Paradigm Principle

Understanding your investment options

Understanding your investment options

Investing is full of jargon and technical terms that can make getting started or managing your investments seem intimidating. Here are some of the key terms to help you better understand the different options available to you.

 Common investing terms

There are a few terms that you’ll see repeated when we’re talking about investing.

Bonds – Bonds are a way for corporations or governments to receive a loan from investors for a promised rate of return over a specific period. Bonds can be issued to pay debts, build new facilities or raise funds for future growth.

Cash – Cash investments are savings accounts and other easy-to-access funds like cash management trusts and money market funds. Cash investments are stable and low risk, generally growing slower than inflation or the increase in prices of goods and services over time.

Diversification – Having a diverse group of investments means that you spread your investments across different companies or sectors (for example, shares or fixed interest). This way, if one sector underperforms or has a loss, you have other investments that may perform better and help balance out any losses.

Another way we diversify our investment options and portfolios is by using different investment managers with different approaches to investing. In some cases, we use multiple investment managers in the same option. These are called multi-manager portfolios.

Dividends – Dividends are a portion of profits or earnings paid to shareholders. They are paid on a regular basis and, in some cases, can be reinvested into the business in the form of more shares. This can provide shareholders with ongoing income.

Domestic Markets – Domestic markets, shares or companies refer to the variety of investments that are connected to that country, either through where they operate or the investment exchanges on which they reside. In Australia, we would refer to Australian bonds as domestic bonds. Likewise, a US-based fund would refer to the US stock market as the domestic market.

Environmental, Social and Corporate Governance (ESG) – ESG is the consideration of an investment beyond its financial performance. It often includes social and environmental factors, like its impact on the climate, the gender or cultural diversity of staff and leadership or general benefit to society. Investors are increasingly applying these considerations as part of their investing decisions.

Equities – Equities are another name for shares. Equities can be bought directly on the share market or through an investment option.

Fees – A fee is the amount charged by a fund to manage your investments. Fees may vary based on factors including the cost to manage an option, the size of the investment and the management style.

Geared Investments – Geared or ‘leveraged investing’ is a way to borrow money in order to increase the size of an investor’s original investment. Geared investments are often made with higher-risk assets like shares and property.

International and Emerging Markets – International markets can give investors access to a variety of investments, including shares, securities, property or bonds from nations other than their own.

International markets can be volatile because of international trade relations or fluctuations in currency value. There is more risk with less stable countries, like those in economic or political turmoil, and less risk in more stable countries.

Emerging markets are international markets that focus specifically on growing and developing economies like China, Brazil or India.

Investment Manager – An investment manager is a professional person or organisation who has been appointed to manage money in an investment option on behalf of investors. One or multiple investment managers may be appointed to an investment option. They generally have specialised expertise in the area they represent, like property, bonds or shares.

Investment managers are selected for their strengths in certain areas as well as organisational stability, solid investment process and a history of strong performance. We also use a specialist investment consulting and research firm when selecting managers.

Managed Fund – A managed fund pools your money together with other investors to buy a variety of assets like shares, bonds or property. Managed funds can be invested in single or multiple asset classes and have single or multiple investment managers.

Risk – Risk in investing is about understanding, anticipating and accepting the potential for financial loss in an investment. All investing has an inherent level of risk.

Risk can be seen as an option underperforming against expectation. Investors can spread their risk by diversifying their investments.

Securities – A security is a way to purchase a portion of an asset such as infrastructure, property, loan or business. For example, shares are a type of security that makes it easy to purchase a portion of a business.

Securities can be bought, sold or traded. The value can change based on market conditions, the value of the asset, expected income or general market conditions.

Share – A share or stock represents the purchase of a portion of a business. The value can increase or decrease based on a variety of factors, including general market conditions as well as industry and company performance and challenges.

Some shares have lower volatility and provide strong regular dividends without necessarily increasing in value.

Short Selling – Short selling, or shorting, takes place when an investor believes the price of an equity (like a share) will go down. They arrange to sell shares on the market with the intention of repurchasing them for a lower price later on. A short position is generally very high risk and can result in large losses if the price of the equity increases.

Mandate – A mandate is an agreement with an investment manager that sets out how the money will be invested. It includes performance benchmarks and expectations, acceptable investments and investment ranges.

A mandate’s structure means that the investments are managed in a unique way for our investors, different from the investment manager’s options with other organisations. This gives CFS greater flexibility around the option, including administration and reporting to investors.

Product Disclosure Statement – A Product Disclosure Statement (PDS) is a review of all relevant product information for an investment option. You should always read the PDS before making any decisions about the relevant products. It offers information including the investment managers, risk measures, objectives, and minimum suggested timeframe.

Units and Unit Pricing – The unit price tells you the value of the package of investments it contains. Investments are packaged in units that are made up of a variety of assets, like shares, bonds and property. Investing this way gives you the ability to invest in ways that you may not otherwise be able to access as an individual investor.

Reading an investment option

We use a standard description to quickly review and compare different investment options. Here’s what you should look for:

Objective
A sentence or two on what the investment option is designed to achieve and the timeframe to achieve it.

Minimum suggested timeframe
How long an investment professional suggests you hold, or remain invested in, an option in order to achieve the stated investment objective.

This is only a suggestion and should not be considered personal financial advice. Because financial markets can be volatile and unpredictable, it’s good to regularly review your investments with a financial adviser to ensure they meet your needs.

Risk
A snapshot of the expectation that an investment option will deliver a similar number of negative annual returns over a 20-year period.

Generally, the higher the level of risk an option has, the higher its return is expected to be. You should review the associated risks to see if the option is suitable for your needs.

Strategy
A description of the way the investment option is structured with some details about its contents and the reasons why those investments were chosen.

Investment Category
A quick way to organise different options by their typical range. These categories are not standardised across the investment industry, so what is considered ‘growth’ in one organisation might be considered ‘moderate’ by another. You should read the full details of an option before making an investing decision. We’ll break down the different investment categories a bit later.

Allocation
A quick view of the different assets, or types of investments, contained in an investment option. In some cases, the assets are given a range (i.e. between 15-25%), which indicates the minimum and maximum ranges that may be held in the option at any time. The investment manager may make changes within that range for different reasons, including market volatility. Not all investments offer an allocation benchmark.

Underlying investment managers
These are the professional investment managers and organisations that have been appointed to manage the money in the investment option. There may be one or more, which is known as a multi-manager fund.

Investment categories and asset classes

There are a few different ways we organise and categorise investments to make it easy to understand how they are structured.

Cash and deposits
Cash is invested in reasonably stable domestic currency, like bank bills. Cash is liquid, making it easier to quickly access funds as required. It also includes term deposits (money invested for a set period) and money market securities. Cash and deposits are generally low risk and provide a low, stable return.

Less liquid than cash and deposits, enhanced cash is invested in money market securities and some fixed-interest securities.

Fixed interest
Fixed-interest investments are investments made with a guaranteed rate of return. These are usually issued by corporations, governments or financial institutions to raise funds. They have a set rate of return, which is usually higher than cash but lower than higher-risk options like shares. The return comes from interest payments from the bond issuer. The amount of that return can change based on interest rate repayments.

Alternatives
Alternative funds may include a diverse mixture of investments, including hedge funds or commodity trading like oil or livestock. Basically, anything that falls outside of the traditional shares, property, infrastructure, cash or fixed interest categories is called an alternative.

Property
Property investing generally involves buying a property or buying a stake in a building through property security. These properties can be office spaces, industrial properties or retail. A company or trust (a group acting on behalf of the investors) generally hold, manage and develop these properties.

Infrastructure
Infrastructure is a broad term that refers to physical assets. It may include public transportation, toll roads or utilities like water desalination. It may also include social infrastructure investments in public housing, hospitals or prisons.

Infrastructure investments or securities (a portion of the investment purchased on a public market) are generally expensive and have high upfront capital requirements. They also feature low ongoing operating costs and have a reasonably stable return.

Shares
The most recognised method of investing, shares are part ownership of a company. They are generally bought and sold on a public stock exchange. Because of the general volatility of the share markets, shares are considered a high-risk asset.

Over time, however, they tend to outperform other asset classes. The amount of risk can depend on the particular company invested in or the industry or region they come from.

Risk measures and categories

Risk is broken down into some general categories in order to help organise different investment options.

Because there is no industry standard around the naming of the categories, the level of risk may vary between funds. What is a conservative investment with one fund may be considered a moderate investment with another.

Risk is generally broken down into the following categories:

Risk bandRisk LabelEstimated number of negative annual
returns over any 20-year period
1Very lowLess than 0.5
2Low0.5 to less than 1
3Low to medium1 to less than 2
4Medium2 to less than 3
5Medium to high3 to less than 4
6High4 to less than 6
7Very high6 or greater

 

Source: Colonia First State

Latest news

Economic and market overview

Economic and market overview
Encouragingly the International Monetary Fund (IMF) raised its global growth forecast for 2024, following ‘surprisingly resilient’ economic conditions. IMF officials now expect global GDP growth of 3.2% this year.
Despite this positive news, major share markets lost ground in April following five months of unbroken gains.
Ongoing geopolitical uncertainty, particularly in the Middle East, was unsettling and prompted some investors to lock in profits from the recent strong rally.
Inflation also remains above central bank targets in most key regions, prompting investors to reassess their outlook for interest rates.
According to consensus forecasts, only one rate cut is now anticipated in the US in the remainder of 2024.
Notwithstanding a moderation in the growth rate in the March quarter, the world’s largest economy appears to be performing well despite elevated borrowing costs. This could reduce the urge for policymakers to lower interest rates.
Government bond yields in the US and other key regions moved sharply higher against this background, which was a headwind for bonds and resulted in negative returns from major fixed income indices.
US
Somewhat alarmingly, US inflation has re-accelerated. Headline consumer price inflation rose to an annual rate of 3.5% in March and the ‘personal consumption expenditure’ measure, favoured by Federal Reserve officials, also ticked higher in the first quarter of 2024. These readings arguably make it more difficult for policymakers to justify lowering interest rates.
Labour market trends remain firm too. More than 300,000 new jobs were created in March, which was nearly 50% above the estimate. Combined with historically low unemployment, the hiring frenzy is exerting upward pressure on wages and making it less likely that inflation will fall meaningfully in the near term.
Australia
Both headline consumer price inflation and the trimmed mean measure came in higher than expected in the March quarter, which was a blow to Reserve Bank of Australia officials and anybody hoping for a rate cut in the near term.
Unfortunately, despite some movement in the right direction, pricing pressures are proving persistent and could prevent policymakers from lowering official interest rates.
At the beginning of April, two rate cuts in 2024 had been priced into markets. By month end, these expectations had been fully removed from forecasts. Most observers now expect Australian interest rates to remain at 4.35% for the foreseeable future.
Consumer confidence remained subdued against this backdrop and deteriorated for a second consecutive month in April.
New Zealand
There are lingering hopes that interest rates will be lowered in New Zealand this year, although it is worth noting that the country already has some of the highest borrowing costs among developed countries.
Although inflation is running well above target, investors are still hoping for one or two rate cuts in the remainder of the year.
Elevated borrowing costs have undoubtedly affected confidence levels in the country. Business confidence fell sharply in April and firms reduced staff numbers in the March quarter.
The unemployment rate has ticked up to 4.3%, which is the highest level for three years.
Europe
The initial estimate of GDP growth in the Eurozone suggested last year’s recession in Europe is over. The economy grew 0.3% in the first three months of 2024.
According to other preliminary estimates, consumer price inflation in Germany eased to an annual rate of 2.2%, down from 2.5% in February. This was the lowest inflation rate for nearly three years.
More importantly, with inflation in Europe’s largest economy now close to the European Central Bank’s 2.0% target, investors were increasingly hopeful that interest rates could be lowered in either June or July.
There were growing suggestions that the Bank of England could lower interest rates in next few months too. Consensus forecasts indicate official borrowing costs in the UK could be lowered in either August or September.
Asia
Chinese officials hinted they will consider lowering interest rates to support activity levels, if required. This may not be required, with the world’s second largest economy showing some signs of improvement.
Chinese GDP grew 1.6% in the first quarter of the year, taking the annual growth rate to 5.3%.
Factory output has improved, suggesting export demand remains intact, although services-related demand appears less strong. Retail sales fell short of consensus expectations in March.
Most of the attention in Japan was on the yen, which weakened to its lowest level in more than 30 years against the US dollar. There was speculation that the Bank of Japan had intervened in FX markets to try and arrest the very sharp currency sell off.
Australian dollar
The Australian dollar drifted slightly lower against the US dollar, closing down 0.7% to 64.7 US cents.
This move appeared to reflect broad-based strength in the US dollar. The AUD actually appreciated by more than 1% against a trade-weighted basket of international currencies.
The AUD added 3.6% against the Japanese yen, breaking through ¥100 and closing at its strongest level since 2007.
Australian equities
The S&P/ASX 200 Accumulation Index returned -2.9% over the month, breaking a five-month winning run.
The prospect of interest rates remaining high for longer than was previously forecast affected sentiment towards consumer discretionary stocks. The sector fell more than 5%, with investors mindful that high borrowing costs could impede spending on discretionary goods and services.
On the positive side, utilities stocks tended to fare relatively well. The sector returned 4.8% in April, making it the best performer in the S&P/ASX 200. AGL Energy was a standout performer, closing the month up 13.4%.
Materials stocks (+0.6%) benefited from improving economic indicators in China, which augur well for future demand for various commodities including iron ore, copper and aluminium.
Gold-related stocks also continued to perform well, with the gold price reaching a record high of US$2,391/oz in mid month.
BHP Group (-4.6%) announced a US$39 billion takeover bid for UK-based miner Anglo American. The proposal was rejected by Anglo American.
Small caps fared slightly worse than their larger cap peers, with the S&P/ASX Small Ordinaries Index declining 3.1%. Online retailer Kogan.com was among the worst performers in the small cap space, falling more than 35%.
Global equities
The interest rate outlook was a further headwind. More bullish commentators suggested the stock market rally can persist even if interest rates remain unchanged this year, but some other investors seem concerned about the outlook for equities if borrowing costs are not lowered as early or as much as previously anticipated.
These factors resulted in some equity market weakness, particularly as some investors looked to lock in profits from the recent strong rally.
By mid month, the bellwether S&P 500 Index in the US was down by more than 5%, although a partial recovery helped claw back some of these losses. Despite the release of generally favourable financial results from large, listed US-based banks, the Index closed the month down 4.1%.
The NASDAQ fell 4.4%, as technology shares were caught up in the broader sell-off.
Netflix was among the worst performers, after the company announced it will stop reporting subscriber numbers. Meta, which owns the Facebook social media platform, also struggled following the release of subdued financial results, while Apple announced weaker than expected sales of iPhones in the first quarter.
European stocks also struggled, with most of the major markets in the region closing the month down between 2% and 4%.
There were some unusual moves in Asia. Hong Kong’s Hang Seng powered ahead 7.4%, but China’s CSI 300 Index closed ‘only’ 1.9% higher. In Singapore the Straits Times added 3.1%, although Japan’s Nikkei closed the month down nearly 5%.
Property securities
Global property securities were caught up in the broader equity market sell-off, with the FTSE EPRA/NAREIT Developed Index closing the month 5.4% lower in Australian dollar terms.
The USA and Canada were among the worst performing markets.
Markets to register positive returns included Spain (+4.3%), France (+3.6%), and Japan (+0.8%).
Stocks in the industrial and data centres sub sectors seemed most affected by the interest rate uncertainty, while healthcare-related stocks were more resilient and registered modest gains over the month.
Locally, A-REITs fell 7.8% with all but one index constituent losing ground. Volatility in the fixed income market and higher Australian Commonwealth Government Bond yields impacted the likes of Charter Hall, Mirvac Group and Ingenia Communities Group, all of which closed the month between 10% and 13% lower.
Global and Australian fixed income
Higher than expected inflation and suggestions that interest rates are unlikely to be lowered in the near term exerted further upward pressure on government bond yields.
Yields on 10-year US Treasuries closed the month up 48 bps, to 4.68%. The moves were slightly less severe in Europe. Yields on 10-year gilts and bunds rose 41 bps and 29 bps in the UK and Germany, respectively.
Yields on 10-year Japanese Government Bonds climbed too, as the bond sell-off extended to all major markets.
Unfortunately, these moves resulted in negative returns from fixed income. The Bloomberg Global Aggregate Index closed the month 1.7% lower in Australian dollar terms.
Similar moves were observed locally, as anticipated interest rate cuts by the Reserve Bank of Australia were removed from investors’ forecasts.
Yields on 10-year Australian Commonwealth Government Bond yields rose 46 bps, to 4.42%, resulting in a -2.0% return from the Bloomberg AusBond Composite 0+ Year Index.
Global credit
Global credit was among few asset classes to generate positive returns in April. Spreads on investment grade and high yield securities continued to tighten, which was particularly pleasing considering both equities and sovereign bonds struggled.
Overall, earnings releases for the first quarter of the year from large companies in the US and Europe affirmed that profitability remains solid. This reduces the likelihood of corporate defaults and means the prospective income from higher yielding credit securities remained appealing for investors.

Source: First Sentier Investors, May 2024

Read More »