2022 has been tough, but portfolios rose in value for most investors in 2020 and 2021. Perspective is vital.’
Norton adds that on the bright side, lower bond prices mean higher yields for investors.
‘In simple terms this means that the return on bonds is now likely to be higher than it has been,’ he says. ‘With returns likely to be nearer five per cent than the one or two per cent we have been used to, investors have a chance of recovering some of those losses faster.’
So what should investors do now?
It is likely that the best action to take is none at all. You have not locked in any losses until you sell your investments – and by then they may well have recovered – especially if you have a long time horizon.
Daniel Jones, financial planner at DGS Chartered Financial Planners, says: ‘Hold your nerve. Stick to your plan. It’s time in the market that gives you positive long-term returns, not timing the market.’
He adds that it’s human nature to feel nervous when the value of your investments is falling, but an emotional response can be costly.
Scholar at Interactive Investor adds that it is notoriously difficult to time the market. None of us really know whether things will get better or worse.
‘Although this year has been extremely challenging for investors, longer-term it is typically much better to remain invested rather than sell out and then try to get back in at the right moment, when you may miss out on the upside potential,’ she says.
On the bright side… there are bargains
When markets fall, investors can buy up stocks and shares considerably cheaper than they could days or months before. Money coach Fanny Snaith says it is a bit like sale season. ‘You don’t lose any money until you sell,’ she says. ‘If you can afford to buy, then great. However, be aware that things could still get worse before they get better.’
Check your portfolio remains in balance
Make sure that you have a balance of different types of assets in your portfolio and that you are not weighted too heavily to any one region or sector.
That should help to shield you from any future market falls. For most investors, this is likely to be the safest approach.
For those who are able and willing to take a bit of risk, some investment experts believe there are opportunities to be found.
James Yardley, senior research analyst at fund research group FundCalibre, says: ‘UK assets are looking cheap because of the fall in the pound.
‘If you can find shares which get a lot of their earnings from overseas – particularly in dollars – but whose shares have fallen, they might represent an opportunity.’
He points to the City of London Investment Trust as an example of a fund that invests in larger UK companies.
It has turned a £1,000 investment into £1,070 over three years and has holdings in BP and Shell – both UK-listed companies that make a large proportion of their revenues in dollars.
TB Evenlode Income holds large companies such as Diageo and Unilever, which similarly stand to benefit from a weaker pound. It has turned £1,000 into £1,021 over three years.
JOHCM UK Dynamic also holds large, multinational companies that are listed in the UK. It has made a 4 per cent loss over three years.
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