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Marcus Brooks

Newsletter  19/10/2018

Balancing Investment Performance & Risk for the longer term

Marcus Brooks, Director and Head of Private Clients & Charities at Cornelian outlines the importance of diversification to deliver real returns over the longer term.

Brexit, emerging market debt problems, political instability, trade wars, withdrawal of QE, rising interest rates – markets have weathered their fair share of uncertainty in recent years but are still not far from all time highs in many cases, driven primarily by an accelerating US economy and strong corporate profits growth.  However, the fact remains that we are now in one of the longest equity bull markets in history while merger and acquisition activity, decreasing breadth (upward momentum in the market being driven by fewer stocks) are both associated with the latter stages of bull markets.

We are certainly long term investors and believers that equities should sit at the core of balanced portfolios with the proportion dictated by a client’s risk tolerance (equities generally being viewed as relatively riskier assets – offering more volatile returns over shorter time periods). This is because, historically and over the long term, equities have offered real returns well in excess of inflation and also of other asset classes such as cash and bonds.  Intuitively this makes sense.  Aggregate sales for global companies should at least keep pace with aggregate global GDP, which has run consistently ahead of inflation, while man’s ingenuity ensures that productivity growth enhances profits and dividend growth in excess of sales growth.  No such gearing effect acts to the benefit of cash and bonds where returns are nominal i.e fixed.

We are certainly long term investors and believers that equities should sit at the core of balanced portfolios with the proportion dictated by a client’s risk tolerance ...

Having said this, it makes sense for active managers to adjust portfolios to take account of their views on likely returns on the various asset classes and securities over shorter time periods and we are certainly active managers.  The problem that we have is that while equity valuations are quite full, valuations on traditional lower risk assets such as cash and government bonds are also extreme.  The 10 year Government Gilt in the UK offers a return of only 1.53% per annum (likely to be negative in real terms) while the equivalent 10 year German Bund yields 0.45% per annum (Sources: Factset).  Interest rates on cash remain low across the world and negative in Germany and Switzerland.  These valuations suggest there are significant risks in government bond markets at present certainly if inflationary pressure begins to rise.

In this context we seek to diversify portfolios and target real returns and limited risk.  The bond portion of our portfolios typically yield over 3.5% in aggregate and include exposure to niche areas such as real estate finance, infrastructure related debt, high yield and unrated bonds, asset finance as well as “strategic” and dynamic bond funds whose managers can hedge against interest rate or inflation risk as well as a rise in credit spreads. For total return portfolios we own a number of hedge or absolute return funds whose managers aim to achieve positive real returns through a combination of strategies uncorrelated to returns on equity or bond markets.  In lower risk portfolios we retain some exposure to infrastructure where the relatively high income yield is partially index linked and returns should not be economically sensitive, while Assura, a Real Estate Investment Trust (REIT) which owns doctor’s surgeries should likewise be unaffected by economic conditions. 

We remain positive on the outlook for global equity markets largely as a result of strong economies and a growing investment and productivity story, which should keep inflation under control.  

We remain positive on the outlook for global equity markets largely as a result of strong economies and a growing investment and productivity story, which should keep inflation under control.  Portfolios are structured on this basis and are not at present particularly defensively positioned.  However, should this bull market come to an abrupt end diversification should allow them to avoid the worst of any resulting volatility.

Marcus Brooks
Director, Head of Private Clients & Charities

Newsletter  19/10/2018

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