Limiting the shock: Adjusting personal finances to market turbulence

Most UK investment managers spent the past week in front of their screens monitoring the impact of the UK market turmoil on their funds. But an executive at a UK mutual fund company spent the week poolside in Dubai mulling over his hotel bill.

“I watched my vacation get more expensive every day,” he said. But his own concerns about the sterling turmoil were overwhelmed by the magnitude of the financial crisis sweeping London. “It’s really one where we probably won’t see anything like it again in our career.”

Although sterling and government bonds have rebounded from lows following massive £65bn intervention by the Bank of England, the market turmoil following Prime Minister Liz Truss’ ‘mini’ budget will continue to hurt, wealth managers say.

They expect further pressure on living standards, with the damage done by higher energy bills, more inflation and higher borrowing costs, especially mortgages.

“It will hit households in the form of inflation, higher interest rates and a tougher mortgage market. . . and pushing it out of the point where inflation peaks,” said Richard Flax, chief investment officer at digital asset manager Moneyfarm.

While some brave investors like to see opportunity in a sell-off, the cloud of uncertainty already hanging over markets from the Ukraine war, energy prices, inflation and economic distress has only darkened.

“There is a lot of nervousness,” says Alexandra Loydon, director of partner engagement and advice at St James’s Place, the UK’s largest wealth manager.

She has spent the week consulting with SJP’s army of 4,600 financial advisors, who answer questions from 800,000 clients. She says: “It’s difficult to provide certainty and reassurance in such uncertain markets, but it’s really important to encourage the right behavior. . . Don’t start moving assets and stay invested.”

Line chart of $ per £ showing Sterling continues to beat

How do money managers assess what happened in the markets this week?

While sterling’s fall following Chancellor Kwasi Kwarteng’s speech grabbed the headlines, the drama that erupted in mid-week over the UK’s sovereign debt was arguably far more meaningful to finance professionals and ordinary savers.

UK government bonds, known as Gilts, saw some of their strongest moves ever. “What we’ve seen is a kind of crisis of confidence in both the gilt market and sterling,” said Peter Spiller, manager of mutual fund Capital Gearing.

Duncan MacInnes, Investment Director at Ruffer, says Gilts have seen “absolutely wild swings for a first world government bond market”.

The BoE intervened after the declines posed a serious threat to pension funds, which used special strategies called liability-driven investments (LDIs) to manage risk.

The yield — the interest rate that rises when prices fall — on the 30-year government bond, which hit a 20-year high of more than 5 percent on Wednesday, fell to 3.85 percent on Friday morning.

The intervention leaves the BoE torn between a promise to raise interest rates to fight inflation and an emergency money printing operation. Professional investors continue to rely on further rate hikes by the central bank. “At this stage, they’ve only added to the confusion,” says MacInnes.

Line chart of UK government bond yields (%) showing gilts hit hard by the'mini' budget

Will mortgage fears fuel the cost-of-living crisis?

Government bond markets are important to households because they provide the basis for mortgages and other personal loans.

Loydon said customers had started to grapple with the upcoming “massive impact” of rising interest rates and were asking questions.

The average variable standard mortgage rate, which had already risen to its highest level in a decade — over 5 percent — earlier in the month, could now rise to 6 percent.

The turmoil has made it difficult for providers to price new fixed contracts as thousands of products have been withdrawn. Around 600,000 fixed rate mortgage contracts will expire by the end of the year, according to UK Finance, and 1.8 million are up for renewal next year.

The government’s energy price cap has somewhat mitigated the immediate cost-of-living crisis and capped the expected maximum inflation rate over the next few months at around 10 percent. But utility bills are still rising, and with Truss’s economic plans expected to expand public borrowing, upward pressure on inflation could last longer.

While many wealthy households who make up wealth managers’ client base will benefit from the end of the top income tax rate of 45 per cent on income over £150,000 a year and a reversal of the tax hike on dividends, for many mortgage holders these gains will be offset by higher interest rates.

According to Rachel Winter, a partner at wealth manager Killik & Co, mortgages “have replaced electricity bills as the biggest fear in the UK is . . . They almost took away the benefit of giving people a lower tax rate.”

Meanwhile, money managers say clients often underestimate the impact of sterling’s moves. Although sterling had regained most of its lost ground by Friday – trading at around $1.12 against the US dollar from a low of $1.03 – it is still widely viewed as fragile. Much depends on how the government reacts ahead of the budget announcement scheduled for November.

“A depreciation in sterling is inflationary and means the cost of living pressures will only get worse,” said Edward Park, chief investment officer at Brooks Macdonald.

What should I do with my portfolio?

The good news for many savers is that global investing can offer some protection from the UK turmoil. Particularly when sterling weakens, assets abroad are worth more in sterling terms.

“If you’re a sterling-based investor with a well-diversified portfolio, a weak sterling is helpful,” says Janet Mui, head of market analysis at asset manager Brewin Dolphin.

Money advisers have been inundated with questions from clients about whether to buy sterling or gilts at current prices or reduce their sterling holdings if the currency falls again.

Experts strongly advise against taking sudden steps. “It’s the old advice: if you’re going to panic, panic first. If you haven’t panicked yet, it’s probably a little too late,” says MacInnes.

But uncertainty in the UK underscores the importance of diversifying away from home. According to a Quilter survey last year, the majority of UK retail investors have more than a quarter of their portfolio invested in UK equities, despite the country making up just 4% of the MSCI World Index.

The UK FTSE 100 index itself brings global exposure with its companies earning 80 per cent of their revenues overseas. This creates foreign currency exposure but still limits company choices, particularly as the UK market is heavily weighted towards energy and mining and little towards technology.

Wealth managers say their clients are also worried that higher borrowing costs are threatening house prices. “Over the past few decades, real estate has been something you can live in while also serving as a diversified investment portfolio,” said William Hobbs, chief investment officer at Barclays Wealth & Investments. The market crisis has challenged assumptions that real estate prices are steadily rising, he argues.

“That’s why you need to have a diversified exposure to the global economy, not just one particular street in the UK.”

Capital Economics bluntly predicts: “Both a recession and a big drop in house prices seem inevitable.”

Meanwhile, investors must be wary of investing in companies with high levels of debt as borrowing costs are rising rapidly. “Debt gets you into trouble, whether you’re an individual, a company, or a country,” says Christopher Rossbach, a managing partner at J Stern & Co. He recommends examining company balance sheets.

Gold, the traditional safe haven asset, has performed well as a sterling hedge, up about 16 percent over the past 12 months. But it is bearish in dollar terms, suggesting there may be better hedging opportunities. “I’d be very wary of those who tell you that whatever the question, gold is the answer,” Hobbs says.

Gold also doesn’t pay income, so as interest rates rise, it becomes less attractive. Although bonds have fallen dramatically this year and the UK government bond market was turned upside down this week, longer term, higher yields are starting to lure investors back into debt.

“We have a lot of customers who, in my opinion, hold too much cash,” says Winter. “It’s now possible to have a fairly diversified portfolio of fairly senior corporate bonds with a yield of about 6 percent.”

Savers looking to hold cash despite the threat of inflation are advised to find the best rates as banks vary and many high street lenders have bad deals.

The return of reasonable interest rates on deposits and borrowing means a big shift for savers. MacInnes says, “This is a profound shift in the investment landscape that has come out of nowhere in the last six months.”

https://www.ft.com/content/81d7dc93-67ad-4823-8f73-6ccaf49047ae Limiting the shock: Adjusting personal finances to market turbulence

Adam Bradshaw

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