Investment markets have been volatile in the last few years. The financial aftereffects of COVID-19, the war in Ukraine, and the increase in energy prices and inflation have created uncertainty, and markets have suffered as a result. What impact does this have on your pension investment strategy?
Traditional portfolio allocation theory says we should invest in equities, bonds, and alternatives to create long-term growth and a spread of assets that balances risk according to the investor’s expected timeframe.
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2022 was a freak year. A perfect storm conspired to create losses in equities and Bonds simultaneously, with the only safe havens being Gold and funds that ‘shorted’ the markets. Shorting refers to the expectation that markets will fall; investors will purchase financial instruments that deliver positive returns in such a scenario.
Since then, equities have recovered to pre-COVID levels, so anyone shorting that market will have seen gains turn into losses. Bonds are slowly recovering, and gold prices have risen to new highs.
Bonds suffered as rapidly rising interest rates and inflation caused capital values to fall, making them less attractive than new issues. Bond funds fell by 30%; until interest rates fall, they won’t return to previous levels.
Interest rate expectations
Market interest rate expectations have moved substantially over the last three months. UK inflation continues to fluctuate and is anticipated to reach the central bank’s target of 2%. The BoE forecast annual headline inflation to dip below 2% in Q2 of 2024, before experiencing a marginal increase in Q3 and Q4. In the US, there was anticipation that the Fed would start cutting rates in March and make at least six 25-basis point rate cuts this year. Since then, optimism has been reined in, with markets now expecting the base rate to end 2024 at 4.85%, with the first of these cuts now expected to materialise in July. Meanwhile, in Europe, the ECB has projected a fall in headline inflation from 5.4% in 2023 to 2.3% in 2024 and then to 2.0% in 2025, reaching 1.9% in 2026.
Central banks will not move until they are certain that inflation is under control. Still, the signs are positive, and bond funds will benefit as a result.
Diversification and pension investment
This means we should revert to ‘normal’ times where investing in a balanced spread of equities and Bonds is safe to grow portfolios in tune with a selected risk profile. In fact, as and when interest rates do fall, Bond funds should be the big winners.
When markets correct, the old question of whether to ‘stick or twist’ is front and centre. Do we sell funds and accept the losses, or do we stay with our portfolio allocation in the hope of recovery?
The last three years' events prove that sticking with equity investments does work even when times are bleak. i.e. selling would only have consolidated losses, and the upside would have been impossible to predict. Time in the market, not timing the market, is the old mantra.
I would agree with this to some extent. My only proviso is that sometimes it’s important to change strategy and make big decisions. For those relying on investment income to provide retirement benefits, for example, some portfolio restructuring might have been better if the only option was to sell funds to pay income.
This wouldn’t be necessary if sufficient cash is held in the portfolio to tide it over until better times or equity funds that pay good dividends are included in the overall allocation.
Either way, the events of 2022 illustrated the importance of reviewing your portfolio regularly. It may have been that a few minor structural adjustments could have saved money and anxiety without doing anything, which would have adversely affected your overall financial planning.
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