Putting up with some insurance

You never buy insurance hoping you’ll be able to claim on it, but you buy it all the same argues our head of multi-asset investments David Coombs.  

Insurance is the biggest pain in the neck you can’t do without. I’ve lost count of the hours I’ve whiled away chatting to insurers’ call centres. Although, to be fair, most of that time was probably spent on hold.

Still, it’s a commanding argument for the importance of insurance as a concept that, despite all that pain, those premiums and wasted youth, I continue to deal with insurers. And I’ll wager you all do as well. Insurance is just too important – it’s that backstop that prevents disaster becoming destitution. I think the same way about insurance in our multi-asset funds. Thankfully, portfolio insurance tends to entail fewer exasperated phone calls. Of course, there’s no Portfolio Insurance® product that you can call up and buy. Your insurance comes from creating a well-diversified portfolio, and, in our case, this has included some more intricate trades of late.

When constructing a portfolio, the correlations between assets are crucial. If all the eggs in your basket are connected by string, you can bet they are all heading for the floor if one of them is. You shouldn’t be upset if some parts of your assets are falling when the others are rising – that means you’re diversified! If everything is going up together, you shouldn’t be celebrating. Instead, you should take it as a warning and investigate why. It’s probably a strong signal that you’re in for an ugly patch in the future.

Some people look at diversification the wrong way. They see something they own continually in the red and think they should sell it because it’s not doing well. We’ve added several holdings to our multi-asset funds, while hoping that we don’t see a profit from them for the foreseeable future. This sounds a bit silly, but it makes sense when you think of these assets as insurance. When you take out insurance, you always pray you won’t need to make a claim. The same holds with our portfolios.

When gilt yields broke through 1.50% for the 10-year, we started buying cautiously for our multi-asset portfolio funds. We had virtually none of these for a year or more because yields reached a point where we felt the value could only go lower. Now that yields have picked back up, we feel gilts are a better bet for portfolio protection. We expect yields to continue rising steadily, but we feel the losses this will incur should be relatively small and that will be more than offset by rising values in our equity investments. On the flip side, if there is turmoil in UK equity markets, gilts should rally, making us money.

Market risks come in very different forms and there is no one all-encompassing type of protection.  For example, gold can be a great diversifier against deflation, but not against rising interest rates in the US. Therefore it’s imperative that we have a range of assets providing protection against the highest probable future risks. Focusing on insuring against past risks can be expensive and fruitless: there’s no point only buying fire insurance if you live next to a river!

Another bit of insurance for our multi-asset portfolio funds: we recently bought a put option on the S&P 500 index, which will make money if the market falls below a certain level. If the US market continues to rise – as we expect – then this investment will lose value. But the cost of this option is small and it’s a sunk cost. We’ve paid our premium, which is just a fraction of a percentage of the fund, to protect ourselves against disaster.

If the market falls it would hurt many of our other investments, so we are not cheerleaders for a market correction. In fact, we’re optimistic about the economic situation for most of the world and the outlook for corporate profits. We feel there’s plenty of steam left in this business cycle’s boiler. But we aren’t psychic; we have no idea what will happen tomorrow. And given the extremely strong performance of equities over the past few years, we feel it’s prudent to be insured.

Important legal information

This area of the site is for professional advisers

Please read this page before proceeding, it explains certain legal and regulatory restrictions applicable to the distribution of this information. It is your responsibility to inform yourselves of and to observe all applicable laws and regulations of the relevant jurisdiction.

This section of the website is directed only at investment advisers and other financial intermediaries who are authorised and regulated by the Financial Conduct Authority (FCA).

The information provided in this site is directed at UK investment advisers only and must not be circulated to private clients or to the general public. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

I confirm that I am an investment intermediary authorised and regulated by the Financial Conduct Authority. I have read and understood the legal information and risk warnings below:

Important Information (Terms and Conditions)

The information contained on this site is believed to be accurate at the date of publication but no warranty of accuracy is given and the information is subject to change without notice. Any opinions or estimates included herein constitute a judgement as of the date of publication and are subject to change without notice. Furthermore, no responsibility is accepted for the accuracy of any information contained within sites provided by third parties that may have links to or from our pages.

Rathbone Investment Management Limited ("RIM") is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Registered Office: Port of Liverpool Building, Pier Head, Liverpool L3 1NW. Registered in England No 01448919.

In accordance with regulations, all electronic communications and telephone calls between Rathbones and its clients are recorded and stored for a minimum period of six months.

The information provided in this site is directed at UK investors only. It does not constitute an offer to sell, or solicit an offer to purchase any investments by anyone in any jurisdiction in which such offer or solicitation is not authorised or in which a member of the Rathbone Group is not authorised to do so.

In particular, the information herein is not for distribution and does not constitute an offer to sell or the solicitation of any offer to buy any securities in France and the United States of America to or for the benefit of United States persons (being resident in the United States of America or partnerships or corporations organised under the laws of the United States of America or any state, territory or possession thereof).

In order to comply with money laundering and other regulations, additional documentation for identification purposes may be required.

Rathbones shall have no liability for any data transmission errors such as data loss, damage or alteration of any kind including, but not limited to, any direct, indirect or consequential damage arising out of the use of services provided or referred to in this website.

Past performance should not be seen as an indication of future performance.

The value of investments and the income from them can fall as well as rise and you may not get back the amount originally invested, particularly if your client does not continue with the investment over the longer term.

Changes in the rate of exchange between currencies may cause the value of an investment to go up or down.

Interest rate fluctuations are likely to affect the capital value of investments within bond funds. When long term interest rates rise the capital value of units is likely to fall and vice versa. The effect will be more apparent on funds that invest significantly in long dated securities. The value of capital and income will fluctuate as interest rates and credit ratings of the issuing companies change.

Tax levels and reliefs are those currently applicable and may change and the value of any tax advantage will depend on individual circumstances.

Investing in emerging markets or small companies may be potentially volatile, as these investments are high risk.

The design, text and images are owned, except as expressly stated by members of the Rathbone Group. They may not be copied, transmitted, displayed, performed, distributed, licensed, altered, framed, stored or otherwise used in whole or in part or in any manner without the written consent of Rathbones except to the extent permitted and under the procedures specified in the copyright Designs and Patents Act 1988, as amended and then only with notices of Rathbones' rights.

Rate this page:
Average: 5 (7 votes)

Subscribe to the In the KNOW blog email