Investment Newsletter March 2014
When it Ukraine’s, it pours By Mike Deverell Investment Manager
The recent turmoil in Ukraine has compounded what has been a difficult period for emerging market investing.
interconnected that decisions by the US central bank, designed with the US economy in mind, can have a big impact on the other side of the world.
Last week, the Russian stockmarket dropped over 11% in a single day. However, emerging markets had been struggling for some time before the Ukraine crisis began, particularly since May last year when the US Federal Reserve announced that it would be “tapering” or reducing quantitative easing (QE) in the near future.
As noted in previous newsletters, QE is partly about increasing the amount of money in the system, but it also reduces the potential return on so called “safe haven” assets such as government bonds by pushing up their prices. This is designed to encourage people to look elsewhere for investment returns, taking more risk by investing in things like equities which (in theory) should support the real economy. However, money printed in the US doesn’t necessarily stay in the US, and much of this has found its way into emerging market assets.
It may seem strange that US monetary policy should have had such a negative impact on emerging market equities, when US equities have powered ahead after a minor blip. However, the financial world is now so
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 March 2014
When it Ukraine’s, it pours cont’d
The US Fed is now gradually slowing its QE program, reducing from buying $85bn of bonds per month to now buying $65bn per month. They are likely to stop buying altogether by the end of the year. However, this is not the same as selling the bonds back to the market or increasing interest rates. They are not reversing stimulus, merely ceasing to add more. Despite this, tapering has triggered investors to move back down the risk scale, leaving emerging markets and investing in developed markets instead. This has been compounded by slowing growth in many
Impact on Portfolios
So what does this mean for portfolios? Most portfolios have exposure to emerging markets and this has detracted from performance. However, this has generally been offset by outperformance in other areas. For example, all our actively managed UK equity funds have beaten the FTSE over 12 months. We have also increased exposure to Japan of late, which again has suffered over the past few months. We are not planning on changing course on these investments in the near future. There are several reasons why we believe these areas should start to do well once sentiment turns.
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Attractive valuations (for example price/earnings ratios) relative to that markets long term average or to other markets or asset classes.
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Positive earnings growth.
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A growing or improving economy.
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A supportive central bank.
There are several factors which make investing an uncertain business, by far the biggest of which is political risk.
However, in Japan you could argue that all these boxes are ticked: valuations are below average, earnings are growing, the economy is improving, and the central bank in Japan is picking up the QE baton from the US. That said, there are plenty of issues which require attention in these regions. For example, both Japan and China need to make structural changes to their economy and reforms to company structures to aid competition and market efficiency. The difficulty they have is in doing this whilst keeping economies growing. If they can do this successfully then both areas should be well placed in the years ahead.
QE
There are various things which tend to drive equity market returns. Some of the main things that tend to lead to positive returns are:
emerging markets. However, it should be noted they are still growing and in many cases, many times faster than their Western counterparts. For example, even the more pessimistic assumptions for Chinese economic growth puts this at well above 6% pa, with more optimistic forecasters predicting nearer 8%. China itself is targeting 7.5% and they have a history of hitting those targets, albeit with some possible massaging of the figures!
Most markets have one or more of these in their favour but few have all of them. For example, the US has a growing economy and positive earnings growth, but valuations are looking a little expensive and the Fed is tapering QE. By contrast, emerging markets have attractive valuations, positive earnings growth and growing economies, even if central bank policy (or at least US central bank policy) is less supportive.
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 March 2014
Political Risk
The directions which governments and central banks take have come to dominate financial markets more than ever before. Events such as those in Ukraine can cause market wobbles or even more serious downturns, however a well-diversified portfolio can help reduce such risks. Even with the recent dip in equity markets our fixed interest and property holdings continued to increase in value, reducing volatility and adding to returns. We are now seeing a new example of political risk closer to home, with more analysis coming out about the impact of a “yes� vote in this years’ Scottish independence referendum. Ignoring the economic arguments for a moment, many Scottish companies have a significant number of customers in England. This includes Nucleus, the wrap platform on which many of our clients hold their investments.
We have been in contact with Nucleus and, in summary, they do not believe a yes vote would affect the way they do business. In particular, the regulated entity that holds the investments is registered in England, even though Nucleus itself is based in Edinburgh. We will of course monitor the situation in respect to any impact that Scottish independence may have on your investments, whether from a wider economic or a specific company point of view.
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 March 2014
General Economic Overview The Global economy is growing albeit at a slightly slower rate, this may be partly attributed to the extreme weather conditions experienced in the US. The UK continues to grow faster than many had expected. The Bank of England revised their forward guidance interest rate policy in the face of fast falling unemployment rates. Lower inflation and stronger growth has seen changes to estimates of when the base rate will rise, in some cases to as early as Q4 2014 although many are predicting spring 2015. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets We have maintained our neutral outlook on equities from last month, meaning an expectation of around 10% pa over the next 18 months. Events in Ukraine are adding to uncertainty resulting in more volatile equity markets, something we would expect to persist until a resolution to the situation is reached.
=
Fixed Interest Corporate and government bonds have stabilised during the recent period whilst equities have proved volatile. With our expectation that yields will rise we have low exposure to interest rates. Our funds are flexible and diverse with more credit exposure which should do well in an improving economic environment.
-2
Commercial Property Property returns continue to impress with capital growth supporting rental yields. Demand is growing for regional property which is taking the burden from London and providing fresh opportunities for growth. We firmly expect returns to exceed our long term 7% pa assumption over the next 18 months. 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 fixed interest and overweight property, we are neutral positioned 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 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