Your investment update Q1 2020
This document has been produced by Seven Investment Management LLP from internal and external data. Any reference to specific instruments within this document are part of widely diversified portfolios and do not constitute an investment recommendation. You should not rely on it as investment advice or act upon it and should address any questions to your financial adviser. The value of investments can vary and you may get back less than you invested. INVESTMENT MANAGEMENT TEAM: Martyn Surguy, ACA, MCSI, Chief Investment Officer, 33 years industry experience, Terence Moll, M.Phil, PhD, Head of Investment Strategy, 28 years of industry experience, Haig Bathgate, CFA, Head of Portfolio Management, 22 years of industry experience, Camilla Ritchie, Chartered MCSI, Senior Investment Manager, 30 years of industry experience, Peter Sleep, Senior Investment Manager, 30 years of industry experience, Stephen Penfold, Senior Investment Manager, 36 years of industry experience, Matthew Yeates, CFA, FRM, Senior Investment Manager, 8 years of industry experience, Duncan Blyth, CFA, Senior Investment Manager, 22 years of industry experience, Ahmer Tirmizi, MSc, Investment Strategist, 10 years of industry experience, Ben Kumar, CFA, Investment Strategist, 9 years of industry experience, Tony Lawrence, CFA, CAIA, Senior Investment Manager, 18 years of industry experience, Christopher Cowell, PhD, Investment Manager, 5 years of industry experience (completed all 3 levels of the CFA program), Jack Turner, CFA, Investment Manager, 10 years of industry experience, Harriet Massie, Business Manager, 4 years of industry experience, CFA level 3 Candidate, Katy Stoves, CFA, Chartered MCSI, Investment Analyst, 10 years of industry experience RISK TEAM: Joe Cooper, Interim Head of Risk, CFA / MSc in Applied Economics, 9 years of industry experience, Alex Mitsialis, Performance and Risk Analyst, MSc / CFA, 5 years of industry experience, Aaron Chhokar, Investment Risk Analyst, MSc / MEng 2 years of industry experience, Hugo Brown, Junior Risk Analyst, BEng, 1 year of industry experience and Haris Slamnik, Risk Developer, MSc, 1 year of industry experience.
Welcome Martyn Surguy Chief Investment Officer Page 4 Strategy Longer-term themes in a low return world Terence Moll Head of Investment Strategy Page 6 Portfolio implementation What we are doing in portfolios Haig Bathgate Head of Portfolio Management Page 10 Featured topic House vs. Pension – save early, save sensibly Matthew Yeates Senior Investment Manager Page 12
Visit us at www.7im.co.uk to find out more about our latest news and views.
welcome
MARTYN SURGUY Chief Investment Officer
It’s a relief that the final quarter of 2019 has not seen a repeat of 2018. In fact, quite the contrary with an apparent reduction in uncertainty from the UK election result, signs of progress on the trade front between the United States and China, and a mild improvement in global economic data. Without being too much of a Grinch, this is probably exactly the moment to take care rather than extrapolate the good news too far ahead. This is the time when forecasts for the coming year arrive in one’s inbox or drop on the mat with alarming frequency. With no disrespect to any of the authors or august institutions producing these often lengthy annual publications, they are of doubtful value for the long term investor. For instance, I have seldom read one that does not expect single digit equity returns with somewhat higher volatility
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for the year ahead. If anything, these ‘wise forecasts’ are a distraction that can invite short termism and emotional responses. The reality is that while market sentiment swings violently around, economic fundamentals change only very slowly. Almost all of the time, the best forecast would be for a long term gentle uptrend in growth. Such a pattern does not lend itself to exciting copy, though!
We prefer to focus on longer term expectations where there can be greater assurance and less variability of outcomes. Given the starting point for equity valuations (high) and bond yields (low), it seems inevitable that returns over the next five years will be somewhat lower than in the last five years. Not dreadful, ahead of inflation, certainly not negative but modestly lower than recent history.
“Discipline and patience around long term strategy will remain the key to investment success, as always.�
Discipline and patience around long term strategy will remain the key to investment success, as always. Given a more modest outlook at broad market level, we are increasingly attracted to more specific longer term investment themes. Terence Moll covers this in his piece on the following pages. Haig Bathgate provides an update on our ongoing pursuit of simplicity and greater conviction within portfolios, while Matthew Yeates challenges the established wisdom on how younger people should provide for their retirement. Enjoy reading, and we look forward to only modest changes in the long term investment outlook in the year ahead!
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strategy
TERENCE MOLL Head of Investment Strategy
Longer-term themes in a low return world Have you ever jumped to a conclusion or judged a book by its cover? Shot from the hip or made a snap decision? We’ve all jumped or judged or shot or snapped at some point – made a choice without considering all of the available information.
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“Even if everyone else is running around screaming about bulls or bears, we think it’s usually worth taking the time to look at the full picture.”
Fortunately it isn’t your fault – you can blame your family. Not your immediate family (I’m afraid), but your ancestors who lived hundreds of thousands of years ago. Humans evolved to react to limited amounts of information as a survival technique. In the uncivilised wilderness, our predecessors didn’t wait around to confirm if the unexpected rustle in the undergrowth was a deer or a lion – they were off! The risk of waiting for the full context of the situation was far too high; curiosity killed the caveman. Things are less urgent in the modern world, especially when it comes to the financial markets. Even if everyone else is running around screaming about bulls or bears, we think it’s usually worth taking the time to look at the full picture.
2019 in context Equity market returns in 2019 appear incredible. The MSCI World Index of global stocks has risen by 25% – the most in ten years! But that excitement is the primitive human response. Step back, and widen the frame. Bring 2018 into the picture too. At the start of 2019 we had just experienced the worst December since 1931, after an already miserable year for equity markets. A large chunk of the fantastic equity returns in 2019 was simply a bounceback from the previous year. So while the MSCI World Index rose 18% in the first six months of this year… this only took it back to January 2018 levels. This wasn’t a rally, it was a recovery. On a two year view, global equities have returned 16% – respectable, but far more mundane. Fast-moving equity markets benefit from context, then, and so do economic indicators. Purchasing Managers’ Index (PMI) surveys are used by economists to gauge different parts of a country’s economy. The rule is simple. A number above 50 means the sector is growing, while below 50 means it’s shrinking.
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strategy
Germany’s manufacturing industry currently has a PMI of 44. But wait before running for the hills! There’s more going on than that one figure tells you. We know that German manufacturers rely on global trade to keep growing. And we know that global trade has been badly beaten up by President Trump. So Germany’s PMI should be suffering. Looking at the bigger picture gives more context. First, the German PMI hit a low in September, and has been rising since. At the same time, manufacturing orders in other global traders such as South Korea and Taiwan are showing signs of life. So a more considered interpretation is that things in Germany have been bad, but are starting to improve. Our investment themes for 2020 As I said last quarter, the global economy is like a supertanker; in the absence of icebergs, it’s likely to keep ploughing on. Our proprietary Recession Risk Indicator still doesn’t show any large, white, floating objects ahead, in spite of the recent cold weather caused by Typhoon Trump. However, the waters remain too choppy for the engines to be set to full steam ahead.
“As I said last quarter, the global economy is like a supertanker; in the absence of icebergs, it’s likely to keep ploughing on.”
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With little reason to worry about a rapidly accelerating or decelerating economy, we are neutral on risk assets in our portfolios. Instead, we’ve focussed on building up exposure to some interesting long term themes.
Longer-term themes in a low return world
Investing in emerging market bonds – which actually pay us for the risk Emerging market countries have had a difficult decade, held hostage to the developed world as it tried to cope with the financial crisis. But tough times breed resilience. In countries like Brazil, Russia and South Africa, there is sometimes rioting in the streets, but this no longer stops governments from paying their international debts. The debt quality of the large emerging market nations now rivals that of investment grade companies in the US, yet the yields are around 3% higher. We view these bonds as a stable long term investment, which are undervalued by nervous investors. Inflation isn’t dead A decade of austerity is coming to the end in the UK as Boris prepares for his first budget. In the US, President Trump will throw money at the economy as he tries to win both a trade war and a second term in office. Europe and Japan are following suit. Even spendthrift countries are changing their ways. South Korea has recently announced a fiscal stimulus programme that will push it into the red for the first time in ten years.
An older world needs more looking after – invest in healthcare companies The world is aging. In thirty years, two billion people will be over 65. As people age, they spend more and more on healthcare. This makes sense – each extra month of good health is far more important to you when you only have a limited number left. Healthcare companies have suffered over recent years due to politics (particulary in the US), and a lack of investment in research over the past ten years. That is now changing, with many of these businesses already developing technology and treatments that are customised, and targeted at a greyer population. We have a position in healthcare companies in all of our portfolios.
A wave of government spending paired with ultraloose monetary policy usually has only one result: inflation. And the world isn’t expecting it. At the moment, financial markets are only looking at recent history, and are suggesting that US inflation is going to average 1.8% over the next thirty years. We take a different view, given that central banks are saying that they will tolerate above-target inflation in the years ahead. We own a position that will benefit if US inflation increases through the coming year.
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portfolio implementation
HAIG BATHGATE Head of Portfolio Management
What we are doing in portfolios This time of the year can be frustrating. You look at the living room floor and sigh. You couldn’t work out which of the many ‘musthave’ toys you should buy the kids for Christmas, knowing full well only a couple will be a hit. So, once again, you ended up buying a range of different ones – most of which are already cluttering up the house, ready to trip up an unsuspecting parent.
We have been enhancing our investment process when it comes to manager selection – partly by trimming down the number of funds we have in each asset class. That’s not to say we’ve bought the children only one present, we are just working to cut down the number of extra toys that are now littering the floor.
Investors sometimes have a similar problem in their portfolios – overdiversification. Investors get attracted to lots of funds in the same asset class, end up holding too many that do similar things, and then don’t get much benefit when one outperforms.
We think carefully about the sort of managers that we are buying. We want strategies that can work well on their own, when combined with other managers we may hold, and as part of the portfolio as whole.
The art is finding the goldilocks number of positions – not too many, but not too few. We follow a simple rule – the larger the allocation to a particular asset class, the more diversification is sensible. For example, our European equity allocation ranges from 4% in Cautious up to 12% in our more Adventurous portfolios. Holding a single manager feels a lot more comfortable at 4% than it does at 12%, so we spread the larger allocation between two or three managers.
Our newest active healthcare manager, Alliance Bernstein (or AB) fits this bill. The fund and its manager Vinay Thapar have a great track record and it slots into the portfolios nicely. Vinay knows about the science involved and, has an excellent understanding of business which is crucial to ensure that he buys companies that will grow and pay dividends. Concentrating our allocation also means we end up putting more money with a specific manager, which allows us to negotiate a better fee deal and gives our clients better value for money.
Please note: Model Portfolios will be rebalanced from February 2020. 10
Underweight
Overweight
Neutral
UK
Equities US
We are neutral on equities. We do not favour any particular regions at the moment.
Europe Japan Emerging Markets
Bonds We remain underweight corporate bonds. emerging market bonds offer more attractive returns.
Government Corporate High Yield
Emerging Markets
Alternatives
Real Estate
Alternatives
We are overweight market neutral alternative strategies. They offer diversified returns and can be viewed as a substitute for bonds.
Cash
Cash and Currencies Sterling
Other Currencies
While we think there will eventually be a Brexit trade deal, the potential for higher volatility in the coming year means we move sterling to neutral.
7IM’s key investment views Equities look moderately expensive in the face of trade wars. Global interest rates are close to all-time lows, making bonds unattractive. 11
featured topic
MATTHEW YEATES Senior Investment Manager
House vs. Pension – save early, save sensibly Common misconceptions Common knowledge can be misleading. When I go to the coffee shop near the office, I’m asked what beans I would prefer for my flat white. Yet, while it is widely believed that coffee comes from ‘beans’, it actually comes from seeds – we just call them beans because of their appearance. You sometimes hear that the Great Wall of China is the only human-made object that can be seen from space. However, the Apollo astronauts confirmed that you can’t see it from the Moon. In fact, when you look at the Earth from the Moon, all you can see is a sphere of white, blue and a bit of colour – no evidence of humanity at all.
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Another widely held belief is that buying a house is the ticket to financial security. But is this true? It’s certainly true that millennials are struggling to buy houses (due to drinking too many expensive flat whites made with their favourite seeds, no doubt). But should younger people like myself be worried by that fact? The maths of retirement – time is your friend A house can be a significant financial asset, especially when people stop working. However, most people don’t realise that with a little planning, their largest financial asset could be their pension – most don’t start saving for their pension early enough as a result. Time for some maths.
“Most people don’t realise that with a little planning, their largest financial asset could be their pension.”
Let’s take a 25 year old, earning 10,000 flat whites a year (or £25,000). Helped by their employer, they save 8% of their salary every year into a pension, and invest in a portfolio which should return around 6% a year over the long term. By age 30, they now earn £28,000, and buy a property worth £110,000, just under four times their salary. Well-disciplined with their money, they keep saving that 8% every year. Fast forward to age 65. With the regular pension contributions and portfolio growth of 6% a year, their pension has grown to £432,000! If we assume the house appreciates in line with inflation at 2%, it would be worth only £220,000. Even appreciating at 3% per year, it would be worth only £310,000 – still over £100,000 short of the pension. That is the power of starting early, and letting time and compounding do the hard work. The conclusions are the same whether you earn £100,000 or £10,000 p.a. 13
featured topic
The financial services industry tends to give out the message that saving for retirement is all about quantity – to have a better retirement, the only answer is to save a large amount of cash. Actually, this isn’t necessarily the case, as long as you start early enough. Start saving early… We can see this if we change the example a little. Back to my saver. Let’s assume they stop saving into their pension after 20 years, at age 45. Twenty years’ worth of contributions mean that this pot will still go on to reach a respectable £281,000. But if they wait until 45 to think about their pension, things don’t look so good. Although they’ll be putting away a larger cash sum each month (8% of a higher salary), they will end up with only £130,000 by the time they retire. Their pension is only exposed to growth for 20 years, versus 40 years for the saver who stopped at 45. So although the early saver contributed less cash to their pension, they’ve ended up better off than the late-starter.
Unfortunately, many savers in the UK leave saving into their pensions late, often because they’ve focussed on saving for a house, rather than for their future. For younger generations, the key point is the difference that starting early can make. Of course, this is also relevant to any parents or grandparents who may be thinking of how they can help their children or grandchildren find their financial feet. Even if it’s not explicit financial help, the right advice and good habits can go a long way. It’s a question of saving smarter, rather than simply saving more. When you are young and your pension pot is smaller than your salary, your savings matter more than your returns. 1% of your salary is more money than 1% growth in your investment. Saving for a deposit is likely to be the number one priority for many young people. However, if this is at the expense of saving nothing for their pension, they may be doing themselves a disservice. We all need somewhere to live and the idea of one’s own home can be an emotional aspiration as much as a financial one. Young people already saving into a pension (and their grandparents) shouldn’t be scared, though. They will likely finish up with a much bigger financial asset than those who prioritised buying a property.
Value
House
Pension Pot 25
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45
House vs. Pension – save early, save sensibly
… stay invested later Of course, financial education doesn’t stop at saving! Once you’ve built up a large pension pot, later in life, investment returns and the overall level of risk taken tend to become more important than saving. 1% of investment growth is worth much more on a big pool of savings, so you need to make sure you stay in the market.
House vs. Pension This chart shows how regular saving into a pension from the age of 25 could result in much greater wealth at retirement than buying a house at the age of 30.
The conventional wisdom in finance is that investment pots should automatically start de-risking as people get older and approach retirement. We think that’s as big a misconception as focussing on buying a house… or that coffee comes from beans. Most people approaching retirement can expect to live for 20–25 more years, and should stay invested for as long as possible.
Source: 7IM
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www.7im.co.uk Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority, the Jersey Financial Services Commission and the Guernsey Financial Services Commission. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales number OC378740.