Investment Newsletter February 2014
A Balanced Portfolio By Mike Deverell Investment Manager
Since the beginning of the year, markets seemed to have embarked on a roller coaster ride. The FTSE 100 ended 2013 at 6,749 before rising as high as 6,836 on 20 January. However, we then saw worries about growth in emerging markets, and some slightly disappointing data from the USA. This hit markets which dropped back globally, the FTSE dropping as low as 6,449 at close on 4 February. It has subsequently rebounded somewhat. Those of you who have read the past few newsletters will recall we had become slightly less positive about equity markets. To recap, this doesn’t mean we do not think we can see some good returns, but the risks have
certainly increased and markets certainly don’t look as “cheap” as they were. As a result, we had made several changes to portfolios by the end of 2013: •
Reduced equity to an “underweight” position
•
Increased exposure to property, where we see some potentially good returns
•
Increased exposure to cash with the intention of investing back into markets on a dip or creating a new “Defined Returns” product
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 February 2014
What have we been doing since the start of the year?
We had initially decided to delay the purchase of a new defined return product after the markets continued to rise at the start of January. Our plan had been to buy a product from Credit Suisse which was based on both the FTSE and the S&P 500, whilst trying to time the entry point as best we could. We had hoped this would have a headline rate of at least 10% pa (simple not compounded), which would be paid out provided both indices were above their starting level on any of the first 6 anniversaries. As the FTSE rose to over 6,800 and the S&P 500 moved as high as 1,848, we felt uncomfortable setting up a new product, particularly as the potential rate of return had dropped to around 9%. We felt it was possible to get around 9% pa from property with lower levels of risk, so we decided to invest the tactical cash in property instead. No sooner had we done so, than equity markets begin dropping!
indices are above these levels on 4 February 2015 the product will end and a return of 11.5% will be paid out. As I write (the morning of 17 February), the FTSE has risen to 6,730 and the S&P is at 1,838, so the market is already significantly above the strike price. However, if the market is not higher than the “strike” level in 12 months, the product will roll over and can potentially kick out at any of the next six anniversaries. If the market is never above the starting level at any of these anniversaries, the product ends and we just receive our money back unless the indices are down 40% or more at that point. If they are, we lose money on a one for one basis. The product is not without risk as it is also based on the solvency of Credit Suisse. If they were to go bust the loss could be 100% of the investment as the product is not covered by the Financial Services Compensation Scheme. We have of course been selective about the counterparty we are using and carried out research into their financial strength.
As we still had some tactical cash (around 3% to 5% of portfolios for most clients) we had to decide whether to use this to top up equities, or to look again at defined returns. We decided to do both. We switched some funds out of alternative equity, which despite having some equity exposure had barely dropped in value, into a UK equity tracker fund. This was bought at an average index level of around 6,577. We may well sell this again if the market recovers to around 6,850. We also asked Credit Suisse to re-quote a new defined return product and, because of the increased volatility, they were able to offer us a rate of 11.5% pa (not compounded). We managed to set this product up with a “strike” date of 4 February when the FTSE was at 6,449 and the S&P 500 was at 1,755. If these two
Market turmoil
So, how has the recent market turmoil affected our other equity funds? The market dips were caused by a number of issues. Firstly, continued speculation about the withdrawal of quantitative easing in the US. Secondly, by weak economic data from China and some other emerging markets. Thirdly, by specific issues in selected emerging countries such as Turkey and Argentina, causing their currencies to dip sharply.
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These events all combined to turn sentiment about emerging market assets to negative. Emerging market equities dipped, dragging down their established market counterparts. There was a particularly pronounced knock on effect to Japanese markets. The change in sentiment caused the Yen, typically seen as a “safe haven” currency, to rise. This reduces Japanese companies’ competitiveness and so the Japanese market performed just as badly as many emerging economies.
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 February 2014
Market turmoil cont’d
We continue to believe that both Japan and many emerging markets, particularly in Asia, look good value based on company earnings and are “overweight� these areas in many portfolios. Whilst in the short term our positions in these areas hurt performance, a typical balanced portfolio still only has around 5% in Japan and a similar amount in emerging markets. In addition, poor performance in these areas this was offset by outperformance of our UK and European funds, which continue to outperform their respective benchmarks.
immunity from such events which can affect both equity and fixed interest. These changes limited the falls in values to around 1%, and most portfolios remain at or above their end 2013 values. We always said we expected a market setback at some point, but that this would be a buying opportunity. We have since seen that opportunity and believe the actions we have taken should help portfolio performance going forward.
Performance was also helped by the fact we had reduced equities before the market sell off, topping up property which has continued to rise. One of the reasons we like property at present is its relative
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 February 2014
General Economic Overview Global economic growth is picking up with the UK continuing to improve. Inflation has fallen back and there seems little prospect of interest rates rising in the next year, possibly much longer. The impact of the withdrawal of US quantitative easing is still being assessed, and this could affect a number of asset classes. Ultimately, QE will only be withdrawn due to a stronger economy, which can only be a good thing in the long term. In the short term, this may continue to cause bouts of concern in both equity and bond markets. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Last month our score was -1 meaning we expected roughly 9% pa over the next 18 months. Given recent market falls, we upgraded our score to neutral, meaning an expectation of around 10% pa. Emerging markets and Japan could have some of the best opportunities but also display higher risk. Within the UK, we still like smaller companies funds.
=
Fixed Interest Corporate and government bonds have rallied during the recent period when equities have proved volatile. We expect gilt yields to slowly rise leading to returns of around zero in this asset class. We believe very flexible bond funds could produce much better returns.
-2
Commercial Property Property returns continue to improve. There is momentum building and rental yields remain attractive. We therefore believe property should provide in excess of our long term 7% pa over the next 18 months or so. Cash With interest rates remaining at record lows, returns on cash could remain below average for some time.
+3 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight equity, overweight alternative equity, underweight fixed interest and neutral property. 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 commercial 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