Investment types & risk
The types of risks that might apply to your portfolio that could affect returns are:
The risk of negative returns on the overall portfolio’s investments, and the risk that the returns are insufficient to meet applicable expenses.
The risk associated with an inability on the part of any investment made as part of your portfolio to meet monetary obligations in a timely manner.
Foreign exchange risk
The risk associated with movements in foreign exchange rate impacting on offshore investments. We seek to manage this risk by currency hedging. Our current policy for the Lifestages World Equity Portfolio is to have approximately 50% of the portfolio hedged and 50% unhedged to the New Zealand dollar. Our current policy for the Lifestages World Bond Portfolio is to have foreign currency exposure fully hedged to the New Zealand dollar. Other International investments may be unhedged.
Currency hedging Dec 2016
The risk of future changes to tax or other investment related legislation which could impact on the operation of your portfolio or any of its underlying investments and the manner in which you are required to account for returns made.
The risk of any investment of the portfolio becoming insolvent and being placed in receivership, liquidation, or statutory management, or being otherwise unable to meet its financial obligations. If this occurs, you may not recover the full amount of that investment.
The risk of a technological or other failure impacting on your portfolio or any of the investments made or on financial markets in general.
Fund manager risk
Investors are exposed to the investment style of the relevant fund manager of any managed fund investment made, and to the risk that decisions made by the fund manager may not turn out positively. As the funds in which your portfolio invests are generally invested in a diversified range of countries and markets, with ‘best of breed’ managers appointed, this risk is minimised but cannot be avoided altogether.
Fixed interest risk
With fixed interest investments there is a risk that interest rates may move against you, and the risk that the issuer or organisation may default on either interest or debt repayments, adversely affecting the overall return to your portfolio. The principal risk of investing in cash and interest bearing deposits held on call is that, due to adverse changes in the economy, the entity issuing the cash deposit may be unable to recover a substantial portion of the loans that it has made to others, or may even become insolvent, and interest rates payable may fall or be more volatile.
When considering the principal benefits and the investment risks involved with your portfolio, you should consider the risks outlined above and following comments about the various asset classes on which FANZ Private Wealth provides advice:
Managed funds enable you to access a variety of professionally managed portfolios of assets, enabling risks to be spread within the managed fund investment. Some managed funds will be listed, although FANZ Private Wealth generally limits itself to unlisted products. Funds will be managed on either a passive basis (such as indexed tracking funds) or on an active basis. Active funds are usually regarded as higher risk than passive funds investing in the same asset classes, given that they rely upon the investment decisions of the fund manager, with each manager having their own investment styles. A key benefit of managed funds investments is that they provide scale, enabling you to access investments that would often not otherwise be available. As a general rule, however, managed funds investments can involve a degree of fee drag, with the parties involved in those products charging fees for the services they provide, which is a factor we take into account in determining appropriate managed funds investments to make.
New Zealand and International Shares
Shares generally have a higher expected risk/return profile than fixed income investments, with shares in some countries performing better than others. As a general rule, shares have a greater potential for capital growth over the medium to longer term than cash and fixed interest investments. The volatility (or market risk) of this asset class is relatively high, although some shares are more stable than others. Different jurisdictions will have different tax treatment for share investments, which can have an impact on any income streams and capital returns. FANZ Private Wealth Advisers will generally only provide advice on listed shares, which means that liquidity risk is generally not an issue for any shares that form part of your portfolio.
Like shares, fixed interest investments can have differing risks/return profiles, and investing in offshore fixed interest investments will carry a currency risk, subject to any applicable currency hedge. Lower risk fixed interest investments include things like government bonds. Also regarded as lower risk are corporate bonds. Historically, fixed term mortgages have been regarded as lower risk, although they carry a greater degree of liquidity risk and are susceptible to downturns in the property market. Investors can generally expect a steady income stream to be derived from fixed interest investments, and that income stream will usually be greater than income available from cash investments and will typically exceed inflation. The capital value of a fixed interest investment will change as economic and market conditions change, meaning that in some circumstances a capital loss could arise, especially where a fixed term investment needs to be realised before maturity.
Many of our clients have been asking us about the proposed listings of the various generation companies by the NZ government. This type of investments falls into the “Infrastructure Asset Class”. As a real asset category, we believe that infrastructure offers risk, return and diversification characteristics distinct from those of other asset classes, and thus merits consideration for allocation in a diversified portfolio.
Infrastructure investments generally feature steady cash flows derived from tangible, long-lived assets with monopolistic-like pricing power; many are regulated and may feature income linked directly to inflation. The non-competitive position of the assets is driven by high barriers to entry, due to the considerable fixed costs required in development as well as a high degree of regulation. “Pure play” infrastructure assets— which include toll roads, power generators, regulated utilities, airports and seaports—are essential to the fluid, effective functioning of societies, and accordingly feature highly inelastic demand patterns.
Two of the key characteristics differentiating infrastructure from other asset categories are the long lives of the assets and the significant amount of capital required to develop them. Because these projects involve such large financial commitments, many are funded by governments as public projects. Yet in recent years, tight budget constraints and voter and legislative reluctance to increase taxes has made public funding of projects more difficult. Consequently, governments have increasingly turned to private markets to finance infrastructure projects.
The long-lived, semi-monopolistic position of infrastructure assets supports a steady cash-flow profile and, accordingly, low volatility as compared with broad market equities. In a portfolio context, infrastructure tends to provide low-beta exposure (relative to the broader global equities universe), a relatively high yield, and—because tolls and user fees for many of these assets are often tied to inflation—a degree of long-run inflation protection. As a result of these exposures, infrastructure tends to underperform broader equity categories in strong market environments and to outperform in weaker environments. The asset class is somewhat unique in tending to provide stable returns in both dividend yield-driven and (to a lesser extent) inflation-driven environments. Through the global financial crisis, infrastructure companies saw smaller earnings downgrades than broader equities, and the sector has had a more measured recovery in the wake of the crisis.
Infrastructure is classified as a real asset because the underlying assets are physical, with real use to a functioning economy—much like real estate. Infrastructure has elements of property investing; of real usage commanding a fee; of inflation protection due to index linked fees; and of diversification to financial assets that are highly correlated with market conditions. Infrastructure is the wheels and grease of a functioning economy. Inflation protection and diversification from financial assets will be more prominent in unlisted investment. Given the essential role of infrastructure assets in serving as the backbone for economic growth, and in light of the growing trend in privatization of these assets, the sector is very much an emerging asset class in its own right, offering investors a strong source of diversification, yield and attractive total returns in a portfolio context.
We believe that there is role for Infrastructure assets in investors’ portfolios (especially Income Portfolios) as they generally behave defensively and generate solid income flows.
Cash has the lowest volatility of all of the asset classes, and provides the lowest level of liquidity risk. Cash is highly susceptible to short term changes in interest rates, and offers the lowest potential for capital growth. At times returns may not exceed inflation.
The above outlines are not intended to be comprehensive. They provide some guidance as to the differences in benefits and risks of the various investments that might make up your portfolio. In addition, some investments will be subject to particular risks or have particular features that don’t apply to the general market. Where an offer or other form of disclosure document is available for the investment, these features will be described in more detail in those documents. It is very important that you read any disclosure material provided in relation to any of the investments of your portfolio to make sure you understand the benefits and risks involved. If you are not sure that you fully understand the risk or other features of a particular investment, please discuss with your FANZ Private Wealth Adviser.