Wednesday, 17 June 2009
Keep your balance as markets plunge
Keep your balance as markets plunge
A mix of different assets will keep your portfolio in positive territory amid the crunch.
By Rosie Murray-West
Published: 1:57PM BST 22 Sep 2008
Attitudes to risk and reward remain individual Photo: PA
For some people an unacceptable risk might be bungee jumping off the Empire State Building, while others might find it too frightening to board a plane.
But while attitudes to risk and reward remain individual, there are things you can do to make sure your investment portfolio is not overexposed to risky markets - and that it is not too safe to be making you any money. While no investment is entirely without risk, some are perceived as safer than others, but may produce lower returns.
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Recent market volatility has encouraged some people to unbalance their portfolios by pulling out of areas that have not performed well, such as equities, according to Christopher Traulsen of Morningstar, the investment analyst. "Panic is never a good thing,'' he says. "Market timing is a difficult thing to get right. There is a tendency to think you need to remake your portfolio, but what you really need to do is look at your risk tolerance, and only maybe tilt your portfolio a little depending on the markets.''
Most investment managers recommend a balanced portfolio, unless you have large amounts of other wealth you can fall back on. "We ask how much can you afford to see your portfolio move and still sleep at night, and what is your time horizon,'' says Nigel Parsons of Bestinvest, the financial adviser.
Stockbrokers and financial advisers will offer at least three basic types of portfolio - high, low and medium risk - depending on how much time you have before you might need the money you are investing and your attitude towards risk.
The current market is completely different from others we have seen before, Parsons says, because the lack of interbank lending has "caused its lifeblood to dry up''. It is more important than ever that your portfolio is able to withstand this volatility.
Reducing the risk in your portfolio without losing its potential is a case of ensuring that you have your money invested in several different types of asset that tend to move at different times. For example, commodities are extremely volatile, but often rise as equities fall. "What you need to do is pair things that move in different ways,'' says Traulsen.
Carl Cross of Rensburg Sheppard, the investment manager, suggests splitting your money between British shares, overseas equities, fixed-income products and hedge funds. "It is the old adage - you need to juggle fear and greed,'' he says. "Some people are too reluctant to accept any volatility, and others cannot see that in the long term they will get superior returns from it.''
Even within the equities component of your portfolio, it is important not to rely too heavily on one part of the market. In order to properly balance your portfolio, says Traulsen, you need to know how the funds you are buying are managed.
"You need to understand how a manager positions his fund so you can take the right types of risk at the right time,'' he says. "For example, if you had bought all of the best-performing funds of 2006, you would be very heavily exposed to mid-cap stocks.'' He advises buying several funds that invest in different areas of the equity market.
When buying overseas funds, he suggests not being too narrow in your choice. "Steer clear of very focused funds - so don't just buy a fund focusing on Russia,'' he says. "Nobody knows what that will do in the next 10 years. Why pay a fund manager and then tie his hands behind his back by allowing him only one country to invest in? Buy an emerging market fund instead.''
A good fund manager will sell and buy stocks to reduce risk. For instance, the City of London investment trust, which has increased its share price by 55 per cent over five years, currently has a bias towards defensive and larger-cap stocks because of economic uncertainty.
To counteract your equities, it is important to invest in both government and corporate bonds, which involve different levels of risk. Government bonds, or gilts, are very low-risk, because the Government is unlikely to default on them, but they do not produce spectacular returns. "Gilts are gilts, so just buy the cheapest,'' says Cross.
Corporate bonds, another useful part of a balanced portfolio, are far riskier than government bonds because of the risk of default. However, Parsons points out that highly rated bonds that are unlikely to default are now available with very high yields. "The market is pricing in Armageddon,'' he says. "There are yields of 7 to 8 per cent on good corporate debt.'' Corporate bonds can be bought outright, but it may be easier to hold a corporate bond fund.
Meanwhile, Cross suggests that between 5 and 7 per cent of a portfolio should be held in hedge funds. "This is one area that most people don't understand,'' says Parsons. However, holding hedge funds may help protect you against falls in the equity market. He recommends funds run by Brevan Howard, including BH Global, which is now listed on the London Stock Exchange.
A combination of all of these asset classes ought to give you a safety net in a market like this, without minimising your returns. In fact, being well balanced is the only way to survive the storms.