Investment Newsletter January 2013
Out With the Old, In With the New? Happy New Year and welcome to our first newsletter of 2013! There has been a flying start to the year in equity markets after the US fiscal cliff negotiations went to the wire. The fiscal cliff was a combination of automatic spending cuts and tax increases, due to come into effect on 1 January 2013. Had all these been allowed to happen at the same time, the US economy would most likely have gone into recession. As it was, a compromise deal was ironed out, although some decisions have been put off for another two months. The day after the deal, on 2 January, the FTSE 100 jumped from 5,897 to 6,027, 2.2% in one day. As I write (14 January) the FTSE is now above 6,100, levels not reached for around 4½ years. Signs of recovery in China as well the US economy, have also aided investment markets. This has really helped boost portfolio returns in all asset classes, not least in the China fund which we purchased at the beginning of October, which has increased by around 17% since then.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | January 2013
Inflationary Pressures We continue to adapt your portfolios to the changing environment. We have been holding back tactical cash in case of a market dip, which would have allowed us to buy in quickly. Given the flying start to 2013, we feel the need for holding this cash has reduced. We are therefore investing this in other areas, depending on the risk profile of the clients. One area which is causing us concern is that inflation remains above the Bank of England’s target, and looks set to stay there for some time. Even the Bank of England itself does not believe inflation will dip back below 2% until late in the year. We think they are being very optimistic. Central Banks have largely concentrated on inflation targets for the past 15 years or so. We have seen many subtle and not so subtle signs that they are willing to allow these targets to be broken, and they continue to pump money into the financial system via ultra-low interest rates and quantitative easing (QE). For example, the US Federal Reserve is aiming to bring down unemployment and have said they will continue stimulating the economy until this is below a certain figure. The implication is that they will not worry about inflation in the meantime, and are currently buying up to $85bn a month of US Treasury and mortgage backed securities. In the UK, Bank of England Governor-in-waiting Mark Carney, has suggested moving from inflation target to nominal GDP targeting. In short, this means worrying about growth and not being directly concerned with inflation. Whilst this is only an idea and may not be implemented, it does show the change in thinking from central banks. With the global economy (if not UK or Europe) recovering, this can only add to inflationary pressures.
Active Management Inflation is generally bad news for fixed interest, particularly low yielding government bonds. These have been slowly selling off, with the yield on the UK 10 year gilt rising from just over 1.5% in the middle of last year, to around 2% now. As yields rise, capital values fall. For now, corporate bonds which yield substantially more than gilts, have held up well. We think they will continue to perform relatively steadily, if not spectacularly, for some time yet. The premium, or spread, for lending money to companies rather than governments, remains higher than average. As outlined in our December newsletter, we have already adapted our existing portfolio to try to protect against inflation, including buying an inflation-linked corporate bond fund. We are also investing some of the tactical cash for most clients into another inflation protected fund, the Standard Life Global Index Linked Bond fund. This invests in inflation linked bonds internationally, with the biggest holding being within the US. We are typically investing around 3% of portfolios into this fund. If corporate bonds continue to do well, these inflation linked funds could underperform. However, we feel this reduces the risk in the portfolio.
Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | January 2013
Other Changes For balanced and adventurous portfolios, we have typically used 2% of the cash to increase exposure to the Credit Suisse Defined Returns plan we set up in November. To recap how this product works, if the FTSE is above 5,791 and the S&P 500 is above 1,409 on 22 November 2013, the product will end and holdings bought at outset in November last year will see a 10.3% gain. Holdings bought at 100p per share will “kick out� in this scenario, at 110.3p per share. As the markets have risen, the new purchases are at approximately 103p per share, so the potential gain is lower (around 7% if the product kicks out in November). However, the risk has also reduced as the FTSE would have to fall around 300 points for kickout not to occur. We therefore believe this is a decent investment for a reasonable level of risk and have topped up client holdings to typically 5% of their portfolio. For cautious portfolios, we have taken the opportunity to reduce risk at recent market highs, banking some gains by reducing equity by 3% to invest in the global index linked fund. We felt it was appropriate to reduce exposure sooner for more cautious clients, and even for those with a higher tolerance, we may reduce risk if equity markets continue rising. Clients with bespoke portfolios may have had slightly different changes depending on their individual circumstances. We will remain vigilant and continue to monitor all asset classes carefully.
Mike Deverell
Investment Manager
Equilibrium Asset Management LLP Brooke Court Lower Meadow Road Handforth Dean Wilmslow Cheshire SK9 3ND United Kingdom Visit us at www.eqasset.co.uk t : +44 (0)161 486 2250 f : +44 (0)161 488 4598 e : askus@eqasset.co.uk Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | January 2013
General Economic Overview The US “fiscal cliff” failed to materialise, but some tough decisions remain and these could concern markets in February. Despite this, the global economy looks healthier than it has for some time. Whilst Europe and the UK will grow only very slowly at best, the US and emerging markets appear much stronger. We are becoming more concerned about inflation, with rhetoric from central banks hinting that they are happy to allow it to be higher than their targets whilst they try to stimulate economies.
Asset class key + positive - negative = neutral (normal behaviour)
+5 -5
strongly positive strongly negative
Equity Markets We remain positive taking an 18 month view, based on company valuations. However, after a flying start to 2013 we could see some short term volatility. We particularly favour the UK and emerging markets.
Outlook
+3
Fixed Interest After a strong run in corporate bonds we believe returns will tail off, but remain positive. We are avoiding conventional Gilts whose values have been inflated. We are also diversifying into inflation linked bonds.
-1
Commercial Property Whilst the rental yield on commercial property remains attractive, this is diluted by high levels of cash in property funds. We are seeing capital losses although we believe that overall returns will probably be positive, but low. However, we don’t believe the returns are worth the risk of investing in property at present.
-5
Residential Property
-5
We believe prices are likely to remain flat over 18 months. Cash With interest rates remaining at record lows, returns on cash could remain below average for some time. However, there is a short term safe haven appeal. Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and cash, neutral fixed interest and hold no 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 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.
-5