Join our community of smart investors

Don’t let coronavirus ruin your retirement

Investors shouldn't be scared off bargain shares
Don’t let coronavirus ruin your retirement

If the Covid-19 crisis teaches investors anything, it should be that asset markets can suffer spectacular falls in value. Profits made by long-term investors are not a free lunch, they’re a reward for being able to take the psychological pain in these times of extreme uncertainty.

Yet one of the worst impacts the coronavirus could have on your long-term financial future is if it were to scare you off completely from investing in riskier assets such as shares. The swings and falls markets are experiencing now are horrifying, but it is possible to choose a balanced asset allocation to alleviate some of the worst losses in bad times and still see your nest egg outpace inflation – a great outcome that is unlikely if you spend your whole life hoarding cash.

This certainly isn’t to say you should plunge into asset markets now, it’s always dangerous to try and catch a falling knife, but to use another cliché, investing is about time in the market, not timing the market. Aside from a few areas of extreme vulnerability, if you’re already invested in a portfolio strategy that suits your personality, situation and objectives the best thing is not a fire sale, it’s to sit tight.

If you are thinking about getting started investing, then right now is one of the most nerve-wracking but fascinating times. Of course, the first thing to say is we are dealing with a global health and humanitarian crisis, but this isn’t about profiting from others’ misery and misfortune. It’s setting yourself up to benefit from the recovery.

In fact, it’s been shown that a large portion of returns from shares (or equities as the asset class is commonly referred to) comes from upside when markets are recovering from troughs. To repeat, you shouldn’t invest all your starting pot right away in a falling market, but there are ways to drip-feed money so that you don’t suffer all the rest of the downside or miss the onset of recovery when it happens.

Perspective was given in a note by Mark Walker, managing partner at Tollymore Investment Partners. He wrote: “Future investment decisions should be made on data not emotions. The median market performance two years after a correction is 45 per cent. This alone statistically suggests investing into corrections is how long-term investors perform better than macro traders and market speculators.”

Some commentators are expecting stock markets to be a lead indicator and turn up before Covid-19 peaks, which is what happened with Sars in 2003, but these markets have made such wild moves it may be wise to be more cautious this time around. The scale of the pandemic and the measures undertaken to stem it will feed through much more into corporate profits than Sars did.   

The flip side to this is that the unprecedented level of co-ordinated fiscal policy (tax cuts, government spending and direct grants for businesses) and monetary policy (interest rates back down to zero and below, quantitative easing (QE) and money market support) could put a rocket under the first stage of recovery when it comes.

 

Risk and loss aren’t the same thing

Running your own self-invested personal pension (Sipp) requires an acceptance of the risk in your investment portfolio, but risk only equates to loss if you need to sell assets in falling markets to draw down cash. Looked at another way, if you are in the accumulation phase – say you’re in your 20s, 30s or 40s and are building up a pot of money that you won’t even be able to touch until you’re 55 or, from 2028, 57 – you want considered risk (note that this differs from reckless speculation) in your portfolio as over time it will be rewarded.

If you’re over 55 and retired or nearing retirement, then chances are you will be drawing from your Sipp, so the approach to running your portfolio will need to differ. That said, many wealthy older people will have low fixed outgoings as they’ve paid off the mortgage on their home and their children are grown up (although this may not necessarily mean the kids are financially independent).

People may also have alternative sources of retirement income – defined benefit pension scheme payments, buy-to-let property rents and the top-up provided by the state pension. Some of these individuals may have no intention of drawing their lifetime pension allowance from the Sipp – they’re using the vehicle in part to shelter the legacy they wish to bestow on loved ones from inheritance tax (IHT) when they die.

Everyone is different, the important thing is to strike a balance. First of all, there is your capacity to take a loss, should you have to crystallise portions of the Sipp in a tough period. Second, is your appetite for risk – as whether you need the money immediately or not, it’s never nice seeing assets lose a third of their value as the FTSE All-Share index has done since the Covid-19 outbreak took hold.

 

 

Rising from the rubble of the world economy

Coronavirus won’t last forever and define your investing life, but the crisis has been ubiquitous, affecting every asset class and unravelling relationships in trading strategies. In the physical economy, companies’ international supply chains have been smashed and the lockdown of populations will devastate consumption in the economy, and therefore business earnings, this year.

The assumption the world would progress with ever more industrial integration and free movement of labour, was already challenged economically with the US-China trade dispute and by political upheavals such as Brexit. The legacy of measures to tackle the pandemic, could accelerate the rethink (but not the reversal) of globalisation and other mega trends that long-term investors, such as those saving for a pension, must navigate.

Arguably, climate change is a bigger threat to humanity than coronavirus. The positive impact of the pandemic in shortening industrial supply chains and stopping air travel, will reduce carbon emissions. While shutting down economic activity isn’t realistic as a strategy to deal with global warming, it shows the impact changes of behaviour can have.

Before Covid-19, the big focus for asset managers was environmental, social and governance (ESG) funds. Sustainability considerations and how companies respond can have a real effect on businesses, if resolutions by asset managers carry the threat of divestment for non-compliance. Reducing demand for companies’ bonds and shares, raises the cost of their capital funding, so investors can have real leverage on how business is done. 

Some companies such as big oil companies, are looking less attractive as long-term investments, both because their operations could produce less profit going forward (a lower oil price and greater costs of exploration, extraction, refinement and distribution) and because assets such as drilling sites and rigs could be stranded because the proceeds of projects are reduced at the same time the cost of funding them rises.

Capitalism is about creative destruction and with billions of dollars wiped off the value of global stock markets, it is an opportune time to reappraise which companies you want to invest in for the 21st century. In the UK, the FTSE 100 index of leading shares is dominated by large ex-growth companies in industries facing major structural challenges such as oil & gas and banking.

Coronavirus may have made these companies cheaper, but the way they make money for investors – primarily by paying dividends – could be less sustainable going forward, largely due to the recalibrations of asset markets sparked by the coronavirus sell-off and compounded by factors such as ESG mandates. This same reset of pricing brought about by the crisis, and the policy response to meet it, will affect the asset allocation decisions investors should make even before choosing companies to invest in.

 

No more risk-free rates, just expensive insurance

The cornerstone of modern portfolio theory is the idea of a risk-free rate of return from high-quality government bonds that won’t default. The yields on US government treasuries are typically used for international portfolios, although UK investors may prefer to benchmark portfolio risk to gilts (the term for UK government bonds). All other assets in a portfolio are selected and weighted according to how risky they are and the excess returns they offer vis-à-vis the risk-free rate.  

The yields on bonds are sensitive to interest rates, and to maintain the prevailing yield the price of already issued government bonds on the secondary market fluctuates. This inverse relationship between price and yields works both ways. Thanks to over a decade of monetary stimulus, first to deal with the 2008-09 financial crisis and now to support economies through Covid-19, government bonds have rocketed in price and are now incredibly expensive.

When economies recover and interest rates start to rise again to control inflation, the price of bonds will fall. This is especially true of bonds with longer until they mature or that have been issued recently and pay a lower coupon. Very short-dated government debt (one to three months) known as Treasury bills are less sensitive to interest rates but their yield is now negative in real terms (once inflation is allowed for).

The yield on treasury bills is the true risk-free rate in these markets, but this is effectively negative and holding them has become paying the government to protect your money. That’s insurance, not investment, but it’s still worth having some of this protection in your portfolio.

The longer-dated government bonds still have a role to play in a balanced portfolio, in case the recession is long and deep (as the deflationary environment will keep yields low). Thanks to their expensiveness, they are about balancing the risk of other asset classes, rather than being a risk limiter in absolute terms, so the appropriate size of the holding is lower than in years gone by.

 

Coronavirus opens pockets of value in other asset classes

The case for government bonds may not sound compelling, but a long-term portfolio can’t just contain shares if you’re serious about managing the size of peak-to-trough falls in portfolio value when times are bad. One thing the Covid-19 crisis has done, is recalibrate the pricing of risk. Government debt may be super expensive, but yields on high-quality corporate bonds are once again offering a spread over government rates.

This is good news for portfolio builders: governments supporting the economy means companies that were well run before the crisis are less likely to go bust, but their debt offers coupons they won’t renege on. This means reasonably priced and reliable income-bearing assets can be planned into portfolio strategies.

As with equities, adding corporate bond exposure to a portfolio will be uncomfortable at times, says Stephen Snowden, fund manager of the Artemis Corporate Bond Fund. He says: “If you can stomach the mark-to-market volatility near term and have a robust selection process, you are likely to be rewarded in the long term.”

Higher-yield corporate bonds – the long-term debt issued by companies at most risk of defaulting – have been hammered by Covid-19. This is another risky asset class that tends to suffer in the same circumstances that hurt shares, so it doesn’t offer much diversification, although it is now incredibly cheap and could come back very strongly on the other side of the crisis.

One traditional portfolio diversifier that has behaved in a puzzling manner during the coronavirus sell-off is gold. Normally a safe-haven asset, even the yellow metal has fallen in price. This reflects the need to raise funds to cover losing trades and positions on other trades. The market for gold is quite liquid – it is easy to match buyers and sellers – so owners who had liabilities elsewhere have ditched their holdings.

In the long term, as a store of value, gold offers protection against deflation in a long recession. The opposite scenario of an an economic recovery, could be inflationary. Supply chains were under pressure to become less international, due to the realisation in the west that some strategic protectionism is not a bad idea. Because of coronavirus, this is likely to accelerate and, although there are benefits to countries of protecting security and intellectual property, it will add to inflationary pressure as the economy grows. Gold mitigates this risk, too.

 

Be optimistic, back the companies of the future

Losing heart is understandable in times such as these, but investors should remember that the world has come through much worse. In the first half of the 20th century, there were the two world wars, the Great Depression, revolutions in Russia and China, and the 1918-20 influenza pandemic that killed millions.

Between 1900 and 1950, despite all the tragedy and disruption, world equities made an average annual inflation-adjusted return of 2.7 per cent including dividends (Source: Dimson, Marsh and Staunton, Credit Suisse Global Investment Returns Yearbook, 2020). Staying invested in shares, recycling dividends into the portfolio and allowing wealth to compound away would have almost quadrupled money in that time, in real terms.

The worldwide death toll from Covid-19 is rising, but still measured in the thousands, the lesson from history is that compounding returns from shares is a wonderful way to build wealth. Between 1900 and the end of 2019, the average annual return from world equities was 5.2 per cent (Yearbook 2020), so when you factor in better times, too, the case for being a long-term investor gets even stronger.

The mega-trends that are shaping our world are not going to disappear because of coronavirus. Biotechnology and healthcare advances to deal with an ageing population are being brought sharply into focus right now, as is the fundamental shift in communications, cloud computing and working practices as people work from home. There is also the rise of artificial technology and robotics; advances in battery power and renewable energy as we shift to a low-carbon economy; electric vehicles; fintech disrupting the financial industry and changing how we pay for goods and services; revolutions in agriculture; the list goes on.

Investors who own shares in companies at the vanguard of these themes will do very well and thanks to the sell-off some big American companies such as Amazon (US:AMZN), Google’s parent Alphabet (US:GOOG), Microsoft (US:MSFT)and Visa (US:V.) are nowhere near as expensive as they were. There are fewer great big companies in the UK, but gems do exist.

Exciting funds are available, too. Investment trusts are an interesting case, these are investment companies that list their shares on the stock exchange. The price of their shares can trade at less than the net asset value (NAV) per share of the securities they own. This is happening for some investment trusts that manage broad and diversified portfolios of shares, or which operate in some of the growth areas flagged.

Measures governments are taking to beat coronavirus are far-reaching and, in the case of lockdowns, draconian. Being in the middle of the situation while having your fears ratcheted up by social media and fake news is unnerving. The long-term perspective is essential, however. This virus may have precipitated the most violent selling in living memory, but investors must not shy from the growth opportunities that will help them build a sizeable pension pot.

See below for all our Sipps special content: 

Building financial security with your Sipp

Don’t let coronavirus ruin your retirement

Secure your retirement income with asset allocation

Unpick the costs of Sipp providers