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.   

When is a duck not a duck?

26th April 2013

If it looks like a duck, it walks like a duck and it quacks like a duck, then logic suggests it must be a duck.  If you apply this simple test to index funds, it could end up costing you a lot of money. For although most investors believe that these passive investments provide a transparent, low cost return on a stated market index – and it may be so of some early index and exchange traded funds - it is not necessarily true for new generation products.

In a low interest rate environment, the actions of central banks have forced investors to seek higher returns in riskier asset classes. An increasing percentage of this money flow has been captured by passive investments, particularly Exchange Traded Funds, with investors aiming for low cost market returns. According to BlackRock, the providers of iShares, there is US$2.04 trillion invested in ETFs around the world, with US$387 billion invested in Europe. With rapid growth in the last five years, new entrants have been tempted into the ETF market, some focusing initially on price to gain market share and then innovation. However, product development has created increasingly complex ETFs, also a willingness to venture into less liquid markets where trading costs are sometimes less transparent.

Institutional and professional investor demand has led to ETF products being created beyond developed and emerging market indices. Today, there are fixed interest, property, commodity, currency and other alternative ETFs to construct part or all of a multi asset portfolio. Furthermore, actively managed ETF offerings have been introduced.  These are a far cry from the original concept of index less fees. This is a result of the inconclusive debate on active versus passive investment, with many institutional and professional investors preferring a blend of each approach.

New generation ETF products require considerable expertise to understand what exactly is going on under the bonnet. That’s not to say they are not worth looking at, merely that closer examination is required,less so for the traditional ETFs which continue to be refined with more efficient tracking methods and reducing fees. These are market timing investments and treated by many investors as core portfolio holdings. It is these products - designed for active investors seeking to add value from tactical asset allocation, or style and sector rotation - that require more analysis. Typically these investments support a portfolio strategy such as risk reduction, enhanced income or alternative capital growth potential. These specialist strategies can often be cyclical and as such will underperform at points in the investment cycle.

The development of both the ETF and index fund market, particularly with the likes of Vanguard entering the market, is most welcome. However, aside from the traditional index products, there is concern that less sophisticated investors will be attracted to increasingly complex ETFs.  Less transparent products may contain hidden fees and charges. Be warned, when a duck is not a duck, it may be a cuckoo come to spoil a nest egg.  

Time Flies

28th March 2013

I am penning this as I sit on a train travelling from London to Manchester.  The guard has just confirmed my journey time - two hours and eight minutes. If the Government succeeds with its plan for a new high speed rail link, HS2, then in twenty years time my journey will be reduced by an hour. Although the exact route has not yet been decided, the proposal is to build from London to Birmingham, and then in phase two, on to Manchester and Leeds. No matter how controversial, ministers are keen to support a project that potentially both improves the transport network and boosts the economy.

And right now, with the UK close to a triple dip recession, a boost to the UK economy would certainly be most welcome. Last week during his Budget speech, the Chancellor was forced to halve his economic growth forecast for this year. Four months ago he had predicted 1.2% growth in his Autumn Statement. The UK’s real economy remains below pre-crisis levels, noticeable amongst other major economic peers. There seems very little chance of a controversial scheme such as HS2 contributing much to the nation's GDP in the near future. Therefore the Government and the Chancellor are still left looking for other more tangible routes to foster growth.

The Government's latest ideas for growth were outlined in the Budget, although it was a vain hope that Plan A would be scrapped. The underlying path of fiscal tightening has been left untouched and ahead of the arrival of its new Governor, the Bank of England has been given a little more flexibility to carry further unconventional monetary policy. This is the primary lever for growth along with some increase in infrastructure spend and policy to accelerate the housing market. The downgrading by Moody's last month confirmed that fiscal austerity rather than stimulus is the order of the day - although in real terms, public spending has actually risen, particularly in healthcare and education. Indeed, the public sector has made a positive contribution to economic growth over the term of this Government.

Overall the Budget was seen as neutral, no budging from Plan A which is still reliant upon a recovery in the private sector - a private sector which continues to be mired in its own tough austerity, squeezed by a lack of credit, higher inflation and tax rises. Fixing the banks has taken longer than expected, whilst the nation's living standards have fallen as a result of a substantial devaluation of sterling with successive rounds of Quantitative Easing. QE has helped the Government to fund its borrowing at very low interest rates, but has also hit the spending power of savers and increased the deficit of private sector pensions. So no surprise that the Budget giveaways were aimed at the private sector - raising the minimum income tax threshold, scrapping petrol tax rises, helping people buy homes and cutting corporation tax. Time flies and we are more than half way through this parliament with the Government still searching for growth.

A tin of beans

22^nd March 2013

This blog was published in Portfolio Adviser on 25^th March 2013 http://www.portfolio-adviser.com/comment---analysis/bens-ketchup-and-fizzy-drinks-husselbee

Old Mother Hubbard's kitchen cupboard was bare, but most people can dig out a can of soup, a tin of beans and a bottle of Tommy K. These essentials were surely part of the attraction to Warren Buffett in swallowing up last month the biggest deal of his career - a US$28 billion takeover of HJ Heinz. His investment company, Berkshire Hathaway, partnered with 3G, the Brazilian private equity firm, to notch up the largest takeover in the food industry to date.

With a strong record of growth and cash generation, HJ Heinz looks a typical Buffett purchase. He likes brands and has long admired consumer goods companies, being famed for his large stake in Coca-Cola. However, as a well-known value investor paying a premium for soup, beans and ketchup  falls short of his customary investment approach. When we review fund managers for inclusion in our client portfolios we look for a robust investment process which makes sense and is consistently applied by an experienced team or individual. If Berkshire Hathaway was a holding in our portfolios, this acquisition would trigger a review - no matter that Warren Buffett is the world's most lauded investor with a long, successful public track record.

In his recent annual letter to Berkshire Hathaway shareholders, (a must read for all investors), Mr Buffett criticised his subpar performance relative to the firm’s S&P 500 Index benchmark in 2012. He firmly believes his company’s intrinsic value approach will outperform the benchmark for shareholders in future.  After all, they could always turn to a low cost tracker.  Yet, I find it hard to believe that his shareholders will be selling. This is only the ninth time in 48 years that Berkshire Hathaway (+14.4%) has failed to outperform the S&P 500 (+16%) in the calendar year. However, he did express concern for the potential loss of its five year rolling track record of market outperformance.

The letter explained that Berkshire Hathaway's relative performance did better when "the wind is in our face." He also told shareholders of his disappointment in failing to make a major acquisition in the year -  "I pursued a couple of elephants, but came up empty handed." That's not to say there was no reinvestment in Berkshire Hathaway investments, they spent a record U$9.8bn on plant and equipment. Buffett berates CEO's for blaming 'uncertainty' for their lack of capital expenditure.

The recent acquisition of HJ Heinz is his latest ‘elephant’, but despite his 82 years he has promised that he still has the appetite to bag some more. We meet many fund managers who adopt the Warren Buffett approach - scarcely surprising bearing in mind his 48 year track record which has compounded annually at 19.7%. His outlook is suited to investors with similar patience.  Short term speculators need to look elsewhere.  I have no doubt that many more fund managers would like to assume Buffet’s investment approach, but the short term quest for performance rules this out. To be the best performing fund in a falling market is a bittersweet marketing accolade.

All good things come to an end....... slowly

28th February 2013

 

Low interest rates in the UK, driven by successive rounds of quantitative easing, may have helped the Government to finance its borrowings, but they have been no good for savers.  In their search for greater yield, they have turned to the fixed interest markets. With government stocks offering little more than cash deposits, corporate and high yield bond funds have successfully attracted significant amounts of new money. Yet, whilst these do offer a much higher yield than cash deposits, they also represent a much riskier investment proposition.

Much has been written about the so called "Great Rotation".   With bond yields at such historic lows the case for switching into cheaper assets has grown compelling. The merit of buying low and selling high is indisputable. However, as we have witnessed in the Eurozone, whilst bond yields can move at lightning speed, it is not in the interests of the Government for yields to rise sharply anytime soon. Indeed, in the MPC minutes released last week, three members, including the Governor, called for more quantitative easing and one for an open ended facility such has been adopted by the Federal Reserve. Further gilt purchases would obviously keep a lid on yields.

The market is now expecting the resumption of more extraordinary measures, not on the grounds of fighting deflation but to support growth and employment. The cost to date has been increasing inflation, with a weak pound pushing up prices and leading to a reduction in living standards. Economic growth has proved elusive with the private sector preferring to pay down debt rather than spend. Indeed, high and rising equity dividends are partly a response to diminishing confidence in their future prospects. We must see the headlines in the business sections shift their focus from dividends to news of mergers and acquisitions before we have proof of a genuine return of confidence in future economic growth.

Investors who buy fixed interest securities now should be looking for income and diversification rather than capital growth. The 'Great Rotation' should not be dismissed, but of greater concern is how to mitigate risk when the buying declines rather than the panic-selling begins. Some investors will look at alternative defensive assets but others, like pension funds, need to invest in bonds. For retail investors the additional risk techniques offered by strategic bond funds may offer a solution. These managers can construct well-diversified bond portfolios as well as wield the ability to hedge out interest rate risk. Bond or credit selection as well as hedging will be critical for these funds. To include currencies in the equation, there is a wide and deep universe to achieve positive returns.

After such a good run in this asset class, there may be some retail investors attracted into bond funds for further capital gains, but this is never a reason to hold a bond fund in a diversified portfolio.  There is a very real danger that this lesson is about to be learnt the hard way.

The Giant X Factor

22nd February 2013

 

This blog was first published in Portfolio Adviser on 22nd February 2013, the link  http://www.portfolio-adviser.com/comment---analysis/rise-of-real-assets-as-fund-giants

 

It may come as a surprise to some fund buyers to learn that Standard Life’s Global Absolute Return Strategies Fund, at £14.4bn, currently stands as the UK’s largest retail investment fund. What is astonishing is that five years ago this giant didn’t even exist.

In those days Invesco Perpetual High Income (£9.5bn) was the largest. Indeed, the manager, Neil Woodford was also responsible for the second largest fund, Invesco Perpetual Income (£6.7bn), heading up a ‘top ten’ dominated by UK equity income funds, including Jupiter Income (£4.0bn) and Newton Higher Income (£3.4bn). UK equity funds were well represented with Legal & General UK Index (£4.5bn) and M&G Recovery (£3.0bn) also ranking. Europe, Balanced, Global and Specialist funds completed the list - Fidelity’s European Fund (£4.8bn) coming in third and M&G matching Invesco Perpetual with two funds in the 2007 ‘top ten giants’.

Flash forward to today and only four funds from 2007 remain - Invesco’s two income funds, M&G Recovery and BlackRock’s balanced fund, Consensus 85.  New entrants include Scottish Widows’ UK tracker, which replaces Legal & General, as well as an Asian, two absolute return and two bond funds.

This shift in orientation reflects investors’ changing appetite for risk following the global financial crisis of late 2008. First State Asian Pacific Leaders (£6.6bn) has attracted investors looking to participate in the growth of the progressive economies of the Far East. Seeking absolute return through investing in quality has proven a winning formula for drawing in new inflow for the manager.

Newton Real Return Fund (£7.1bn) has also been a success as investors have prioritised capital preservation over growth. M&G’s two bond funds, Optimal Income (£11.2bn) and Corporate Bond (£6.4bn), both managed by Richard Woolnough make up the ‘ten’. The fund flows into the IMA’s fixed interest sectors are well documented.  In an environment of low interest rates unsurprisingly, investors have been chasing yield. Gilt yields fell to record lows last year, with fund buyers preferring corporate to government debt. M&G’s Optimal Income Fund, launched six years ago has been a major beneficiary. This is a strategic bond fund where the manager looks to maximise returns in a diversified bond portfolio.

Absolute Return funds have also been a magnet for much retail investment - not those pursuing the strategies associated more commonly with hedge funds, but diversified multi asset funds prepared to invest in both traditional and alternative asset classes.

Is there a way to predict the giants of 2017?  Let’s consider the trends. The growing economic independence of the East will lead to the accumulation of more Asian and Emerging Market assets.  However, domestic equity, therefore UK funds, long the cornerstone of portfolio construction, will remain in contention. RDR favours outsourcing, so arguably more managed funds may rise to the top, whilst absolute return funds could become less attractive as we enter a new secular equity bull market. As for bond funds, that depends on the future path of interest rates - and if inflation rises, real assets will become the asset class of choice.

Who wants to be a Millionaire?

25^th January 2013

This blog was first published in Portfolio Adviser on 29^th January 2013 and can be found via the following link:

http://www.portfolio-adviser.com/comment---analysis/credence-end-of-year-ftse-predictions-january-(1)

"Prediction is very difficult, especially about the future" is attributed to the Nobel Prize winning Danish physicist, Niels Bohr. However predictions are frequently expected in the fund management industry. At this time of the year, to be asked where the ‘Footsie’ will close at the year end is a fairly typical investor request. “Frankly, I haven’t a clue!" is probably not acceptable as no view tends to be seen as a sign of weakness. Some fund managers may excuse themselves on the grounds of being stock pickers with little interest in the day to day fluctuations of broad market indices however, most will be expected to answer, no matter how wrong it turns out.

Should you find yourself in this situation here’s an approach that may help. Imagine you are a contestant on the popular TV game show "Who wants to be a Millionaire?" You are well on your way to the big prize when Chris Tarrant asks you what the closing level of ‘Footsie’ will be this year. There are four possible answers. As you scratch your head, deep in thought, you are reminded that you have all three lifelines left - 50/50, phone a friend or ask the audience.

Taking the 50/50 lifeline would be to state the direction but not the closing level of the market. The prospects for a further move upwards in the equity markets look encouraging for this year, supported by a gradually improving global environment as the easing monetary cycle persists. New political regimes in China and Japan, the second and third largest global economies, have promised further stimuli and renewed economic growth.  Even the Eurozone appears to be stabilising, evidenced by peripheral government yields falling dramatically since last summer. Long term challenges remain, but markets can make progress in 2013.

Then phone a friend, quote the opinion of one of your favoured market commentators. For example, Mark Tinkler at Axa Framlington writes a regular strategy piece known as Market Thinking. He has forecast a high single figure return for equities this year, driven mainly by earnings growth with the slight possibility of a multiple re-rating. He also acknowledged that returns could be greater after the perceived reduction in risk over the last six months.

Then perhaps the game show’s most popular and indeed most successful lifeline – ask the audience. In his book, “Wisdom of the crowds,” James Surowiecki wrote on the theory that the many are smarter than the few, highlighting the predictive powers of polls under the right conditions. The annual fund manager poll carried out by the Association of Investment Companies (AIC) last year found that 71% felt that markets would be positive in 2012 and 50% predicted the FTSE 100 would close above 5,500. The many were correct last year, so what is the majority forecasting according to the AIC's November 2012 poll? The answer: 87% of fund managers expect the market to rise, whilst 76% expect the closing level of FTSE to be above 6,000.

Us and them

3rd December 2012

RDR is fast approaching and with it the hope of a new dawn for the closed ended fund sector. The removal of adviser commission will 'level the playing field' with open ended funds, say many industry commentators. Over the years there have initiatives to encourage advisers to engage more with closed end funds. Most have failed. Despite lower fees and charges, the complexity of the structure and the additional time and effort required to understand discounts, gearing and liquidity have represented barriers to advisers. There is a common belief that these characteristics create extra layers of risk, often without tangible benefit. However, the key differentiator has been the growth of platforms and many platforms have offered limited access and availability to invest in closed ended funds.

The Association of Investment Companies (AIC), the industry body representing closed ended funds should be praised for its continuing efforts to educate advisers. It has also been lobbying platforms to provide wider access to their members’ funds. However, this is a gradual process and one that requires ongoing support from fund managers and their investment trust boards. Boards need to recognise that RDR will continue to change the attitude and requirements of their shareholders in demanding simpler structures, improved transparency and in some cases greater governance. That will mean more frequent communication with shareholders and greater retail fund management experience on the boards.

It seems that the closed ended versus open ended debate is growing in similar fashion to active versus passive management. The battle ground for both ‘us and them’ debates is long term performance and fund charges. Managers and analysts regularly publish data showing the outperformance of closed ended fund over ten year periods, with lower fees and the ability to benefit from gearing and discounts. Whether measuring returns in this way is a fair comparison is doubtful, particularly when open ended fund sectors are much larger and more diverse. The fee advantage has also been eroding with the availability of institutional charging on platforms and RDR will continue to drive down the price of open ended funds. Interestingly, active managers take long term performance to market their superiority whereas passive funds demonstrate their clear cost advantage.

The renaissance of closed ended funds will not come directly from advisers but from discretionary fund managers to whom they have outsourced their investment activity. To discretionary fund managers wanting to access as many asset classes as possible to achieve the best results for their clients, the debates on closed ended versus open ended, active versus passive are nonsense. They prefer to construct multi asset, multi manager portfolios using a range of fund structures side by side. An asset allocation decision is implemented by determining the best choice of either direct equity or bonds, open ended funds, closed end funds, structured products, derivatives or ETFs. So less talk of levelling playing fields! Discretionary managers are familiar with the sector and most importantly have the time and resources to dedicate to search for opportunities.

Rocking with Status Quo

21^st November 2012

The US election result maintained the political status quo, with Obama in the White House and the majority in the Senate, but the House of Representatives remaining in the hands of the Republicans.  It was the expected outcome but markets rocked to the pessimism of deadlock fears over the so-called Fiscal Cliff.  This highlights the main issue for us, in that market and political timing are rarely aligned.

Western economies need much reform over the coming years and whilst much of this is already taking place, change, which often requires new legislation and constitutional amendment, inevitably takes time to implement.  As investment managers with a broad client discretionary agreement, we are free to make changes whenever necessary.  This is not the case for our global, democratic leaders and policy makers. That is not to say that they cannot act swiftly in response to a major crisis - the G20 proved that in early 2009.

Indeed, at a recent presentation at the London School of Economics, Dr Gerard Lyons, Chief Economist at Standard Chartered Bank, praised the efforts of our former Prime Minister, Gordon Brown, and other global leaders in co-ordinating the initial response to an economy sliding deeper and deeper into recession. This period he referred to as 'SSS,' - Sizeable, Synchronised and Successful - in propelling the global economy into a recovery. This global, synchronised policy lasted until the first Greek bailout in 2010. Thereafter, policy changed tack, 'TTT' Dr Lyons cited – Tiny, in scale compared to the previous stimulus, Targeted, rather than synchronised and Temporary, which has created the so called "risk on, risk off" rallies.

We have now entered the latest stage of policy, Dr Lyons argued.  After SSS and TTT, now comes 'UUU.'  In this case the first U is Unlimited, commencing with ECB's President, Mario Draghi stating his readiness this summer to do whatever it takes to defend the Euro and then the US Federal Reserve announcing unlimited money printing until unemployment falls to an acceptable level. Unclear is the next U, a reference to the law of diminishing returns which has seen the impact of recent monetary policies last for shorter and shorter periods. And finally, the Unknown consequences of the many hundreds of central bank initiatives that have been introduced around the globe since the credit crisis of late 2008. The obvious consequence is inflation if central banks are unsuccessful in removing policy and extracting liquidity without disruption to the economic environment.

Inflation though is clearly not the main concern for markets today.  A global recession next year is more immediate. Sentiment and confidence have deteriorated post the re-election of Obama, despite the all-in approach of global central banks.  We believe a repeat of the dysfunctional US debt ceiling debate will be avoided and a compromise will be reached on the Fiscal Cliff.  In addition, the Eurozone debt crisis and economic growth in China will continue to rock n' roll but gradual improvements will allow investors to commit more to equities.

A Nightmare on Wall Street

26^th October 2012

This blog was first published in Portfolio Adviser on 26^th October 2012 and can be found following the link:

 

http://www.portfolio-adviser.com/economics/nightmare-on-wall-street

Halloween is just a few days from now and investors remain spooked by fears of a deceleration in global economic growth. From West to East, central banks are scared too and have recently sanctioned further monetary stimulus, together for the first time since 2009. Mario Draghi, president of ECB, launched a scheme he called Outright Market Transactions (OMT), a facility which will allow the ECB to purchase a potentially unlimited amount of sovereign bonds of any member nation that requests aid. The prospect of this action has already been instrumental in driving down the short and medium term borrowing costs. The next step will require member nations officially to request aid.  In the case of Spain the government is frightened of forcing further austerity on an already distressed population with terror in its eyes.

 

The horror of high unemployment in the US has resulted in the Fed unleashing further quantitative easing. However, in a marked deviation from previous rounds of QE, this will be open-ended and not constrained in size. Initially, the Fed plans to buy $40bn of Mortgage Backed Securities (MBS) each month. The focus on Agency Backed MBS (government backed) as opposed to Treasuries is designed to reduce further the cost of mortgages and help stimulate the haunted housing market. The re-financing of existing mortgages at lower rates should also help free up disposable income, with the hope that consumers then proceed to spend.

Elsewhere other central banks, including those in the UK and Japan, have treated their economies to further money printing whilst Asian economies are cutting interest rates. This is a trick which has been played many times since the beginning of the global financial crisis, one that historically has been beneficial to both equity and credit markets. Indeed it is difficult to see that current market levels would be sustained without such support. How much higher we go from here is questionable.

Housing data in the US remains encouraging, whilst manufacturing surveys appear to have at least stabilised. The latest quarterly company results show earnings remaining solid but the all important revenue growth lagging expectations. It seems that companies lack confidence, preferring share buybacks to reinvestment, seeing the future as dominated in the short term by the US ‘fiscal cliff,’ which may yet prove to be the issue that dips the economy into recession.

The fireworks will begin on 6^th November, the day of the US Presidential Election. Current polls suggest that Obama will achieve a second term in the White House but that Congress will be Republican. If this occurs then we can probably expect a repeat of the thriller of last year’s debt ceiling debate, when a deal was reached close to midnight after much political brinksmanship. The Fed has gone further with monetary policy than any commentator would have dreamt. Its objective is to remove the lurking fear of uncertainty and restore confidence to support the politicians in fostering economic growth. A nightmare on Wall Street is that the fiscal cliff becomes a reality.