Profit-Taking Season

During August I have been busy with investment portfolio reviews. A key element of these has focused on profit-taking. It is always very pleasing to present an investment report to a client that shows a portfolio and individual funds in the black. However gains are only paper profits until they are banked or crystallised. They can disappear much faster than the time they took to accrue. In the same way paper losses are only real losses until they are crystallised.

Profit-taking can take various forms. The most obvious is to sell the profits to cash. This may be required if clients have a major item of expenditure that needs funding or if they wish to top up their cash savings. The alternative is to retain the cash within the investment for example an ISA deposit facility or a money market or cash fund.* This gives the option of fast tactical investment back into equities in the event of a significant market sell-off.

When I advise profit-taking I normally recommend retention of the original capital unless the market or sector the fund invests in is overvalued or there is a risk of a sell-off. For example a client invested £5,000 in August 2013 into a Japan smaller companies fund and it was valued at just over £7,850 nearly three years later. We sold £3,000 to ISA cash but retained nearly £5,000 in the fund because in my view there is further potential for strong capital growth from Japanese smaller companies.

Profit-taking is generally about risk reduction, especially with switches to cash. A less defensive alternative is to invest in cautious risk investments of which there are a variety of options including managed multi-asset, targeted absolute return, or short dated bond funds. One benefit of these is they have the potential to beat the returns on cash and usually inflation as well especially over the medium to long term. Cash is great for the short term but holding too much for too long is a drag on portfolio returns and its real value will invariably be eroded by inflation; so cautious investments offer something extra.

A final option for profit-taking is to invest in assets or markets where the client has no exposure to or is under-represented in the portfolio, especially where valuations are attractive. It permits rotation out of highly valued markets where further upside potential is limited or is liable to a sell-off if large numbers of investors take profits and exit, to markets or sectors with better prospects. Here risk reduction is created through adding diversity and holding funds with less downside risk and more attractive valuations.

To finish I want to cover the tax position on realising gains from investments held outside ISAs or pensions. As you may know everyone has a capital gains tax (CGT) allowance. In 2016/17 this is £11,100. This is a very useful allowance for absorbing realised gains without incurring a tax liability.

Now as it is exam results season this blog comes with a test. Don’t think you can get away with just being a passive reader!

Using the example above but rounding up the figures – Patrick invests £5,000 into a Japanese smaller companies fund outside an ISA and exactly three years later it is worth £8,000. He draw out £3,000 representing the accrued profits. Ignoring any buying or selling costs:

1. What is the gain realised for CGT purposes?

2. What is the relevance of the three year period?

You’ve got one minute to think about it. When done please scroll down the page.

Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook
Brain activity, calculations, CGT, taxman, gobbledegook

OK here are the answers. If you said £3,000 to question one I’m sorry it is not the correct answer. If you said £1,125 award yourself a prize. This is because the withdrawal of £3,000 is deemed part original investment and part profits. As a proportion the £3,000 encashment from an investment worth £8,000 is 3/8ths. So on the same fractional basis the amount of original capital withdrawn is 3/8ths of £5,000 i.e. £1,875. This means the profits are £3,000 – £1,875 = £1,125.
This is the figure that counts against the £11,100 CGT allowance. The key point here is that more money can be encashed without realising CGT than might appear at first sight. Subsequent withdrawals are more complex but by now you have probably enough of the maths, are bored stiff or are miffed you were asked to take a test!

As for question two, the period over which profits arose is irrelevant to the calculations. It does not matter whether the gains were accrued over one year or three years. In the past, the investment timeframe did matter as an allowable reduction in the chargeable gain was available for inflation over the period. This so-called Indexation Allowance was scrapped for private investors some years ago although it is still available for companies paying corporation tax including life assurance companies running investment life funds.

*A cash or money market fund is a collective investment like a unit trust rather than a deposit account. It invests in cash deposits and near cash instruments such as floating rate notes and short term bonds such as Treasury bills or commercial paper (please google if you want further information on these). Money market funds are highly secure and liquid but because they have a management charge or may potentially be affected by defaults they may yield very small negative returns occasionally.

The content of this blog post covers investment strategies in general that I use and should not be construed as advice to you. This article is not a recommendation to invest in Japanese smaller companies as these may not be suitable for you. You should seek individual advice before making investment decisions.

A Month On From That Vote!

It would be fair to say that it has been an interesting time since the EU vote, both politically and from an investment perspective. The extent of the rally in UK equities has been surprising given the mantra, “markets hate uncertainty.” Logically equities should have fallen as there has been uncertainty by the bucket load. However the attractive investment opportunities that have arisen in the last month have trumped uncertainty, for the time being at least. The fall in the pound has been a boost to exporters and companies with significant overseas earnings. At the same time UK assets whose prices have been effectively discounted by a weaker pound are attractive to foreign buyers, offsetting the fear of less inward investment. Finally with bond yields falling income investors are turning to risk assets. Columbia Threadneedle observe that UK equities are yielding four times more than 10 year gilts. With dividend yields on solid blue chip companies such as Shell, HSBC and Glaxo north of 5% or even 6% p.a. you can see why investors are attracted to equities given the added potential for longer term capital growth as well.

M&G Investments correctly highlight the risks of a return to inflation from weak Sterling and the UK’s reliance on imports. A rising oil price is a key factor especially as commodities are priced in dollars. In addition M&G see inflation rising in the US, the engine of the global economy. As the slack in the labour market disappears so wage growth is expected. They recommend investors consider buying inflation protection for example from short dated index linked bonds.

Finally Fidelity Investments comment on the poor PMI figures, announced recently. The PMI is the UK Purchasing Managers’ Index and is a survey of economic activity in the manufacturing sector based on hard data such as new orders and employment. Of course reduced inward investment into the UK will be a drag on economic growth but Fidelity think that this view is too cautious. They highlight the attractive valuations of UK assets as noted above but also cite the fact that companies have hoarded cash in recent years due to an uncertain outlook for end demand, especially in software and healthcare. This cash may be used to bid for UK companies. Finally they observe the robust UK economy has been broad based and by implication it is sustainable.

So what do I conclude? Firstly economics cannot be divorced from politics and it seems to me that the quicker than expected installation of a new Prime Minister, considered by many to be a safe pair of hands has reduced uncertainty for investors. The economic impact of the EU vote is clearly more nuanced than predicted and it has thrown up new risks and new investment opportunities. It was never going to be all bad or all good.

At a broader level the EU vote has not changed much for me. Ultimately fundamentals will re-establish themselves and my role is to continue to find good stock picking and asset allocating fund managers for my clients’ investments and to encourage them to stay invested through thick and thin.

The content of this blog post is intended to be my own general investment commentary and a summary of my understanding of investment company views. It is not an invitation to invest in equities or inflation linked investments as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.

 

Seismic or Temporary Shifts?

One of the most interesting aspects of my job is to produce updated portfolio valuation statements for my clients’ investments. Sometimes it makes good reading, other times not. In my report I compare the figures with previous valuations, typically undertaken six months’ earlier. Aside from the change to the total figure it is very instructive to see investment trends i.e. what asset classes, sectors or funds have done well or poorly over the period in question. In the last six months there has been some significant, unexpected and interesting changes to asset performance.

To explain I want to go back almost a year to August 2015 to the global equity sell-off, triggered mainly by fears about China. You will recall her economic growth was slowing, global trade was falling and Chinese debt was a worry. During the sell-off the shares of large companies represented by the FTSE 100 index fell sharply whereas UK smaller companies and many mid-caps did not. Why was this? The falls in the share prices of larger companies was a rational reaction by investors to concerns about the health of the global economy. FTSE 100 companies are global players with around 70% of their earnings derived from outside the UK. The index also has a high weighting to oil and other commodity companies whose fortunes and share prices are extremely sensitive to the global economy and specifically Chinese demand. In contrast UK smaller companies and mid-caps, typically represented by the FTSE 250 index are much more domestically focused with most of their earnings arising in the UK. As the UK economy was recovering well and smaller companies are less impacted by global events they were largely insulated from the slowdown in China and their share prices held up well.

Roll on to the EU referendum and in the two weeks since the UK voted, FTSE 100 companies have generally rallied sharply (the banks being a notable exception, due to their domestic focus). Why? The pound has fallen sharply against other currencies notably the dollar which means overseas earnings are worth more when repatriated back to Sterling. A weak pound is bad for imports but it sure gives a turbo charge to global earnings and UK exporters. In contrast a vote to leave Brexit has resulted in uncertainty and fears about the UK economy specifically. You will be aware of all the potential problems – trade tariffs, reduced investment into the UK, jobs relocating to the EU, higher inflation, recession, higher taxes and interest rates. It would be fair to say some of the fears are illogical or over-stated. For example if the UK goes into recession it is likely to be mild and interest rates are unlikely to rise.* Other fears are of course entirely justified and uncertainty itself is a powerful disincentive for investors. It is for this reason that smaller and medium sized companies with their focus on the UK domestic and consumer economy have fallen sharply in the last few weeks. House builders and recruitment companies have been hit especially hard.

So in summary, global events last August hit FTSE 100 companies hard but the vote to leave the EU has now triggered a rally in their share prices whilst the opposite has happened to smaller companies and mid-caps. I should also add that in the last five years smaller companies significantly outperformed larger companies and mega-caps and I suspect investors used the Brexit vote to take profits.

Moving on I want to highlight another asset allocation shift in the last six months. Anyone who has invested into a commodities fund in recent years will have seen huge losses on their investment.^ As an example take the JP Morgan Natural Resources fund. Data from FE Trustnet (6/7/16 and for all other performance statistics) shows the fund is down 53.9% in the last five years. However the last six months there has been a rally of 50.5%. Yes you are reading correctly! The rally has been due to the significant recovery in the oil price since the January and February 2016 lows, a small decline in the value of the dollar~ since the beginning of the year, more efficient deployment of capital by commodity companies, some abatement of fears over China and investors recognising the exceptional value in an over-sold sector.

Precious metals have been beneficiaries too with the spot price of gold and the shares of gold producers rising sharply. Gold has recovered its safe haven status whilst a fund I recommended to many of my clients and bought myself, the Blackrock Gold & General is up a staggering 117.5% in the last six months. I will be the first to admit I wrongly called the bottom of the commodities’ crash and advised clients to invest too early but I am pleased I got one thing right. I recommended clients hold their loss making funds on anticipation of a recovery. I always suspected that when a rally comes it would be rapid and substantial. It’s nice to be right occasionally!

The other major assets that have finally rallied in the last six months are global emerging market equities reversing a long trend of underperformance compared to developed market equities. The average global emerging markets fund is up 22.1% in the last six months. There are multiple factors here, one of which is the rally in commodity prices; the two sectors are correlated. More perhaps at a later stage on emerging markets.

Whether these asset allocation changes are the start of seismic shifts in favoured asset classes or just temporary rallies is too early to say. I think the global economy needs to recover more before we can conclude the rally in commodities and emerging markets is sustainable.

*Mark Carney, the Governor of the Bank of England warned of a technical recession. This is hardly a scary prospect as it could mean as little as a 0.1% decline in GDP for two successive quarters. If there is a recession interest rates are more likely to fall than to rise unless inflation is a serious issue in which case we could see so called “stagnation.”

^A loss is only a paper loss unless an investor crystallises the fall in value by selling or switching to another investment.

~There is a historic negative correlation between commodity prices and the US dollar. Commodities are priced in dollars and when the dollar falls in value against other currencies it is cheaper for non-dollar investors to buy commodities and vice versa.

This blog post is intended to be general investment commentary only. Nothing in this article should be construed as investment advice. You should seek individual advice based on your own financial circumstances before making investment decisions.

Initial Thoughts on the Vote to Leave the UK

 

The result of the EU referendum was a huge surprise to me but the initial market reaction certainly was not. Sterling has fallen especially against the dollar whilst the FTSE 100 stock market initially plunged 8.5% but has reversed some of these losses. As I write at 10.06 a.m. the index is down 5.19%. As investors we know markets hate uncertainty and I expect volatility to continue for the next few weeks and months at least.

It is important to recognise not all the consequences of market falls are negative. So let’s consider a falling pound. Yes it makes imports and foreign holidays more expensive but there potential benefits. Exports become cheaper whilst the economy would benefit from modest inflation. Further around 65-70% of FTSE 100 company earnings are from overseas and therefore large companies and mega-caps are less dependent on the state of the UK economy compared to FTSE 250 and UK smaller companies. In addition if a company has earnings in overseas currencies such as dollars, euros and yen on redemption back to the UK and conversion to Sterling there is a currency boost. This should support dividends. Finally UK assets become cheaper for foreign investors and whilst there will be concerns about investing in the UK given the economic certainty, merger and acquisition (M&A) activity could be boosted by attractive valuations of UK companies.

You have no doubt listened to competing voices and experts on the UK economy throughout the referendum debate. Today I want to refer to two. The first Mark Carney, Governor of the Bank of England said today that the banking system in the UK is much better capitalised compared to the financial crash in 2008. I have not encountered anyone who believes we are witnessing the start of another global financial crisis on par with that which followed the collapse of Lehman Brothers. That was caused by too much leverage or debt in the banking system. Today’s events are geo-political with terms of global trade at stake.

Secondly this morning I read a blog post by Neil Woodford, founder of Woodford Capital. He is rightly recognised as arguably the best UK equity fund manager. His firm commissioned an independent report from Capital Economics to examine the implications of the UK leaving the EU. The conclusion of the report was that in the long-term the effect on the British economy would be largely unaffected. Woodford himself subscribes to this view. He is a long-term investor and believes that fundamentals ultimately will determine the movement of  equity prices. He does not buy the market, he buys strong companies with robust cash flows that can grow earnings, at attractive valuations. He backs his convictions and avoids short term noise on the belief that if a company has strong fundamentals it will deliver solid returns for investors. That is my opinion too. However with the potential for fast moving and unpredictable turns of events this is unlikely to be my last blog post on the subject of Brexit.

This blog post reflects my views and interpretation of third party commentators on the UK economy and the vote to leave the EU. Nothing in this article should be construed as investment advice. You should seek advice before making investment decisions.

 

 

Market Rumbles & Negative Yields on Bonds

Equity markets have been on the slide recently but this afternoon the FTSE 100 closed up 43 points. However the index is still below the psychologically significant 6,000 level. Naturally fears of a vote for the UK to leave the EU is clearly weighing on investors as is negative economic data and concerns about rising US interest rates. The flip side of uncertainty is a rally in traditional safe haven assets such as government bonds and the Japanese Yen. This is a risk-off market.

A rally in government bonds causes yields to fall and in some cases into negative territory. For example 10 year German Bunds turned negative for the first time yesterday. Buying such bonds at such high prices and ultra low interest rates means investors are guaranteed to make a capital loss if they keep the bond until redemption, even taking into account the interest received (these are called the coupons).* The question is why would investors buy bonds with negative yields? Institutions such as banks may be required to hold them due to regulation whilst pension funds hold bonds to match their liabilities with the guaranteed interest stream they pay. However for the private investor it would be daft to buy bonds with a negative yield.

So is it worth holding gilts? They are not yet negative in the UK so there is a case for their inclusion for portfolio diversification purposes and as a safe haven asset.  With returns expected to be like thin gruel low cost index trackers or ETFs can add value if not active management. Alternative cautious risk investments include cash, gold, currencies such as the Yen and Dollar or multi-asset targeted absolute return funds.

*Consider a bond that costs £105 to buy with a coupon of £1.50 p.a. The bond has three years to redemption. The investor receives three interest payments of £1.50 and a return of capital at its par value i.e. £100. The investor would have paid £105 to get a total return of £104.50.

The content of this blog post is intended to be my own general investment commentary.  It is not an invitation to invest in the defensive assets discussed as these may not be suitable for your financial circumstances or your risk profile. Aside from cash the investments mentioned do not guarantee to deliver protect capital in all market conditions. You should seek individual advice before making investment decisions.

BREXIT – Good or Bad for Investors?

I guess you have been following with interest the debate on the upcoming vote on BREXIT. Some people could be forgiven for thinking that BREXIT will either mean economic collapse for the UK followed by a plague of locusts or a country flowing with milk and honey and an economic boom. However we know the truth lies somewhere in between these extremes.

Tactical Trading

Whilst issues such as the economy have been widely discussed the impact for investors has not, so I thought I would offer my penny’s worth based on what I have gleaned from investment companies and my own thinking. Most fund managers argue investors should not make big asset allocation calls and investment decisions based on a binary outcome. I can explain this with an example. Investors fearing a vote for BREXIT would result in a sharp sell-off in UK equities and other holdings might be tempted to sell investments and portfolios to cash prior to the vote on June 23rd.  It could work. In the event of an out vote UK stocks at least are likely to fall the following day, who knows by 5-10% or more, with a downward trend thereafter. We know that markets hate uncertainty and the “leap in the dark,” card has been widely played by the remain campaign. In my view uncertainty, economically and politically, applies even if we remain in the EU, especially in the long term but I think it is fair to say as far as the markets are concerned a vote for BREXIT carries much more uncertainty especially in the shorter term.

The problem with selling to cash is that a vote to remain is likely to trigger a relief rally in equities not only in the UK but globally so the investor who sells to cash before the vote may end having to buy back in at higher prices. As I have previously argued short term tactical investment is notoriously difficult to get right and for most investors, who are in for the long term, doing nothing may the best choice. After all adopting a buy and hold strategy is probably what you signed up for in the first place.

Sterling

So what are the consequences of a vote for BREXIT for investors? We need to consider this from a number of perspectives. JP Morgan argue the impact on Sterling will be crucial. A BREXIT is highly likely to lead to sharp falls in the pound on the basis the UK is a more risky place to invest and the economy will shrink, at least in the short term. This will makes imports more expensive which should push up inflation. On the other hand exporters will enjoy a tailwind from a weaker pound and modest inflation itself is beneficial for an economy, as it removes deflation risk and erodes the real value of debt. Moreover historically equities have done well in this environment.

A fall in Sterling against the major currencies of the dollar, euro and yen will boost returns to UK investors in overseas equity markets. This will provide some compensation if UK equities fall and this is a factor in favour of retaining global funds, unless they hedge their foreign currency exposure. A currency hedge only works when the Sterling strengthens. This is explained in a footnote.

Government Bonds

As a safe haven gilts or UK government bonds are expected to rally on a vote to leave the EU and this will hedge to some degree losses on equities. However around 25% of UK government debt is owned by overseas investors and with a drop in Sterling, returns in their local currency will fall. Large scale redemptions will send bond prices lower and yields higher. The cost of borrowing will therefore rise when the Treasury seeks to issue new debt and higher interest payments adds to the budget deficit. Another downward pressure on gilt prices would be from rising interest rates employed by the Bank of England to combat inflation.

Fidelity’s view is that in the event of a remain vote gilts will weaken in favour of riskier assets such as equities. This is a perfectly logical expectation.

Equities

In the event of a leave vote most commentators believe equities will fall at least in the short term. UK smaller companies should however be more insulated than larger companies which have significant overseas earnings and are more geared to the global economy. The crucial factor here is the predicted fall in Sterling. When overseas earnings are repatriated to Sterling they take a hit. In contrast smaller companies which are more domestically focused and principally depend on UK earnings will be less impacted by a weak pound.

Defensive stocks are likely to do better than cyclicals which are more economically sensitive. These include banks, construction and the consumer discretionary sector.

Summary & Conclusion

The question asked was “BREXIT – Good or Bad for Investors?” The key point for me is to distinguish the short term from the long term. In the short term the answer is clear. It will be bad. Markets hate uncertainty and a vote for BREXIT brings many.  Asset prices which to some degree have already discounted a BREXIT vote will take a big hit.  However in the longer term I think the UK economy and asset prices will repair and rally as trade deals are negotiated and the consequences of BREXIT play out. Questions about whether the UK will have access to the single market and the length of time taken to negotiate trade deals (from the back of the queue if you believe Obama) arguably misses the point. You don’t need a trade deal to trade. The UK economy has been a bright light in Europe and shares the creativity and dynamism of the US economy, so in the longer term I think the UK economy will be fine.

What has been interesting is that fund managers seem pretty relaxed about the vote in contrast to the doom and gloom and scaremongering by politicians. Long term they seem reasonably confident about the UK economy and the prospects for the funds they manage. They may have made some adjustments with the addition of defensive or overseas assets but there have been no radical overhauls of their portfolios. In part this is because they are long term investors and are conscious that the long term impact of BREXIT on the UK economy is very difficult to predict. All the voices that told us that if the UK did not join the Euro it would be a disaster for the economy were proved wrong. And which central banks or global financial institutions predicted the global financial crisis of 2008? Making predictions about the UK economy in 2030 seems plain daft to me.

I think the UK will vote to remain in the EU but if  you as an investor fear a vote for BREXIT there may be some action you could consider. You could buy gilts or gold or overseas equities. However I would not advocate doing anything radical or disruptive to your portfolio.

Finally if you need to withdraw cash from investments in the next few months or wish to crystallise profits you may prefer to do this prior to the vote, although do bear in mind the risk that a remain vote will raise equity values and you may cash out at lower prices.

Footnote on Currency Hedges

This can be explained by an example. Currently the pound is worth about 156 yen. Let us say you invest £1,000 in a Japanese equity fund. Your investment is valued at 156,000 yen. If the underlying fund grows by 20% in three years, in local terms your holding is now worth 187,200 yen. Let us say Sterling has weakened and has fallen to an exchange rate of £1 to 125 yen. If you sold the investment you would get back £1,497.60 (187,200/125). In Sterling terms you have made a 49.67% return on your £1,000 investment even though the underlying stocks returns in yen were just 20%. If however you were invested in a hedged fund or share class and the hedge was set at £1 to 156 yen the currency uplift from weak Sterling would be lost. You would also be expected to get back less than 20% due to the cost of the hedge itself.

Hedges are not a panacea for removing currency or any other risk. They can detract from returns. Of course in the example above if Sterling strengthened against the yen the hedge would be of benefit to UK investors.

 

The content of this blog post is intended to be my own general investment commentary on the impact of a BREXIT on investments. It is not an invitation to invest in the defensive assets discussed as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.

 

Property Investment & Residential Property Fund

It would be fair to say I have never been a great fan of direct property as an investment. However I need to qualify that and say I am referring to scenarios where clients look to invest in a single buy to let property funded by cash. Aside from the high costs of purchase and maintenance in time and money, there is no spread or diversification with a single property and this carries risk of rent arrears, periods when the property is unoccupied, bad tenants or neighbours, an area declining or an accident or damage that makes the property uninhabitable. Buying a holiday home is perhaps different given the use of the property primarily will be for personal use.

However my biggest issue with buy to let is that the asset allocation of a client’s portfolio may become highly skewed and unbalanced. As an example consider an investor who has a home with no mortgage worth £350,000, cash of £300,000 and equity funds and stock and shares ISAs worth £200,000. It is a reasonable spread. If he or she buys an investment property for £200,000, total exposure to property increases to £550,000, nearly 65% of the portfolio. Finally residential property has high entry costs; rental yields may be low especially in the South East, returns are taxable, you can’t make a small investment of say £5,000 to £10,000 unlike with equities and property may be illiquid and difficult to sell. Apart from these issues property investment has got a lot going for it! In all seriousness I like property as an investment, as part of a balanced portfolio, principally for its lack of correlation to equities and lower volatility. Moreover property is a real asset with historically good long term returns that is expected to beat cash and inflation.

So how do investors get access to property investment if not through a direct buy to let? Anyone who has ever invested in a with profits fund in a life assurance bond or pension plan will have had indirect exposure to commercial property. For example my local retail park at Sovereign Harbour in Eastbourne is owned by Prudential’s pension fund. In addition there are specialist commercial property funds many of which invest in physical bricks and mortar including offices, retail parks, industrial units and warehousing. Other funds buy into the equities of property companies or adopt a mixed investment strategy.

The investment profile of commercial property differs from residential property. The former is very economically sensitive and is geared to the business cycle. Returns are principally from rent with long term tenancies, high rental yields and regular upward rent reviews. It is less about capital appreciation as it is with residential property.

Another key difference with commercial property is it is more illiquid than residential, it is a restricted market with few institutional buyers and typically there is a requirement for substantial borrowing. During the credit crunch and the subsequent recession lending dried up and commercial property became difficult or impossible to value and sell. Trading in many unit trusts holding physical property was suspended. This meant investors were unable to cash out and values took a big hit. In contrast prices of funds invested in the shares of property companies recovered at a faster pace because equities are more liquid.

Whilst I have been aware of residential property funds these are unregulated schemes and many invest overseas. The former include student lets whilst the latter are especially exotic and high risk. Buying into a development of holiday villas in Cape Verde seemed about as attractive to me as forestry in Costa Rica. Naturally I have steered clear of recommending these funds. However recently I became aware of a fully authorised and regulated UK residential property fund, that can be marketed to UK retail investors. Crucially it is covered by the Financial Services Compensation Scheme (FSCS) in the event of default unlike unregulated investments and is located in the Investment Association (IA) Property sector.  As far as I am aware it is unique and on reviewing the fund I like the look of it. It avoids investment in prime London locations and currently holds 146 properties. Returns are from rental income and capital appreciation. Crucially the fund has no borrowings and it has an especially favourable PAIF* status which provides freedom from corporation tax. It can also be held with ISAs and SIPPs.

Returns from the fund have been good since launch on 7/1/13 and interestingly they have been negatively correlated to virtually all other classes including other funds in the IA Property sector, which invest in commercial property (Source: Fund provider, quoting Financial Express Analytics (three years to 31/3/16 with net income re-invested). It is a genuine portfolio diversifier although please be aware that correlations are not fixed and can turn positive. The principal downside of the fund are the high management costs which affect the net yield to investors. Capital growth is likely to be the prime source of returns in the long term.

In conclusion I am likely to consider this investment for suitable clients in future for part of their portfolio.

*A PAIF is a Property Authorised Investment Fund. They were introduced in 2008 by HMRC to address a unfavourable tax anomaly for property investors in funds. The taxation shifted from the fund to investors. Interest and other property income is paid gross. Within an ISA all returns are tax free.

The contents of this blog post is intended to be my own general investment commentary and is not an invitation to invest in property or property funds  as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.

Word on the Street

As I have gone about my business in the last month or so I have been picking up a consistent consensus view from fund managers. The figurative word on the street is that the global equity sell-off at the start of the year was an over-reaction, something which I thought at the time. Investor sentiment is clearly more volatile than fundamentals. Neil Woodford, arguably the UK’s best fund manager believes that fundamentals always reassert themselves over time. This is why he does not follow the latest investment fad – typically driven by news flows, momentum or sentiment. Instead he focuses on reliable companies with prospects for sustainable dividend growth at attractive valuations.

Concerning fundamentals the global economy faces considerable problems from sluggish growth, weak global trade, over-supply of commodities and other woes. Monetary policy remain abnormal with ultra-low interest rates and QE acting as life support for markets. Expectations for the timing of the normalisation of interest rates seems to have pushed out further into the future. It supports the view that the global economy is going nowhere fast. None the less there are some bright spots, markets and sectors which fund managers are attracted to – European equities are especially favoured. Another theme I have picked up on is a growing appetite for risk assets – cyclical sectors, emerging markets and resources are receiving attention based on good valuations. This could be an emerging fad. However a rising dollar will be a significant head wind to emerging markets and commodities.

On balance I still favour developed market equities although dividend risk is a worry notably in the UK with dividend cover (the level to which dividends are covered by earnings) now well below their 10 year average. I remain positive to smaller companies and US equities. A strong dollar benefits Sterling investors.

Fixed interest or bonds valuations remain generally unattractive. I favour high yield for income especially in an ISA. More latterly I have seen some value in gilts or government bonds given their safe haven status. They provide a hedge against equity sell-offs and are portfolio diversifiers. Other safe havens are the dollar, the yen and gold. Gold has rallied strongly this year re-establishing its defensive qualities.

The contents of this blog post is intended to be my own general investment commentary and interpretation of fund manager views and is not an invitation to invest in equities, bonds  or specific markets and sectors as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.

 

A View of the Global Economy

I recently sat an online training module offered by Invesco Perpetual on the outlook for the global economy. It was a thorough and interesting analysis and I thought you may benefit from various observations I gleaned as you think about your own investments.

Chief Economist, John Greenwood, who I have previously referred to as the sage of Henley re-iterated his view that the economic crisis since the financial crash of 2008 has been due to a balance sheet recession. In summary governments, companies and households have been carrying too much debt. Whilst deleveraging or paying down of debt has been occurring globally with various degrees of success, debt is still a major drag on the global economy and in many cases including in the UK it has actually increased since the crash. Borrowing is clearly encouraged by ultra-low interest rates and weak economic growth. Greenwood observed that in the USA balance sheet repair has progressed well whilst the UK and Europe are further behind in the process. Overall it has been a sub-par recovery.

The global economy is not only weighed down with high debt but has been impacted from declining global trade and sluggish growth. Demand for commodities, notably from China has collapsed and prices have fallen for the fifth straight year. This has negatively impacted on oil exporters and commodity producers such as Russia and Brazil. In addition a strong dollar is typically inversely correlated to commodity prices as these are priced and bought in dollars. If the dollar strengthens it makes commodities more expensive in local currency terms due to the adverse exchange rate and this is a market force that then reduces demand and hence prices.

A bull market for the US dollar has also brought other problems, Emerging market currencies have fallen sharply against the dollar in the last few years, making debt interest payments on emerging market government bonds that are issued and priced in dollars more expensive. In contrast bonds issued in local currencies are not affected by the strong dollar. The strength of the Greenback itself is a boon to the US consumer making imports cheaper but it is a headwind for exporters and global US companies with significant overseas earnings. On exchange of these earnings from local currencies back to dollars the earnings take a hit. The Chief Finance Officer is left with fewer dollars in his hand!

With this economic backdrop the outlook for company earnings growth which are a driver for dividends and equity prices is not great. Consequently expected returns from equities in the next year are unlikely to be spectacular. However the outlook for earnings is mixed with the greatest potential for growth in major markets being in Japan and Europe, which are continuing with QE. In theory the Yen and Euro should weaken and initially they did against other currencies. More recently however they have strengthened notably against Sterling. For example Yen strength has been linked to its safe haven status. Finally in Japan and in cyclical sectors of the European economy equity valuations are attractive and these regions remain favoured for me.

In UK fears of a Brexit are causing investors to get jittery. Moreover Invesco Perpetual state that earnings growth from UK companies has been negative for the last four years. This is due in part to the high representation of mining companies and oil majors in the FTSE 100 index. In addition the pay-out ratios have risen. A pay-out ratio is a dividend to earnings comparator. Dividends are paid out of earnings and the higher the ratio the less earnings the companies are retaining. This is a clear threat to the sustainability of earnings. These observations have left me less positive on the outlook for UK equities especially for income investors.

Finally Invesco Perpetual favour equities over bonds. The latter are especially expensive although there are selected opportunities in investment grade and high yield corporates. The latter are especially attractive for tax free interest especially when held within an ISA.

The contents of this blog post is intended to be my own general investment commentary and interpretation of Invesco Perpetual’s views and is not an invitation to invest in equities or specific markets as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.

Tax Matters

With the tax year end fast approaching on 5/4/16 and significant changes to the taxation of interest and dividends coming next year I have decided to write on a variety of tax matters. Although I have covered most of these issues previously a timely reminder is in order. If you are interested to make use of various allowances still available this tax year you will need to act very quickly.

Tax Year End Planning – up to 5 April 2016

Let’s start with the obvious. You are aware you have an allowance of £15,240 to invest in a tax free* ISA, either a cash plan or into stock and shares. The former is barely worth it given the ultra-low interest rates on cash whilst global stock markets are still below their peaks. This favours investing cash savings as opposed to a “bed and ISA” deal, i.e. switching unwrapped funds outside an ISA to a stocks and shares ISA. As with most other tax allowances it is a case of use them or lose them.

Pension contributions can be made with significant tax relief and it is possible for those in employment or self-employment to carry forward unused allowances from 2012/13 to make a large payment in 2015/16. Even those who have no earnings and non-taxpayers can pay in £2,880 p.a. to a pension net of basic rate tax and get £720 tax relief. This results in a £3,600 pension investment. However these people cannot carry forward unused £3,600 p.a. allowances from previous tax years.

Finally Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs) offer 30% tax relief and other significant tax benefits. For example VCTs pay tax free dividends and EISs provide freedom from inheritance tax after two years. VCTs and EISs are most suitable for experience investors, high earners and those with a risk appetite that is comfortable in investing in small or fledgling companies.

Tax Changes Coming – from 6 April 2016

From 6/4/16 all interest received from bank and building society accounts will be paid gross with no tax deducted at source; but the interest will still be taxable income. However for basic rate taxpayers the first £1,000 p.a. of interest will be tax free. If you are a higher rate taxpayer the first £500 p.a.is tax free whilst  45% taxpayers get nothing! Given interest rates on cash are so low the amount of savings where interest will be payable tax free is approximately £66,667 for a basic rate taxpayer assuming an interest rate of 1.5% p.a. This is about the best buy rate for an easy access savings account. A married couple or civil partners could hold a whopping £133,334.  Of course if you hold fixed rate bonds paying higher rates of interest the amount of savings that will generate tax free returns will be less than £66,667.

Regarding dividends from shares or equity funds the 10% dividend tax credit will be scrapped from 6/4/16. Currently if you receive a dividend of £90 from an equity fund you get a tax credit of 10% of the gross dividend i.e. £10. For those interested here is the maths. The gross dividend is £100, i.e. the net dividend (£90) plus the tax credit (£10). The tax credit is 10% of the gross dividend or 1/9th of the net dividend. The tax credit satisfies an investor’s tax liability at the basic rate. Higher rate and top rate taxpayers have an additional tax liability on dividends.

From 6/4/16 the tax credits will be scrapped and you will just receive a dividend of £90. In addition to tax free dividends from ISAs everyone will have a £5,000 tax free dividend allowance. This is very good news for most investors who don’t receive dividends in excess of £5,000 p.a.

*ISAs provide returns that are tax free in the hands of investors. However the internal tax credit of 10% is not reclaimable by ISA fund managers or non-taxpayers.

The contents of this post are intended to be my own general commentary on tax planning and not an invitation to invest in any of the investments mentioned as these may not be suitable for your financial circumstances, tax position or your risk profile. You should seek individual advice before making investment decisions.