Making money in the first quarter of this year hasn’t been easy. Unless you were fortunate enough to hold one of the few individual stocks that investors hope will profit from the coronavirus crisis – such as Zoom Video Communications (which makes the now-ubiquitous Zoom video-conferencing software and was up by 115% by 31 March) – just a handful of major asset classes would have turned a profit globally. These were US Treasuries and German Bunds (ie, the safest government bonds), gold, US dollars (a safe-haven currency in the eyes of most investors – see the column on the right) and – to a lesser extent – Swiss francs and the Japanese yen (other safe-haven currencies), according to calculations by Bloomberg.
If you were a UK investor, you might have done better than that, because other currencies that were weak versus the safe-haven currencies still strengthened against the pound. That would have increased gains or – more likely – trimmed losses on a wider range of international investments. UK government bonds also rose strongly, in sterling terms at any rate. Nonetheless, the broad picture is that the traditional safe havens did well and everything else crumbled.
The power of diversification
While there isn’t much encouragement to be taken from these three months, they have been a reminder that diversifying across the handful of core asset classes (stocks, property, bonds, cash and gold) is still the simplest way to protect your wealth. The power of diversification depends on these investments having distinctively different properties from one another and performing in complementary ways during bull markets and bear markets, and this time they’ve done what investors would hope. A balanced portfolio of around 60% global stocks and real estate investment trusts and 40% in safe havens (eg, cash, gold, US Treasuries and UK government bonds) would have been down by around 9% by 31 March. That’s not much to celebrate, but it’s still better than the 20%-25% drop in global stockmarkets.
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• Last week, I wrote that cuts to UK dividends in this crisis are on course to be far worse than in the global financial crisis. Link Group – which handles dividend payments for many of the UK’s largest firms – has just published an estimate of the damage. The best-case scenario is that dividends fall by 29% in 2020; the worst-case estimate is a 53% slump (similar to the falls seen in the Great Depression). Realistically, Link expects a fall of 33%-41%. Food retail, food and drink, tobacco and healthcare still look relatively safe.
I wish I knew what rebalancing was, but I’m too embarrassed to ask
Rebalancing is the process of bringing the amount of each asset in a portfolio back in line with the investor’s target weight for that asset. For example, let’s assume that you want to have 60% of your investments in shares and 40% in bonds. One year later, bonds have performed very well and stocks have done poorly, so the balance in the portfolio has changed to 50% shares and 50% bonds. You would then rebalance by selling enough bonds and buying enough shares to restore the portfolio to the original 60/40 split.
The purpose of rebalancing is to prevent a portfolio drifting too far away from the level of risk and return that investor hopes to achieve. If you do not rebalance, after a few years your portfolio is likely to have different characteristics from those you intended. Shares have tended to beat bonds over the long run, so without rebalancing you would expect to end up with a portfolio that is heavily invested in them. This might have higher expected long-term returns, but would also be more volatile – which may not be what you want.
A second benefit of rebalancing is that you tend to sell investments that have risen strongly and buy those that have fallen. This can sometimes help improve returns by shifting money from investments that have become relatively more expensive to those that have become cheaper.
There are three main approaches to rebalancing. Time rebalancing means that you rebalance on a fixed schedule (eg, once a year). Threshold rebalancing means you rebalance when the weight of an asset exceeds the target by a fixed amount (eg, five percentage points). Time-and-threshold rebalancing combines both: you rebalance on a fixed schedule, but only rebalance each asset if it is more than the threshold amount away from the target weight. Since rebalancing incurs trading costs, the third approach is likely to be the most efficient for most individual investors.
Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.
Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.
He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.
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