One of the major considerations for a client when contemplating an investment portfolio is their attitude to risk. The adviser and client will have a discussion resulting in the selection of a portfolio best suited to the agreed level of risk; the level of risk selected will determine the blend of fixed interest, property, equities and cash.
Traditionally, the blending was fairly straight-forward; the more cautious the risk, the higher the fixed interest content and consequently the lower the equity weighting. As the desire for more risk increased, the fixed interest weighting would give way to more equities-property would be used to diversify the risk of the other asset classes.
However, over the past few years low inflation and central bank asset-purchase programmes (Quantitative Easing) have distorted the norm, sending fixed interest bonds to levels where the risk out-weighed the reward, making them a less obvious selection for cautious portfolios.
With this in mind I’ve provided a quick guide to the different risks posed to asset classes, and I’ve thrown in an often over-looked risk at the end.
Historically considered the safest asset class there are now several categories of bonds that are exposed to (or hedge against) different risks:
Too often the focus is on the risk of investing, rather than the risk of not investing. Cash is the least risky asset over the short-term, but holding investable cash over the long term runs the risk of being eroded by inflation. Take a look at the chart below:
Even during a period of fairly benign inflation, a cash ‘non-investment’ would be worth less in today’s terms. Over the longer-term equities tend to rise, so an actively monitored ‘buy and hold’ strategy should out-perform inflation.
We construct robust, diversified portfolios designed to capture much of the rise in prices but preserve capital when markets fall. Currently we hold less fixed interest than would be expected, preferring a blend of equities, property and absolute return funds. Most funds have a small gold weighting which has proved to work well when other asset prices fell.
The above chart plots our mid-range portfolio against a selection of UK assets; this shows that the portfolio added value but held up better when markets dipped.