Investment Newsletter November 2013
Share the Gains By Mike Deverell Investment Manager
Stockmarkets have been back on a fine run recently, with the FTSE 100 hitting over 6,800 during trading on 30 October before dropping back towards 6,700.
past few years. However, as markets rose we generally sold some equity in portfolios at a market level of circa 6,750.
Meanwhile, in the US the S&P 500 keeps hitting new record highs.
This means for most clients that we are now back at a “neutral” equity position. In fact, for some investors we have even moved slightly “underweight”.
This is clearly welcome and has boosted portfolio returns. We hope to see some good returns for the remainder of the year, a period which often sees positive markets – sometimes dubbed the “Santa rally”! Many investors are just jumping onto the equity bandwagon, reassured by the momentum of markets. As usual they are doing so at a point that markets are beginning to look more expensive, and therefore risks are rising. In our ideal portfolios we have generally been overweight equity, in other words holding more equity than we would in “normal” market conditions, for most of the
In many parts of the equity world, stocks are starting to look relatively expensive based on company earnings. In a lot of cases, we believe expectations about future growth in earnings look overly optimistic. We still think UK equities have further room to grow, but stocks are nowhere near as compelling as they seemed 18 months ago. We also believe emerging markets look attractively valued, having been left behind in the recent market rally, and we see further value in Japan. These are areas where earnings are growing strongly and where markets are still priced attractively.
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 November 2013
Share the Gains cont’d
However, in Europe and the US in particular, we are struggling to see value. For example, the price/ earnings ratio on the US market is over 19, around 15% overvalued relative to its long term average of around 16. The market is pricing in around 23% earnings growth in the next 12 months, which in our view is unrealistic. As a result, we have recently cut exposure to US equities in most portfolios. Markets face the additional issue of the end of extraordinary levels of stimulus by Central Banks. Quantitative easing in the US is likely to be tapered in the near future, and eventually stop altogether.
Defined Returns
Finally, political issues in the US remain and we are concerned about further effects on the US and the impact on the wider global economy. You will not be surprised on reading the above that we may well cut equity exposure further should markets continue to rise. However, this does not mean we think we cannot generate returns over the next 12 months. We have several strategies that should help returns even if equities begin to struggle.
Most existing clients reading this will be invested in some of our “Defined Returns” products. These are structured products which pay a fixed return should markets stay the same or rise.
not have risen then, clients will get their money back provided the market is not down 50% or more at that point. If it is down more than this, clients will lose money on a 1 for 1 basis.
Our clients have held two products which have just recently “kicked out”. We will receive the proceeds from these products from Credit Suisse and Royal Bank of Canada in the next couple of weeks. These products have returned 10.3% and 7.5% over 12 months respectively for those that purchased at outset.
The product also depends on Barclays remaining solvent and being able to repay what is effectively a loan.
Although markets have gone up substantially in this time, had they remained level the products would still have returned 10.3% and 7.5%. These are great options for times when we think markets could go sideways or only marginally up.
If we decide to cut equities further we may look to create a second product to replace equity exposure, meaning we can make money even if markets go sideways.
We are currently planning a new product with Barclays which should provide an 8% return IF the FTSE stays the same or rises over the next 12 months. If it is not higher in 12 months’ time, the product would roll over for another year. If the FTSE is then higher than the starting level in November 2015, it will then pay 16%. If the market doesn’t rise it will keep rolling over until 6 years have passed. Should the market still
Achieve Returns at the Lowest Possible Risk
We think Defined Returns are a good way of achieving equity-like returns with less risk than equities. Our aim is not to provide the best returns we can as this will encourage us to take too much risk. Instead, our aim is to provide the target returns at the lowest risk possible. We could be wrong about equities and they may shoot up further. If this happens we will underperform the market but will still achieve very positive returns on this part of the portfolio.
We also remain overweight alternative equity which we think is a way that we can benefit from further equity growth, whilst reducing the risk of losses should markets fall back. The alternative equity funds we hold have the ability to make money no matter whether equities rise or fall. This of course depends on the fund managers getting their decisions right, and so we are very selective about which fund managers we use.
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 November 2013
Not Just the Stockmarket
When talking about investments we can sometimes get carried away talking about the stockmarket. The investment world is much more than just equities and it is our job to make sure we benefit when markets go up, but try to guard against possible market falls.
We remain underweight property for most clients only because we still have Defined Returns to kick out shortly. Once they do so we will likely top up property by around a further 5%, taking a typical balanced portfolio to around 20% property.
As we have been discussing with clients recently we are now much more positive towards commercial property. Our ideal property portfolio has returned around 3.2% over the past 6 months and returns have been accelerating. We think there is a very good chance that property will beat the 7% pa return we think is a “normal” property return.
Active Management
Having seen some excellent returns from equities over the past few years we believe now is the time to think about banking some gains and investing elsewhere. However, should markets fall back we would not hesitate to top equities back up again. To that end we continue to hold “tactical cash” for most clients, which we will use to dip back into markets should they fall to attractive levels.
As always in investing, it is best to buy low and sell high and this is what we aim to do. Sometimes this means selling your best performing asset (equity) and buying the worst performing over the past few years, property. However, we believe it is the right time to be doing so.
We think it is just as important to manage portfolios actively right now, even when everything might appear to be more positive, as it is when things look more difficult.
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 November 2013
General Economic Overview The UK economy has continued to improve and inflation has fallen back. We still do not know the effect of the recent US shutdown which will probably have slowed growth in the US. In addition, the Federal Reserve is likely to taper quantitative easing in the near future which could affect equities and fixed interest in particular. Interest rates are likely to remain low for perhaps the next two years, even though unemployment has fallen quicker than expected. The Bank of England has committed to not increasing rates until unemployment falls below 7%. Asset class key + positive negative = neutral (normal behaviour)
+5 -5
strongly positive strongly negative
Asset Class
Score
Equity Markets As the FTSE 100 hit around 6,750 we reduced equity exposure in most portfolios. We still think there is good value in certain types of equities but at these levels we think returns should slow. A -1 score means we expect around 9% pa rather than our long term 10% pa assumption.
-1
Fixed Interest Corporate and government bonds have proved very sensitive to concern about the Federal Reserve tapering quantitative easing. However, our funds have great flexibility and have done reasonably well in this period. We expect returns to stay relatively steady.
-2
Property Over the past quarter, property has returned more than a 7% annualised return. There is momentum building and rental yields remain attractive. We therefore believe property should provide more than our long term assumption of 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.
+1 -5
Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and alternative equity, underweight fixed interest and are increasing property exposure. 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