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.