Category Archive: Market Commentary

  1. Navigating the Coronavirus – Part 2

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    This week the Dow Jones Industrial Average (The Dow), which is the oldest U.S. stock market index, posted its biggest single-day percentage gain since 1933, up over 11% in one day!

    Volatility both ways (up and down) remains off the charts with all of the year’s best and worst days happening in March.

    So what is happening?

    Central banks and governments globally are pulling out all the stops to stimulate the economy, to slow or minimise the financial effects of COVID-19.

    Boris Johnson announced a significant series of measures to financially support employees, self-employed, companies, mortgage holders and renters – I have written a number of posts separately on the details of these on www.LexingtonWealth.co.uk/coronavirus

    The stimulus packages have not been limited to the U.K., in the U.S. the Federal Reserve, Congress and President Trump all agree on one thing, that they will do whatever it takes (almost!) to keep the economy going.

    You see, it’s easier for them to keep the economy ticking over than it is to allow it to collapse, and then face the fall out from this and then ‘try’ to stimulate it again, that is what happened in the 1930’s.

    The U.S. support for this is different than it was in the 2007/8 financial crisis, they reacted slower then and allowed companies to fail e.g. Lehman Brothers and AIG.

    They have stated that they “learned from the past” and are willing to intervene earlier and in a far bigger way. This week they did just this by aggressively supporting the bond markets, cash system and banks.

    This week President Trump publicly stated that he wants everyone back to work within weeks, “not months” – I’m not sure he’s going to get his way on this unless it’s several weeks!

    Congress just passed a $2 Trillion Coronavirus spending bill unanimously 96-0!  I don’t think that’s ever happened!  They are calling this a survivor bill.

    As a comparison, the U.K.’s Coronavirus package is close to £65.5 Billion, including the £9 billion support for the self-employed announced yesterday.

    Because of the significant drop in credit/money supply in the economy, these massive stimulus packages are needed and will be swallowed up by the economy, and inflation is unlikely to move.

    We follow the U.S. markets, at least as much as the U.K., because the U.S. is 52% of the overall world stock market and as the old saying goes, when America sneezes the rest of the world catches a cold, it’s not quite that, but when the S&P and Dow jump in value on the back of a stimulus package, so do your investments.

    But, please know this is not over.

    Every bear market has at its core an issue that must be resolved to move forward. With the 911 pullback, the bear market could not recover until people felt safe again. That took time, and only then did the economic incentives work to pull the economy and the markets into recovery.

    With the 2007/8 financial crisis, the bear market couldn’t recover until there was a certainty that the banking system would survive and continue to function. After the banks were stabilised, the economy and the markets began to respond to incentives.

    What we have today is no different, at the centre of this is a health crisis. COVID-19 continues to spread, and numbers continue to rise, this week America became the country with the most recorded cases of inflection, and I believe this will continue.

    The markets are fearful and hence volatile until we remove that fear, we will continue to see market volatility.

    To see a sustainable market recovery, we expect first to see an indication that the coronavirus is under control. Note that it doesn’t actually have to be under control, the economy and markets just have to believe that it will be under control in the near future.  The markets are always forward pricing in the available information.

    Many things can initiate that feeling, from potential treatments, a vaccine (according to the World Health Organisation, there are over 20 vaccines in development) or a plateau or deceleration of the infection rate.

    But I expect much larger number first from America, before this occurs, the U.S. is not following procedures like China and South Korea to achieve success, i.e. total lockdowns and massive testing and tracking.

    So, cutting through all the noise, where are we?

    The bottom line, the problem COVID-19 is still here, highly contagious and at the current infection rate may overwhelm many health care systems globally.  Given that almost everyone knows this, why is the market reacting positively to the financial support packages?

    Before COVID-19, the U.S. economy was exceptionally strong. Unemployment was very low and the earnings were very high.  As with all bear markets, this will pass.

    Economies weaken during bear markets when there is widespread fear, everyone reduces their spending and economies slow. This makes some bear markets scarier than others because everyone goes from worrying about the root cause (safety after 911, lending after 2008, or COVID-19 now) to worrying about whether the system will even survive.  The Governments and central banks globally are doing what they can to take that fear off the table. They are aware we are all in a transition period and the stimulus packages provide us certainty.

    How long will all this last?  The answer to that can be answered only by resolving our core issue, the campaign against the coronavirus.  That reality has not changed. Until it does, there is no time for celebrating.  While we know it will pass, the reality is the crisis is not over yet.

    The Chief Medical Officer Chris Whitty has said the peak may be in June, but more recent reports suggest this may be as soon as Easter.  Once the virus is under control, market normality will resume.

  2. Navigating the Coronavirus

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    What a difference a fortnight can make!  I last wrote a couple of weeks ago and over that time we have seen the global effects of the Coronavirus, so I thought I would write again to keep you updated.

    I am sure you are well aware there is a global pandemic with over 183,000 cases globally, which we know of and 7,175 deaths.  According to the Chief Medical Officer, we are still several weeks away from the peak, on 12 March Chris Witty said the UK is likely to peak in 12-14 weeks, which would take us to early June.

    We have found the BBC and https://www.worldometers.info/coronavirus/ to be two good sources of information about this.

    Last Thursday, the S&P 500 fell by 10%, marking its worst day since the 1987 crash. This was immediately followed on Friday with a market gain of 9.4%, the largest single day gain since 2009.  We use the S&P 500 as a bellwether of the global markets.

    What in the world is going on?

    The markets like certainty and at present they have uncertainty in bucketloads.  They work on a supply and demand basis and when this is distrusted, they react very negatively.

    Because the US markets are 52% of the overall world markets by capitalisation, what happens in the US generally effects the rest of the world. The saying ‘when America sneezes, the rest of the world catches a cold’ is true, albeit possibly not the most appropriate analogy for today.

    After the terrorist attacks of 9/11, the markets plummeted into well below today’s levels because of a disruption in demand, in the weeks and months that followed, shops and business were open, so supply was available, but the demand dried up slowing the economy because an economy needs people to spend money.

    Americans particularly were worried and many stayed home in the following months, they were shocked and did not feel safe.  However, over time life resumed and they started spending money again. The markets recovered from their lows in March 2003 and moved on to new highs.

    The 2008/9 financial crisis was the opposite. Back then the big banks were reckless and the whole financial system froze and there was a lack of supply.  No one could get a mortgage, many could not maintain the mortgage payments due to business risks. Without a supply of funds, businesses began to fail, reducing the supply of many things. Consumers felt less wealthy and were consumed by fear so did not spend and banks were not lending, so the flow of money significantly reduced. The flow of money is essential for a strong economy.

    The markets “bottomed” in March 2009 down just over 50% from their high.  Central Banks around the world stepped in with a variety of fiscal stimulus, which eventually gave consumers the confidence to go out and buy again and the economy and the markets returned to normal.

    The financial stimulus stabilised the system and incentivised individuals to spend money (taking care of the demand side).  Over time, people did start to return to normality and the markets fully recovered and once again moving on to new highs.

    Today’s market conditions are a combination of both a supply and demand.

    Like 9/11, there is a fear related to personal safety and the wellbeing of our loved ones.  Normal fiscal controls are unlikely to work until confidence is restored, that’s why we didn’t see much of a boost in the stock market after the Fed or BoE cut interest rates.

    We still have uncertainty, so demand will remain low during this period (unless you make loo rolls or hand sanitiser).  The Chief Medical Office has told us that things will get worse before they get better, peaking around June.  This is a health care crisis with serious financial side effects.

    Potential Scenarios

    From a financial perspective, the markets will continue to be volatile until certainty can be brought back to the market, more specifically, the markets will need to believe the coronavirus is contained and that there is a path to defeating it.

    There are a few options which can support this;

    • A vaccine is found
    • A cure is announced
    • Treatment is available to reduce the spread.
    • We find out millions of people have it, I feel that this would be incredibly reassuring because it would mean that far more people were infected than first realised. This, in turn, could mean many that are infected don’t get sick, which obviously means a far smaller percentage of those that are infected are dying. If we find the mortality rate is 0.2, for example, the markets could react very positively.
    • The virus runs its course quicker than expected, or that it’s seasonal or others which you may think about.

    All these scenarios provide an element of certainty and that’s what the markets are looking for, then fiscal support will have effects, but until then the markets won’t know if the fiscal stimulation is enough.

    When leaders announce plans to curb the virus i.e. tackling the health care crisis, they are more likely to react favourably because this provides the markets with certainty.

    Once we can see the health care is no longer a crisis, the markets will react very positively to any fiscal stimulus and a global pandemic like this would mean a coherent global response would be welcomed.

    Crisis’s are defeated and this crisis will be no different, but we don’t know when for certain.

    As with every crisis, there are things we can control and things we cannot, we want to focus our attention on the things we can control.

    We don’t know when the markets will go down, or when they will recover.  We don’t know for certain when the pandemic will peak and normality return.  The day to day swings we experience in the markets are a reflection of that.

    This will end, life will continue, and the markets have experienced crisis before and continued.

    So what is our position?

    We do not expect this to get better soon, or that the worst case scenarios will play out.  We expect the markets to continue to be volatile and we are sure that it will pass someday and when it does pass, the markets will recover.

    We are offering clients four scenarios which will reflect their feelings.  Remember, it’s important you are happy and comfortable and what’s right for one person may not be right for another.

    Remain invested

    • For the majority of you, you will choose to remain in your current portfolios and invested during this time, appreciating that you do not need access to your investments in the foreseeable future and that this will pass.
    • I would urge you to capitalise on this downtrend if you are a longer-term investor by rebalancing i.e. selling some of your more stable investments and buying the world equities, whilst they are cheap, to bring the allocation back into line.

    Reduce your equity exposure

    • You may feel that with the prospect of further market reductions, this would worry you and although you appreciate you cannot time the market, reducing your allocation in equities will allow you to rest better.
    • Therefore, we can rebalance your portfolio selling some of your equities and increasing your bond holding.

    Change your investment allocation

    • We do offer a portfolio which has a far higher allocation to bonds, both long and shorter.
    • This portfolio tends to perform better in market uncertainty like this, although it tends to underperform during growth periods.
    • Some clients may want to still obtain a return, but feel a smoother ride would be better, this allocation is far different from your current allocation and includes a small allocation to Gold.

    Switch to cash

    • The final option would be that you really feel uneasy and although you appreciate it would be against my advice, you would want to switch to cash.

    Summary

    During periods of crisis, we have encouraged clients to rebalance their portfolios, taking advantage of buying more equities as the markets fall, this time will pass and if you have no plans to access the portfolio, it’s a great opportunity to buy.

    Our clients who did this in 2000 and in 2007/8 came out not only with their portfolios in one piece, but all that followed our advice saw their portfolio move on to new highs, with each of our recommended investments fully recovering.

    There is an opportunity here for the patient and the disciplined, but we appreciate it’s not for everyone.

    This is a difficult time for all of us, some will be affected medically and others will have work and business worries.  With good faith and kindness, we will all see this through, our thoughts and best wishes at Lexington are with you all, keep safe.

  3. The 2020 Budget in a nutshell

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    On Wednesday, Rishi Sunak delivered his first Budget in this Government. For those that watched, the emphasis was very much on ‘Getting it done’ in relation to the Tory manifesto promises.

    Aside from the global and economic challenges, we provide a brief overview of what we believe will be of most importance and relevance to financial planners:

    • The main rates of income tax, capital gains tax and inheritance tax remain unchanged for 2020/21.
    • The personal allowances (aside from a slight increase in the married couples’ allowance) for income tax remain unchanged. This means that those with ‘adjusted net income’ below £100,000 will have a personal allowance of £12,500 from 6 April 2020. (The personal allowance reduces by £1 for every £2 for those with adjusted net income in excess of £100,000. This means that, as now, there will be no personal allowance available once adjusted net income exceeds £125,000 in 2020/21.)
    • For those who can benefit from top-slicing relief, where they incur a chargeable event gain on or after 11 March 2020, it will be the ‘slice’ that will be added to their other income to determine whether their adjusted net income is above £100,000 to determine the loss of any personal allowance (for the purposes of top-slicing relief).
    • The starting rate band for savings income remains at £5,000.
    • The personal savings allowance remains at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers.
    • The dividend allowance remains at £2,000 for all individual taxpayers.
    • The threshold for National Insurance will increase from £8,632 to £9,500 for 2020/21. Those earning over £9,500 will be around £85 better-off per annum.
    • Child benefit for the eldest child will increase from £20.70 to £21.05 per week, which is an increase of 1.7%.
    • The capital gains tax annual exemption rises from £12,000 to £12,300 from 6 April 2020.
    • The lifetime limit for entrepreneurs’ capital gains tax relief will reduce from £10 million to £1 million for qualifying disposals made on or after 11 March 2020 – a slash of 90% and back to the original limit when it was first introduced in 2008. The new lifetime limit can also apply to pre-11 March disposals, made in anticipation of this change, which had not completed before Budget day. Also, note that the new lifetime limit will have to be used when taking into account the value of entrepreneurs’ relief claimed in respect of qualifying gains in the past.
    • The inheritance tax nil-rate band remains at £325,000 and the residence nil rate band increases to £175,000 for 2020/2021 for those with estates below £2 million.
    • The corporation tax rate remains at 19%, despite an earlier announcement that it would reduce to 17%.
    • The employment allowance for National Insurance will increase from £3,000 to £4,000 from 6 April 2020.
    • The annual subscription limit for Child Trust Funds and Junior ISAs will increase from £4,638 to £9,000 for the 2020/2021 tax year.
    • The adult ISA subscription limit remains at £20,000.
    • The pension lifetime allowance increases from £1,055,000 to £1,073,100 from 6 April 2020.
    • The Threshold Income level for the tapered annual allowance will be increasing by £90,000 in 2020/21, to £200,000, and the Adjusted Income level will be set at £240,000. The minimum the taper can take the annual allowance down to will be £4,000 from 2020/21, a reduction from the current £10,000. The minimum will be reached when Adjusted Income is £312,000 or more. Proposals to offer greater pay in lieu of pension contributions for senior clinicians in the NHS Pension Scheme will not be taken forward. This may impact plans already in place for some senior clinicians for the next tax year.
    • As always there was an emphasis on more tax avoidance measures.

    Click here to download the full overview

  4. Market Volatility and Covid-19

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    Most likely you would have heard in the news that the world stock markets have retraced some of their growth, that’s the same, non-emotional way as the news headlines saying ‘trillions of dollars have been wiped off the value of the world’s companies’.

    What they did not tell you is that in the preceding months, trillions of dollars were added, unfortunately, the media tends to spread fear, but you don’t need to accept it.

    The MSCI World Index had fallen from a high on 20th February to Friday’s close down 9.94%, the index is now back to mid-October 2019’s prices.  This is a significant retracement, but not unique.

    I use the MSCI World Index, which reflects a market cap-weighted global portfolio, similar to what you invest in at Lexington, and not the FTSE (UK index) or S&P (US index) because it’s more relevant.

    Beyond the headlines

    Is this the bottom?  Who knows however you should expect these falls in your portfolio, that’s why I always speak about the historical maximum drawdown of a portfolio.

    Fundamentally the economy is strong, the market volatility is based on the uncertainty surrounding what impact the Convid-19 virus will have economically.

    We don’t know how severe it will be, some reports are worrying, others are less so, even those in charge don’t really know.  I read in the Spectator that there are strong signs that the virus has peaked.

    The virus is causing a supply issue not a demand issue.  Most central bank financial stimulus work on consumer spending by using quantitative easing and reducing interest rates.  If there is no product to sell, because of the lack of goods being manufactured, this will have little immediate benefit and earnings/share prices could be affected until supply recovers.

    If you are able, use this as a buying opportunity to invest more, or if you are fully invested, look through the headlines to the next 10 or 20 years, there will always be headlines to worry you.  If you are drawing an income from your portfolios, we have already planned for scenarios like this and you will hold cash and low-risk bonds that will cover your income needs.

    The recovery may not be immediate because it will take a little time for the factories in the Far East to reopen and get back up to speed.  Weak companies with poor cash flow may not be able to survive a shortage of business so expect some corporate failures but overall fundamentally most companies and the economy are strong.

    Here is a recent interview on CNBC with Warren Buffett one of the world’s most successful investors, it’s 5 minutes, but it’s really the first 30 seconds you should watch.

    Warren Buffett CNBC Interview.

    After 25 years as a Financial Planner, I feel more experienced and prepared than ever in my career, you are in safe hands and if you are concerned, please get in touch.

  5. January Inflation Numbers

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    The CPI for January showed an annual rate of 1.8%, up 0.5% from December. The market had expected a 0.3% increase, according to Reuters. Across December to January prices fell by 0.3%, whereas they dropped by 0.8% a year ago.

    The CPI/RPI gap was unchanged at 0.9%, with the RPI annual rate rising to 2.7%. Over the month, the RPI was down 0.4%.

    The Office for National Statistics’ (ONS’s) favoured CPIH index rose 0.4% for the month to 1.8%. The ONS notes the following significant factors across the month:

    Upward

    • Housing and household services: The largest increase came from this category. In January 2019, a fall in gas and electricity prices partially reflected energy providers beginning to operate Ofgem’s initial energy price cap. There was no such Ofgem adjustment this January because of a change in the timing of new pricing caps. These now take effect on 1 April and 1 October. The 0.2% inflation increase in gas and electricity bills created this month by the January 2019-January 2020 comparison will disappear in February, and in April energy prices will bring downward pressure on inflation because the cap rose by 9.3% in April 2019 but will drop by 1% in April 2020.
    • Transport: The main upward contributions came from fuels and lubricants, and airfares. Prices at the pump rose between December 2019 and January 2020 but fell between December 2018 and January 2019. There was also a large upward contribution from airfares where prices fell between December 2019 and January 2020 by 17.9%, compared with a fall of 25.5% a year earlier. There were further small upward contributions from vehicle maintenance and repairs, and other services. These upward contributions were partially offset by small downward contributions from rail and sea fares and the purchase of vehicles.
    • Clothing and footwear: This category also made a large upward contribution to the change in the inflation rate, with the main impact coming from women’s clothing. There was no evidence to suggest a reduction in the proportion of items being recorded on sale compared with January 2019, despite evidence of increased discounting reported in December 2019.
    • Restaurants and hotels: Overall prices for overnight hotel accommodation fell by 3.9% between December 2019 and January 2020, compared with a fall of 9.1% between December 2018 and January 2019.

    Downward

    • Furniture, household equipment and maintenance: Overall prices fell by 3.1% between December 2019 and January 2020, compared with a fall of 2.1% between December 2018 and January 2019. The main downward movement came from furniture and furnishings, in particular from settees and double beds.
    • Food and non-alcoholic beverages: Overall prices fell by 0.1% between December 2019 and January 2020, compared with a rise of 0.1% a year earlier. There were downward contributions from margarine or low-fat spread; fish; fruit; and fruit squash. These were partially offset by upward contributions from bread and cereals; and sugar, jam, syrups, chocolate and confectionery. CPI inflation in this category is now 1.5%.

    Overview

    In six of the twelve broad CPI groups, annual inflation increased, while three categories posted a decrease and the remaining three were unchanged. The category with the highest inflation rate remains in the Communications category, which fell 0.1% to 4.2%.

    Core CPI inflation (CPI excluding energy, food, alcohol and tobacco) rose 0.2% to 1.6%. Goods inflation rose 0.7% to 1.3%, while services inflation was up 0.2% at 1.6%.

    Producer Price Inflation was +1.1% on an annual basis, up 0.2% on the output (factory gate) measure. Input price inflation increased to 2.1% year-on-year, a 1.2% rise from December. The main driver here – for a change – was imported metal prices, not oil prices (which were the main driver for the output inflation rise).

    These inflation figures were higher than expected, but the quirks of energy price capping mean this could be a temporary blip rather than an omen of the end of sub-2% inflation. With earnings growth of 2.9% a year (total pay – 3.2% regular pay only) according to the latest statistics, real earnings growth continues to be positive.

    These inflation numbers to some extent vindicate the Monetary Policy Committee’s no change decision on 30 January. The MPC next meets on 25/26 March, by which time it will have another set of inflation statistics and the impact of the Budget to consider.

  6. Buy To Let and FTSE in the last 10 years

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    The Great British Public has long had a love affair with bricks and mortar, witness the continued (if waning) popularity of buy-to-let, despite all the tax obstacles being thrown at it (with more to arrive in April). It set us wondering what the last decade revealed about the returns from UK residential property compared to UK shares.

    The graph above is a limited attempt to do just that, looking also at inflation, as measured by the RPI and CPI:

    • It re-bases everything to 100 at December 2009 for consistency.
    • It uses the Land Registry index of house prices, which only runs to November 2019 – December’s figures are about a fortnight away. The Land Registry numbers are slower to appear than those of Nationwide and Halifax but include more underlying data as cash purchases are covered. Interestingly, the Nationwide figure for the decade shows house price growth of 33% against about 40% for the Land Registry. At 33%, the Nationwide Index very marginally underperformed the RPI over the ten years.
    • Similarly, we have used the more comprehensive FTSE All-Share rather than the FTSE 100 to show UK equity market performance. The FTSE 100 posted a gain of 39.9% over the decade, against 52.0% for the FTSE All-Share. That difference reflects the strong performance over the period of the FTSE 250 mid-cap shares (in the tier below the FTSE 100) – up 135.1%.
    • The gap between the RPI (blue line) and CPI (yellow line) is a 0.84% a year difference, which helps explain the controversy surrounding moves to reform the older index.
    • The FTSE All-Share and House Price data are capital values only. Consideration of income has been excluded mainly because of the paucity of rental data. For the FTSE All-Share, reinvesting dividend income would have produced a total return of 114.6% (7.94% a year).

    Past performance is not a guide to the future, as every financial ad reminds us. However, it can be a useful reminder of the past. How many people remember that house prices spent much of the first half of the decade growing at a slower pace than inflation..?

  7. Friday the 13th… Should you be scared?

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    If it wasn’t so important, politics would be a joke. We are experiencing unprecedented uncertainty and tension in the political system with Trump’s impeachment hearing, US/China trade tariffs, Brexit and the British elections on the 12 November, which for some will be a scary announcement on Friday 13th.

    Does all of this, and who sits in Number 10, affect your investment strategy?  If it does, do you need to rethink your plans ahead of the election?

    Surely, the economic policy of a Conservative Government will affect the economy and the returns we achieve on our investment portfolio differently than a Labour, Liberal Democrat or coalition government.

    Their fiscal policies are often completely different; the left-wing governments are known for taxing the higher earners and greater Government spending, whereas right-wing parties are better known for reducing taxes and simulating businesses, or that’s what traditionally we have seen.

    So, how has the stock market performed under the different parties?

     

    The above chart shows the total return of the FTSE All Share from inception in 1962 to the present day and the relative government in office during the period.

    Although the chart makes the earlier years difficult to distinguish, the resulting trend is positive, through Conservative (grey), Labour (blue) and Coalition (green) periods in office the FTSE All share index, a bellwether of the British economy, has risen.

    So what is in the data; can we see any trends of party led returns?

    The average FTSE All Share monthly returns for each party is shown in the table below;

    The data shows that over this sample period of 691 months, or 57 ½ years, a Conservative Government has produced a 34% higher monthly return in the FTSE All share than under a Labour Government.  This is the difference in you doubling your money every 15 years to doubling your money every 11 years.

    When Warren Buffet was asked his favourite holding period for an investment, the legendary investor replied, “forever”, however, forever is a long time.

    Fidelity did some interesting research, which shows the impact of market timing with your investments.  They showed the effect when you missed best 10, 20, 30 or 40 days in the market and compared this to the overall return if you had remained fully invested all along.

    Over a period of fifteen years, the message is clear.  If you try and time the market and get it wrong by just ten days over a fifteen-year period, you could be looking at a reduction in your annualised return from 7.7% to 3.5%pa.  Miss the best 30 days in the fifteen-year period and you’ve gone from making money to losing money.

    Timing the market, switching your investments around, increases the costs and taxes associated to your portfolio which has a further drag on your returns not included in this research.

    A Conservative Government has shown to improve the investment returns, when they sit in Number 10, and holding your nerve during the investment ride and not trying to time the market, weather an election or recession, significantly improves your chances of a successful investment experience.

    Develop a plan which reflects your personal needs and goals, work with a Certified Financial Planner to support you, because when the markets are climbing, any fool can make money in the market, it’s during times of uncertainty, like this, when we need a coach, a sounding board to ensure you stay on track and don’t waiver.

    Warren Buffet would say, ‘it’s only when the tide goes out do you discover who has been swimming naked’.

    So maybe it is who’s sat in the Financial Planners chair that will have a greater affect your outcome, not who’s in Number 10.

     

  8. Lexington’s 2019 Third Quarter Market Review

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    Please see Lexington’s 2019 Third Quarter Market Review which we thought you might find useful.

    This report features world capital market performance and a timeline of events for the past quarter. It begins with a global overview, then features the returns of stock and bond asset classes in the UK and international markets.

    Please click the image below to open up the report.

    We hope you enjoy the read and if you have any questions please do not hesitate to contact us.

     

  9. Styles of Investing; Active or Passive

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    Before I became a financial planner, investing was all about making money and buying a ‘hot stock’, 25 years later, I reflect on my naivety and appreciate how others may also be thinking this and asking themselves what is the right way to invest?

    Over the years there has been so much research in how stock markets work, this makes sense since there’s a lot of money at stake, it seems sensible to understand it.  You’re unlikely to trust your neighbour on medical decisions, preferring to rely on a qualified doctor, so why would you trust your neighbour over your qualified financial planner, or what some of the leading business schools have been telling us for decades, on investment decisions?

    There are, at a top level, two ways to access the stock market; directly by buying a share yourself, or via a fund, which is a collection of shares, managed by a fund manager.  If we agree that you want to entrust an expert to manage your investments i.e. a fund manager, because of the benefits this brings, you have a choice in the type of manager you choose, as they manage money differently;

    • They can manage your money actively, or
    • They can manage your money passively

    Active vs Passive Investing

    After reading this ask yourself which would you prefer, an actively managed fund, or a passive fund?  Surely, all our life we have been taught that doing something i.e. being active, is better than doing nothing, i.e. being passive, so why would investing be any different?

    I think this is a reason so many people have chosen active management in the past, however recently we have seen more and more institutional (big players) and retail (you and me) investors buy passive funds.

    Buyers of active funds say things like the fund managers are entrepreneurs, they believe in capitalism and making money, they surely know what they are doing.  The passive guys just ‘buy and hope’.

    Nothing could be further from the truth, and after decades of research and hundreds, possibly thousands of academic studies conclude that it’s too difficult, to consistently outperform the stock market or in another way, active funds are unable to consistently outperform passive funds.  I even wrote an article about a $1m bet Warren Buffett placed to prove this.

    But rather than tell you, let me try to explain the differences and how each works.

    How the managers work

    The manager of the fund has a mandate which explains what and how they should manage the fund.  An active fund manager will buy and sell shares with the hope that their decisions make a profit, which is in excess of the index.  The index is their benchmark or the league ranking they are measured against, to give a sporting analogy.

    Each day the manager will arrive at their office and trade (buy and sell) shares in the fund, because they think (often based on some research or meetings) the shares that they sell are going down in price and the shares that they buy are increasing in price.  This is the activity, of active fund management.

    Now let’s compare this to passive fund management.  Their remit may be, for example, to buy every share in the index, like buying each team in a league, and therefore rather than buying shares than rise and selling shares than fall, they buy both.

    You may say that’s silly why do both? Well long term overall, share prices increase in value, historically this has been by c.9%pa, so the shares that rise often increase by more than this, and the shares that fall, fall by less than the risers, so the net effect or average is 9%.  They don’t return 9% every year, sometimes the risers win, sometime the losers win, but overall the winners win, they win by an average of 9%pa.

    I appreciate that logically it makes sense to only buy the winners, but if you think about it, the fund manager doesn’t know for certain that they are winners, until they have won, then it’s too late.  It’s like being at the bookies, you may have a favourite, but the favourite doesn’t always win.  When you talk about the future, you’re giving an opinion, nothing is certain.

    A picture can paint a thousand words, and below is a chart of the average active fund (in blue) and the UK stock market (in red) from January 1990 to November 2019.

    active versus passive investing

    Diversification

    Some shares win and some loose, in fact, some loose so badly they go out of business and you lose your money.  This is why we buy funds rather than one or two individual shares; it spreads our risk.

    So, how much does it spread your risk, investing into a fund?  If you are an active manager, typically your portfolio will have about 300 shares, therefore the fund manager, will need to know the ins and outs of all 300 companies, what they are doing, how they are trading and their challenges…a difficult job, if one or two go bust, you’ll feel it, not massively, but you would.

    Whereas some passive funds, like the ones we operate at Lexo.co.uk have over 10,000 shares, so if a couple go bust…we’re less likely to be effected by it, and when you must own all the companies, it’s less essential knowing everything about them.

    When investing, unless you have a crystal ball, diversification is your friend.

    Charges

    There’s a cost to investing, these costs are rarely explained in detail, but as a summary you have a manager’s fee, a custodian fee and trading fees, which includes the buy sell spread.

    The managers fee pays for the management of the fund, the fund manager, the offices and marketing etc of the fund.  This is referred to as the Annual Management Fee (AMC)

    The custodian’s fee is the price for your money to be held safely, in a custodian’s account, away from the fund manager.  You see, your money is not held in the fund managers account, encase they go bust, it’s held in a custodian’s account, so it’s safer and protected for you.

    Finally, there are trading fees to include.  When you buy a share, there are several costs some of which are;

    • The difference, or spread, between the buying and selling price, which if you sold immediate would be a cost.
    • The stockbroker receives a brokerage fee for placing the trade.
    • HMRC receives stamp duty on every purchase.
    • There is also a cost referred to as slippage, which is where the agreed purchase price moves from the actual price paid hence the term slippage, this is also a factored costs.

    If you are holding a share for a long time, you can loan the shares out to another fund, who has security and pays an income to you for the loan period they hold the shares.  Why they do this, is probably beyond this article, but they are hoping to make money on the shares if they fall in value!  Irrespective of their plans, you’re making money whilst you hold onto the shares, often whilst they are rising in value.

    These are the charges, lets see how they effect the different managers; active managers are often paid substantially more than the passive managers, mainly because the passive managers are guardians and a computer programs makes decisions, so passive funds tend to have a lower management fee.

    Custodian fees are generally similar for both active and passive funds, because this is a storage/safe keeping charge.

    If you’re an active manager, your trading costs are substantially more, because you’re always buying and selling, hence active manager.  The turnover ratio (how much you sell of the fund and replace it) can sometime be over 100% in a year for an active fund, and less than 10% for a passive. Therefore, a passive fund has much lower trading costs.

    If you’re always buying and selling and not holding on for long periods of time, you can’t really loan your shares and receive an income for this, but passive managers can, and this income effectively reduces the other fees charged.

    It’s fairly typical for the total costs to be in excess of 2% for an active fund, and less than 0.5% for a passive fund.  Charges are a guaranteed (negative) drag on your investment returns each year.

    Emotions of the manager

    We’re all human and effected by our emotions, and market turmoil is a great example that effects our emotions, when the markets fall it can be worrying.  If you see your shares falling in value, selling them and holding cash seems a sensible decision, but when do you buy back in? It’s one thing to get out, but you can’t stay out, your job is to manage money, so when do you buy back in? When it’s recovered, so you have the cost of the trade, and you could end up buying back in at a higher price.

    An argument against passive is that they follow the market down, it’s true they do, but to complete the sentence, they follow the market back up again too and without additional trading costs.

    Summary

    So in summary, with active fund management you are betting that the person managing the money has skill and insight to beat the collective market as a whole plus the additional cost incurred to achieve this.  Or you could accept that it’s virtually impossible to beat the market, why take the chance with your retirement money, and accept that a market return of c. 9% is acceptable.

    The challenge is that you don’t know that you can beat the market, until you have given the manager a period of time to prove it, say five years.  So, you could look back and say over the last five years, you’ve done well, so you will in future?  However, Morningstar researched this and found that the top fund managers over one period, did not repeat their success over the following period, so novice investors were buying funds based on a track record, not knowing the probability the funds were about to go down!

  10. How do Currency Returns affect my International Investments?

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    Many investors take a global perspective when building portfolios to achieve their investment goals. With the potential benefits of an expanded opportunity set and increased diversification comes exposure to foreign currencies. Currency returns can be volatile, creating winners and losers. While there is little evidence that currency movements can be predicted, investors still want to know about whether to hedge their currency exposure.

    To answer this question, it is helpful to see whether exposure to currency returns is consistent with the investor’s goal. Some investors may want to hedge currency exposure due to the volatility of currency returns and the impact on a portfolio. In global equities, currency hedging does not meaningfully reduce portfolio volatility, since equities are generally more volatile than currencies. For fixed income, currency hedging can be a useful tool to reduce portfolio return volatility.

    This article looks at the impact of currency movements on global equity and fixed income portfolios as well as the merits of hedging.

    CURRENCY RETURNS

    For investors with unhedged international investments, when their home currency appreciates it has a negative impact on returns; when it depreciates, the impact is positive.

    In 2018, the weakening of the pound versus the strengthening of other currencies had a positive impact on returns for British pound investors with holdings in unhedged non-UK assets, and contributed 3.9% from the returns as measured by the difference in returns between the MSCI All Country World IMI Index in local returns vs. GBP.

    Currency movements have had a positive versus negative impact on returns for British pound investors with about the same frequency, being positive half the time (12 out of 24 years) as measured by the difference in returns between the MSCI All Country World IMI Index in local returns vs. GBP. The implication for investors is that although currency returns may be volatile at shorter time horizons, they are not expected to be a driver of expected return differences over longer time horizons.

    DOES HEDGING REDUCE VOLATILITY?

    Equity
    Some investors may want to hedge currencies with the goal of reducing the volatility of returns. For an investor with a global equity portfolio, hedging currencies tends not to significantly reduce return volatility, as illustrated in Exhibit 1. Equities tend to be more volatile than currencies, so the volatility of an unhedged global equity portfolio tends to be dominated by the volatility of the underlying equities, not the currency movements. As a result, unhedged and hedged equity portfolios have had similar standard deviations.

    Fixed Income
    In global fixed income, hedging currencies is an effective way to reduce return volatility because currency returns are more volatile than investment grade fixed income returns. If the currency exposure is unhedged, the currency will be mostly responsible for the volatility in a fixed income portfolio. As shown in Exhibit 2, the annualised volatility of the hedged index (1.50%) is much less than the unhedged index (8.06%).

    INVESTOR TAKEAWAY

    For investors with global portfolios, their return is determined by the return of the foreign asset and the return of the currency. However, academic evidence suggests that currency movements are very difficult to predict in the short- to medium-term in a manner that is relevant for making investment decisions.

    Should an investor with a global portfolio hedge the currency exposure? The answer depends on investor goals and the underlying asset. For global equities, our research indicates that currency hedging does not meaningfully reduce portfolio volatility. In contrast, for fixed income investors with investment grade securities, hedging can be an effective way to reduce the volatility of returns.

    GLOSSARY

    Currency hedging: Establishing a position that mitigates or decreases the risk associated with an existing currency position.
    Forward contract: An agreement to buy or sell an asset at a specified price on a future date.
    Market capitalisation: The total market value of a company’s outstanding shares, computed as price times shares outstanding.
    Standard deviation: A measure of the variation or dispersion of a set of data points. Standard deviations are often used to quantify the historical return volatility of a security or portfolio.
    Volatility: A statistical measure of the dispersion, or variability, of returns for a given security or portfolio. Volatility is often measured using standard deviation.

    RISKS

    Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful. Diversification does not eliminate the risk of market loss.