Portfolio Adviser: PA Interviews

17th July 2013

I was recently interviewed by Esther Armstrong, the News Editor at Portfolio Adviser. Esther records a monthly series of videos with investment managers which are published online. We discuss here Emerging Markets underperformance, the balance between low cost & top talent and finally the first six months post RDR. Here are the links to three short videos:

Part one: Husselbee tells the truth about GEM underperformance

http://www.portfolio-adviser.com/video/pa-videos/wealth-manager/pa-interviews-john-husselbee-part-1

Part two: "Price is what you pay, value is what you get."

 

http://www.portfolio-adviser.com/video/pa-videos/wealth-manager/pa-interviews-john-husselbee-part-2

Part three: Six months on from RDR

http://www.portfolio-adviser.com/video/pa-videos/wealth-manager/pa-interviews-john-husselbee-part-3

Growing Pains

28th June 2013

This blog was published in Portfolio Adviser on 2^nd July 2013. Follow the link:

http://www.portfolio-adviser.com/comment---analysis/growing-pains

Emerging markets have had a difficult start to 2013. In sterling terms (as at 25/06/13) the MSCI Emerging Markets Index was down -10% whereas the S&P 500 Index gained +18.7%. Over the period, fund investors holding active managers have been slightly better off than those investing in the index, the average fund in the IMA sector being down -9.2%.

 

Those managers who have typically been more defensive and steered their investment process towards absolute return have sheltered investors from most of the decline. Here I am thinking of First State and its large investment team headed by Angus Tulloch in Edinburgh.  The First State Global Emerging Markets and Global Emerging Markets Leaders Funds fell -3.0% and -3.7% respectively. Other notable performers for the year to date include two perhaps less well-known names, Hermes Global Emerging Markets Fund (-2.1%) and Somerset Emerging Markets Small Cap Fund (-2.1%).

Today many of the major emerging markets - Brazil, Russia, India and China - are suffering from growing pains, mainly stemming from the global financial crisis, a creation of western economies. The long term growth story for emerging markets, born out of the growth of the middle classes and government infrastructure spending to support private investment, is well-understood. Over the last decade the acceleration of the wealth transfer from West to East has resulted in these economies contributing more and more to global economic growth. However rapid growth needs to be handled with care, particularly when coupled with the challenges inherent within structural change and reform.

Following the 2008/9 crisis, economic growth in emerging market economies remained robust, leading to strong investment flows. This accelerated growth and inflation in the regions, particularly as some authorities were reluctant to see their currencies strengthen, a development which would undermine the competitive advantage that they had so effectively exploited for many years. However, inflation has risen, and with increasing domestic demand, wages have increased sharply too – in China particularly. These economies have lost some of their competitive edge, with growing imports deteriorating trade surpluses.

If western economies are facing some difficult choices, so too are emerging markets, where economic growth is slowing and inflation remains high. As a result, interest rates will have to rise to combat inflation in consumer prices which will be negative for bond and equity investing.

There is also a close relationship between commodity prices and emerging markets. Producers in Brazil and Russia rely on consumers in India and China. Slowing demand has resulted in weaker commodity prices which have added to further selling pressure. These views on the economy and commodity prices, I believe, have already been reflected in bond and equity markets.

Clearly, some investors have chosen to reduce weightings in favour of economies at a different stage of the economic cycle. Indeed, prices have now fallen to levels where valuations are considerably cheaper relative to those in western markets. These valuations, however, reflect the less favourable fundamentals of today and may present an entry point for long term investors wanting to build up their holdings.

Stand by me

27th June 2013

This article was published in Professional Adviser on 11th July 2013.

The inauguration of Franklin D. Roosevelt as the 32nd President of the United States of America was held on Saturday 4th March 1933. After taking the oath, he delivered a speech perhaps best remembered for the words, “The only thing we have to fear is fear itself.”

This astute observation was made at the time of the Great Depression, a period of slow economic growth, high unemployment and volatile equity markets. We find ourselves living in similar times, with sluggish growth, high unemployment and as we have just witnessed, the fourth large sell-off in equities since the lows of early 2009 – a fall, once again prompted by talk of the removal of central bank liquidity in the form of QE.

Uncertainty heightens the anxiety of clients who easily become fearful and risk averse. Indeed, there is a whole field of academic study dedicated to investor behaviour and irrational, emotion-driven decision-making. Many of these studies conclude that as financial assets fall and investors become more risk averse, they put at risk their long term financial goals. This is where ongoing education and strong client relationships are so important.

Having worked in partnership with many advisory firms for a very long time, I believe that in these uncertain markets the role of the Adviser has assumed even greater significance.  Advisers establish and build their long term relationships with clients on trust. They maintain that trust by meeting client’s long term goals whilst understanding and respecting their appetite for risk. Essentially their job is to manage client emotion and ensure they remain focused on achieving their objectives, especially during periods of market turbulence.

I firmly believe that education is the key to reducing client anxiety brought on by short term market fluctuations. A large part of this often subliminal instruction has to be delivered by the Adviser demonstrating an ability to translate theory into practical advice. I am keen to support our Advisers and typically once a quarter will present to their clients. At a recent presentation, clients although delighted with the returns I had delivered over the last year, nonetheless had concerns about the near future. I warned of a potential decline in prices, but could foresee no reason to abandon the asset class. To support my argument I showed how equities had historically helped clients to achieve their long term financial goals despite the interim ups and downs.

It has been nearly five years since the Global Financial Crisis when many investors decided to head for equity market exits. Whilst bond investments, supported by extraordinary monetary policy have been very rewarding since then, the chances of this being repeated are unlikely. As we all know, equities have recovered strongly, albeit not in a straight line - and it is Advisers who have played a critical role in managing clients’ risk, emotions and return expectations. Clients who have not wavered from their long term strategy have been rewarded, but we can be sure that the recent heightened market turbulence will test their nerve once more.    

The Grand Old Duke of York

31st May 2013

"Oh, the grand old Duke of York,

He had ten thousand men;

He marched them up to the top of the hill,

And he marched them down again.

And when they were up, they were up,

And when they were down, they were down,

And when they were only half-way up,

They were neither up nor down."

I am sure this popular nursery rhyme brings back some childhood memories. Can you still remember those actions? Standing up, sitting down and then hovering halfway!

The market has been on a march for the last six months, another leg of a liquidity-fuelled rally supported by global central banks. Last week Ben Bernanke's testimony hinted at the beginnings of a QE withdrawal as the US economy sustains a recovery led by the housing market and the consumer. However, the market reaction must have terrified Bernanke and his fellow Fed members. Clearly the Fed is still walking in the shadows of the two previous occasions when QE was withdrawn in 2010 and 2011.   Both led to sharp market corrections. I am not sure whether this latest reaction is enough to shake the bull markets out of their complacency, but I do believe it is time to review the investment style of our equity portfolio. Indeed, in a recent market commentary, Invesco Perpetual's Neil Woodford commented "the overall market is no longer as cheap as it was, but some high quality, dependable, growth companies remain significantly undervalued."

Typically, in Grand Old Duke of York style, the same market leaders, whether it is an index, sector or a stock tend to lead on the way up and then back on the way down. Last week, for example, Japan, which has been one of the strongest market performers over the last six months, suffered one of the biggest falls. From our fund analysis at North Investment Partners, we have found that reliable, high yielding, large cap, defensive stocks have performed well over the last three years and fared particularly well over the last quarter. Sectors such as pharmaceuticals, utilities, tobacco and consumer staples have flourished in a low yielding environment. These are the bread and butter sectors for UK Equity Income managers to construct their income portfolios. Whilst companies in these sectors remain in very good shape, valuations are getting stretched. To make meaningful strides from here we would need to see a more sustained economic recovery.

With signs that the market may be preparing to descend from its recent peak, we are wary of the 'Grand Old Duke of York' effect. There are opportunities which are yet to reach their peak and some of these sit within the UK equity income fund universe. Many quality businesses have raised net cash and at some point need to decide whether to reinvest or return to shareholders. Furthermore there are companies that have strengthened their balance sheets post the credit crisis and remain undervalued. Consequently, we are reviewing our funds with a preference for the stock pickers with a robust and disciplined approach to finding undervalued assets.

Terror shocks Big Ben

30th May 2013

The four year equity bull market has been fuelled by a mass of liquidity around the world created by central banks. The US Federal Reserve was the early advocate of this policy with the UK happily tagging along. The Eurozone was more reluctant. Also late to the liquidity party, but now making up for lost time following the change of government last December, was Japan.  More sceptical investors believe this last leg of the equity rally is completely out of touch with the pace of economic growth and a reality check is required.

A crude, yet effective check on any stock, sector or index in the case of equity markets can be gauged by reference to the 200 day moving average. Whilst writing, the FTSE 100 Index is hovering around the 6,800 level whereas the average closing price of the past 200 trading days is around 6,100. So the market is trading around 10% above the moving average, typically perceived as a significant overbought position. The more serious technicians of Technical Analysis would calculate the standard deviation of the gap between the current price and the moving average, seeing significance greater than one standard deviation. For me a simple chart of these two indices tells me all that I need to know - and currently, I agree with the sceptics.

The calculation of the moving average supports the theory of mean reversion, the investment industry's answer to Newton's Law of Gravity, although in this theory when the current price is either above or below the moving average it will eventually fall or rise. Typically there are two ways to achieve this, either a short sharp market correction or a sideways moving market which allows the two lines to converge. I don't believe that the current overvaluation will lead to a 10% fall in the FTSE 100 Index, more likely a gradual convergence over the next few months. The UK equity market remains relatively good value on historic terms, whereas government bonds are not.

The US equity market, (I use the S&P 500 Index), was, before Ben Bernanke's recent testimony, around 12% overvalued on a 200 day moving average basis. No doubt his testimony caused some panic last week near this peak. Supporting asset prices has been a clear strategy since the credit crisis to sustain an economic recovery. Mean reversion is a powerful force, as investors witnessed when QE ended in 2010 and 2011. When the time comes to start withdrawing liquidity Bernanke would obviously prefer a less violent reaction to those previous occasions. Last week he hinted at slowing down QE as the economy recovers.  The market reaction must have petrified him and his colleagues on the Fed. Weaning a market addicted to central bank liquidity was never going to be an easy task.

One last observation on moving averages - I calculate that the current gold price in US dollars is nearing 20% below the 200 day moving average. With inflation being the long term threat, perhaps this could be a buying opportunity.

Investing by Numbers

25th April 2013

In a post RDR world, independent financial advice is increasingly being repackaged to incorporate a range of wealth management solutions. Many advisers believe that their core competency and, indeed, their added value is giving financial advice to their clients rather than constructing and monitoring investment portfolios, an activity which to them can be onerous in terms of time and resource. No wonder there has been a growth in the outsourcing of investment management to discretionary fund managers.

In terms of investment solutions, we see that once an advisory firm has segmented its clients and taken into consideration the new regulatory environment, there are four investment options: first, advisory portfolios where advisers buy into strategic asset allocation and fund research, often available via a suitable platform; second, managed fund solutions which will frequently be actively managed and may follow either a multi manager or multi asset approach and  two other options which fall into the category of discretionary managed portfolios - either on a model or bespoke basis.

For each of these outsourced investment solutions, there is a range of investment objectives, from capital preservation to capital growth. Whichever objective is recommended by the adviser, it will be as a result of an assessment of risk, usually via a risk tolerance questionnaire. What is important in this process is that the recommended investment solution remains - from initial investment and through duration - aligned to the client’s risk appetite. Hence the recent proliferation of risk graded managed funds and discretionary managed portfolios. These are easily identified as they typically, although not always, carry a number rather than a name.

This market is being established in a post RDR environment so there are very few discretionary fund managers who can boast a five year track record. In seeking to achieve a risk rating from a third party some providers have reversed engineered existing investment products and services. However, advisers recommending this route should be aware that risk ratings have proven inconsistent over time. The investment manager historically may have been more focused upon return which would have led to a variable outcome in risk metrics. If this is the case, in choosing one of these funds, the adviser will in the future consistently need to review for client suitability.

Finally, there is another consideration for the adviser when seeking an appropriate investment solution. Some non-investment management companies offer risk graded strategic asset allocation models. These provide a wide range of outcomes and are usually linked to risk tolerance questionnaires. The temptation to adopt the given strategic asset allocation model is best avoided if outsourcing to a discretionary fund manager. For, in doing so you allow your investment manager full use of all the tools to construct and manage a risk graded fund or portfolio by mapping out the range of outcomes. For any given outcome, there are a number of ways to construct a portfolio.  It would be a mistake to herd all investment managers into the same strategic asset allocation.