Investment Newsletter August 2014
Expect the Unexpected By Mike Deverell Investment Manager
Markets have fallen back recently but have remained remarkably resilient. As I write, the FTSE 100 is at around 6,630 (the afternoon of 12 August), down over the past few weeks but still within 3.5% of its recent peak at around 6,870. We had an interesting conversation on this subject in the office recently. I was asked why I thought markets had fallen. My response was that this was the wrong question to be asking! The right question was (in my view) “why haven’t they fallen any further?” There are plenty of worrying events in the news recently that you will all be aware of: •
Israel and Gaza
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The advance of Islamic State (formerly known as ISIS) in Iraq and Syria
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Civil war in Ukraine including heightened tensions after the shooting down of a Malaysian airliner, Russian troops at the border and mutual sanctions between Russia and the West
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The outbreak of Ebola in Africa
We mustn’t also forget the other preoccupation of markets, fretting about when central banks will cease stimulus and start increasing interest rates! With all of this going on, why aren’t equity markets through the floor and the oil price through the roof (in actual fact, the latter is down)? We are not geopolitics experts, but my non-expert summary is that things are pretty bad right now. This brings an odd level of comfort, in that despite all this uncertainty the markets have only reacted in a relatively minor fashion. As a result, should things improve then we could possibly see quite a sharp rebound.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.
Investment Newsletter August 2014
Expect the Unexpected cont’d
If markets drop much further we therefore think this would be a possible buying opportunity. We have been holding “tactical cash” in most portfolios which we can invest quickly should markets dip much further.
can then say what we think might happen to markets if they do. We then already know how we might react to a particular event, or in an ideal world we will have already positioned portfolios in advance of the event!
However, it goes without saying that it is possible we could see things get a lot worse before they get better. It is therefore something we need to watch carefully.
Whilst there are always going to be events that we can’t possibly foresee, there is still a very good defence against such happenings; diversification. Most events which cause one asset class to fall might well cause another one to rise, or at least have no effect.
We have talked before about the need to expect the unexpected. We can’t predict the future, but we can look at what possible events we think might happen and we
Commercial Property
One asset that would not be affected in the short term by most of the above macro events is UK commercial property. This sector has seen some phenomenal returns over the past 12 months with our property portfolio returning over 11%. We had a meeting today with a property fund manager and I have rarely met a fund manager so enthused about their asset class! Most fund managers have at least an unconscious bias towards the area in which they invest. When we meet a US equity fund manager they rarely tell us not to buy US stocks. Where we do find a fund manager who tells us not to buy his fund, we tend to listen carefully! We also
Interest Rates
tend to remember that if they come back and tell us that now is the time to invest. Even with this possible bias both the fund manager and the analyst from the Investment Property Databank (IPD) we met seemed unbelievably excited. More to the point, they also provided evidence to back up their assertions. This also only served to reinforce what we found from our own research. The momentum behind commercial property investing is very strong at present and the fundamentals still stack up. Property also brings added diversification to portfolios. It would be unlikely for unrest in the Middle East (for example) to hit property returns in the UK in the short term.
One of the potential dangers with property and with any of the other asset classes, is the timing and magnitude of interest rate increases. At present, inflation is relatively low and wage growth is still weak. This may pick up, but if it doesn’t then there is little benefit to the economy (rather than for savers) of increasing rates as yet.
In addition, the Bank of England’s new Financial Policy Committee also has other tools at its disposal, for example compelling mortgage lenders to apply more stringent borrowing criteria or restricting the income multiples they can lend. Some restrictions have already been put in place and it appears this is slowing down the housing market slightly.
However, the Bank of England may want to get the first rate rise out of the way sooner rather than later. A 0.25% increase would not in itself pose too many issues, although if the market was surprised that this happened sooner than expected this could have short term implications.
We’re not going to try to predict when rates will start to go up, but we need to be prepared for what might happen when they do. The Bank must be careful not to increase rates too soon or too steeply, something they have already stressed they do not plan to do!
One argument for increasing rates now is to stop house prices getting out of control. However, outside of London house prices have not exactly been booming, just slowly improving.
In investing it’s just as much about focusing on the things that could go wrong as the things that could go right. If we can avoid most of the pitfalls and capture opportunities when they arise then returns should take care of themselves.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.
Market Views August 2014
General Economic Overview The global economy continues to do well, led by the US and the UK. Emerging markets remain weaker than developed economies although this has improved somewhat. However, all asset classes are being affected by geopolitical events and we remain concerned about interest rate increases. We think rates will rise early next year but will do so slowly. Inflation is not currently an issue but this could pick up next year. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets We continue to maintain our “neutral� stance towards equities. We are less positive about UK, European and American markets, but emerging markets and Japan look good value and have recently started to perform well.
=
Fixed Interest Interest rates are likely to increase in the near future which is normally bad news for bonds, however much of this is already in the price. Liquidity is a potential issue for less highly rated corporate bonds. We think fixed interest will underperform our neutral 6% pa expectation but not by a huge amount.
-2
Commercial Property Property continues to do well, despite the fact we still have not seen much in the way of rental increases or reduction in vacant buildings. If this starts to happen this will give property another boost. We firmly expect returns to exceed our long term 7% pa assumption over the next 18 months.
+3
Cash
-5
With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future. Rates may increase by 0.25% perhaps early next year. Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest and overweight property, we have a roughly neutral position towards equity and alternative equity. A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5 means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall. These represent Equilibrium’s collective views. There are no guarantees. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission.