From an investment point of view 2018 has really been an annus horribilis.  Therefore, for those of you whose portfolios are lower in value when compared with 31^stDecember 2017 you are in good company.  For those whose portfolios are higher you are also in good company!

The figures speak for themselves:

 

Equities
Region	Index	Gain/loss
UK	FTSE 100	-11.69%
US	S&P 500	-6.99%
Europe	FTSE Eurofirst 300	-13.49%
Japan	Nikkei 225	-12.64%
Asia ex Japan	MSCI Asia ex Japan	-14.02%
Emerging markets	MSCI Emerging markets	-16.90%
China	China Shanghai Composite	-23.87%
Fixed Income
		% change	31-Dec-17	31-Dec-18
UK	10yr Gilt	-3.61%	1.1910%	1.1480%
US	10yr Treasury	10.57%	2.4600%	2.7200%
Currencies
		% change	31-Dec-17	31-Dec-18
£/USD		-5.29%	1.3503	1.2789
£/€		-0.61%	1.1253	1.1185

 

I have picked these three asset classes as I believe they are the most important and their interaction is what has affected markets over the course of 2018.

Fixed income.

As I have stated in discussions on an individual basis with clients the most important influence on markets in 2018 has been interest rates.  In the US there have been interest rate rises in short term rates but more importantly we have seen large movements in the price and yield of the US 10yr Treasury bond.  This and the 10yr Gilt are benchmark bonds which give the best indication of where interest rates are headed.  Although the US 10yr Treasury rate today is 10.57% above the rate at the end of 2017 it is some way below the highs of October and November of 3.2%.  [Remember that a rise in interest rates means a fall in bond prices which means a reduction in the value of bonds/bond funds in portfolio.] The growth in the US economy is probably exhausted and we may well begin to see a recession or at least a slowdown in the economy.  The yield curve is beginning to invert which means that short term rates are higher than longer term rates.  Normally longer-term rates are higher than short-term rates.  A fall in interest rates is a consequence of slowing growth in the economy.  There is a similar phenomenon going on in the UK as 10yr Gilt yields have fallen by 3.61% over the past year.  The case of the UK is somewhat different as there is a reduction in economic activity fuelled by the uncertainty surrounding Brexit.  Businesses are not at all sure as to what they should be doing as they have no idea what the outcome of the Government’s negotiations are going to be.  The consumer also seems reluctant to spend money.  Household savings ratios have increased which will lead to recession as money is taken out of the system and not invested.  This spending reticence is reflected in the problems in the retail sector with various well-known chains going into administration.  Property prices have fallen as a result of the rise in interest rates.  Most areas of economic activity have been adversely affected by the higher interest rates.

Equities

The fall in the main stock market indices can be put down to a series of factors.  We have had a 9-year bull market and a reversal was due.  The S&P 500 hit its highest point in September but has declined ever since and is down 6.99% for the year.   Many other stock markets take their lead from the US.  The rise in long term interest rates, especially the US$ in which much of the world’s debt is denominated, has reduced share prices because of the likely effect on company profits from the rise in interest expense.  Quantative easing has been withdrawn and so the cheap money that acted as a stimulant to the stock markets is no longer available. In the UK as a result of the Brexit uncertainty many have sold their equities and are holding cash waiting for opportunities when the market is lower to buy in again.  The UK’s main index, the FTSE, is down 11.69% for the year.

Currencies

As this is written from the perspective of the UK investor our interest is the value of sterling versus particularly the US Dollar and the Euro.  The EU is our biggest export market and so the strength or weakness of sterling is critical in terms of the value of our goods in the local currency i.e. the Euro.  The lack of change in sterling’s value versus the Euro is due in large measure to the poor state of most of the European economies.   The US$ has strengthened against sterling because of the growth in the American economy. From an economic point of view sterling weakness is a good thing for exports but bad for imports, making manufacturing goods with foreign raw materials or parts expensive and consequently reducing profits.  However, from a UK investor’s point of view weak sterling is a good thing as any investment in foreign markets is enhanced by a fall in sterling’s value vis-à-vis the currency of the investment.   From this you can see that a well-diversified portfolio including currency diversification, which every investor should have, is beneficial.

What then is the outlook for 2019 and what should one do, if anything?

Until the Brexit issue is resolved the UK stock market is likely to be in a state of flux.  Once there is clarity on this, it will settle down and there will be less volatility.  It is unlikely that interest rates will rise given the weak condition of the economy. Investors will probably return to the equity markets but cautiously.  If dividend yields stay at their current high levels of about 4% for most FTSE 100 companies (over 30% have a yield in excess of 5%) then people will be happy putting their money into the stock market for the yield with less concern for the risk. As far as the US equity market is concerned, many commentators believe that the S&P 500 will not rise above 3000 (currently 2506).  Thus, no great gains there and other equity markets will probably follow.  Unknowns are the following: in the US the trade war with China and in Europe the Italian debt problem.  Neither issue helps their respective market.

 

Investing for the long term is critical.  It is not a good idea for the retail investor to be trying to outwit the market.  He almost always fails because by the time he decides what to do the rest of the market has done it.  It is a case therefore of finding good fund managers who have a long-term view, do thorough research and are prepared to stick with their allocations.  It has been shown consistently that this modus operandi produces the best results.

 

RF

Following on from last month’s post about investment funds (open-end-vs-closed-end-funds), you should now be armed with the knowledge you need to understand what we mean by an open-end (OEF) and a closed-end fund (CEF). So, where you do you go from here? You have some money to invest and want to put it into stocks and shares – how do you decide what’s best for you and your money?

The most logical way to invest in stocks and shares is via an OEF or a CEF as either one will give you the greatest diversification across a variety of assets. Imagine you wish to invest in the UK stock market. You could choose and buy the shares yourself, or you could invest in a CEF or OEF that specialises in UK shares, in which case you will have a professional watching the market all the time and managing the shares in the fund for you. If you wish to diversify further, you invest in a number of funds specialising in other geographical areas or sectors, such as fixed income, commodities, smaller companies or property. You can therefore have a well-diversified portfolio of funds. So, which type of fund do you choose?

Open-end funds

• Advantages
  • You can buy them directly from the fund manager rather than being obliged to have an account with a stockbroker as you do with a CEF.
  • As pricing takes place only once a day there is less volatility in their price than with a CEF.
• Disadvantages
  • On the flip side, because pricing is only carried out once a day the investor does not know exactly at what price he is buying or selling.
  • The annual management fee is normally clear but there are often ‘on-going fund charges’ that are simply added as a percentage and you are rarely told what they are upfront.
  • In certain markets, e.g. property and emerging markets, the underlying shares may go through periods of illiquidity and it is not easy to sell them or consequently the fund itself.

Closed-end funds

• Advantages
  • They benefit from all-day pricing during market hours as the funds are quoted on the London Stock Exchange.
  • OEFs distribute all their income on an annual basis whereas CEFs can keep 15% of their income in a revenue reserve in order to be able to pay dividends during less good times.
  • Over the long haul – say on a 5–10 year basis – performance from CEFs is superior to OEFs. Fund managers are able to take a longer-term view as there is a constant level of cash and the manager does not have to sell investments in order to meet customer sales.
  • Performance is enhanced by gearing, i.e. borrowing to invest in more of the underlying investments assuming the share prices rise. (This can also be a disadvantage as explained below.)
  • Shareholders in CEFs can also benefit from an undervaluation of the shares when the price of the share is at a discount to the ‘net asset value’ (NAV) per share. If the discount narrows and the underlying value of the shares rises, the investor makes an additional gain.
• Disadvantages
  • There is greater volatility of price movement, most likely due to their quotation on the stock market and market pricing based on supply and demand.
  • The effect of gearing on the portfolio: just as profits can be enhanced if prices rise, so losses can be increased if prices fall. There is no doubt that gearing has to be used judiciously.

Which is better – an OEF or a CEF? Sadly, there is no definitive answer to this question and ultimately the choice is down to the investor and their views on the above conditions. However, as a general rule, where there is likely to be reduced liquidity in a particular sector’s shares, then it is best to opt for a CEF. Typical sectors would be property, emerging markets and smaller companies. Otherwise, in the case of liquid company shares (such as the FTSE 100) it simply comes down to the investor’s preferences.

Archiemidas
This article is not to be construed as financial advice. The views expressed above are those of the writer and do not constitute a recommendation to purchase, hold or sell. It must be borne in mind that the value of investments and any income will fluctuate. The value of your investment can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future returns.

In the tax year 2017–2018 the ISA allowance has been increased to £20,000 so it is likely that both new and established investors will think about investing in funds. As the title of this post suggests, there are two different types of fund, though I should clarify that the terms above are those used in the USA, rather than in the UK, as I believe these make a clearer distinction of the difference between them.

In the UK we use the terms ‘Unit Trust funds’ or ‘Open-ended Investment Companies’ to refer to open-end funds, and ‘Investment Trusts’ to refer to closed-end.

An open-end fund (OEF) has no restrictions on the number of shares that can be issued –every time a new investor or returning investor wants to invest in the fund new shares are issued. The pricing of an OEF takes place once a day and the price is based on the net asset value of the shares, which is calculated as follows:

Total fund assets less liabilities divided by the number of shares issued less any costs.

When shares are sold by an investor they are taken out of circulation. It is up to the investment manager when they feel that the amount of money invested in the fund is sufficient or the fund is becoming too large; they just stop further investment by closing it to new investors and even, in extreme cases, to existing investors.

A closed-end fund (CEF) has a different legal structure to an OEF. It is a public limited company quoted on the London Stock Exchange. It makes an initial public offering of shares to which investors subscribe and a fixed number of shares are issued. These shares are traded on the stock exchange like any other public company. The investment manager makes his decisions about the investments secure in the knowledge that the total fund is available at all times and is not likely to change on a daily basis. The price of the fund on the exchange fluctuates according to supply and demand for the shares, which is in turn a reflection of the demand for the underlying investments. The price of the shares will vary during market trading hours and may be at a premium or a discount to their net asset value depending on demand for the shares.

The similarities between the funds are that they are both run by investment managers who are backed up by a team of analysts; they both pay dividends and charge a management fee; and they both offer diversification within a given sector of the investment market.

The above is a very brief introduction to the topic to give you a bit of background to the funds themselves; I will be covering the reasons to invest in each in greater detail in my next post and outline their advantages and disadvantages. When is it better to use a CEF in preference to an OEF, for example? Which have better performance when comparing an OEF and a CEF, both invested in Europe? All will be revealed in a couple of weeks’ time.

 

Archiemidas
This article is not to be construed as financial advice. The views expressed above are those of the writer and do not constitute a recommendation to purchase, hold or sell. It must be borne in mind that the value of investments and any income will fluctuate. The value of your investment can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future returns.

This week’s post was initially going to tackle the somewhat intriguingly named subject of ‘helicopter money’ but as my editor struggled to understand even the first paragraph, let’s instead look at something a little less challenging, but above all very relevant to you as an investor: fund charges. By this I am referring to the charges levied by fund managers. They are a minefield and have provoked considerable comment in the press because we do not know nor are we told what exactly is included in the ‘charges’.

As a minimum you would expect that the buying and selling costs of the investments plus stamp duty would be included, as well as the fees associated with holding the securities in safe custody and the charge for the management (in effect, payment to the individual fund manager(s) for their skill). However, you then have questions such as the marketing costs of the fund, the legal costs, the accountancy costs of auditing, and external research and the problem is that different funds have different ways of dealing with these costs and there is therefore no consistency across the fund management industry. This in turn means that as an investor it is difficult to compare funds from a cost point of view.

Funds will generally quote a Management Charge (AMC) and an Ongoing Charges Figure (OCF), sometimes referred to as the Total Expense Ratio (TER). The AMC is just the charge for the management of the fund payable to the fund manager. The OCF includes a lot more charges but not necessarily all the associated costs. The Financial Express Trustnet website defines OCF as ‘expenses which include payments to the manager, the trustee, the custodian and their representatives. The figure also includes registration, regulatory, audit and legal fees, and the costs of distribution. The OCF is calculated by taking the sum of these expenses incurred in the last 12 months and dividing this by the average net assets of that class for the last 12 months. Performance fees, transaction costs, interest on borrowing, costs associated with derivatives, entry and exit fees and soft commissions are not included in the OCF calculation, and should be factored in separately by the investor.’ These latter fees are not easily obtainable, if at all, and so it is very difficult for the investor to calculate them – hence all the furore.

Some funds will quote a Management Charge (AMC) of 0.75% p.a. and an Ongoing Charges Figure (OCF) of 1.36% p.a., while at the other end of the scale a fund could have a management charge of 0.75% and an OCF of 0.89%p.a. Why is the OCF so low on the latter? Without having it spelt out it is extremely difficult to know. The other extreme examples of fund charges are Exchange Traded Funds (ETFs) and index tracker funds which, given that they are not actively managed, attract lower OCFs. These range from an OCF of 0.40% down to 0.07% – the low charge being part of the attraction of ETFs or trackers.

For you as an investor, it is important to consider fees because of their effects on performance. Let us compare two funds of £100,000 with average annual returns of 7% p.a. but one with an AMC of 0.5% and the other with an AMC of 1.0% p.a. These are the valuations of the investment after the following periods:

Effect of charges on £100,000 portfolio over different time periods.
Investment	£100,000.00
Rate of return	7.00%	before AMC not including other charges
Time period		5yrs	10yrs	20yrs	30yrs
Valuation of investment after deducting AMC	0.5% AMC	£137,008.67	£187,713.75	£352,364.51	£661,436.62
	1.0% AMC	£133,822.56	£179,084.77	£320,713.55	£574,349.12
Difference		£3,186.11	£8,628.98	£31,650.96	£87,087.50

 

You can see that the effect is significant. A difference of £8,628 after 10 years is a lot of money. Consider that in the case of a pension fund, where one could easily be invested for 30 years, and you are looking at a difference of £87,000. Although the difference is significant, one should not become too obsessed about charges and automatically go for the lowest charging funds; this table shows the effect that charges have, other things being equal. As I have discussed in a previous post, there are other issues to take into account when seeking a ‘good’ fund. Charges can, as the above table shows, have an important impact on the value of your investment pot, but when choosing your fund they need to be considered alongside other factors, such as historical performance, experience of the fund manager, investment choices (especially shares) and volatility.

Archiemidas
This article is not to be construed as financial advice. The views expressed above are those of the writer alone and do not constitute a recommendation to purchase, hold or sell. It must be borne in mind that the value of investments and any income will fluctuate. The value of your Investment can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future returns.

 

As a reader of this blog, you have invested or are intending to invest available cash, or to switch investments. Unless you are familiar with the different types of investments and ways of investing, I imagine you will have wondered how financial advisers arrive at their decision to recommend a particular fund or group of funds and what criteria they take into account.

Asset allocation/risk

Before any discussion regarding an investment can take place an IFA assesses your attitude to risk. Once this is established it is then possible to carry out the asset allocation appropriate to that attitude. It is a question of determining the proportions of the different asset classes within the portfolio i.e. the percentage of shares, fixed income, property, cash etc. This is known as the asset allocation process and is critical in any form of portfolio management whether it is an institutional pension fund or an individual ISA.

Fund performance

We are constantly being told that past performance is not a guide to the future. This is true, however the figures have to be analysed. If the fund is consistently in the top quartile over a number of years in different economic environments, there are reasonable grounds for assuming that this will continue into the future. The performance should in any case be monitored on a 6 monthly basis.

Age of the fund

The longer the fund has been going with consistently good performance, the better.

Fund manager

How long has s/he been running the fund? What has his/her performance been like in comparison to his/her peers? Has s/he always been running funds similar to the current one?

Foreign exchange (FX) exposure

This can be critical. If, for example, a third of a fund’s investments are denominated in a currency other than sterling (the currency of reference for a UK investor) and sterling weakens against other currencies, the performance of the fund will improve. If sterling strengthens, then logically the value of the fund will decrease.

Industry concentrations

This is what we pay portfolio managers for and where they have to make decisions. For example, recently funds that have stayed clear of banks have had better returns; a concentration in mining stocks would have contributed to an out-performance of a fund. Success is determined by the right concentrations at the right time.

The above list is not exhaustive but will hopefully provide an introduction to your understanding of the factors that need to be taken into account when evaluating funds for inclusion in a client’s portfolio. It may also assist you in asking the right questions of your adviser.

Whoops! I fear I may be talking myself out of a job…!

 

Archiemidas

 

 

This article is not to be construed as financial advice. The views expressed above are those of the writer alone and do not constitute a recommendation to purchase, hold or sell. It must be borne in mind that the value of investments and any income will fluctuate. The value of your Investment can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future returns.

In investment terms, what does risk mean? Why is it a concern to financial advisers? And how can they assess their clients’ attitude to risk?

One way to consider attitude to risk is by examining the different types of investment that are regarded as high risk. For the purposes of this post, this is looked at from the point of view of a UK investor who is using sterling as his currency of reference, i.e. he automatically converts any foreign currency back to sterling. Some examples of higher risk assets are:

• Equities/shares
• Long-term fixed income bonds (defined as bonds with more than 10 years to maturity)
• Foreign currency cash

Their common feature is their volatility. Volatility means frequency of movement and range of movement up or down. All is well when the movement is upward but of course that is not always the case.

• We know that shares are volatile and that stock market indices can fluctuate widely – we have only to look at the steep falls in the market in 2009 and 2015 to have this confirmed.
• Bonds are regarded as safe instruments but the longer the maturity, the higher the risk. Bond yields are quoted on the basis of interest rates today; but who knows what will happen in 10 or 15 years when they mature? There is also a leveraging effect on the price of a bond: the longer the maturity the greater the change in yield as a result of any price movement.
• Cash is normally a no-risk investment but not if you are in a foreign currency. With this you are exposed to the movements of the currency against sterling; if sterling strengthens against it your cash is worth less in sterling terms and vice versa. Currencies are traded 24 hours a day all around the world so their volatility is notorious.

Shares, bonds and cash are long-term ventures and one has to accept that volatility is an inevitable side-effect to investing in them. An investor must have demonstrated an ease with potential risk if an adviser is to advise opting for these.

To assess a person’s attitude to risk a financial adviser needs to determine how well an investor reacts to downward movements in their portfolio. Can they handle it? Will they be able take the view that the decline is temporary and that things will recover? The risk profile questionnaires all investors are required to complete before being able to receive advice from an IFA are essentially designed to assess their attitude to volatility and consequently ensure they sleep comfortably at night. When the market is going up, all investors are bullish and think it will carry on forever; more important is how they react when that market starts to fall.

From my experience asking a client how he would feel if his portfolio dropped 10% in value is a clear indicator of his risk tolerance. If he is reasonably sanguine and understands that it is simply part of investing, you have a higher risk investor. If he says that he would not be able to tolerate that fall, then you have an indication that he is a conservative investor regardless of what he may think or proclaim.

So what is the significance of risk and why is it important for you? As an investor, you need to be conscious of your own risk profile and therefore your ability to deal with volatility. Your attitude to risk will determine the products your adviser offers you and above all it will condition your choice of investment.

 

Archiemidas

This article is not to be construed as financial advice. The views expressed above are those of the writer alone and do not constitute a recommendation to purchase, hold or sell. It must be borne in mind that the value of investments and any income will fluctuate.  The value of your Investment can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future returns.

You, like me, have probably had enough of reports on the likely negative consequences of Brexit.  However, there are reasons to feel positive. Mr Osborne had warned that there would need to be an emergency budget; the UK economy would shrink; pensioners would suffer; the UK debt would be downgraded. However, not much was said about the stock market and even less about the bond market. But let’s take a look at the good things that have happened for you investors in the last few weeks. The indicators below suggest there are things to be happy about.

Index or Currency Pair	23-Jun-16	28-Jul-16	% change
FTSE 100	6338	6742	6.37%
GBP/USD	1.4797	1.3174	-10.97%
GBP/EUR	1.3015	1.187	-8.80%
10yr Gilt price	105.52%	111.18%	5.36%
10yr Gilt yield	1.36%	0.73%	-46.35%
S&P 500	2113.32	2166	2.49%
Euro Stoxx 50	3037.86	2989	-1.61%

 

Imagine you have a balanced portfolio of bonds of short to medium maturity and equities invested in large companies (i.e. predominantly FTSE 100 shares as many of the most popular funds are), you will not have done badly.

• The FTSE 100 has risen because most of its component companies have large international operations and benefit from sterling weakness.
• The Euro and US$ denominated assets are suddenly worth a lot more in sterling terms. Euros and US$ repatriated to the UK produce more sterling.
• Gilt prices have risen. Thus the capital values are higher, which will be reflected in the value of the bonds in the portfolio. Remember, however, that higher gilt prices mean lower interest rates and lower yields. Obviously lower rates for borrowers reduce interest costs both for companies and individuals seeking mortgage loans. Lower interest expense has a direct positive impact on profit and loss accounts for companies.
• The S&P 500 is up for investors holding US$-denominated funds to add to the currency gains.
• Even though the Euro Stoxx 50 (the index of the 50 largest companies in Europe) is down, the fall in sterling against the Euro more than compensates any losses on the index. (It is important to note here that this assumes that you are invested in line with the index or are in a Euro Stoxx 50 tracker fund; it does not apply to all European equity funds.)

It is not all bad, is it? The market has been reassured by the Bank of England saying that they would provide up to £250bln liquidity in the event that it was necessary. This has undoubtedly helped the stock market in the same way that it did when Europe had its own crisis and Mr Draghi said he would do ‘whatever it takes’ to support the European economies with his bond-buying programme.

Clearly we must not get overexcited as matters can change just as rapidly (watch out for a Greek repayment on its European debt and the Italian banks, which are said to be weak), but since 23 June you as investors have reasons to be cheerful.

Archiemidas

 

This article is not to be construed as financial advice. The views expressed above are those of the writer alone and do not constitute a recommendation to purchase, hold or sell. It must be borne in mind that the value of investments and any income will fluctuate.  The value of your Investment can fall as well as rise and you may not get back the original amount invested. Past performance is not a guide to future returns.