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.
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 1st 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.
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.
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