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What drives the value of investments?

An animated guide to the factors determining the value of financial assets.

 

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The whole point of asset allocation is to take advantage of the variety of ways that different assets behave. Some are especially safe and help to reduce volatility. Some are higher risk, but help us to generate income or growth. 

In previous videos, we looked at the behaviours of the main types of assets, equities and bonds. In this section, we want to look at some of the factors that affect the behaviours of financial investments more generally. 

There are two key differentiators – geography and industry. Let’s start with geography. 

One way of looking at it is to compare developed and emerging markets. Whether we’re looking at bonds or equities, private or public sector, it will make a difference if it relates to a developed or an emerging economy. 

Developed economies tend to have more mature industries and more established processes of governance and regulation. They are likely to have a hard, tradeable currency. Emerging markets are at an earlier stage of the journey. Investments in emerging markets are likely to be higher risk, and therefore more volatile, but they may also offer more potential for higher long-term returns. 

There are other interesting geographic differences. For example, the US market is rich in large, globally dominant technology businesses. Companies listed on the UK equity market are renowned for the significant proportion of their earnings sourced from overseas. Canada and Australia tend to be influenced by demand for commodities. The German market is known for its high quality engineering and manufacturing companies. 

Emerging markets are similarly diverse. China is very different to Peru or Mexico, and it is very different to India, which in turn is different to Russia. 

Industries, like countries and regions, also have varying characteristics. Let’s look at some examples: 

Utilities run large, capital-intensive infrastructure and supply essential services such as electricity or mass transport. They tend to have steady, long-lasting cash-flows, but modest prospects of growth.

A high-tech start-up is likely to have limited short-term cash-flows and a higher risk of failure, but excellent prospects for long-term growth if it survives.

A media company is likely to have cash-flows sometimes described as cyclical, or economically sensitive, as their income from advertising tends to follow the business cycle. 

There are other factors that can affect financial assets too, such as currency, resource prices and political change. 

These differences are all of value to the asset allocator who is seeking to build and refine a portfolio suited to specific investment goals.

Investment risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

Other important information:

This video was produced by Vanguard Asset Management, Ltd. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

If this is to be used on third party websites for an audience of professional investors as the submission suggests I would also include the for professional investors disclaimer at the top.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

© 2018 Vanguard Asset Management, Limited. All rights reserved.