In the second article of Inform’s two-part series, we look at different strategies you and your financial adviser might consider to protect and build long-term financial security in response to the current economic climate.
When the economy and markets are booming, investing can feel like ‘plain sailing’. But when the economy ‘runs out of puff’ and growth and interest rates are low, you may find that the return on your investments isn’t sufficient to meet your needs.
If you’re a younger investor, this may mean it takes longer to save for a home or your children’s education. For those nearing retirement, it may mean you need to work longer or accept a lower standard of living, or run the risk of outliving your savings.
Your financial adviser can help you manage these risks by targeting investments that may be more likely to thrive in a low-growth environment.
Aman Ramrakha, Executive Manager, Research at CBA Wealth Management Advice, says aligning your portfolio to make the most of the prevailing economic winds is a two-part process, beginning with diversification.
Diversify your returns
“Diversifying the sources of your returns makes sense in this uncertain environment”, says Ramrakha.
Take shares as an example. Our local market is dominated by resources companies and banks, with the resources sector particularly hard hit by low growth and falling commodity prices. Yet there are quality companies in the healthcare and tourism industries, for example, that have been performing well as we transition to a services-led economy. So, instead of concentrating a portfolio on the biggest sectors of the market, investors should consider broad exposure across the market to take advantage of some of the better performing companies under the different economic climate.
It also pays to think globally. Ramrakha says investors can find additional sources of returns from investing globally in the US, Europe and emerging markets. This can take advantage of areas of the world that are exhibiting higher growth like China and tap into some of the world’s leading companies.
A simple way to tap into global markets, and plug gaps in your portfolio, is via managed funds that provide broad global exposure.
Yet even if you diversify your shareholdings across different markets and market sectors, a major market correction can sink good companies along with the bad. In a difficult market, Ramrakha says it’s important to work closely with your financial adviser as they can help you construct a robust portfolio and most importantly monitor the portfolio over the various market cycles.
Avoid correlated returns
The second part of Ramrakha’s two-part process involves the correlation of returns. Investments are said to be ‘positively correlated’ if they tend to move up or down in value at the same point in the investment cycle. He points out that the global financial crisis highlighted the importance of holding defensive assets such as bonds with the potential to provide positive returns when shares perform poorly.
Even though bonds are traditionally regarded as income investments, in a long-term portfolio they also provide protection against an economic downturn. In an economic downturn, interest rates generally fall which in turn can increase the capital value of bonds, particularly those that have a higher coupon than the current interest rate.
Ramrakha says it is advisable to invest in asset classes that are inversely correlated, which means that if one move down in value the other tends to moves up. As well as bonds, he says so-called ‘alternative’ investments such as hedge funds can also make sense in the current environment. Hedge funds use a variety of investments and sophisticated strategies in an attempt to produce positive returns in all market conditions. They are designed to have low correlation with traditional asset classes such as shares and bonds and to provide additional diversification of returns at a portfolio level.
“Ask yourself, ‘have I made sure, as I diversify sources of returns, that they are not all correlated?’”, says Ramrakha. In your search for returns Ramrakha says having realistic expectations is critical. “With the expertise at our disposal, all signs are pointing to returns over the near term future being very different to what investors have experienced in the past”, he says.
Utilise the expertise of your financial adviser to decide if and how you should diversify and actively select investments with strategic advantages in the current low-growth environment.
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