The Small Print

The contents of these muses are my own opinions, should not be taken as a personal recommendation to invest in the areas mentioned and does not replace the need for individual independent advice.

Did you get a tin of baked beans?

I am not asking about your shopping experience here but I do hope you have been able to get your essential food supplies amid all the supermarket queues and panic buying. What I mean here is did your various multi-asset and other defensive investments do what they said on the tin and protect your capital during this sharp sell-off? Yesterday I undertook some analysis of performance of the funds I have frequently advised to see how they have done in the past year. I decided to focus on performance in the last 12 months rather than the last one month for several reasons. Firstly cautious risk funds that have performance targets, (many do not), normally state that positive returns are expected over a cycle, typically around three years. They don’t claim they will deliver absolute returns over all time periods, notably shorter ones. Secondly I wanted to see the effectiveness of the gains in the previous 11 months in cushioning the subsequent losses. After all 2019 was an excellent year for investors. Good cautious risk funds must be able to capture some of the market gains in the good times in order to insulate investors during subsequent downturns. I wanted to test this theory. However to be fair I did not want to look at three year performance to avoid too much of the upside masking the recent losses.

Here are my findings with all performance data from Trustnet (24/3/20) unless otherwise stated. The returns do not take into account the very sharp rises in shares yesterday. For example the FTSE 100 was up more than 9% and the Dow Jones rose by more than 11% on hopes of a $2 trillion stimulus package in the US. Remember it could prove to be a tin of baked beans bounce.

The figures in brackets are FE fundinfo Risk Scores. FE is Financial Express. These are measures of fund volatility over three years relative to the FTSE 100 index, which is used as a benchmark. The FTSE 100 index’s rating is 100, so a fund with a Risk Score of 45 has experienced 45% of the volatility of the FTSE 100 over the last three years. Bear in mind volatility is not a measure of absolute risk or losses. It just tells us something about the extent of the ups and downs of the fund’s share price. For the technically minded amongst you it is a type of Beta.

For comparison the FTSE 100 Total Return (TR) in the last year was -27.48% (Source: Investing.com). The total return index includes re-invested dividends. In contrast the spot price of gold rose 24.5% since 31/3/19 (Source: Bullionvault.com), showing the benefit of investing in assets that are non-correlated to equities.

Mixed Investments (20-60% Shares)

Axa Global Distribution-7.5%(51)
Artemis Monthly Distribution-14.2%(62)
Investec Cautious Managed-20.0%(57)
Liontrust Sustainable Future Defensive Managed -4.3%(46)

Multi-asset funds vary significantly in their asset allocation and fund management style and there is a wide disparity of returns here. Bear in mind too these funds can in theory invest 60% in equities and so many are still fairly highly exposed to equity market movements. I am happy with the returns of the Axa and Liontrust funds but not those with double digit drawdowns.

Mixed Investments (0-35% Shares)

Fidelity Multi-Asset Income-9.2%(48)
Royal London Sustainable Managed Growth -1.4%(37)
Vanguard LifeStrategy 20% Equity -0.3%(31)

These funds can hold a maximum of 35% in equities but not all do, for example the Vanguard fund. The returns from this and the Royal London Sustainable Managed Growth are good, in relative terms.        

Targeted Absolute Return

BNY Mellon Real Return-7.4%(51)
Argonaut Absolute Return  40.9%(71)
Jupiter Absolute Return-12.7%(30)
Janus Henderson UK Absolute Return 0.7%(38)

These funds had come in for a lot of criticism prior to the crash for their inconsistent returns, their failure to meet their performance targets and capture the upside in a bull market. The Argonaut fund under the management of Barry Norris has had a very bumpy ride and after a period of poor returns he has delivered exceptional performance for investors in the last year.

Direct Property

TM Home Investor1.5%(3)
Time Commercial Long Income4.5%(3)

These very cautious funds invest in physical property rather than the shares of property companies which are much more volatile and like the rest of the equity market have been hit hard in the sell-off. The TM Home Investor invests in residential UK property and the Time Commercial Long Income in long leases and ground rents. Both funds are now closed to new investors and sellers due to uncertainty of valuations not due to liquidity problems and lots of investors wanting to exit.

Volatility Managed

Architas Multi-Asset Blended Intermediate  -9.3%(55)
ASI MyFolio Maerket III Platform-12.2%(62)
HSBC Global Strategy Cautious-1.8%(29)
Santander Atlas Portfolio 4-6.8%(31)

Funds in this sector have volatility targets. These then determine the asset allocation of the fund. Congratulations go to HSBC here for capping losses to less than 2%.

One Month Returns

Having focused on one year returns I want to look at the best performers in each sector to see how they did over the last month. This enables us to see how defensive they were in the sell-off itself without the benefit of the good returns in the preceding 11 months.

Liontrust Sustainable Future Managed-15.4%
Vanguard LifeStrategy 20% Equity-8.0%
Argonaut Absolute Return 9.9%
Time Commercial Long Income 0.3%
HSBC Global Strategy Cautious-9.1%

For comparison the FTSE TR was down 26.7% over the last month.

Some of these returns are less impressive and show that even defensive funds with low equity content don’t escape sharp downturns. However like a bear or other hibernating animal if it puts on enough fat during the summer it will survive the winter. A fund that captures a significant chunk of the upside but never loses money in the sharpest of sell-offs probably does not exist so investors have to accept unless you want to be 100% in cash, investment risk will always be an occupational hazard.

Finally it should be said that differential performance of funds in the same sector in the last year will be down to a combination of the calls of the fund manager in terms of asset allocation, stock selection and use of hedging, spiced with luck. To find out why for example the Liontrust Sustainable Future Defensive Managed did so much better than the Investec Cautious Managed will require further investigation – an examination of the contents of the tins. Similarly fund managers will adopt a variety of measures to protect investors during these difficult times. Some may not do anything significant on the principal that are long term buy and hold investors or they entered the sell-off with a very defensive asset allocation. Others will use cash to add to their best ideas at depressed prices in anticipation of a recovery. The next test for them will be to manage their portfolios in a long term bear market and know when to make changes to benefit from the recovery when it finally comes. For investors the general advice is stay invested if you can.

The content of this blog are my own views.  It is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest in any of the funds highlighted, gold or other safe haven assets. You should seek individual advice based on your own financial circumstances before making investment decisions.

The Prospects for Gold

This morning I listened in to an interesting webinar on gold and its prospects from WisdomTree Investments. A number of my clients hold a gold ETC (Exchange Trade Commodity) from iShares or WisdomTree (formerly ETF Securities). An ETC is a low cost security that tracks the spot price of gold without the investor having to take physical delivery of the metal nor pay for storage and insurance costs.

Gold is traditionally viewed as a safe have asset and hedge against geo-political risk and inflation. The performance of gold is highly correlated to the US consumer price index. Returns tend to be uncorrelated with other assets and gold plays an important role as a portfolio diversifier. Of course one downside of gold is that it pays no interest but WisdomTree made the valid point that this is less of a detraction for investors given globally there is $12 trillion of negative yielding bonds. Finally central banks have been net purchasers of gold since 2011 reversing a multi-year trend of them being sellers.

After a strong rally in January and February gold hit a peak on 7th March of $1,700 per ounce but it has sold-off since. Currently it trades at $1,471 (Source: Bullion Vault, 19/3/20 @ 13.48 p.m.) This is counter-intuitive to its supposed safe haven status, something that has puzzled investors. You would have expected gold to have rallied in the last few weeks with the spread of the Coronavirus pandemic and the damage to the global economy and stock markets. WisdomTree consider that it has been a liquidity driven sell-off which has also affected US Treasuries* another safe haven asset, with investors selling to meet margin calls. These are contractual cash deposits investors must make to a futures broker to maintain their account at a minimum level when securities fall in value.  In other words gold and Treasuries have been treated as near cash i.e. liquid, easy to access money. That makes sense.

Another interesting point was that during the global financial crisis in 2008 the price of gold fell initially even in the aftermath of the collapse of Lehman Brothers. It then rallied from a low of around $735 per ounce in early October to a high of nearly $1,918 in August 2011. If gold follows the same trajectory prices may rise in the current crisis. WisdomTree modelled two scenarios – a V shaped recovery and a U shaped one. In the former the gold price would go higher than today for the rest of the year, peaking at $1,965 in the third quarter and then decline in the first quarter of 2021 to $1,370. With a less favourable U shaped recovery with a longer downturn in the markets, gold prices would go higher for longer breaking through the $2,000 barrier in the next four quarters. These models require making complex assumptions about federal reserve policy, the dollar exchange rate, nominal yields on bonds and speculative positioning forecasts so the numbers must be treated with caution but the conclusion is clear, the case for gold is good and the worse the economic downturn, the more attractive the shiny metal becomes. The nightmare L shaped recovery was not discussed but you can guess what impact this will have on gold.

It must be remembered although gold is a safe haven asset it is  volatile one and there have been long periods were prices were depressed or flat. Other candidates as defensive assets include US Treasuries, UK Gilts, the Swiss Franc and the Japanese Yen. The ultimate is of course cash which is most attractive when inflation is low.

*US government bonds.

The content of this blog is based on my understanding of the investment case for gold.  It is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest in gold or other safe haven assets mentioned. You should seek individual advice based on your own financial circumstances before making investment decisions.

Extraordinary Times

As investors we are living in extraordinary times. US stocks surged on Friday with the Dow Jones rising by 1,985 points, its biggest ever one day points gain. In percentage terms it was pretty impressive too, climbing 9.4%. The index spiked due to Trump promising stronger government action to deal with the Coronavirus in the US. Normally US markets are trend setters for the rest of the world but not so this morning. Overnight the Hang Seng fell 4.03% and Japan’s Nikkei 225 dropped 2.46% (Source: BBC News. This link is worth bookmarking for market watchers   https://www.bbc.co.uk/news/business/market-data ). Europe has opened sharply lower. As I write at just before 9.00 a.m. the FTSE 100 is down just over 7.5% dipping below the 5,000 level, something not seen for a long time. European bourses have fallen further. Despite co-ordinated action by governments and central banks investors are worried that there is very little ammunition left to combat the impact of the pandemic on the global economy.

Whilst I am sure most individual investors are holding tight, large number of institutional investors must be selling equities at already depressed prices and driving prices lower. I am not sure what they think that will achieve unless they reckon it is a case of selling now or selling later at even lower prices. Do they know something we don’t?

It is clear the global economy will slow sharply. It is now inevitable with the lockdowns in many countries some sectors will collapse. It doesn’t look good for airlines nor the travel and leisure industries, nor their suppliers. Business failures and redundancies are inevitable. Those companies with strong balance sheets and large cash piles should be OK. It will be a case of survival of the fittest. Large scale unemployment will mean many will be unable to maintain mortgage payments and this will impact the banks. If they come under severe financial stress that would become a systemic risk. In conclusion a global recession now looks inevitable. On the positive side modern technology enables many people to work from home whilst orders and demand will be delayed. Not all will be cancelled. A post crisis surge could follow although inevitable permanent damage will means the global economy will not recover to its pre-crisis level.

These are extraordinary times requiring investors to hold their nerve. Some may even be brave enough to buck the trend by investing some cash into the market to buy at very low prices. No-one is talking about the ISA season at the moment. Perhaps they should.

The content of this blog is based on my own understanding of global stock markets.  It reflects my personal views and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest cash tactically or use your ISA allowance. You should seek individual advice based on your own financial circumstances before making investment decisions.

Global Stock Market Crash

In my last blog on the 5th March I explained the market rally may be a “dead cat bounce,” jargon used to describe a temporary increase in a stock or index in an otherwise falling market. The rally appears to have life in it but it proves to be an illusion as prices subsequently continue to fall. So it proved. A month ago on 12/2/20 the FTSE 100 stood at 7,534. Yesterday it closed at 5,237 a fall of 2,297 points or a whopping 30.48%. This morning however the FTSE 100 is up 6.45% as I write. Similarly the Dow Jones Industrial Average fell from 29,551 on 12/2/20 to 21,200 yesterday, a fall of 28.25%.

Yesterday was especially savage. The FTSE 100 fell 10.9%, the worst daily plunge since 20/10/87, so called Black Monday when the FTSE 100 fell 12.2%. The Dow dropped 9.99% yesterday whilst European indices were hit even harder with 12% falls in Germany and France and 17% in Italy. These are the worst daily falls in the 29 years I have been a financial adviser and worse than during the bursting of the technology bubble in the early noughties and the global financial crisis in 2008. The only crumb of comfort is the hit to the global economy from the Coronavirus appears to me to be less of a systemic threat. The technology bubble was created by the market setting absurd valuations on businesses with no earnings. This all proved to be an illusion and like a house of cards and the market crashed. In contrast prior to the Coronavirus pandemic company earnings and earnings growth were reasonably solid and valuations generally justified in most markets.

The global financial crisis was due to bank’s excessive debt, weak balance sheets and poor liquidity. Today the banks are much better capitalised and the global financial system seems OK. What the markets are therefore reacting to currently is the inevitable hit to the global economy. Trade and economic growth will slow and some countries will go into recession, however orders and demand will remain and back-up until the crisis passes. In some sectors at least there will be a post-crisis surge, although the lull if prolonged and sharp will lead to job losses and business failures. Cue government support.

If I am right about the low level of systemic risk the question is what happens when the pandemic wanes and ends? Logically if the markets were right on stock valuations prior to the crisis you would expect a sharp rally in prices after the crisis– a rubber ball bounce! That said there is no other way of putting it, your portfolio valuation currently looks awful. However unless you are invested 100% in equities your portfolio would not have fallen as much as the 30% drop in the FTSE 100 index in the last month. Many of my clients hold multi-asset, bond and other cautious risk funds or gold and these investments would have cushioned the falls to some degree.

The other point to make is the depressed values of your holdings and losses are paper figures. They only become real losses if you crystallise them by selling out at current prices. It would be the worst thing you could do and if you have retained a sufficient cash reserve you should not need to be a forced seller. Even if you must sell funds due to an immediate requirement for money selling defensive investments will cap losses. For the brave now may be an excellent time to invest cash. If you are thinking about ISA contributions for 2019/20 you will certainly buy at low prices. For most investors however the advice is as repetitive as that about hand-washing – do nothing, stay invested for the long term and wait patiently for the recovery.

The content of this blog is based on my own understanding of global stock markets.  It reflects my personal views and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest cash tactically. You should seek individual advice based on your own financial circumstances before making investment decisions.

Market Update

Last week turned out to be the worst for global stock markets since the financial crisis in 2008. This week there has been a rally on the back of investors taking the opportunity to tactically buy equities at low prices but more crucially with central bank and government support or at least the promise of it. The Dow Jones Industrial Average posted its biggest single day points rise in history on Monday gaining 1,294. At 5.1% this was not however the biggest rise in the index in percentage terms. The gains were sparked by anticipation of a US interest rate cut which happened the next day. The FTSE 100 sank to 6,460 on Friday afternoon but at 8.30 a.m. this morning it was up to 6,823 before falling back to 6,732 at 9.13 a.m.

Some commentators have described the rally as a “dead cat bounce,” jargon used to describe a temporary increase in a stock or index in an otherwise falling market. The rally appears to have life in it but it proves to be an illusion and it can be a trap for investors who buy on the hopes of a sustained recovery.

With stock markets all over the place it reminds me of several things. Firstly markets are hypersensitive, overreacting on news and single events. The reality is the underlying economy doesn’t change half as much or half as fast (nor indeed does the cause of the current malaise, the Coronavirus epidemic). Can we say the real prospects for the US economy improved by 5% on Monday? Of course not, especially when on Tuesday the market changed its mind and fell 786 points before flipping on Wednesday to gain 1,173!

Secondly we should remember that investment is different to trading. My clients are invested for the medium to long term and history shows that those who buy and hold generally do very well. The ride may be volatile but equity investment normally proves profitable in the long run. Although a buy and hold strategy is foundational to all good portfolio management I see room for occasional tactical investment to buy equities at low prices from cash. Recently I have undertaken this for a number of clients, a couple of personal pension transfers undertaken before the crash and some ISAs. Naturally there is no guarantee that equity prices will not carry on falling post investment, thereby incurring immediate paper losses. After all it is impossible to correctly call the bottom of the market and the recovery may not be V shaped. It may be U shaped with a long trough or a volatile W shape. However we can be certain we bought in at significantly lower prices than applied prior to the sell-off as well as compared to the market peaks. If the second step is now followed, holding for the medium to long term it should prove profitable in the end.

The content of this blog is based on my own understanding of global stock markets.  It reflects my personal views and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest cash tactically. You should seek individual advice based on your own financial circumstances before making investment decisions.

Coronavirus and Stock Markets

As I write at 4.40 p.m. the FTSE 100 index is down 3.04% and the Dow Jones down 2.27%. The more domestically focused FTSE 250 index is off 3.5%. The equity market sell-off this week has been sudden. Logically it makes sense with global economic activity and trade being hit hard and with it expectations of falls in corporate earnings. Incidentally since January 17 the UK market has declined more than other major markets with a near 10% fall in stock prices (Source: JP Morgan Asset Management). This is because of the UK market’s high exposure to economically sensitive energy stocks which have fallen along with the price of oil.

Today I listened to a webinar about the impact of the Coronavirus epidemic from JP Morgan, presented by Karen Ward and Tai Hui, both Chief Market Strategists at the firm. Tai Hui’s remit is Asia Pacific and he is based in Hong Kong, so he is close to the action. Ward believes that China is now the engine of global growth not the US and so clearly what is going on there impacts the rest of the world. In China the number of daily reported new cases of infection with the Coronavirus, now called Covid-19 has fallen substantially since the beginning of the month but they have correspondingly increased elsewhere as the disease has spread globally. Manufacturing in China has been hit hard and although most factories are now open according to Hui reduced numbers of people are back at work, meaning factories may only be operating at 30-40% capacity. Lengthy supply delays are the result with the greatest impact being on China’s near neighbours. However in China there has been differential performance between companies in different economic sectors. Healthcare and IT have done well generally with the worst performing sectors being utilities, energy and financials. In other economies airlines and travel companies have been damaged. This illustrates why a broad brush judgement of an equity market is not always helpful. Ward observed there will always be winners and it is that at times like this active fund management is favoured. Elsewhere safe haven government bonds and gold have rallied.

Globally governments have been active in providing support for business and the economy. In China government fees and charges have been waived or delayed which relieves pressure on already strained cash flows. In Hong Kong there is a $3.8 billion relief package to support retail businesses, whilst interest rate cuts and fiscal stimulus are other tools available. Singapore is set to run its biggest fiscal deficit* since 1997. Central banks and governments will be aware of the “paradox of thrift.” This is a concept popularised by economist John Maynard Keynes who argued consumption and spending drives economic growth. However in a recession consumers tend to tighten their belts, spend less and save more, the very opposite of what the economy needs. That said I understood the concept in a different way. If you are a business owner facing a sharp downturn and recession naturally cost savings need to be found. However if the belt is tightened too much by closing factories and making too many people redundant for example the business may be incapable of recovery when the economy improves. Paradoxically the measures designed to protect the business may end up killing it. Government support can help mitigate this risk.

Ward and Hui were very careful to stick to the facts and not make predictions about the longer term impact of Covid-19 on the global economy and stock markets. Quite right too, we are in uncharted ground. I certainly don’t want to make predictions. However on this one I can’t help wondering if there has been an over-reaction. If so there could be a sharp V shaped recovery in the spring or summer if the epidemic dies back. Of course I may be totally wrong. If there is a pandemic equities could fall much further. So far none of my clients have been in panic mode. At this stage I would be minded to say hold tight.

*A fiscal deficit means a government spends more than it receives in income

The content of this blog is based on my own understanding of the impact of the Coronavirus on the global economy and global stock markets.  It reflects my personal views and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

LF Equity Income Payments

Payments of the first capital distribution from the LF Equity Income Fund (formerly Woodford Equity Income) have now been made to investors. These have been stock sales from the liquid part of the portfolio, representing just over 70% by value. The residual assets of the LF Equity Income fund are illiquid unquoted stocks which will take longer to sell. However investor can expect one or more further payments in due course.

The distributions amounts were as follows:

Share Class ISIN Code Pence Per Share
LF Equity Income C Acc GB00BLRZQ73758.6631p
LF Equity Income C Inc GB00BLRZQ62048.2426p
LF Equity Income Z Acc GB00BZ01L372 58.9936p
LF Equity Income Z Inc GB00BLRZQB71 48.4932p

Most investors will have held the C share classes. The ISIN numbers are fund codes – each share class having its own unique reference. You can check your cash payment is correct by multiplying your shareholding by the appropriate pence per share figure in the table above.

The cash paid will be sitting in your ISA or other account awaiting investment or withdrawal.

Following the distribution, investors will continue to hold the same number of shares in the fund, but the value of them will be correspondingly lower. The bottom line of course when the fund is finally wound up investors will lose money. The amount will depend on how much additional money will be paid out from the residual holdings, any disposals prior to the closure of the fund and the price you paid to buy into the Woodford Equity Income in the first place.

Naturally I am sorry my clients have lost money from this investment, one I never dreamed would run into problems. Fortunately the amounts my clients invested at outset were relatively small in most cases. I do not recommend large sums are invested into single funds due to fund manager risk, the risk that they make big asset allocation and stock selection mistakes and it all goes pear shaped. Fortunately though it is very rare and it highlights the importance of having a diversified portfolio where the winners outnumber the losers. Advocates of index tracking would argue this is evidence that passive investment is better than stock picking strategies but that is another story.

Finally it is worth highlighting the difference between a crystallised and an uncrystallised investment loss. The Woodford Equity Income fund is a rare example of a forced crystallised loss. With the closure of the fund, investors had no choice but to accept they would lose money. However aside from Woodford in the vast majority of cases investors will experience uncrystallised or paper losses where the value of their funds are less than the amounts invested. A paper loss is just a snap shot at a specific point in time. Six months or a year later fund values may have risen and may now be in the black. In most cases investors need not be forced sellers and can therefore avoid real losses.  

The content of this blog is based on my own understanding of the winding up of the Woodford Equity Income fund. It is intended as general investment information only.  Nothing in this article should be construed as personal investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Quality Growth Investing

A quality growth style of investing focuses on identifying companies with superior earnings and earnings growth, high returns on invested capital, strong balance sheets and dominance in their markets. A growth investor is less focused on price and valuation compared to value investors. Quality is much more important. As Warren Buffet has said:

“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”

A leading advocate of quality growth investing is Terry Smith, fund manager of the Fundsmith Equity which many of my clients hold. It is a high conviction, concentrated global portfolio of large companies. It is a pure stock picking fund. It has delivered exceptional returns for Smith’s investors. From launch of the fund on 1/11/10 to 31/12/19 the T Accumulation share class rose 364.4% or 18.2% p.a. (Source: Fundsmith LLP). The MSCI World Index, a fair benchmark for comparison in contrast gained 180.3% or 11.9% p.a. over the same period (Source: Bloomberg).

Each year Smith sends out an annual letter to owners of the fund with a review of the year and his investment thoughts. Please note you are unlikely to receive this letter if you hold the fund via a platform. This year’s letter ran to 13 pages. It makes an excellent read so I thought I would highlight a few key points. Smith says his fund has a simple three step investment strategy:

*Buy good companies

*Don’t overpay

*Do nothing.

The 10th annual letter detailed what Smith and his team consider makes companies good. They have for example superior returns on capital invested than the market as a whole, higher margins and lower levels of debt. They also have high levels of interest cover meaning they don’t pay out too much in dividends. Instead there is an emphasis on re-investing earnings to compound growth over the long term. As Smith concludes:

“Our portfolio consists of companies that are fundamentally a lot better than the average of those in either index (the S&P 500 and FTSE 100) and are valued more highly than the average FTSE 100 company and a bit higher than the average S&P 500 company but with significantly higher quality. It is wise to bear in mind that despite the rather sloppy shorthand used by many commentators, highly rated does not equate to expensive any more than lower rated equates to cheap.”

One point to make here is that companies may be cheap for a very good reason – they are poor quality. Value investors buy undervalued stocks that are unloved by the market in the hope of a turnaround. They may be successful but how long it will take and what the catalyst for change might be is anybody’s guess. In some cases they may end up buying what is referred to as a “value trap.” There is nothing to stop a cheap company’s share price falling further. 

The do nothing leg of the fund’s strategy means a long term buy and hold investment strategy. If you buy high quality companies with an expectation of superior returns and compounding of invested earnings why would you not hold the stock for the long term?  Smith and other quality growth investors prefer to invest in relatively predictable businesses, which goes hand in hand with long term ownership. The goal here is to leverage the unique characteristic of equities – that retained earnings are re-invested in the business, thereby compounding returns. This does not happen with bonds, cash or property. After interest or rent is paid out you don’t get more investment in bonds or buildings.

Another consequence of the do nothing strategy is that portfolio turnover is minimised and hence fund transaction expenses are reduced. To truly compare investment charges you must consider the total cost of fund ownership not just the annual fund management charge.

Another theme of the annual newsletter was Smith’s thoughts on the Woodford debacle, the main news of the investment industry in 2019. The main problem was the incompatibility of running a fund with daily dealing when holding a large amount of investment in unquoted smaller companies. These are not listed on a recognised stock exchange and their shares therefore have to be traded privately. With no market for their shares they are highly illiquid and are unsuited to selling quickly, a pre-requisite for daily dealing. Woodford ran into problems when large number of investors wanted to exit the fund and it could not meet demand. As the Fundsmith Equity only invests in easy to sell large companies Smith estimates they could liquidate 57% of the fund in seven days. The other problem Woodford faced was his investment in poor quality larger companies such as Capita, Imperial Brands and Provident Financial. His famed stock-picking skills went badly awry.

Finally Smith addressed the issue of “star” fund managers of which he is undoubtedly one. After the failure of the Woodford Equity Income other leading fund managers came under a similar scrutiny, unfairly in my view. It led to investor panic and selling out of high quality funds such as the Fundsmith Equity and Lindsell Train UK Equity despite the fact their quality growth investment styles were radically different from Woodford’s and their portfolios were much higher quality. Smith argued that it is irrational not to support a sport’s team just because they have star players. No the problem with Woodford, he says, was that he changed his investment strategy – referred to as style drift. Smith observes that this started whilst he was at Invesco Perpetual, where he began to accumulate large stakes in small unquoted companies. It was taken further once Woodford set up his own firm. Smith likens the change to Cristiano Ronaldo playing for Juventus as a goalkeeper. You wouldn’t expect the team to be as successful.

Smith concludes with an assurance there is no desire to change the Fundsmith Equity’s investment strategy. There will be no style drift and the fund will continue to buy and hold high quality businesses.

I like Smith and his investment thinking. The theory of quality growth investing is compelling and it has delivered consistently superior investment returns than value since 2007. The global financial crisis has resulted in investors being more cautious and favouring quality companies. With solid earnings and strong balance sheets they are more predictable and defensive in nature. Value investors have long expected a rotation in investor sentiment away from growth but it has failed to materialise in any meaningful way. However data I have seen shows prior to the banking crisis, notably from 1975 to 2006 value outperformed growth in many years. So I would never say quality growth will always outperform value.

There is more I could write about growth versus value but space and time doesn’t permit here.

The content of this blog is based on my own understanding of the 10th annual Fundsmith Equity newsletter and the concept of growth and value investment. It reflects my personal views and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest in quality growth funds, the Fundsmith Equity or Juventus. You should seek individual advice based on your own financial circumstances before making investment decisions.

Investment Outlook 2020

With the start of a new year and a new decade what is the outlook for investors? Normally you might start with the question – where are we in the economic cycle? Are we early stage expecting recovery or expansion or late stage expecting a slowdown or recession? In an interesting article co-authored by the excellent Karen Ward, a Chief Market Strategist at JP Morgan, they conclude it is difficult to tell. Logically with an expansion lasting more than 10 years since the global financial crisis and with record low unemployment in most parts of the developed world you would think we are late stage. However there does not appear to be the classic signs of end of cycle exuberance. Business and consumer spending is not excessive and the US consumer savings rate is holding up, normally it falls at the late stage of the cycle. Also we don’t have runaway inflation. On the contrary central banks are worried about economic growth and inflation being too low! Consequently monetary policy remains loose and highly accommodative, with ultra-low interest rates being very supportive of equities.

I think pretty well everyone agrees that economic growth has been weak and slow during this long period of expansion and with a phase 1 trade deal between China and the US it is not unreasonable to conclude that the longest bull market for equities in history is set to continue in 2020. However JP Morgan note that valuations are less attractive than this time last year and there is a risk of slowing corporate profits growth. For example company margins will be squeezed by wage demands caused by skilled labour shortages. JP Morgan also think manufacturing is flying a red flag for recession risk and they see ongoing geo-political risks for example disputes on unfair trade practices and other areas of disagreement between the US and China. Resolution and certainty will feed through to business confidence and investment but the opposite is true. In other words geo-political risk has binary outcomes which are tough to call. Who knows for example how events will unfold between Iran and the US?

From an asset allocation perspective JP Morgan favour a regionally neutral defensive equity position. I broadly concur but at the same time Jon Cunliffe, Chief Investment Officer of Charles Stanley observed in a blog for intermediaries that UK equities were very attractively valued compared to both 10 year gilt yields and their European counterparts whilst Sterling’s recovery was a potential draw for overseas investors. I also noted from the JP Morgan article that the Bank of Japan is a buyer of equities and with reform in corporate governance this market remains one I favour. Finally both commentators highlighted the importance of ESG investing. ESG is environmental, social and governance. Investor demand for responsible capitalism will be an increasingly important driver of investment returns.

The content of this blog is based on my own understanding of selected points made in the two articles referred to. It reflects my personal views and is intended as general investment information only.  Nothing in this article should be construed as personal investment advice for example to invest in UK or Japanese equities. You should seek individual advice based on your own financial circumstances before making investment decisions.

General Election Investment Commentary

Whether you celebrated or mourned the general election result politically, stock markets reacted very positively yesterday and sent the value of your investments higher. The FTSE 100 index rose almost 80 points or 1.1% whilst the more domestically focused FTSE 250 index gained 3.44%. At one point it was up 5.2%, posting a record high. UK housebuilders soared, for example Persimmon by 12% whilst Severn Trent rose 9%.

The pound also rallied against the dollar and to its highest level against the Euro for three and a half years. Gilt prices fell meaning yields rose.

Much of the market reaction can be explained by removal of uncertainty, at least in the short term. The UK is set to leave the EU on 31 January whilst the threat of nationalisation of utility companies such as Severn Trent has been removed.

One reason why the domestically focused FTSE 250 index outperformed the globally focused FTSE 100 index was due to Sterling strength which impacts adversely on the value of repatriated overseas earnings. Gilts prices typically fall when markets perceive less risk, so investors may have rotated from gilts to equities.

So what next? Alan Collett manager of the TM Home Investor fund, the UK’s only authorised retail residential property fund thinks a “wait and see” attitude has affected the housing market and with some of the uncertainty removed, housing transactions are expected to pick up.

We may see a traditional Santa rally in the equity market for the rest of the month but of course there is still plenty of  uncertainty in 2020 as the UK negotiates its future relationship with the EU. Of course global events will also impact the UK economy notably the outcome of the US/China trade talks.

Markets tend to over react and we may see a paring back of yesterday’s optimism and gains in the next month or two. There are reasons to be cheerful for investors but we shouldn’t get carried away.

This will most likely be my last blog post of the year. May I take this opportunity to wish you all a very happy Christmas and New Year.

The content of this blog is intended as general investment information and commentary only.  Nothing in this article should be construed as personal investment advice, for example to invest in equities or property. You should seek individual advice based on your own financial circumstances before making investment decisions.