Three investment strategies to help navigate uncertainties

31/05/2019

When markets are choppy, there are days when being an investor can feel uncomfortable. Tolerating fluctuations in prices is part and parcel of long-term investing, but too much volatility might be unpalatable if your investment horizon is nearer.

Glossary

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Depending on your circumstances or disposition, you may prefer to try and keep a lid on how much your savings could fall in value over any given period – even if that does mean sacrificing some of the potential upside that investing for growth can offer.

If you are more concerned with navigating uncertainties than growing your capital or income, here are three strategies that could resonate with your current investment goals.

1. Target absolute returns

Certain approaches to investing look to deliver a profit whatever is going on in the market.

Funds that target absolute returns will usually look to achieve a specific positive return – say beating interest rates by a certain amount over a given period – while aiming to limit any losses when markets are falling.

By using a wide range of investment tools to profit from both the ups and downs that markets experience, these funds attempt to deliver smoother returns for investors. This is not to say that positive returns can ever be guaranteed, however. It is important never to think of these strategies as risk-free investments.

Targeting lower volatility in this way could mean you miss out on potential gains. During periods when the prices of assets deemed to carry greater investment risk, like company shares, are rising, a fund targeting absolute returns is likely to underperform. This is because large exposure to more volatile assets is normally inconsistent with investment strategies that target an absolute return.

However, if you are willing to sacrifice some potential upside – in the form of investment returns – in favour of limited potential downside – in the form of investment losses – strategies that target absolute returns could be a good fit for part of your portfolio.

2. Link income to inflation

Unless your savings keep pace with the rate at which prices are rising, their real value will be eroded over time. While many types of investment offer the prospect of inflation-beating returns, inflation-linked bonds specifically target protection against this threat.

Unlike normal bonds, both the regular income paid to bondholders – the coupons – and the amount owed to the bondholders at the end of the loan – the principal – are linked to inflation. So long as the company or government that issued the bond honours its repayments, you should be left no worse off. The possibility of default is an unavoidable risk for bond investors, of course.

It’s worth bearing in mind that inflation linking can work both ways. If inflation falls, so would the value of inflation-linked bonds and the income from them. Protection from inflation can therefore come at a price.

If you are worried about the possibility of rising prices, however, funds that invest in inflation-linked bonds could help you aim to preserve the real value of your capital and income.

3. Link income to interest rates

When central banks like the Bank of England raise interest rates, it is typically bad news for investors who hold long-dated bonds that promise to pay a fixed coupon over many years, or even decades. This is because the real return you receive, versus the interest rates on cash savings, will be less attractive.

Unlike conventional bonds, so-called floating rate notes are bonds that pay a variable coupon that goes up and down according to the interest rates in an economy. The income generated from floating rate notes will therefore rise and fall in line with interest rates.

Remember, the value of income payments from floating rate notes would fall if interest rates become lower, so holding these assets can cut both ways. However, if you are concerned about interest rates rising, funds that invest in floating rate notes could offer some protection – or possibly even allow you to benefit – from tighter monetary policy.

Are these investment approaches right for me?

Generally speaking, funds that target an absolute return, or aim to diffuse the specific threats posed by higher inflation or interest rates, will not be the most appropriate if you have ambitious goals for capital growth or income from your investments over the long term.

Instead, these solutions will typically be more suitable if you are willing to sacrifice some potential upside, in the form of investment returns, in favour of limited potential downside, in the form of investment losses or losing out to the effects of rising inflation or interest rates.

Whatever your priorities, strategies that look to navigate uncertainties could play a helpful role as part of your wider basket of investments. In certain market conditions, they have the potential to hold up better than other assets, helping to cushion the impact of any sharp downturn.

Ultimately, the suitability of any investment will always depend on your circumstances and attitude towards risk and return. If you’re at all unsure, please speak to a financial adviser.

Please keep in mind that we are unable to give any financial advice. The views expressed in this document should not be taken as a recommendation, advice or forecast.

Remember that the value and income from the fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.