Review and rebalance to help enhance returns

INVESTING CASH: It can be tricky to know where to put funds

INVESTING CASH: It can be tricky to know where to put funds

First published in Business: Personal Finance

AS we are approaching the middle of the year, it is interesting to review the progress (or otherwise) of the investment markets since January 1.

At the start of the year, the financial press is usually full of predictions from leading pundits of which investment sectors will be the best and worst performers over the next 12 months.

Opinions can differ greatly, which means that, if you read enough papers, the chances are you will find a recommendation in favour of just about every sector. Consequently, it is inevitable that at least one of the forecasts will turn out to be correct.

The problem is that it’s all speculation and not a sensible basis on which most of us should be making investment decisions.

According to data from Financial Express, the two bestperforming investment sectors since January have been the IMA Sterling High Yield and UK Smaller Companies sectors. High yielding investments are fixed-income bonds paying an above-average rate of interest with the promise that capital will be returned in full at the end of the investment period.

The higher the yield, the less financially secure is the issuing company, hence a high rate of interest is required to compensate for the extra risk.

These bonds can be held to maturity or traded during their term and become more valuable as interest rates fall, and less valuable as interest rates rise.

As the name suggests, the UK Smaller Companies sector invests in UK-based companies which are relatively small in size as measured by their market capitalisation. It is considered that companies of this size can be more responsive to economic conditions.

It has also been demonstrated by academic research that smaller companies tend to produce returns which are in excess of those from the market as a whole, over the longer term. They also present greater risk to capital than do larger companies.

Although some pundits will have forecast correctly that these two sectors would perform relatively well (so far) this year, many did not and there is no way of knowing in advance how investments will perform. If there was, everyone would give the same forecast and everyone would get it right.

Since there is no reliable way of forecasting which sectors will provide the best returns over any time period, the strategy of investing in a broadly diversified portfolio, compatible with your appetite for risk and ability to withstand loss, may prove to be the most sensible choice for longterm investment. Returns should be enhanced by regularly reviewing the portfolio and rebalancing to the original asset allocation as differential performance between the asset classes will always change it over time.

Basically, rebalancing involves taking the profits from whichever sector has done well and buying more of the sectors that have done less well, thus ensuring that you are reducing the holding in the good performer at a high point in its cycle and buying more in investments which are at a lower point in their investment cycle. There are now a number of multi-asset funds which have been set up to provide regular automatic rebalancing to make it easier to keep to the strategy.

There is a fund to meet most attitudes to risk, eg with asset mixes from 80 per cent low risk/20 per cent high risk to 20 per cent low risk/80 per cent high risk, and automatic rebalancing helps to ensure the portfolio remains at the chosen risk level.

This approach is well suited to a “passive” equity strategy, which brings the added benefits of low fund charges and eliminates the need to speculate to try to pick the next winning fund or stock.

Over the long term, this type of strategy should offer the best chance of a satisfactory outcome for most individual investors.

Before entering into any particular investment strategy, you should consult a suitably qualified and experienced independent financial advisor.

• Written by Nigel Bourke CFP, managing director of Stockton-based Mercury Wealth Management Ltd. Call 01642-670307 or go to mercurywealth.co.uk

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