Geopolitical uncertainty, interest rate concerns, and renewed inflationary pressures are again testing advisers and clients. Amid ongoing uncertainty, it’s crucial to remain calm and act rationally when reviewing portfolios for long-term resilience.
But this is not 2022, and it’s certainly not a time to panic. The current climate demands caution but claims that we’re about to face shocks comparable to 2022 are not supported by the available evidence. For advisers and investors able to set aside market noise, there are sensible steps that can strengthen portfolios without abandoning long-term strategy.
Safeguarding against inflation
Inflation in the UK is currently at 3%, sitting above the Bank of England’s 2% target. It’s worth noting that fuel prices linked to conflict in the Middle East are not yet fully reflected in official data, so the complete inflationary picture should become clearer in the coming months.
A prudent approach to the current situation may include defensive positions, including inflation-linked bonds. As the name suggests, these bonds track inflation and are designed to safeguard investors and their portfolios from some of its effects. If inflation remains at this higher-than-expected level, returns on investments can struggle to keep pace, reducing purchasing power over time.
We do not know how long the situation in the Middle East will persist, or how long its economic effects may last even after any resolution. In that context, inflation-linked bonds could offer insulation from inflation and form part of a sensible strategy.
Diversifying the portfolio
Another key consideration is whether their portfolios are protected against a broader market sell-off, particularly in traditional equities.
Diversification remains a straightforward and effective strategy to manage this risk, particularly if conflict in the Middle East continues to shake markets. It may be worth weighing up assets that have traditionally performed differently from mainstream equities and bonds during periods of market shock.
This might include selective exposure to commodities such as energy or precious metals. The latter, particularly gold, is viewed as a safe asset during crisis periods. In other words, they can help bolster a portfolio to perform effectively, even in periods of uncertainty.
Commodities tend to be negatively correlated with government bonds and even less so with equities, so they can be a sensible option for diversification. The goal is to build a portfolio that is not overly dependent on equities alone, especially when markets are reacting aggressively to geopolitical shocks.
Again, this can be seen as an insurance policy against prolonged conflict, even if a quick resolution comes to fruition.
There may also be a temptation to hold more cash in times of uncertainty. However, too much cash can become a problem if inflation stays above targets and erodes purchasing power over time. A balanced portfolio makes more sense for covering most eventualities.
Not the time to panic – this isn’t 2022
Some parallels are being drawn between the current situation and the shocks that followed Russia’s invasion of Ukraine in 2022. Four years ago, soaring energy prices pushed inflation into double digits, while many asset classes experienced sharp declines.
During that period, interest rates rose from almost zero to as high as 5.25%, pushing bond yields higher and prices lower. The outlook today is considerably different. Even if interest rates were to rise further from here, the impact on bonds should be less severe. Gilt yields are already much higher than they were going into 2022, which should help to cushion potential capital losses.
After the pandemic of 2020, high levels of economic stimulus were introduced by governments and central banks as a response to the economic weakness. Today, the amount of capital flooding the global financial system is much less, and inflation is expected to be less sticky, even if it rises further from here.
For advisers and their clients, the current backdrop should be handled with care. Reviewing inflation protection and promoting diversification can help strengthen portfolios for the months and years ahead. There’s no reason for this to become a high-stress environment for advisers and their clients. Instead, it’s a time to build credibility by executing effective investment decisions to build balance and resilience.
By Neal Foundly, Portfolio Manager at Equilibrium Financial Planning
This is intended as an informative piece and should not be construed as advice.
