- Get 2023 off to the right start by investing and allocating capital intelligently.
- When you invest, you buy now, and hope to earn positive returns in the future through capital growth and dividends and aim to maximise returns.
- But what should you invest in? Here we highlight some of the best investments for 2023.
What are the best asset classes to invest in for UK investors?
The most popular investments I the UK are stocks, funds, and bonds. The rule of thumb here is that you allocate your capital according to your needs. Investors who want a diverse portfolio invest in all three; for those who want lower risk, they hold more bonds than stocks – due to lower risk appetite. Or for more risk, and therefore more potential returns, hold more shares. There is no ‘right’ allocation for everyone – only the right allocation for you.
It’s also important to remember is that there are bull and bear markets. Whilst the best investments appreciate in value, nothing goes up in a straight line. A bull market is a period when prices keep rising. A bear market is the opposite, where the value of investments go down.
The UK stock market is one of the largest in the world. The prestige of a listing in the London Stock Exchange (LSE) lures many companies here.
Why should you invest in UK shares?
- Many world-class companies are in listed in London – including consumer titans like Unilever (ULVR) and leading pharmaceuticals such as AstraZeneca (AZN).
- Plenty of resource-rich companies – including Rio Tinto (RIO), BHP (BHP), Anglo American (AAL) and Glencore (GLEN); on energy, we have Shell (SHEL) and BP (BP.)
- Attractive financial- and property-related sectors such as HSBC (HSBA), Barclays (BARC), Standard Chartered (STAN)
- Generous dividends from many UK companies – for example, insurance giant Aviva (AV.) currently yields 6.8 percent.
Buying US Stocks and the US stock market is indispensable to global investors. It is simply too large to ignore. The NYSE and Nasdaq host some of the biggest corporations in the world, including Apple (AAPL), Microsoft (MSFT) and Tesla (TSLA) – just to name a few.
When ‘animal spirits’ run high in the States, literally few markets can outperform US stocks. For example the wonder ‘meme’ stock – GameStop (GME)? At the height of its popularity last year, GameStop’s share prices soared 100x in a matter of days. Where can you find stocks like this? Not many.
But it is not the speculative froth that investors buy into. It is US’s long-term price trend. Look at the top five US stocks over past three decades. Their market capitalisation have soared 30x from $300 billion.
“In its brief 232 years of existence,” Warren Buffett once opined, “there has been no incubator for unleashing human potential like America. Despite some severe interruptions, our country’s economic progress has been breathtaking.”
In a nutshell, you should ‘never bet against America’ when investing.
Exchanged-Traded Funds (ETFs) are one of the fastest growing areas of the financial markets. Investors like them because they are cheap, transparent and offer easy access in terms of coverage. Even sophisticated hedge funds trade ETFs because of their deep liquidity.
Three advantages of investing in ETFs are:
- You can diversify your portfolio with ETFs. You can allocate capital across asset classes with ease. In the past, you bought stocks and gilts separately, topped up with a vault full of physical gold coins. Now, you buy a stock ETF (SPY:US), a bond ETF (BND:US) and a gold ETF (GLD:US) – all in the same account.
- It is much easier to invest in global markets. You can invest in emerging markets (EEM:US) or a single country market (say, China FXI:US) at a click of the button. Or try riskier frontier markets (FM:US)
- You can invest in themes. For example, the recent emergence of the electric vehicle industry resulted in the creation of several EV ETFs (eg DRIV:US). Other thematic ETFs cater to a wide variety of interest, including Cathy Woods’ ARK Innovation (ARKK:US), Global Agriculture (COW:US) or Cloud Computing (SKYY:US)
REIT is the acronym for a Real Estate Investment Trust (REIT). Launched in 2007, REITs have become a significant sector in the UK. You can buy and sell REITs just like any other listed companies on the London Stock Exchange. There are more than 50 REITs in the LSE.
Source: London Stock Exchange
REITs offer several advantages for ordinary investors:
- REITs offer investors access to a wide portfolio of commercial and residential properties at a corporate level. REITs have experience and knowledgeable teams to manage properties professionally on your behalf – and save investors the hassle of direct property ownership.
- REITs offer the prospect of a stable income. Remember that a REIT distributes most of its property-derived income to shareholders.
- You can trade major REITs throughout a trading session. Liquidity is good on a FTSE 100 REIT. Investing £1,000 or half a million in a REIT will earn a proportional amount of income. Unsurprisingly, many pensions and large investors are increasingly reaching to REITs for their dividend yields.
The downside is that REITs share price can fluctuate like any other stocks. They can go up or down depending on current supply and demand. Price volatility is higher on REITs than traditional brick-and-mortar.
Buying bonds is an essential part of the investment landscape and any diverse portfolio. Simply put, a bond is a financial security that pays a fixed amount of income over time. The debt issuer usually redeems the bonds at the end of the life of a bond (at par value).
There are different types of bonds on the market, such as government, corporate, and other forms of bond-like securities. In the UK, government bonds are known as gilts. The bond market is huge – over $140 billion in value according to the American bank JP Morgan.
Source: JP Morgan (Guide to the Markets)
Why should you invest in bonds?
- Bonds provide investors a degree of price stability. The interest amount and maturity date investors received are known and usually fixed in advance.
- Most bond issuers redeem the debt. Default can happen due to financial distress – but these events are not in the majority.
- Bond prices can also fluctuate. Astute investors can take advantage of these fluctuations to buy bonds at a cheaper price.
What to watch for when buying bonds?
- the credit strength of the issuer. That is, can they repay the interest and debt?
- is the bond secured on any asset?
- are you getting on enough return for the risk?
Remember, real interest rates are low/negative (inflation minus nominal rates) these days. So even if you get 3-4 percent nominal interest per year, the real purchasing power is still being eroded. Lastly, prices can fluctuate throughout the life of a bond. If an investor sells a bond before maturity, he/she can lose money.
The popularity of buying index funds has increased sharply in recent years. This is a structural growth across the world because investors prefer the ease of investing in index-related products. And they are cheaper too.
In a nutshell, index funds track a particular financial index, such as the most-watched equity index like the S&P 500 or FTSE 100. In the US, the top 3 ETFs (SPY:US, VOO:US, iVV:US) that track the S&P totalled more than $900 billion.
Why are index funds favoured across the world?
- Reduces the risk of active management. Many investors prefer the simplicity of just buying a major market index instead of trying to find a ‘star’ fund manager.
- Stay invested in the biggest stocks – as major stocks indices undergo regular “reshuffling”. Weak stocks are automatically phased out from the index.
- Capture the upside with less transaction costs – it is well known that costs erode long-term return.
Like most assets, index funds are not the panacea to all investment shortcomings. While a major index (sometimes known as ‘blue-chip index) can appear solid, prices can and do drop precipitously occasionally. In 2008, the S&P slumped by more than 40 percent. And there are some index funds that track the more obscure indices. But they are smaller and less popular, and prone to wilder price swings.
Open Ended Funds
An open-ended fund is known as OEICs in the UK. These are investment schemes that pool capital together under a structure and invest the total capital. Because the number of shares vary over time due to issuance and redemption, it is ‘open ended’. Another benefit is that OEICs are regulated in the UK.
Some investors favour open-ended funds because of a) the high level of fund’s expertise and b) the market it invests in. Perhaps the fund’s prospective return complement what they have already owned.
Investing in these funds carries the same risk as other funds: The value of the fund depends on the performance of the underlying assets.
As a prospective investor, some research about these funds are required:
- What is the investment goal?
- What are the charges to manage the fund? (professional managers aren’t cheap these days).
- Geographical bias and concentration of the portfolio
- Risk level of the fund,
Until you have clear answers to these questions, you should monitor these funds further before investing.
Investment Trusts (IT) are funds that pooled capital and invest in a structured way. Sponsoring and managing these ITs are big fund management companies such as Fidelity, JP Morgan, Ballie Gifford etc.
Many ITs are closed-ended. This mean that the number of shares of an IT remains static for a period of time (unlike open-end funds). For most ITs, you can readily trade their shares during a business day. But the bid-ask spread will probably vary depending on the size and liquidity of a trust.
Some of the biggest investment trusts have assets under management in the billions. The biggest include the Scottish Mortgage IT (SMT:UK), Smithson IT (SSON:UK), and Foreign & Colonial IT (FCIT:UK).
Why you should take a look at IT
- Brilliant fund managers do exist – but they are a rare breed. Scottish Mortgage (SMT) benefitted enormously from the brilliant James Anderson who helped propelled SMT into a FTSE 100 company.
- Some investment trusts provide diversification – since they can hold a basket of investments and in different asset classes
- Some investment trusts can outperform the British general market index over a period of time because they invests outside the UK
However, no one should invest in an investment trust until he/she reads the trust’s mandates and its various parameters of investments, include the investment universe, charges and leverage.
ESG is a new factor in the investment process. In the past, investors only care about how much money the firm is making. Now, they want to know if the firm is making the money the right way.
But there is an ongoing debate about what exactly is ESG (short for environment, social, and governance) and how to define and measure ESG appropriately. There is a cottage industry trying to do this with banks, consultancies and index providers getting in on the act. (Check out MSCI’s ESG page).
While there is no universal definition of how to score ESG, nonetheless investors are starting to blend ESG factors alongside traditional financial metrics. To start with, a fund lays out an ESG scoring mechanism. Then the system picks out higher ESG ranked stock and construct a portfolio out of it. One such ETF is the iShares ESG Aware US (ESGU:US) ETF, which has $21 billion in net assets.
Why you should start investing in ESG sectors
- These companies are more socially responsible and environmentally friendly. When most other variables are the same, always invest in better-governed companies.
- ESG investing will only grow in the years to come – as investors become more attuned to this concept.
- Higher ESG companies may provide better returns.
Naturally, seasoned investors are sceptical about ESG when it first appeared. Is that not just a new fad, they wonder. Perhaps, but things are probably changing for good this time. Note: ESG investing is tangentially related to ‘ethical investing’. The latter avoids sectors and companies that are engage in socially unethical operations and like tobacco, gambling and adult entertainment.
While ESG is important, always investigate if the firm is exaggerating its ‘green, ethical or ESG’ credentials just to attract investors.
IPOs & New Issues
When companies grow, many of them became public companies which you can buy when they IPO. The process of bringing privately-held companies to the public is called an IPO, short for Initial Public Offerings. Many major companies started their journeys as a small public company and then grew rapidly over time.
In 2021, more than 120 companies chose to list on the London Stock Exchange and raised £16.8 billion. It was a bumper year for the LSE.
What are the advantages of buying into new securities?
- New exciting sectors. A newly-listed company is often young and dynamic. You can buy into these high-growth companies for a fraction of what they will be worth in the future.
- Untapped potential. A company uses funds raised from the IPO to invest in new corporate expansion. In time, these investments bring revenue growth.
- Booming industries. New sectors need funds to grow. That’s why these companies list in public markets to attract more investors. You can get a piece of the action this way.
But like any other investments, the downside of investing in new securities is that these companies are untested. They may or may not survive the next economic downturn. Corporate longevity is unknown.
Another point worth remembering is that IPOs are more vibrant during a bull market when Investors are more receptive to new positive ‘stories’. Ergo, wildly enthusiastic investors overpay for IPOs.
Look at one ETF that invests in IPOs (ticker IPO:US). Its price action succinctly captures the rise and fall of the investor sentiment during the covid boom.