Portfolio Focus: Outcome

Portfolio Focus: Outcome

Portfolio focus:
Outcome

When constructing a portfolio it has become increasingly difficult to find assets that are paying a reasonable yield for a given amount of risk.


Many defensive yielding assets are now looking expensive and we see little value in them. A good example of this would be gilts or debt issued by the UK government. At the end of January the yield on 10 year gilt fell to 1.35% - an all time low. As yields are inversely correlated to prices, investors are also at risk of significant capital losses, with every 1% rise in yields potentially resulting in an 8% fall in capital.

This trend is especially relevant to more cautious portfolios where typically, a much higher proportion of their total return is generated by the yield of the underlying assets. It is also important for more aggressive portfolios where income can still represent an important component of overall returns. However, we do still feel that there are some compelling asset classes to consider when looking to enhance the yield of a portfolio.


Large UK companies

Over the past eight years, companies have been increasing their dividend pay-outs to attract investors at a time of an economic downturn and political uncertainty. UK companies alone forecast to pay circa £80bn* in dividends to investors in 2015. Furthermore a very large proportion of UK companies generate their earnings from overseas operations, often in US Dollars. Given the recent strength in the Dollar this is beneficial when converting their earnings back to Sterling.


Fixed interest assets

Whilst we feel that gilts currently offer limited value, other parts of the fixed interest market are looking more compelling, such as corporate debt (bonds). These assets provide investors with regular interest payments and a known redemption date when the initial capital will be returned to investors. Due to the higher levels of risk associated with this asset class versus gilts, corporate bonds pay a premium interest rate. However corporate bonds are still less risky than direct equities because bondholders rank higher on the list of creditors than shareholders in the event of the company’s bankruptcy. An investment manager undergoes rigorous due diligence on each corporate debt investment to include only the most reliable investments within their portfolios.


Alternative assets

An actively managed investment portfolio has the ability to adapt the underlying investments to take advantage of prevailing market and economic conditions by investing outside the traditional classes such as stocks and bonds.


Property

This asset class is associated with regular rental income streams; however tend to be illiquid in nature, meaning that an investor could not easily cash in the full value of their investment on short notice. Due to the lack of liquidity, an investor is usually rewarded with higher rates of return.


Derivatives and hedges

These advanced investment techniques are designed to provide short-term protection to the portfolio against undesirable economic events which would erode the value of the portfolio. For example, gilt futures provide protection against interest rate rises to bond assets. Bonds bought at lower interest rate levels will be protected by the futures contract until the maturity date, at which point the amount can be reinvested at the prevailing (higher) market rate.

A well diversified portfolio can provide investors across the risk spectrum with a secure source of income. By spreading the risk across a wide range of asset classes, diversified portfolios can provide protection from downturns in a particular area of the market, such as low interest rates, which may result from prevailing economic and political events. In addition, a degree of exposure to asset classes such as equities and property provide the potential to grow capital, which in turn protects investors from the erosive effects of inflation. The goal of these portfolios is to work within specified risk parameters towards mitigating extreme swings in the value of the investments caused by external political and economic events, and provide much needed stability and protection in the years to come.

*Morningstar, January 2015
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