Cash to Equities – US, China and Gold

Early this month I decided to move more but not all of my pension fund cash into equities. Historically December is the best month for stockmarket index gains. I am not sure of the precise reasons for this but it may be due to end of year performance fees, fuelling buying by fund managers and institutional investors or the holiday season and upcoming New Year making investors feel more optimistic. Markets also traditionally do well in November and December following US presidential elections. This is due to the removal of uncertainties that precede elections. Markets like to know what administration and fiscal policies they will be dealing with.

I also took the view that a deal will be struck on the US fiscal cliff mitigating the impact of tax rises and spending cuts due in January and that markets would respond positively. Finally Chinese equities which have performed badly in recent years seem to offer good potential and buying in at low prices is a risk worth taking. Data from Morningstar to 16/11/12 showed the average IMA China/Greater China fund returned -0.1% over three years and just 3.6% over five years. Chinese shares have hardly been at the races whilst there seems to be more confident signals coming from China.

So I allocated some cash to Chinese and US Mid Cap funds from Jupiter and Schroders respectively. The reason I opted for the latter was that medium sized companies should outperform larger caps in the recovery and growth phases. They are also more domestically oriented, positive given that 70% of the US economy is consumer dependent. Finally I decided to buy into the Blackrock Gold & General fund. This mainly invests in the equities of gold producers. In recent years these have underperformed and there has been a sell off despite the rising price of gold itself. The Blackrock fund was down a whopping 20% in the 12 months to 16/11/12 (Source: Morningstar). The significant disparity between the gold price and gold equities has been explained by high production costs, falling ore grades, hedge fund manipulation of prices, the popularity of ETFs and specific stock selection issues. However in discussion with Blackrock it was explained that gold equities have been more affected by equity markets in general rather than the gold spot price but the fundamentals are positive with good bottom line profits. Some miners are also starting to pay dividends for the first time. That said a trigger for re-rating of gold equities would only happen when equities in general come back into favour.

Time will tell if my tactical asset allocation strategy will work. If not it will be budget slippers for me in retirement! As for you, you should seek individual advice before making investment decisions.

How to Create and Service Your Investment Portfolio

The content here is an article to be published in the Eastbourne Herald in December. I have agreed to write six monthly articles on investment issues. It is pretty basic but perhaps a useful reminder for you.

 

For those with a portfolio or money ready to invest this article will help you grasp key principles and increase the potential for you to make money and avoid pitfalls.

Firstly it is essential to set aside accessible cash from the investment portfolio for emergencies and short term needs. This will normally remove the need to cash out investments at low market prices if money is needed urgently.

An investment portfolio must be compatible with your existing investments and suited to your financial objectives, timescales, requirement for ethical investment, tax position and attitude to risk. However a balanced risk investor should include a range of risk assets including cautious and adventurous investments, provided the overall risk profile of the portfolio is balanced. This spread is to ensure diversity and wide market exposure.

Further you should understand the risk issues of individual investments. The risk of stockmarket  investments is not just about volatility of value – there may be inflation risk, default risk, liquidity risk and counterparty risk. For example inflation risk affects gilts and investment grade corporate bonds whilst counterparty risk affects structured products. Finally it is essential to grasp that the risk profiles of different asset classes are not fixed. For example gilts, underwritten by the UK government are traditionally viewed as safe investments. However they have enjoyed a spectacular rally since the banking crisis of 2008, they yield returns less than inflation and are arguably in bubble territory. In my view gilts, except index linkers carry considerable risk and offer low potential.

The single most important decision in constructing an investment portfolio is your asset
allocation; how you divide your money between and within the main asset classes – equities, fixed interest, index linked, commodities and property. A broad portfolio reduces risk through diversity and negative correlations. However asset choices should also reflect to some degree valuations and potential. For example within bonds I would avoid traditional gilts but recommend index linked corporate bonds and high yield corporates.

Whilst strategic asset allocation determines the long term game plan I don’t think a pure buy and hold strategy is sufficient. It should be overlaid with tactical asset allocation. For example cash can be held within an investment portfolio for good buying opportunities that might arise in the shorter term.

Finally it is imperative to regularly review your portfolio to bank profits, switch to cash for
tactical investment, use capital gains tax allowances and adjust the strategic allocations. If higher risk investments perform best they will increasingly dominate and the portfolio will need rebalancing. Reviews also should check the ongoing suitability of the portfolio and weed out and replace poor and underperforming investments.

In conclusion adopting key strategies and avoiding the traps will improve your chances of making money but you should seek individual advice before making investment decisions. The value of investments can fall as well as rise.

 

Dividend Growth Points to Equity Rally?

In the Business section of  last Monday’s Daily Telegraph (22/10/12) I read a brief but interesting article on dividend payments from British companies. A record £23.2 billion was paid out to investors in the third quarter. Citing Dividend Monitor from Capita the article reported that UK companies are distributing unprecedented amounts of cash. Capita have estimated this year will mark an annual record of £76.6 bn with 2013 set to top £81 bn.
 
I have noted previously that global companies are generally in very good financial health and are sitting on large cash piles. In the UK this is £750 bn. With economic uncertainty, investment of that cash may look unattractive whilst paying off debt may not be a priority given their low servicing (interest) costs. This suggests a sweet spot for UK equity income and illustrates why equity investing may be attractive even if the economy is not doing well.
 
On a similar theme about a month ago I listed to a web based presentation from Investment Week on US equity income. It was a round table discussion with three US fund managers. Overall I came away with a positive view of this sector. Some key points were:
 
* US companies have very strong balance sheets; valuations are reasonable and not expensive.
 
* Apple paid a dividend for the first time, however it was described as stingy. However they have $115 bn of cash on their balance sheet and $60 bn p.a. free cashflow. Dividend payments are likely to increase in future.
 
* In general American companies are miserly dividend players. Many like the security and flexibility of holding cash, after the 2007-2009 credit crunch and recession – the worst financial crisis in a generation. CFOs* and CEOs* have been ultra conservative and are petrified to hold debt.  Consequently dividend payouts have not kept pace with profit growth depressing payout ratios. However investors are hungry for yield and companies are realising the benefit of dividend increases on share price providing a positive loop. 
 
* Stocks yield more than bonds. In these scenarios equities are clearly favoured with the added potential of prospects for medium to long term capital growth and income growth.
 
* On the so called “Fiscal Cliff” of tax rises and spending cuts coming, some tax rises may be deferred. However the fiscal cliff could knock 0.7 to 0.8% off US GDP but it has been priced in.
 
* Historically election years have yielded very good returns for American equities in November and December  – the result removes uncertainty.
 
 
In conclusion equity income look attractive whilst the underlying fundamentals of dividends could signal a rally in global stockmarkets. Of course slowing economic growth may put the brakes on turnover and profits growth and this would result in pressure on dividend payouts. To this end funds with a focus on high quality companies with an ability to maintain and grow dividends are preferable to funds offering high yields which may be unsustainable.
 
* CFOs and CEOs – Chief Financial Officers and Chief Executive Officers.
 

Asset Allocation

There are different fundamental strategies available to investors both active and passive however it is universally accepted in the investment community that asset allocation is the single most important contributor to investment returns. The latter does not principally come from choosing the best stocks or fund managers. Estimates I have seen is getting the right asset choices accounts for 90% of returns. An example can be seen from 2008. The banking crisis in the autumn led to a savage sell off in equity markets whilst property and corporate bonds also fell. The best performing assets were safe haven government bonds including UK gilts and US treasuries. The point here is with hindsight in 2008 it would have been best to have held government bonds and avoided equities. Holding the best stocks or fund managers was largely irrelevant in equity markets that were selling off sharply and indiscriminately. You might have lost 20% that year rather than 30% – better than the average equity investment perhaps but cold comfort none the less.
 
In March 2009 equity markets rallied sharply and shares were the best performing assets. Those who bought into markets in late 2008 and early 2009 made a killing, although many investors having recently had their fingers burnt were too cautious to put cash into the markets when sentiment was so bad.
 
Similar analysis of historical asset performance from Scottish Widows show that commodities were the best performing assets in 2005 whilst data from Jupiter shows that European equities outperformed UK, US, Far East and Japanese equities in both 2003 and 2004. In recent years of course the tide turned for both assets –  European equities have fared badly with the EuroZone crisis whilst commodities sold off sharply in 2011 and early 2012. This demonstrates that asset performance is volatile and dynamic. Further valuations may reach bubble territory and turn traditionally low risk investments into high risk assets – for example UK gilts look very expensive and vulnerable to a fall in prices.
 
The problem with this analysis on asset performance is that it is observable with hindsight. Few people have the foresight to make a right tactical asset call in advance and those that do rarely commit all their investment monies to a single asset class as it would eliminate diversity from a portfolio and be extremely high risk if the assessment was wrong. Moreover it is not just about picking the right asset but getting the timing correct. All the evidence suggests timing the market is notoriously difficult. It is for these reasons that most investors have a spread of assets and many adopt a long term buy and hold strategy. This is advocated by a number of fund managers who stress the importance of “time in the market” not “timing the market” and offer evidence from historical data that the latter is costly if you miss a relatively small number of days where markets perform strongly. This is a fair point but I am not convinced a totally passive approach delivers the best results. Whilst most of us do not have the time to actively trade on a short term basis I think it is possible to overlay some tactical investment strategies over a core long term strategic asset allocation. 
 
So building a new portfolio from a cash today I would suggest a two strand approach a strategic long term asset allocation of some monies – currently I favour equities, commodities and high yield bonds over safe government bonds (index linked excepted) and property. Within equities I favour emerging markets, global equity income and smaller companies. In addition I would retain a sum of money in cash as an emergency fund and in part for tactical asset allocation to equities if markets crash.
 
In conclusion the greatest priority with your investment planning should focus on your asset allocation. It will need to be dynamic and active – monitoring and reviewing, taking profits, rotation in and out asset classes or adjusting the balance of a portfolio. In addition the right asset allocation for an individual investor naturally depends on a number of other factors – the size of a portfolio, the timescales for investment, attitude to risk and the purpose of investment. All of this is has to be assessed in the wider context of the global economy, current market conditions and the risk/reward dynamics of different assets. As usual individual independent advice should be sought.
 
Finally you may have come across model portfolios with set asset allocations. These are funds with allocations to different asset classes that depend on risk assessment or investment objectives. Space does not permit comment here except I don’t like them and don’t use them. They are off the shelf “Centralised Investment Proposals” (CIPs) which are matched to suitable investors. Personally I prefer individual tailored solutions whilst recently the Financial Services Authority have expressed concerns about IFAs “shoehorning” clients into CIPs. More on this subject in a future blog post.  

Favoured Investment Opportunities

Recently in advice to a client on investment of cash I briefly surveyed a variety of my current favoured ideas and other options. I thought my comments would form the basis for a blog post, so here goes.
 
1. Cash
 
This can be retained for risk reduction purposes. Cash is suitable for very cautious investors who are more interested in the return of capital rather than return on capital. However cash is also excellent for tactical re-investment into equities at a later stage, if there is a stockmarket crash. Last autumn with the EuroZone back in crisis and clear systemic risk I feared a major meltdown in equities. A variety of sticking plaster actions from the authorities have arguably treated the symptoms not the underlying causes  – government indebtedness, unemployment and poor economic growth is deep rooted. Elsewhere China’s ecomony faces a potential hard landing and the US a “fiscal cliff” of pending tax rises and reductions in government spending.
 
A crash may not occur but if it does it could knock equities back a long way similar to the banking crisis of 2008 and subsequent recession, and therefore provide excellent buying opportunities. In March 2009 the FTSE 100 fell to a low of 3,519 well below the closing value of 5,793 on 10/9/12. In contrast the risk of risk reduction i.e. in holding onto cash is if the crash does not happen and markets rally; buying into equities at a later stage then becomes more expensive. Further holding cash is a poor medium term investment – interest rates are low and are set to remain low and your capital is eroded by inflation in terms of its real purchasing power.
 
2. European Equities
 
Europe offers good long term recovery potential and should benefit from the recent decision of the ECB* to buy unlimited Spanish and Italian bonds. This will drive down yields and the costs of borrowing although as noted above it does not deal with the underlying EuroZone problems.. Despite the issues with the EuroZone, Europe is home to some excellent companies with global franchises and strong balance sheets. Exposure should be through an actively managed stockpicking fund rather than an passive ETF or index tracker. A good manager can weed out the basket cases for example financial stocks with exposure to EuroZone debt and the toxic Spanish property market.
 
3. IMA** Global Funds
 
This sector provides broad and diversified global equity exposure which can form a long term core element to a portfolio. A fund manager may asset allocate to favoured regions, although top down stockpickers may consider the domicile of a company to be largely unimportant. 
 
4. Global Equity Income
 
I am very positive about global equity income for long term investment, either for income and income growth or pure capital growth. We all know the importance of re-invested dividends. With large amounts of cash on company balance sheets, some will be returned to shareholders and the outlook for this sector is good although a slowing global economy may put pressure on the sustainability of dividend growth further down the road. Given this I favour funds with a focus on high quality companies rather than yield.
 
5. American Smaller Companies
 
These are my above average risk pick. I retain my positive view on America and this sector which has slightly underperformed the broader market in the last 12 months has strong growth potential especially as US consumer confidence picks up. The US smaller companies’ market is large, diverse and comparatively liquid. It includes relatively large capitalisations and established franchises. So we are not principally talking about micro caps and start ups. Smaller companies tend to be be more nimble, innovative and dynamic compared to large caps and during recovery and growth phases they typically outperform. During recessions however they underperform.
 
6. Absolute Return/Multi-Asset
 
These lower risk funds are arguably a better alternative than cash. There are prospects for capital protection but this is not guaranteed. There is also the potential for cash plus returns. Although there are target returns there are no guarantees of outperformance of cash nor guarantees of absolute returns.
 
7.  Gold
 
Here I refer to investment through an ETC (Exchange Traded Commodity). Gold is traditionally considered a good hedge against inflation and is inversely correlated to the US dollar. Prospects of further QE***in the USA is considered a positive reason to invest in gold as QE should weaken the greenback
 
Gold is also traditionally viewed as a safe haven and a store of value. However prices can be volatile and although the spot price is about $200 per ounce off the September 2011 highs, gold has had a long strong rally over the last 10 years. Some commentators predict the price of gold will go much higher; others are more bearish and consider it vulnerable. I am currently neutral about gold but reckon it could be suitable for many portfolios, but only as a minor holding.  
 
8. Commodities
 
These have been covered in a previous blog on 11/7/12. Along with emerging markets and technology these higher risk sectors are favourites of mine as long term holds, for regular savings and for tactical investment from cash – the latter two strategies can benefit from volatility.
 
 
Please note these investment options carry different risk profiles and may not be suitable for you. Independent financial advice should therefore be sought.
 
* ECB is the European Central Bank.
 
**IMA is the Investment Management Association, who group funds with similar investment mandates into sectors. This enables meaningful comparisons between funds.
 
*** QE is Quantative Easing or money printing. It is designed to stimulate the economy through increasing the money supply and involves buying governments bonds from banks and other institutions. This drives down the costs of government borrowing but I am not convinced money is getting through to the real economy.
 
Mike Grant

Perspectives on China

I like fund managers and economic commentators who are opinionated. They are likely to come up with interesting contrarian thinking and challenge established norms. They stimulate investment ideas and if right the strategies that come out of these ideas are profitable. Recently I came across Michael Godfrey co-manager of M&G’s Asian and Global Emerging Markets funds. I have to admit I have never used M&G for these sectors and Godfrey had not previously come onto my radar as a fund manager to watch. However in an article in Investment Week he made some interesting observations on China. He argued that back in 2007 valuations of Chinese equities were ridiculously expensive at 45x earnings. Now they have shrunk to a more realistic 10x earnings. However he considers State Owned Enterprises to be uninvestable due to poor deployment of capital whilst private sector firms have used resources more wisely. Godfrey is however wary of the domestic consumer story – it is safe but equities in this sector are now very expensive.
 
Godfrey looks for undervalued companies which will add shareholder value. He likes companies with a good long term strategy and berates investors for looking at short term figures and being obsessed with forecasts. He is particularly scathing on macro metrics, for example supporting an investment case for China based on high GDP growth.* In words reminiscent of Yorkshireman Geoffey Boycott’s forthright views on cricket he says this is utter rubbish! What counts is how companies use and benefit from that growth. To support this he states that Chinese equities have been very volatile and a terrible investment despite high GDP. Finally he contrast this with firms in Mexico, South Africa and Brazil where GDP growth has been lower but equities have performed better due to being shareholder friendly.  
  
At the same time in another recent article on China, famous US investor Jim Rogers dismissed fears of a hard landing and rounded on Hugh Hendry of Eclectica (he appears occasionally on BBC2’s Newsnight as a studio guest discussing the economy) and Albert Edwards from SocGen who have both been long term bearish on China. Edwards reckons a hard landing will result in a collapse in stock prices. Rogers does not dispute a scenario of share price collapse but is bullish on Chinese equities and sees a sell off as an opportunity to buy back in. There are clear opportunities here as recently the Shanghai Composite index closed 40% down on its August 2009 highs. Rogers is not concerned about slowing growth and sees this as proof the authorities are managing the economy as intended. He compares China with the US which in the 19th century went through 15 depressions before emerging as an economic success in the 20th. Finally he considers China better able to withstand global shocks due to substantial foreign exchange reserves.
 
 So what’s my view?** I am moderately positive on China. I see it continuing to power ahead with strong economic growth and development of a large affluent middle class and to become the world’s leading economy. However there are substantial risks for investors and I strongly favour an active stockpicking style of fund management over passive index tracking or a top down investment. There is clear value and opportunities to buy in at low prices. Figures from Morningstar show the average IMA China/Greater China fund is down 18% in the year to 27/7/12 and just 1.7% up over three years. To reduce risk China can be accessed via a global emerging markets or Asia Pacific fund. For a pure China fund my old but spurned friend of monthly savings should be considered, not only to reduce risk but to benefit from volatility.  
 
* Godfrey touches upon a classic distinction between top down and bottom up investment styles. The former seeks to formulate strategies based on macro economic analysis or global trends; the latter focuses instead on company specific issues and stockpicking. Many managers employ a blend of the two styles.  
 
** Individual independent advice on investing in China should be sought.
 

Liquidity Squeeze in the Bond Market

Liquidity Squeeze in the Bond Market 

The lead article in a recent edition of Investment Week, a trade paper I subscribe to highlighted significant liquidity issues in the bond market. Liquidity refers to the ability of traders, fund managers and investors to trade stock. It is crucial to ensure a properly functioning market whilst a liquidity crunch can cause difficulty in establishing prices which may collapse with no buyers. It could increase the time or even ability of a fund manager to meet requests for redemptions and could even cause parts of the corporate bond and gilt market to shut down and funds to close. There is a recent history of this during the credit crunch and financial crisis of 2007-2009 where the commercial property market became highly illiquid and effectively shut down. Specialist commercial property funds were forced to cease trading and investors could not sell out. Eventually as the credit crunch eased liquidity improved and these funds re-opened.

The causes of the liquidity issues in the bond market are various. Banks are reluctant to trade as they are forced to raise capital and bond issuance has fallen as companies hold cash on their balance sheets. At the same time demand for corporate bonds from investors has risen due to their perceived lower risk compared to equities and the high income they provide compared to cash. The Investment Management Association (IMA) reported that the Corporate Bond sector has been the best selling sector for 10 out of the last 12 months.

Given these market conditions corporate bond funds may be forced to hold large cash balances as a buffer to help meet redemptions whilst the Bank of England could intervene to help maintain liquidity by acting as a market maker, buying and selling corporate bonds.

So should a liquidity crunch worry investors holding corporate bond funds? Possibly. The most popular funds are mega sized investments which face trading issues in normal circumstances not just during periods of illiquidity. For example the M&G Corporate Bond fund held £6.2 bn at 29/6/12 whilst the Invesco Perpetual Corporate Bond held £5.4 bn (Source: Morningstar). Imagine the practical difficulties if the fund managers want to change the asset allocation of their portfolios and this requires selling £1 bn of bonds. Aside from the difficulty of finding buyers, dumping a large amount of stock onto the market can distort prices. In contrast a smaller fund of say £500 million is much more nimble.  

Whilst I have no knowledge or expectation that “super tanker” sized funds plan to close to new investors, if they do income payments should continue as usual and redemptions may still be possible. However a large number of sellers from funds will drive prices of corporate bonds lower if the unit trust or OEIC manager does not have enough cash and has to sell stock to cover redemptions.* 

If redemptions from corporate bond funds are suspended investors will need to ensure they can access cash elsewhere, highlighting the importance of keeping an emergency fund. It will also mean you will be unable to undertake tactical or strategic investment decisions for example a rotation from corporate bonds to equities. However the real concern is if panic selling drives values of bonds lower. Aside from a liquidity crunch that may cause this, it could be triggered by the bubble in the gilt market bursting.** Prices will fall and this could drag corporate bonds down as well, especially investment grade stock. That said the government and the Bank of England will employ every tactic in the book to keep gilt yields at record low levels.

So what is my advice? For long term income investors corporate bonds are excellent investments, very tax efficient within an ISA and most people would be advised to stick with their holdings. However I prefer high yield to investment grade given the former offer an attractive yield premium for the additional credit risk, low default rates and less sensitivity to interest rates. They provide equity like returns but with lower volatility. For those investing in corporate bonds for low risk growth and sitting on profits it is worth reviewing your holdings and possibly switching to alternative lower risk investments in whole or part. As usual you should seek individual independent advice.

* In contrast to OEICs and unit trusts, closed end funds such as investment trusts, which are legally structured as companies listed on a stock exchange do not have to sell underlying assets when investors sell their shares and this is a distinct advantage over open ended unit trust or OEICs. Selling drives the share price of the investment trust down but not its asset value. More on this at a later stage.

** Not everyone subscribes to the view that there is a bubble in the gilt market. Yields have been driven to historic lows and hence prices to historic highs since 2008. Many professional investors have been surprised that prices continue to defy gravity and have continued to rise. Various factors including government and Bank of England policy are supportive,such as Quantitative Easing (QE). If there is no bubble nor danger of a collapse in prices on the scale of 1994 all one can say is that at best gilts offer poor value.

Tactical Asset Allocation Shift

Following my last post in which I stated I was taking a more active role in asset allocation advice you may be aware that last autumn concerned we were heading for a stockmarket crash from the Eurozone debt crisis I switched my pension fund to cash. This is despite the fact that I am bullish on equities as a long term investment. They remain my favoured asset class. Corporate balance sheets are generally strong with the significant deleveraging that has taken place in recent years and companies hold large cash balances. Valuations are also good both in absolute terms and relative to gilts and corporate bonds. In my view equities have suffered in the last few years from the sins of the bond markets and the profligacy of government debt. This has meant equities have been priced not on fundamentals but “risk off” sentiment and good quality companies have been sold indiscriminately.
 
The crash has yet to happen and may not, but I have targeted the FTSE 100 index, a proxy for global stockmarkets hitting 4,000 as a trigger for me to rush back into equities. The intended temporary switch to cash was therefore a tactical asset allocation decision. If I get it right I’ll make a significant profit – if I get it wrong and eventually buy back into equities at higher prices than I sold out at I’ll take a hit.
 
Last week during a review of a client’s portfolio I spotted an excellent buying opportunity that should have been blindingly obvious to me earlier – that commodities and mining and natural resource companies had fallen sharply in the last year. One favourite fund of mine, the JP Morgan Natural Resources with a long track record of excellent performance was down 30.1% to 22/6/12 (Source: Morningstar). The downturn is due to slowing global economic growth especially in China and fears of a Euro break up. Commodities are very economically sensitive and hence prices are highly volatile. However the long term investment case is compelling – with a rising global population, strong economic growth in emerging markets and limited supplies of commodities. It is classic market with favourable long term supply and demand characteristics. Consequently I expect a strong rebound at some stage in commodities and resource companies. So I decided to re-invest 25% of my cash into the JP Morgan fund. I’ll let you know in due course how I get on.
 
Now I am a high risk investor and there is a real risk that commodity prices may fall signficantly further or stayed depressed for longer, but this was an opportunity that I could not resist. For investors sitting on cash or looking to invest this year’s ISA allowance you could do no better than consider a similar exercise although this is not for the faint hearted. Naturally individual advice would be required and you should not consider the JP Morgan Natural Resources fund as a definite recommendation for you. Finally you should note there are alternative buying opportunities. The average IMA Europe (excluding UK) fund is down 17.5% in the year to 22/6/12, the average IMA China/Greater China fund is 14.9% lower and several India funds have fallen by more than 20%.
 
Finally to end on something I have banged on about previously – monthly investment. When I switched to cash last year I maintained my regular monthly pension contributions and continued to invest in equity funds. I figured with the downturn in prices following the re-emergence of the Greek financial crisis in August and a possible crash I would pick up units cheaply. A prolonged period of depressed values is highly beneficial when followed by a rally in prices. The risk reducing features and investment opportunities of regular savings is not widely adopted enough by investors who are holding onto cash. I have noticed a significant downturn in new investment since August. In my view risk adverse investors who are not prepared to commit lump sums should seriously consider a flexible regular savings plan instead for example using ISA allowances. These have low minimum contributions, typically £50 p.m. and there is no minimum term unless they are life assurance based. Savings can be suspended at any time and investment trust savings schemes offer a low cost option. 
 

Episode Investment

Inspiration for my investment blogs and previously my investment e-mails may come from unexpected sources. This one was from a normally dull type of communication that I regularly receive, about changes to a fund range – investment objectives, mergers or fund names. They normally get filed or sent for recycling. The letter and document in question was from M&G about changes to their multi asset funds including the M&G Cautious Multi Asset I have recommended to some clients.
 
M&G are rebranding their multi asset fund range to include the phrase Episode in their name. It reflects an evolution in their management of this type of investment which they claim is unique. The name reflects an approach that seeks to identify “episodes” where assets are inappropriately priced as a result of investors reacting emotionally to events rather than considering normal investment principles. M&G cite inflation or interest rates here. The episodes could be short or medium term.
 
This well respected investment company make an excellent point and touch upon a key issue in investment known as behavioural finance; how investors think and behave. When they get it wrong it results in panic selling, indiscriminate selling irrespective of quality, buying high, selling low and burying heads in the sand. This is also true for professional investors who drive markets and asset prices to irrationally low or high prices detached from fundamentals.
 
M&G do not say what episode investment means in practice but presumably it includes tactical asset allocation, buying underpriced quality assets and contrarian investment, going against the herd. I like active brave fund management. It also reflects my general aversion to inflexible model portfolios, fixed risk assessments of asset classes and closet tracking.
 
Whilst I have sympathy for a buy and hold investment strategy especially for long term investors for example those saving for retirement, asset allocation has been proven to be the single most important factor in delivering investment returns. For this reason I have taken an increasingly proactive interest in asset allocation advice to my investment portfolio clients – for example my recommendation to consider selling to cash last autumn. At another level I also recommend multi asset funds where I delegate active asset allocation to fund managers I think do it well.   
 
As previously noted in an earlier blog post http://www.montgomuse.co.uk/expectation-of-future-investment-returns/  
 
an environment of low returns and high volatility is expected in the future. In these circumstances I consider episode investment to be a key tool for fund managers in adding value. It would not also surprise me to see this phrase becoming commonly quoted by investment commentators and the concept copied by other fund managers. Logically and perversely if it is widely adopted it should end panic selling and other bad behaviours by causing a return to a focus on fundamentals. Then again pigs might fly or should I say have episodes of aerial movement.

Future Outcome for the Eurozone

I recently read an excellent article on the Eurozone from John Greenwood, Chief Economist of Invesco Ltd. In it he argues that there are now only two possible outcomes to resolve the debt crisis – unilateral default and exit by Greece and possibly other economies or full fiscal union. Prolonged austerity will not work.
 
The first scenario with a Greek exit runs the risk of contagion. A default on all external debts and a new depreciated drachma would rapidly restore Greece’s competitiveness and growth. This would then become an attractive option for Portugal, Ireland, Spain and Italy. Exit would lead to a run on the banks as depositors including foreign institutional lenders seek to protection funds from conversion to new drachmas, escudos, punts, pesetas or lire. Greenwood also detailed the difficulties in constructing sufficient firewalls and concluded there would be grave consequences for financial markets.
 
Full fiscal union means a move to central control of Eurozone government revenues and expenditures with a federal government issuing bonds on behalf on all states collectively. Greenwood sets out some examples from history. The one I found most interesting was the monetary union of the United States. The US created a fiscal union before a monetary union, following the War of Independence where the federal government would bail out the indebted states and pay off foreign creditors in exchange for powers to raise revenue in future. Greenwood argues if Brussels took over the debts of Greece etc. the immediate credit crisis would recede and Euro credit could rank alongside US Treasuries.
 
In the 1830s, following a slump in the rail road boom,  many US states became over indebted again. However the federal goverment which had established a good name in the credit markets did not bail them out to avoid undermining this. Monetary issues were not finally settled until after the Civil War.
 
Various commentators have argued Euro monetary union was destined to fail as it was flawed from the outset. Greenwood concurs that it is a huge mistake to combine economies with different per capita income, productivity and social systems into a single currency. Booms and busts in the periphery will inevitably lead to debt and banking crises undermining the integrity of monetary union. The Eurozone will need to move to a fiscal union with the powers to tax, borrow and spend in the name of the union. If the federal entity is financially secure it can impose a no bail out policy. There would be no repeat of the Eurozone capitulation to bail outs to date that now threatens the monetary union. Greenwood finishes that we’ll know in a few weeks whether we will see break up or full fiscal union.