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Striking a balance with your ISA investing

Author Image Paul Fidell Senior Business Development Manager
8 minutes read
Last updated on 28th May 2020

Paul Fidell, Senior Business Development Manager – Investments at Prudential, looks at how to strike a balance for investors who can see opportunities resulting from the current crisis.

Overview

Life always presents us with choices and the decisions we make as a result are often based not just on our understanding of the issues but also our natural pessimism or optimism.    Whilst there has been turmoil and difficulty in the financial markets because of the Covid-19 pandemic and the bad news and uncertainty it has created; this in turn has undoubtedly created opportunities as well. 

Financial markets don’t like bad news and respond accordingly.  However, history tells us that there have been many periods where markets have seen declines of 20% and more, lasting at least two months.  The SARS outbreak in February 2003, Avian Flu in 2006, the new strain of Swine Flu in 2009, Ebola outbreaks of 2014 and 2018 and the Zika virus in 2016 all caused significant stock market turbulence.  Global stock markets weathered all of these and did recover over time. 

But of course, what happened in the past isn’t always a guide to what might happen in the future or indeed over what timescales.  There are many debates and arguments taking place, on both sides, about the full scale of the economic impact of Covid-19 and how the world might look going forward.  But to put this in simple terms; as investors we can either feel optimistic or pessimistic about the future; positive or negative.  Winston Churchill once summed this up when he said “the pessimist sees difficulty in every opportunity.  The optimist sees the opportunity in every difficulty”.

In very simplistic terms for investments; this is fundamentally a question of market timing.  Are we still on the downslope, heading towards a new low or have we reached a point where things have got as bad as they will in this current period and the next phase is the start of recovery?  Irrespective of which you believe is the case, the one thing that can probably be agreed on is that there will still be heightened levels of volatility for some time and quite a few “false dawns”.

And does your perspective change when you have a lump sum to invest or are looking to make regular contributions?  Nobody likes the idea of the market falling immediately after they have made a significant investment.  Indeed, for many, this might actually result in the investment being delayed or never made; potentially missing the opportunity.  That can then potentially lead to FOMO (Fear of Missing Out) as market perhaps rally in the short term.

Conventional investment theory in these situations sometimes suggests making use of “pound cost averaging”, spreading the investment over a period of time. 

But, to make pound cost averaging work, you have to believe that eventually the markets will recover in time.  That being the case, wouldn’t you just be better off investing the lump sum and waiting it out?  Doesn’t drip feeding into the market simply dilute your potential returns?

There are, of course, some additional benefits to the use of pound cost averaging.  It can help to deal with the worry of making the investment, avoiding the feeling of regret if the timing is a little awry; it can perhaps instil a discipline for investors, which is no bad thing, and perhaps it can encourage closer attention is given by the investor to their investments with a focus on longer term goals rather than a short term obsession with intra-day market movements.

So, is there an alternative? 

If you are in the fortunate position of having both a single lump sum, perhaps a consolidation of previous plans, and a regular investment to make; then could a balanced approach make sense?

How about using a smoothed fund for single contributions and ISA consolidation and an unsmoothed one for regulars?  The smoothed fund removes much of the nervousness around timing the market with the single contribution and the regular can then take advantage of any pound cost averaging that might be available through volatile market conditions.

Single contributions and ISA consolidation

PruFund has been available through an ISA for a number of years now and has proved extremely popular with investors during this time.  PruFund uses a combination of active management by M&G Treasury & Investment Office (T&IO) and the established PruFund smoothing process, which aims to protect investors from the short-term ups and down of direct stock market investment.   Obviously, the extreme events in Q1 2020 have tested this smoothing process to a great extent; but it is fair to say that it has performed very much in line with expectations. 

Of course, it is entirely unrealistic to expect any fund, smoothed or not, to be able to somehow defy gravity and produce positive returns when most of the underlying investments are themselves failing in value by an extreme amount and over a short period of time.  When the market movements go beyond the capacity of “normal” smoothing, it can feel like the process has stopped working.  But smoothing can still make a difference even in these extremes and essentially “put the brakes on” to reduce the impact.  This can be clearly demonstrated by the following chart, looking at maximum drawdown (peak to trough movements) over the 12 months to end April 2020:

Maximum Drawdown 30 April 2019 to 30 April 2020

Source: FE Analytics

 

This chart shows how the PruFund smoothing process has reduced the impact of extreme market movements otherwise felt in unsmoothed funds.

For new investors, there is the further protection offered by the Holding Account within PruFund.  This ensures that an investor is not impacted by making an investment on one day and then seeing a significant fall in value on the following day.  They will effectively be held in the Account until the next quarterly investment date; receiving the same level of growth as if they were in the main version of the fund and, importantly, being protected during this time from any Unit Price Adjustments (UPAs).  At the quarterly investment date, they will transfer to the main version of their chosen PruFund with no change in their investment value.      

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Regular contributions

For those thinking more strategically and aiming to take advantage of pound cost averaging, at Prudential we have a couple of choices here and crucially both use the same approach to asset allocation as the PruFund range; with T&IO at the heart of things, managing the process using the same philosophy across all our multi asset funds.

The Risk Managed Passive and Active ranges offer 5 different risk levels and use a similar volatility ceiling objective to the Risk Managed PruFunds.  As with the PruFund range, all our funds follow a well-diversified, risk-controlled approach.

The Passive range is the lowest cost approach, with Ongoing Charge Figures (OCFs) of between 50 and 51bps per annum, when held within the Prudential ISA and including the costs of that tax wrapper.  These funds will invest at least 70% in passive investments and will give globally diversified exposure to equities, fixed interest, alternative assets and cash.

The Active range has OCFs of between 80 and 82bps per annum, again when held within the Prudential ISA.  These funds will invest at least 70% in active investments and will offer additional diversification by investing into commercial property alongside the equities, fixed interest, alternative assets and cash found in the Passive range.

One final point is that, unlike the PruFund range, both the Passive and Active ranges can be invested in directly as OEICs or through a wide variety of platform-based ISA wrappers.  This would have the effect of reducing the OCFs to between 25 and 26bps for the Passive range and to between 55 and 57bps for the Active range.

So, if you like our philosophy and the way in which T&IO manage your client’s money; we can now offer a comprehensive range of Smoothed, Active and Passive alternatives to suit a wide variety of different requirements.

But fundamentally this is surely just a question of market timing versus time in the market; which then neatly brings us back to whether you regard yourself as a pessimist or an optimist.

The value of any investment (and any income taken from it) can go down as well as up, so your customer might get back less than they put in.

Learn more about Prudential’s investment options.

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