Investing can be a highly rewarding endeavour, but it’s also full of risks and challenges. A significant factor that can impact decisions is the behavioural traits that investors can be swayed by. As such, the decision making process is not always led by rational considerations. Hence, biases can significantly impact outcomes. With input from our investment partners, LGT, below are some common behavioural biases that affect investors, along with real-life examples of these biases, and how to be more aware of them to limit their impact.

Confirmation bias

Confirmation bias occurs when individuals seek out information that confirms their pre-existing beliefs while ignoring contradictory evidence. When investing, this bias can lead to a skewed perspective and poor decision-making, influenced by emotions. For example, an investor who believes that a certain stock is undervalued may actively seek news or research that supports this belief, ignoring any negative signals that may suggest otherwise.

To overcome confirmation bias, it’s important to actively seek out diverse perspectives and information that challenges your existing beliefs. Engage with different sources of information, consider alternative viewpoints and maintain a healthy scepticism towards your own assumptions.

Loss aversion

Loss aversion refers to the tendency of individuals to strongly prefer avoiding losses over acquiring equivalent gains. This bias can result in overly conservative investment decisions, as investors focus more on preserving their capital than on pursuing potential gains. For instance, an investor may hold onto a losing stock for too long, hoping to avoid realising the loss, instead of cutting their losses and reallocating their capital elsewhere.

To prevent this, we must recognise that losses are a natural part of investing and embrace the concept of risk. You must establish a well-diversified portfolio that aligns with your risk tolerance and investment goals. Then regularly review and rebalance your portfolio to ensure it remains aligned with your long-term strategy.

Herd mentality

Herd mentality occurs when individuals follow the crowd and make investment decisions based on the actions and opinions of others, rather than conducting their own independent analysis. This bias can lead to overvalued or undervalued assets as investors pile into or flee from certain investments without a thorough understanding of the underlying fundamentals. A famous example is the dot-com bubble of the late 1990s when investors followed the hype and poured money into technology stocks that were fundamentally overvalued. A more recent example would be the GameStop bubble of 2021 fuelled by retail investors on Reddit.

To correct this, one must take the time to conduct their own research and analysis before making investment decisions. Avoid making impulsive choices based solely on market trends or popular opinions. Be patient and rely on your own judgment to identify sound investment opportunities.

Overconfidence bias

Behavioural finance has its roots in psychology and Kahneman’s book Thinking fast and slow (2011) believes humans make decisions using two ‘systems’ that operate for different purposes and at different speeds. System one is thoughtless and acts instantaneously based on human emotions. Whereas system two is more rational and analytical, used for reading poetry, for example. Humans mostly use system one, with system two ‘monitoring’ in the background. The psychological bias, overconfidence, originates from the unconscious actions of system one and is possible to control, but not eradicate.

Overconfidence bias refers to an individual’s tendency to overestimate their own abilities and knowledge. This bias can lead to excessive risk-taking and overtrading, as investors may believe they possess superior skills or insights that will consistently generate above-average returns. For instance, an inexperienced investor may have initial success with a few trades and become overconfident, leading them to make riskier and less researched investment decisions.

Practicing disciplined investing strategies, such as diversification and long-term investing, is a sure-fire way to control the risks associated with overconfidence, along with continuing to learn and develop your knowledge.

Other common heuristics, or rules of thumb, include:

• Familiarity bias can be explained by the home bias or quality bias – investing in assets/markets we are familiar with or consider good quality/brand names, rather than because valuations tell us to.

• Anchoring bias is setting an anchor based on some early piece of information/reference and interpreting new information around that anchor. For example, whether people sell shares is influenced by what they paid for them.

• The gambler’s fallacy has echoes of the widespread belief in mean reversion. Mean reversion refers to the idea that an extreme movement away from a long-term average or norm in some activity, such as the performance of an asset market, will tend to correct itself in time, and that the activity (or the price) will eventually move back towards the mean.

• Mental accounting is where people place investments in ‘different accounts’ mentally and treat them differently.

Behavioural biases can significantly impact investment decisions and hinder investors from achieving their financial goals. The key to overcoming these natural behaviours is to remain objective, conduct thorough research and develop disciplined investing strategies.

By investing with Five Wealth, you have the benefit of an Investment Committee that self-monitors and has diversity of thought. It is important to invest for the long-term and not letting the herd, short-term news or underperformance, drive decisions and detrimentally influence investment decisions.

If you would like further information on anything covered in this article, please get in touch via the contact page.

* Investments carry risks. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

As investors, it’s natural to feel slightly nervous when markets are volatile and in such times the ability to converse with an adviser really does reap rewards. In this blog we share an insight on the issues when trying to ‘time the market’, with input from our investment partners, LGT Wealth Management.

Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.” – Peter Lynch, Mutual Fund Manager

During periods of heightened financial market volatility, and increased levels of uncertainty, it can be tempting to try and time the market by selling assets and then buying them back at a later stage. However, timing the market is virtually impossible, even for the most experienced investors. This is why it’s often said that time in the market is more important than timing the market.

Emotions and investing

Human nature can lead investors to be emotional about financial decisions. When markets dive, too many investors panic and sell; when stocks have had a good spell, too many investors go on a buying spree.

Past experience can lead to panic selling

People tend to ‘panic sell’ based on their past experiences. There have been six major crashes in the past 30 years, so psychology plays its part.

Source: LGT Wealth Management

It is never an easy ride on the way up in a bull market. Investors seem perpetually concerned, worried about the valuation levels, forever peering around the next corner and ever watching for the canaries in the coal mine that might signal the onset of the next market downturn. Prospect theory from behavioural finance suggests that investors are more likely to focus on gains rather than the perceived risk of loss when the outcome of an investment is uncertain. This ties into regret aversion and the fear of loss outweighing the joy of winning – hence many investors panic sell when the going gets tough. This is a large reason why investors are always encouraged not to look at their investments every day.

The issue with trying to time your entry/exit

The pace at which markets react to news means stock prices have already absorbed the impact of new developments and when markets turn, they turn quickly. Those trying to time their entry and exit may actually miss the market bounce. Attempting to predict the future may mean you could end up being out of the market when it unexpectedly surges upward, potentially missing some of the best performing days. Missing one or two big days, compounded over time, can greatly impact your portfolio.

The graph below illustrates how a hypothetical $100,000 investment in the S&P 500 Index would have been affected by missing the market’s top performing days over the 20-year period from 1 January 2002 to 31 December 2021. For example, an individual who remained invested for the entire time-period would have accumulated $616,317, while an investor who missed just five of the top performing days during that period would have accumulated only $389,263.

It’s important to note, most of the best days happen around the worst days. Over the last 20 years, 70% of the best 10 days happened within two weeks of the worst 10 days (Source: Factset). If you were to incessantly go in, and out, of the market it would erode returns, alongside having tax implications and transaction costs.

It is true that a broken clock is right twice a day and hindsight is wonderful, but we are not soothsayers. If it was easy to time the market, lots of investors would be doing it and retiring early in the Bahamas, but this is not the case. We must remember that short-term volatility is the price you must pay for the chance of higher long-term returns and let the power of compounding take effect rather than potentially crystallising losses.

If you would like further information on anything covered in this article, please get in touch via the contact page.

*Investments carry risks. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Types of Savings Accounts

As interest rates continue to rise, so does the importance of ensuring your savings are in the right place. The savings market is flooded with various types of accounts, which makes it difficult to decide which is best for you.

Factors such as interest rates, access, tax and timing of payments will all influence your decision when selecting the best deals. Below I have covered the various types of accounts and key points to consider when finding the best deal for you.

Easy-access

• Does what it says on the tin. They allow you to access your cash as and when you need it. Due to this, interest rates tend to be lower than other options.
• They come in many forms; some are online only, some come with cards, some only allow a certain amount of withdrawals per annum.
• Most suitable for those who need ready access to their cash, and for ‘emergency funds’.
• Interest rates are likely to be variable, so it is important that you keep an eye on rates being offered. Variable interest rates fluctuate over time and are non-guaranteed.

Notice accounts

• Require you to tell your provider in advance that you wish to access your cash. Terms of notice can vary drastically but typically they will be 30, 60 or 90 days. Generally, the longer the notice period the better the interest rate offered.
• Most suitable for those looking for better interest rates, who do not need immediate access to their cash.
• As with easy-access, these are likely to come with variable interest rates.

Regular savings accounts

• Require savers to contribute on a regular basis. They are ideal for those just starting their savings journey, or those that wish to drip feed their savings.
• Interest rates are fixed (guaranteed for a set period) or variable.
• Typically last for 12 months and restrict how much you can contribute each month. Some accounts also restrict the number of withdrawals you can make over the period.
• Often offer attractive AERs (Annual Equivalent Rates), say 5%+, but it is important to be aware that you are drip feeding your savings, so the actual interest received will be much lower than the headline AER. For example if you contribute £3,000 in regular £250 instalments, the interest paid in the first month will only apply to £250, rather than the annual total whereas if you contributed £3,000 as a lump sum into a regular savings account, interest would be applied to the full amount.

Fixed-rate bonds (term accounts)

• Offer a fixed rate of return over a period of time. They often offer the most attractive interest rates but without any access to capital over the term (other than a few limited situations such as death or severe financial difficulty (e.g. bankruptcy)).
• Bond terms vary drastically, with typical terms being 1, 2, 3 or 5 years. Normally the longer the term the better the interest rate offered.
• In a falling interest rate environment these can be great, as they fix your interest rate for the term of the bond, but the opposite is true in a raising rate environment, as your cash would be tied and you may miss out on better rates in the future.
• Many fixed-rate bonds require large initial deposits – so if you’re a beginner saver, you may struggle to find a suitable deal. In addition, some fixed-rate bonds allow you to invest just one lump sum when you open your account, and do not permit additional deposits during the term of the bond.

Cash ISAs

• Contributions form part of your £20,000 annual ISA allowance. The main benefit of these accounts is that any interest paid in excess of your personal savings allowance is non-taxable. Basic rate tax payers have a tax free personal savings allowance of £1,000, higher rate tax payers have an allowance of £500 and additional rate taxpayers do not have an allowance.
• These often have lower interest rates than other types of savings account. Some individuals prefer to use their ISA allowances elsewhere, e.g. for stocks and shares ISAs.

Conclusion

There are many types of savings accounts available on the market. There is not one correct answer to which account you should use, and often people will use a combination of accounts to suit different needs. In the current environment it is especially important to keep an eye on the interest rates on offer, to ensure you are on the best deals. It is also, important to understand the terms of your accounts, to avoid being penalised.

At Five Wealth we offer a cash management service, which allows clients with large cash balances to sign up to one platform and seemly move their cash between various accounts without the need to undergo the application process each time. Saving clients time and effort, whilst ensuring they have the best deals available. If this is of interest please contact one of our advisers to discuss in more detail.

Please note our cash management service, comes with a fee and is only suitable for those that have cash balances in excess of £50,000.

If you would like further information on anything covered in this article, please get in touch via the contact page.

Consumer Duty – What does it mean for clients?

In the ever-changing world of Financial Regulation, the Consumer Duty is a new standard introduced by the Financial Conduct Authority (FCA). The new standard has been brought in to build upon existing regulations to ensure that financial firms are delivering on products and services they are providing to their clients.

The duty has outlined three rules, which the FCA wants firms to follow, to deliver good outcomes for clients:

• To act in good faith – to ensure decisions made are in a client’s best interest and work towards achieving their financial objectives.
• Avoid causing foreseeable harm – making sure products are suitable for the client in their design, structure and pricing. The intention is not for a firm to predict the future, that’s not reasonable, but any risks should be clearly outlined.
• Support and enable retail customers to pursue their financial objectives – Clients should be able to contact firms when they need to in an effective and understandable manner. Overall products should be designed for retail customers to reach their objectives and that products and services are readily accessible.

To coincide with the rules the following outcomes are expected to be achieved for clients:

• Products and services designed to meet the needs and objectives of its’ target audience. This should be assessed on an immediate and ongoing basis and relevant actions taken when identified that a product or service isn’t doing what it should.
• Price and value i.e., the price paid should be reasonable for the service that is being received.
• Consumer understanding in that customers should be provided information that they need at the right time and in an understandable format.
• Consumer support to ensure customers should be able to realise the benefits of the product and service they are receiving for their financial objectives to be met.

In summary the Consumer Duty aims to place a clear onus on firms to show that they are providing a service that matches the needs and objectives of the client. Firms must be able to clearly demonstrate that the service they provide is in line with the fees that a client pays and that they are ultimately providing value for money. No one can ensure that investments will always grow, that’s just not possible, but the intentions should be positive and clear. Clients should be kept well informed and have appropriate levels of communication available to them as per their individual needs.

The points raised in the Consumer Duty Regulation are important but hopefully nothing new to the service we already, and continually strive to, deliver to all clients new or old.

Investing in China – Risk & Opportunities

When investing your money, it’s important to be diversified across asset classes, factors (see here for a recent blog post explaining this), business sectors and regions. In this blog, we take a look at the Chinese market, highlighting 5 risks and opportunities that need to be considered when investing here.

Background

Since 1978 China has averaged 10% annual growth in their GDP, placing them second in the world with GDP of $12.23 Trillion behind the US with $19.48 Trillion.

So, what are the reasons for this impressive growth?

• Urbanisation

Over the last 5 decades, economic reform has changed China from a highly rural country to urban – many predict that this will continue for the next 20 years. There is a certain ‘snowball’ effect when a country goes from rural to urban. Cities need to be built, which requires rapid growth in infrastructure, commerce, and other services. This rapid growth requires more education, more education generally means people become wealthier and a wealthier society means more businesses are set up thus leading to even more wealth.

• Rapid Productivity Growth

China is considered as the ‘worlds manufacturer’, but it wasn’t always this way. The reallocation of resources to more productive uses, especially in sectors heavily controlled by central governments, such as Farming, has boosted efficiency across the board. Looking at farming as an example; Investment into agriculture by the State has boosted efficiency which has freed workers to pursue new opportunities in other sectors. This decentralisation of the economy led to a huge increase in new private firms who were more market orientated and a larger share of the economy was exposed to competitive forces.

• Capital Investment

Foreign direct investment into China led to new technology which further boosted productivity.

Risks

As with any investment, there are specific risks associated with investing in China. Some of these are as follows:

1. Slowing of GDP Growth

Can the 10% average annual GDP growth continue? Many sceptics do not believe so – especially if its State driven. Coupled with this, if the powers that be continue to impose restrictions on foreign firms this will reduce the likelihood of this continue growth further. Foreign enterprise accounts for a significant share of China’s output but this is falling – 2.3% in 1990, 35.9% in 2003 and most recently 25.9%.

2. Geo-political Relations

China may align itself further with Russia and become less dependent on the US. We could even see an emboldened attack on Taiwan which could lead to similar sanctions we have seen placed on Russia.

3. Ageing Demographic

In 1980 China’s population was rapidly expanding and the government launched its ‘one-child’ policy which ended in 2016. This policy has led to a rapidly aging society and by 2035 more than 30% of its population with be over 60. This has led to a declining workforce and a need for an increase in spending on healthcare and elderly services meaning less resources for elsewhere.

4. Zero Covid Policy

China is still implementing a zero Covid policy – an outbreak of cases results in whole cities being sent into lockdown which slows the economy. An outbreak in Shanghai could result in the port being shutdown which would not only slow China’s economy but the world’s, given that China is the ‘worlds manufacturer’.

5. Government Corruption

There is a view that alleged corruption can play a major part in success/failure rather than market forces. As well as this, due to the court system in China, intellectual property rights can be hard to protect and enforce.

Opportunities

China is c.20% of the world’s population so is it too big to ignore? Below are 5 points which may suggest there is an opportunity for investing in China.

1. GDP Growth

I have highlighted GDP as both a risk and opportunity… China is restructuring its economic model after a successful period of going for growth. The new model aims for sustained growth with an emphasis on innovation as the new driver. The new focus will provide a lot of opportunities for new businesses to grow and flourish.

2. Less Bureaucracy

The government is aiming for China to be the number one economy in the world and will use all its power to help it achieve this. If they want to bring in a policy to help them achieve this, less bureaucracy within their system will mean they can.

3. Geo-political Relations

China is currently benefitting from cheap fuel from Russia. We have all seen the impact of extortionate fuel prices in the UK so nothing further needs to be said!

4. Low Inflation

Coupled with the cheap fuel from Russia, China didn’t offer much financial stimulus during Covid which is helping to keep inflation down. As well as this, they produce a lot of their own resource in country so are being less impacted by global inflation.

5. Valuations

Chinese stocks are on affordable valuations at 8x price to earnings ratio whilst the UK is 14x and the US is 19.5x. This means that Chinese equities are at a discount compared other markets.

Summary

To summarise, as with any market, there are risks and opportunities with investing in China and it’s our job to assess your circumstances and conclude if an allocation to China is suitable for you. Generally, China would be more suited to high-risk clients with a long timeframe for investing but some exposure can be achieved for lower-risk clients through an Asian fund.

As always, if this blog has raised any questions, please get in contact with your adviser.

The content of this newsletter is for your general information purposes only and does not constitute investment advice. It is not an offer to purchase or sell any particular asset and it does not contain all of the information which an investor may require in order to make an investment decision. Please obtain professional advice before entering into any new arrangement. Although endeavours have been made to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. We cannot accept responsibility for any loss as a result of acts or omissions taken in respect of any articles.

Your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Topping Up Class 3 NICs

State pensions are a crucial aspect of financial planning because they are secure sources of income guaranteed by the State and paid until death. State pensions are funded on a ‘pay-as-you-go’ basis which means that there is no underlying fund from which to provide retirement benefits and the National Insurance Contributions (NICs) of the current working population are used to pay the State Pensions of those who have reached State Pension Age (SPA).

Entitlement to the new State Pension is accumulated through Class 1 NICs (for employees) or Class 2 NICs (for the self-employed). Class 4 NICs (paid by the self-employed) do not contribute towards an entitlement to the new State Pension. Entitlement is based on ‘qualifying years’ and 35 years of NICs are required to gain the full State Pension.

If an individual has gaps in their contribution record they can pay Class 3 NICs. They are voluntary and can be paid by individuals with an inadequate NIC record, allowing them to increase their entitlement to the new State Pension. Generally, if an individual wishes to pay Class 3 NICs, they should ensure they are paid within six years of the end of the tax year in which the contribution shortfall occurred.

The Class 3 NIC rate for 2022/23 is £15.85 per week, so it would cost £824.20 to purchase a full year of State Pension entitlement. If you make payment in respect of a gap in contributions that occurred in the previous two tax years, then you will pay the rate that applied for the tax year in which the gap occurred. If the payment is in respect of a tax year more than two years previously, the rate will be the one applicable in the tax year of payment.

Warning! The current arrangement of being able to pay class 3 NICs to fill gaps in your NIC record going back to the 6^th of April 2006 ends on the 5th of April 2023, after which you can only fill gaps going back six tax years. It is crucial to ensure that gaps prior to the 6th of April 2017 are filled in because topping up your State Pension is a very worthwhile exercise – each additional year of State Pension purchased provides an extra pension of £5.29 per week (£275.08 a year). Looking at this from another perspective, it effectively represents an annuity rate of 33.37%(!), meaning the payback period on your initial capital is only 3 years. This represents excellent value for every taxpayer to obtain secure income for life guaranteed by the State.

If you would like further information on anything covered in this article, please get in touch via the contact page.

Understanding investment charges

When looking to make investments, as well as considering the potential returns of the proposed holdings you should also make sure that you fully understand the costs involved.

Naturally there are a variety of different charges that can be applicable in the financial planning space and with the industry ‘jargon’ it can be difficult to understand what you are actually paying. We have therefore covered some of the main costs that you could incur with an advised investment portfolio.

• Adviser Charges
• Commission
• Platform Charges
• Investment Charges
• Entry and exit fees

Adviser Charges:

From 2013, adviser fees must be discussed up front and agreed with the client using a pre-determined payment structure based on the service provided rather than the product recommended. Advisers can charge both initial and ongoing adviser fees. Initial charges may be on an hourly basis or a fixed fee for a piece of work which will depend on the complexity of the work and the time it will take. Ongoing adviser charges are either expressed as a fixed percentage charge based on the asset value, or they can be a pre-agreed annual fee – it is only possible for an adviser to levy an ongoing charge if an ongoing service is provided to the client. If ongoing adviser charges are expressed as a fixed percentage, e.g. 0.5% of the total investment value per annum, the fee will increase or decrease in line with the value of your portfolio.

Many financial advisers will offer an initial meeting free of charge, and this gives a good opportunity for both parties to work out if they feel it to be a good fit. You should normally have the choice whether to pay both initial and ongoing adviser charges directly from your investment portfolio or separately from your cash balances.

Commission:

It has not been possible for financial advisers to receive commission on new investment products purchased after 31st December 2012. Trail commission was an annual fee paid to financial advisers over the lifetime of the investment product, therefore it can still be in place on investments set up prior to this date. Commission was a percentage fee and was included in the annual management charge of the investment, so it was not always clear how much was being paid. Other considerations which led to it no longer being used were that it was also paid to financial advisers each year without requiring them to review the investment or provide further advice to the client, and it was thought that commission payments provided an incentive for advisers to recommend investments which paid the highest fees, rather than because it was the best solution for clients. It is still possible to receive commission on non-investment products such as mortgages, insurance or protection products (e.g life insurance, critical illness cover, income protection)

Platform Charge:

Most investments these days are held on a platform – think of a platform like a supermarket, allowing you to buy all your different brands and products under one roof, rather than having to visit multiple establishments. Using a platform simplifies the management of your investments but it does come with a cost. Platform fees are most commonly charged as a percentage of the assets you have invested on the platform. Charges are often tiered, reducing the total percentage charged as the size of the investment portfolio increases, and are usually taken from a cash balance held within the plans. Sometimes platforms will charge a fixed annual administration fee charges in addition to or instead of the percentage charge. They may also charge further for ad hoc activities such as transferring in or out of your portfolio, withdrawing monies or for buying and selling certain investments.

Fund Charges:

If you are investing in funds (e.g. Unit Trusts or OEICs) then you will incur a fee known as the ongoing charge figure (OCF) – this is made up of the annual management charge levied by the fund house as well as various additional costs such as administration, accounting and regulation (not including transaction costs). The OCF has to be published by the fund managers on the fund Key Information Document (KID). This charge is expressed as a percentage of the asset value and is taken from within the investment as a price adjustment, rather than coming from a cash balance. Due to economies of scale, many platforms can access institutional classes of investment funds which have a lower annual charge, or OCF.

Entry and Exit Fees:

In addition to an OCF you may also have to pay entry and exit charges when you buy or sell an investment fund. This is very similar to a ‘bid offer spread’ which is the difference between the price at which you buy an investment and the price at which you sell it.

Some financial advisers will also charge exit fees, particularly if you wish to sell a plan or transfer away within the first few years. They are often on a sliding scale, reducing over the period the investments are held for. Exit fees are currently being reviewed by the FCA as they believe that unreasonable exit fees discourage consumers from leaving products or services which are not right for them. Firms are bound by the FCA rules and principles to treat their customers fairly and for this reason Five Wealth will never charge an exit fee.

This article does not cover all possible charges but is intended to be a guide to the most common. You may come across charges which have not been covered here, especially on older style investment or pension plans.

Whilst you will always pay fees for holding investments, it is important to understand what you are paying and to factor in the costs when making decisions. If you are paying more than you need to, compounding charges can make a big difference to the value of your investments over the longer term. Five Wealth take the overall cost of plans we recommend into consideration for all our clients, and aim to provide a service that is good value over the long term.

If you would like further information on anything covered in this article, please get in touch via the contact page.

Cutting through the jargon

Have you ever come across phrases such as ‘deep value’, ‘generating alpha’ or ‘currency hedging’ in an article about investments and felt slightly bemused as to what they mean?

Part of our role at Five Wealth is to ensure clients are comfortable with the investment strategy put in place for them. This can involve translating fund manager terminology into something more understandable for those who may not have had a great deal of experience with investments.

Investor documents, fund manager updates and the more technical newspaper articles can be packed full of jargon which often puts clients off reading them. The intention of this article is to pick out a few of the more topical phrases and try to explain them in an understandable manner.

Currency Hedging

Put simply, if an investment fund is undertaking currency ‘hedging’, it’s typically trying to remove some of the risk that fluctuations in currency can have on investment performance.

Let’s look at an example of how currency fluctuations can affect investment performance.

The share price of the US listed company, Apple, is down just over 20% year to date at the time of writing. A US investor would have felt the full extent of those falls and if they bought Apple shares on 1^st January 2022 and were forced to sell them now, they would have lost c.20% of their money.

A UK investor who bought Apple shares at the same time (using £s) and was also forced to sell them now, would have lost just 2.6% of their money! This is because what the UK investor is effectively doing is converting £s into $s when they buy the shares, and then back to £s when they sell them. You can now buy more £s for each $ than you could at the start of the year and so in this example, the UK investor has benefitted from currency fluctuations. Currency movements can just as easily move against investors.

Currency markets can move quickly and many fund managers take the view that they are less predictable than the market for company shares. Some fund managers will take the approach of ‘Que sera, sera’ when it comes to currency movements, whilst others will ‘hedge’ their currency risk by using a “currency forward” agreement to purchase an offsetting currency in the future at a fixed exchange rate.

Gilt Yields

A gilt is a type of investment issued by the UK government. By purchasing a gilt, you are effectively lending money to the government in exchange for a regular interest (or ‘coupon’) payment. The name gilt comes from them being ‘gilt-edged’ and they are viewed as being extremely secure – the British government hasn’t defaulted on its debt since the Bank of England was founded in 1694!

You might have picked up in the news that gilts, used heavily by large institutional pension funds and ‘low risk’ strategies, have had a torrid year. Year to date, the FTSE gilt index^*1 is down by almost 30%!

If they are so secure – how have they lost such a large chunk of their value?

Let’s say you bought a 15-year gilt at the start of the year for £10,000, which pays you 1.75% interest annually over a 15-year period, at the end of which you get your initial £10,000 back. If you held it for the full term, you wouldn’t ‘lose’ any money (except by way of inflation but that’s a topic for another blog!)

However, interest rates have increased over the year and perhaps more importantly, long term interest rate expectations have also increased. So, if you wanted to sell your gilt to someone else now, who would be prepared to pay you the full £10,000 for your gilt generating a fixed interest of 1.75%, when you can currently open 1-year savings accounts that pays 3% interest? You would be hard pressed to find a buyer. To sell the gilt, you would have to reduce the price, which effectively increases the yield on the gilt.

Factor Investing

You will often find that investments are categorised into one or multiple types of strategies, sometimes referred to as ‘factor investing’. Our investment approach is to maintain a diverse, long-term view which means using funds that span across multiple styles.

Growth strategy – Typically means investing in companies where the objective is long term growth. The companies may not be paying dividends to shareholders, instead choosing to reinvest their profits into growing the business. Some growth companies may not even be profitable, but fund managers invest in them because of what they think they will be worth in the future.

An example would be Snap Inc, the company that owns Snapchat, whose share price rose by 28% through 2021, despite it being largely unprofitable during that time.

Value strategy – Involves investing in companies that the investment manager feels is undervalued. This might be because it’s been caught up in a wider market sell-off, or because that type of company/sector is out of favour. The nature of value investing means that what is considered ‘value’ changes over time. As well as spotting opportunities, a value investor would typically try and avoid areas of the market that they consider to be expensive, such as asset bubbles. A prime example would be the 1999/2000 dot-com bubble, where investors poured money into anything associated with the burgeoning internet economy before the bubble burst and a lot of money was lost. In theory, a value investor would have looked at some of the company fundamentals such as how much cash they held, debt levels, revenue streams etc and steered clear when company valuations became detached from their balance sheets.

Quality strategy – Both growth and value strategies can incorporate ‘quality’ into their investment philosophy, and it simply means that you seek out companies which have features that enable them to perform well in all market conditions. What makes a company good quality is subjective, but typical attributes include strong revenue streams (e.g. subscriptions models), barriers to entry for other firms (e.g. protected intellectual property rights), sustainable levels of borrowing etc.

Changes in the economic landscape such as those we have seen this year with inflation and interest rate rises can quickly shift investor sentiment so that one ‘factor’ performs better than others. Our strategy at Five Wealth is to create a balanced investment approach with exposure to different factors.

If you come across any terminology within investor correspondence that you aren’t familiar with, we will be more than happy to explain it in a way which you will understand so please do get in touch with your adviser.

Please remember that your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

*1 – FTSE Actuaries UK Conventional Gilts All Stocks