- Tolerating price fluctuations is an indissoluble aspect of investing in the long term, but excessive volatility can be unpleasant if one has a shorter investment horizon.
- Funds that pursue absolute returns tend to pursue a specific positive return – for example, exceeding interest rates by a certain percentage during a previously stipulated period – and limit any loss when markets fall.
- If savings do not grow at least at the same rate at which prices rise, their real value will be eroded over time
By Funds Society
When markets go through turbulent phases, there are days when being an investor is not easy. Tolerating price fluctuations is an indissoluble aspect of investing in the long term, but excessive volatility can be unpleasant if one has a shorter investment horizon.
Depending on your temperament and particular circumstances, you may prefer to try to limit the possible fall in the value of your capital in a given period, even if it means sacrificing part of the potential return that investment directed to growth can offer.
If navigating uncertainty worries you more than achieving capital appreciation or raising your income, M&G Investments then presents three strategies that could fit your current investment objectives.
- Pursue absolute profitability
Certain investment approaches try to generate profit regardless of what happens in the market. Funds that pursue absolute returns tend to pursue a specific positive return – for example, exceeding interest rates by a certain percentage during a previously stipulated period – and limit any loss when markets fall.
Using a wide range of investment tools to benefit from the ups and downs experienced by the markets, these funds try to provide stable returns to investors. However, this does not mean that the achievement of positive returns can be guaranteed: it is important to never see these strategies as risk-free investments.
Pursuing lower volatility in this way could mean giving up potential gains. During periods in which the prices of the assets considered as riskier – such as the shares – increase, it is likely that a fund that pursues absolute returns will lag behind. This is because a large exposure to more volatile assets is often incompatible with such strategies.
That said, if you are willing to sacrifice some upward potential – less investment return – in favor of limited downward potential – lower losses – absolute return strategies could be an appropriate element in your portfolio.
2. Link income to inflation
If your savings do not grow at least at the same rate at which prices rise, your real value will be eroded over time. Although many types of investment offer the prospect of higher returns to inflation, inflation-linked bonds try to protect specifically against such a threat.
These instruments differ from normal bonds in that both the income regularly paid to the bondholder – the coupons – and the amount that will be returned to their maturity – the principal capital – are linked to inflation. As long as the company or government that has issued the bond fulfill its payment obligations, the investor will not be harmed. Of course, the possibility of default is an inevitable risk for investors in fixed income.
It must be taken into account that this link with inflation is also valid in the opposite direction: if inflation falls, so will the value of the bonds linked to it and the income they generate. Thus, protection against inflation can be a cost.
If you are concerned about the possibility of price increases, the funds that invest in inflation-linked bonds could help you try to preserve the real value of your capital and income.
3. Link income to interest rate
The decision of a central bank to raise interest rates often hurts investors with long-term bonds, which promise them the payment of a fixed coupon over many years, or even decades: after all, the Real return they receive will be less attractive compared to the interest offered by savings.
Unlike conventional bonds, the so-called “floating bonds” (or FRN) pay a variable coupon based on interest rates in an economy. Thus, the income generated by these bonds will rise and fall in line with the price of money.
Remember, the income generated by FRNs would fall from lower interest rates, so that the investment in these assets has a double edge. That said, if you are worried that the rates will rise, the funds that invest in floating bonds could offer some protection against a tightening of monetary policy, or even allow you to benefit from such a scenario.
Are these investment approaches suitable for my profile?
In general, funds that pursue absolute returns – or that try to minimize the danger posed by higher levels of inflation or interest rates – will not be the most appropriate if you have ambitious goals of capital growth or income generation for the long term.
Such solutions are usually more suitable for investors willing to give up some upward potential (in the form of investment returns) in favor of a limited downward potential (in the form of investment losses or the effect of interest rates or rising inflation).
But whatever your priorities, strategies that attempt to navigate uncertainty could be a valuable component of your investment portfolio. Under certain market conditions, they have the potential to show more solidity than other assets, thereby helping to cushion the impact of a sharp downturn.
Ultimately, the suitability of any investment will always depend on your specific circumstances and your risk and return profile. If in doubt, consult a financial advisor.
The value of the fund’s assets could both increase and decrease, which will cause the value of your investment to be reduced or increased. You may not recover the amount initially invested.