ISSUE NO.1 • SUMMER 2020
WHAT PORTFOLIO TYPE MIGHT BEST MEET CLIENT OBJECTIVES?
THE GREAT BIG NATURAL LIE
AN ACTIVE APPROACH TO PASSIVES
AHEAD OF THE CURVE?
OUTLOOK FOR UK DIVIDENDS: STILL A RELIABLE INCOME?
We’ve launched RSMR Active 2 to 10 portfolios to assist financial advisers in achieving improved investor outcomes, a simplified advice process and an enhanced overall client experience.
The portfolios combine strategic asset allocation, including key inputs from specific third parties, with RSMR’s established fund selection and portfolio construction methodology. If you’d like to talk about our approach and how we can help shape your client proposition, do get in touch on the details below.
01535 656555 | enquiries@rsmr.co.uk | rsmr.co.uk Important Notice This is intended for investment professionals and should not be relied upon by private investors or any other persons. Past performance is not a guide to future performance. The value of investments and any income from them can fall as well as rise, is not guaranteed and your clients may get back less than they invest. RSMR Portfolio Services Limited is a limited company registered in England and Wales under Company number 07137872. Registered office at Number 20, Ryefield Business Park, Belton Road, Silsden BD20 0EE. RSMR Portfolio Services Limited is authorised and regulated by the Financial Conduct Authority under number 788854. © RSMR 2020. RSMR is a registered Trademark
Summer 2020 www.rsmr.co.uk
Contents
Summer 2020
04 A VIEW FROM RMK
WELCOME to the first edition of our DFM
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Academy Bulletin, providing a roundup of news, views and ideas from the ever-changing world of discretionary fund managers. My thanks to all participating member private client groups, whose support has helped make this happen, creating a single centre of excellence dedicated to private client investment management. The DFM Academy has been designed for advisers seeking one specialist gateway covering all key aspects and information relating to DFMs who have achieved an independent rating by RSMR.
Robin Minter-Kemp Chairman RSMR
ENSURING THAT YOU INCLUDE THE RIGHT INGREDIENTS, AND PUTTING DUE DILLIGENCE IN CONTEXT
WAVERTON WHAT PORTFOLIO TYPE MIGHT BEST MEET CLIENT OBJECTIVES?
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We do hope you like the read but also go online to the RSMR Hub to get access to the full content – www.rsmr.co.uk. Enjoy the read and keep safe. n
AKG
7IM THE GREAT BIG NATURAL LIE
RATHBONES AN ACTIVE APPROACH TO PASSIVES
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COVID-19 POSES TEMPORARY SETBACK TO THE ENERGY TRANSITION
AHEAD OF THE CURVE?
Rayner Spencer Mills Research Limited Number 20, Ryefield Business Park, Silsden BD20 0EE.
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CAZENOVE
BREWIN DOLPHIN
CONTACT DETAILS:
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QUILTER CHEVIOT OUTLOOK FOR UK DIVIDENDS: STILL A RELIABLE INCOME?
Tel: 01535 656555 or Email: enquiries@rsmr.co.uk All editorial and advertising enquiries should be directed to sarah.mcculloch@rsmr.co.uk
DFM Bulletin is published by Rayner Spencer Mills Research Limited (RSMR). The views expressed do not necessarily reflect the views of RSMR or any other party affiliated to RSMR, and no liability can be assumed for the accuracy or completeness of the content, nor should any of the content be used as the basis of any advice offered. Content is offered on an information only basis and intended only for professional financial advisers and should not be relied upon by private investors or any other persons. Content is published with all rights reserved and any reproduction of content, wholly or in part, must only be made with the written permission of the publishers. © RSMR 2020. RSMR is a registered Trademark.
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SECTION HEAD
A VIEW FROM RMK RSMR's Robin Minter-Kemp explains the demand for the sector and gives the background and benefits of the new RSMR DFM Academy.
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hen I started in the fund industry in 1988 most fund management groups were completely ring fenced from their competition, providing little or no opportunity to compare differing propositions. Whilst protecting their interests, this environment created significant inconvenience for advisers who had to find information from multiple sources. Since then, major changes in the areas of technology, CPD and product wrappers have changed the distribution landscape.
from gauging the latest individual opinion of a single DFM provider through to the detailed DFM Profile produced by RSMR providing an independent assessment of each DFM.
Black Swan event It’s virtually impossible to launch a new service in these times without referencing the ultimate Black Swan event of Covid-19. The media has been keen to highlight that this virus is indiscriminate and accordingly, few investors could have avoided the ongoing fallout. This includes even experienced professional luminaries such as Warren Buffett, who only last year increased his significant overweight in American Airlines, resulting in Berkshire Hathaway dumping its entire 10% stake in both Delta and Southwest airlines during May. Buffett based his decision on the ‘world has changed, and I made a mistake’.
The RSMR DFM Academy reflects this sentiment in providing advisers with the knowledge and tools to thoroughly evaluate the DFM propositions
In line with guidance from the regulator and the requirement to have a robust selection process in place, adviser demand for research and due diligence information and data has also increased significantly. The RSMR DFM Academy reflects this sentiment in providing advisers with the knowledge and tools to thoroughly evaluate the DFM propositions and ensure they meet individual client needs. The information included ranges
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The term ‘Black Swan event’ is characterised by its rarity, retrospective predictability and extreme impact. Whatever effect this may have had on the mind set of
investors, if they have properly delegated the decisionmaking process of managing their wealth to a professional third party, little will have changed. This notion of investor calm in the face of adverse volatility particularly applies to investors in discretionary management services where there is now comprehensive product governance and a regulatory process. These both educate and inform end users on an investment journey that is only able to reference history to provide a possible range of return outcomes following assessment of their attitude to risk. So when many investors recently received correspondence from DFM providers advising them that their portfolio valuations have fallen by 10% (a MIFID ll requirement) a well-informed client is likely to take no action. Efficient adviser assessments of client suitability, including their ability to weather the volatility during the investment term is helping to safeguard client concerns. This has been particularly important as investment strategies have significantly diverged in performance terms – growth has significantly outperformed value leading up to and during the pandemic, leaving investors that opted for high dividend objectives at the expense of a total return approach more vulnerable to extreme volatility. Underlying companies have looked to hoard cash rather than distribute to investors or cease share buybacks or have been persuaded through political interference to suspend payments altogether.
DFMs and Advisers in partnership These experiences help to demonstrate why the DFM service proposition and the financial adviser have been such a successful partnership, particularly since the introduction of the Retail Distribution Review (RDR), with broader availability via platforms and a reduction of single premium life company offerings. Most DFM’s have reported significant increases in AUM through advisers compared to inhouse private client direct sales teams. There is scope to grow this type of market share further following the pension freedoms introduced by George Osborne as the Centralised Investment Proposition (CIP) evolves into a default Centralised Retirement Proposition (CRP) with further pricing and product opportunities to come.
Transparency With DFM transparency increasing through third party evaluation, including relative performance comparisons from ARC Private Client indices, demand for highly prized overachieving intellectual capital has never been higher in the form of collective investment funds, which now form the building blocks of most DFM services.
Given the scale of demand for selective fund strategies, the need for advisers to be assured of ongoing due diligence regarding the funds that their clients are ultimately exposed to continues. Recently we have witnessed industry legend fund managers Neil Woodford, Mark Barnett and Alistair Mundy all being relieved of their fund responsibilities, in some cases with dire consequences for investor returns. Most DFM providers were devoid of these managers leading up to the events that unfolded, but these events highlight the importance of understanding the existing and new fund selection processes, such as the fund’s exposure to different types of clients, liquidity awareness and any deviation within the funds holdings from the stated investment philosophy and objective. So in addition to DFM providers adding value within portfolio construction through fund selection, tactical and strategic asset allocation; the ongoing monitoring of successful fund outcomes is an important criteria of due diligence when RSMR rate DFM providers, after all good performance is always historic.
Why the DFM Academy? A key aim of the DFM Academy portal is to dispense topical and relevant information enabling advisers to obtain a deeper understanding of private client services helping to ensure that the longevity of appropriate investment returns is sustained to the end investor. The Academy supports this aim by providing the adviser with: z Ideas – thought leadership and best practice tips z Ratings – full details of the DFM ratings & factsheets z DFM Profile – a detailed ‘under the bonnet’ report on each proposition z Video – video content supplied by DFMs in support of their proposition z Adviser events – adviser events promoted to promote links and encourage attendance z DFM – half yearly online magazine We hope you enjoy this DFM Bulletin and if you have not already done so please go to the DFM Academy on the RSMR Hub – www.rsmr.co.uk. n
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INCLUDING THE RIGHT INGREDIENTS
– AND PUTTING DUE DILIGENCE IN CONTEXT Matt Ward, Communications Director at AKG, looks at the requirement for carrying out due diligence exercises when selecting (or retaining) DFM partners, suggests an overarching framework which can be used by intermediary firms to support this type of work and discusses why it’s important to contextualise and review such exercises. The requirement for due diligence It is in the best interests of intermediary firms to carry out robust, repeatable and recordable due diligence exercises when selecting (or retaining) partners for their business, including outsourced investment partner such as DFMs. These exercises should be done to facilitate best practice within the intermediary firm and, crucially, to support the delivery of good customer outcomes. Furthermore, the regulator remains keen to see evidence of deeper and more engaged due diligence being carried out by firms. In a market experiencing great change and challenge, due diligence will continue to play an important role and intermediary firms should be reminded that this is something which should be done when first identifying and selecting DFM partners, and then reviewed to support retention decisions on an ongoing basis.
Putting a due diligence framework in place There are a variety of ways in which intermediary firms might go about their due diligence exercises and they should certainly be encouraged to tailor these to meet the
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specific requirements of their firm (from both an investment beliefs and business model perspective) and crucially their clients. In order to establish a robust and repeatable due diligence framework when selecting or reappraising DFMs, and to create a supporting audit trail, AKG proposes a balanced four-step process which can be tackled in any order and seeks to cover the following overarching areas: Step 1 – Proposition research and analysis Step 2 – Investment style and performance analysis Step 3 – Operational capability and service delivery Step 4 – Company-level assessment.
A suggested four-step framework Step 1 – Proposition research and analysis The nitty gritty research and analysis required to search the market and compare what's available in terms of the proposition(s) being marketed by DFMs to intermediary firms, i.e. What type of investment portfolio/ service does the customer need? Who does what and how does it compare? Items may include analysis of:
z Type of portfolio solution – Bespoke, Managed or Unitised Portfolio Service z Key features and composition of portfolio service
z Operational approach, governance and risk procedures z Image and strategy z Intermediary distribution capability and support.
z Associated terms and conditions z Cost of service versus value provided; transparency of charges z Accessibility of portfolio service via relevant product wrappers/platforms.
Step 2 – Investment style and performance analysis When selecting a third-party investment specialist, an assessment of their performance credentials, and an understanding of their investment approach and style, will inevitably form part of the due diligence process for intermediary firms:
Contextualise against evolving market Intermediary firms should also seek to contextualise these due diligence exercises, and key considerations for their clients and their business, against the backdrop of an uncertain economic, regulatory and political landscape, allied with an ever-changing financial services marketplace.
Reasons to review – how are DFMs responding to some of the key considerations/challenges faced?
z Gain an understanding of, and be comfortable with, the investment approach and style
z Covid-19 – Approach to business continuity, adviser/ client communications and service delivery, investment approach response.
z Seek out relevant past performance and request regular ongoing performance data
z MiFID II – Not quite a footnote yet. How did the DFM cope with delivering key MiFID II requirements.
z Match portfolio service to agreed risk parameters for customers
z M&A activity – The DFM sector is large in terms of the sheer number of companies operating in this space. For a variety of reasons, there will inevitably be consolidation, indeed we’ve already started to see some.
z Monitor portfolio service performance against the objectives and parameters agreed at outset for the customer.
Step 3 – Consideration of operational capability and service delivery Intermediary firms should also try to get a feel for the infrastructure in place within DFM businesses to support the ongoing delivery of portfolio services to customers and advisers. Items may include consideration of: z Resource, staff, team structure z IT systems, digital/tech development z Risk management systems and governance structure z Security of customer data and assets z Online/offline servicing capability z Integration with other relevant systems in the intermediary firm, i.e. CRMs, platforms.
Step 4 – Company-level assessment Beyond the headline level of assets under management held, intermediary firms should seek to understand more about the DFM business that customer assets will be entrusted to by considering the following: z Business structure and senior management team z Core financials and capital position z Financial strength and sustainability
z Sheer competition for business in the market for managed investment solutions ranging from multiasset funds through to bespoke portfolio services. z Ability for DFMs to fund and drive through required enhancements to digital/technology capability. z MPS performance track record will come under more scrutiny as various solutions clock up more time in the market. z MPS pricing is an extremely competitive area and hence achieving cost efficiencies in the servicing of MPS business is a pre-requisite for survival here. z Quality of interaction and data sharing with relevant third parties such as investment platforms, SIPP operators and offshore bond providers.
The benefits of due diligence By adopting robust due diligence processes, and continuing to review and reflect on key associated considerations, intermediary firms will put themselves on the front foot with regards to sustaining winning relationships with DFMs. Ultimately this will help adviser businesses and their partners to deliver positive customer outcomes and be able to better respond to change and challenge when it comes. n l www.akg.co.uk
www.rsmr.co.uk Summer 2020
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John Bellamy, Head of Adviser Solutions, Waverton Investment Management
WHICH PORTFOLIO TYPE MIGHT BEST MEET CLIENT OBJECTIVES?
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s difficult as this period has been for advisers, paraplanners, asset managers and clients, we must keep all things in perspective. All around us are frontline key workers doing far more important, valuable and dangerous jobs and for that we thank them. Having said that, as advisers the recent setback has provided the perfect opportunity to review your preferred investment solutions (and those on the bench) with the benefit of a full investment cycle behind you.Whatever volatility awaits in the coming months and beyond, you can now judge your providers through one of history’s longest bull markets and, most recently, through a surprising, savage and swift bear market. It is important that advisers are armed with this information so that they can communicate effectively with their clients in terms of how the selected portfolios have performed, whether any changes are to be recommended and the reasons for those changes.
In the protracted period of steady, if unspectacular, economic growth and consistently rising markets it was all too easy to be charmed by the top-quartile returns of investment services coupled with the promise of active management and downside consideration. The problem being that whilst stellar historic returns are easy to demonstrate the protections within are not. There are too many stories now of clients in all mandates receiving 10%, or even 20% drop letters during the downturn which goes to prove that there is more to active management than glossy slides and riding the risk train.
We are hearing of most active managers falling in to one of two particular camps. The hares or the tortoises.
We are hearing of most active managers falling in to one of two particular camps. The hares or the tortoises.
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Equally, there are well known investment houses that are rightly lauded for their caution. Positive returns in the last great sell-off in 2008 and outperformance in Q1 2020 speak to investment processes that really are doing something very different. However, if these same processes were delivering little or none of the upside in the intervening years then surely they are guilty of reckless conservatism. Maybe neither the tortoise nor the hare won this race?
There is a middle ground. It starts with a clear understanding from all parties (investment manager, adviser and client) of what the client’s objectives are, followed by a clearly articulated process to deliver these objectives within appropriate risk parameters. The challenge for the investment manager is to meet these objectives in such a way as to participate reasonably in rising markets and also protect from the worst of the ravages of the downside. This challenge can be met with a broadly diversified portfolio that gives exposure beyond the traditional asset classes of bonds, equities and cash. It requires the managers to make full use of these tools and the discretionary permissions that they have been trusted with. So when the process is reviewed there is clear evidence of active (proactive not reactive) management through the last full cycle. There should also be good examples of how the portfolio construction dampened down the volatility of returns without minimising the gains in positive markets. We find that such portfolios are best constructed from direct holdings (equities and bonds) rather than through a fund of funds approach. This allows for more control of the portfolio and a multitude of risk levers to pull through the cycle. Within such portfolios there is no reliance on third party managers to make the right calls at the right time. Using this approach allowed us to enter the crisis underweight risk assets. We did not see the crisis coming, but we did see an equity market that was looking fully valued and an economic outlook that was challenged. With this in mind, over
the course of the preceding 12-18 months we gradually reduced equities and corporate bonds in favour of lower risk sovereign debt and alternatives. At the same time our long-term strategic hedges were increased. For portfolios managed on third party platforms it is not straightforward to deliver the necessary diversification, in particular the hedging instruments. The fact is that most managers are reliant on the limited funds that are available and these are not always there across all platforms. Whilst past performance cannot be guaranteed, at Waverton, we find that our portfolio construction (blending five asset class funds: Waverton Sterling Bond Fund; Waverton Global Core Equity Fund; Waverton Tactical Equity Fund; Waverton Absolute Return Fund and the Waverton Real Assets Fund) has worked well, allowing for a more sophisticated approach that enables delivery of consistent client outcomes regardless of where the assets are booked. These measures, and others, whilst costing a few basis points of performance in 2019, made a significant difference to the relative experience of clients in the last quarter. And while this approach doesn’t aim to “knock the ball out of the park” on the way up, it does allow for all to sleep well at night knowing that, as more testing times come, they’re better protected than the hare and they enjoyed more of the journey than the tortoise. n l We would be delighted to discuss Waverton’s approach in more detail with you. If of interest please contact Mark Barrington, Head of Intermediary Sales: mbarrington@waverton.co.uk +44 0207 484 2058
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Matthew Yeates, Senior Investment Manager, 7IM
THE GREAT BIG NATURAL LIE
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rganic. Free range. Natural. When I see these words on a weekend brunch menu, I know two things — I’m expecting high quality produce… and I’m going to pay for it! Most of us regard natural food as unequivocally good – with no additives or preservatives or anything unexpected. ‘Natural’ means “not made or caused by humankind”. It seems absurd that the idea should be applied to anything in finance, which is created entirely by humans. And yet time and time again we hear about ‘natural’ income, as the media and investment managers push high-dividend stocks and income-focussed funds.
In the UK, some of the largest payers historically have been banks and oil companies. Not long ago we found ourselves writing about how HSBC suspended its dividend for the first time since the Second World War, with all other UK banks following suit. And the oil companies aren’t much more reliable – plunges in the price of oil aren’t good for pay-outs to shareholders! In some cases dividend payments from entire countries are being halted, like in France and Germany. For investors with a long term-time horizon this looks like an investment opportunity, but if you were relying on those dividend payments for income this year, you’re out of luck.
Income in retirement
It seems absurd that the idea should be applied to anything in finance, which is created entirely by humans.
But, despite what many believe, ‘natural’ doesn’t automatically mean quality. And it certainly doesn’t mean guaranteed. Buying a stock just because it pays a high dividend is a weak investment strategy. If the managers of a business think their shareholders would be better served by cutting the dividend and reinvesting in the business, they have every right to do so. Then of course, there are external events that impact the payment of dividends and reminds us that ‘safe’ dividend-paying firms are not necessarily safe at all. Unsustainably high dividends usually end up being cut – as we’re seeing now in the current coronavirus climate. Sometimes they even disappear altogether.
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When people investing for retirement stop working, suddenly they have a new investment need, a new goal. Rather than accumulating wealth and trying to maximise the size of their nest egg, they want an income to live from that will last.
Investors looking for a portfolio that maximises their chance of meeting their retirement spending needs should not view income assets and capital growth assets as separate things. It’s better to focus on the total return of portfolios, incorporating both capital returns and income. After all, income can be created by selling the proceeds of capital growth just as easily as from ‘natural’ dividend payments. So why do people follow the natural income approach? The most common answer is that focussing on the dividends of
investments “leaves the capital intact”. One of the best kept secrets in finance is that this statement is absolutely, 100% not true. Assets that pay an income (e.g. when a stock pays a dividend) drop by the value of that dividend on the day that payment is made, i.e. the capital isn’t left intact at all. People often don’t realise this, simply because the size of the individual drops is so small. At 7IM we believe in a longterm, total return approach to retirement income. To allow us to take a long-term approach we split investments into different pots that provide for short-term income needs, longer-term needs and a buffer to provide income when periods of volatility arise. We have rules in place to follow for rebalancing portfolios when markets are up or down. We have
built systems to test those rules through periods like the last few weeks and much worse, covering thousands and thousands of different potential outcomes. This approach allows us the flexibility to look across all types of investments, not just those with high levels of ‘natural’ income. It allows retirees the flexibility to work out how to spend their total return in retirement, without worrying that they’re getting a little less this year from dividends. n l Find out about how the 7IM DFM team delivers it’s award winning Retirement Income Service at https://www.7im.co.uk/ financial-intermediary/what-we-offer/ retirement-income
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AN ACTIVE APPROACH TO PASSIVES Alex Moore, Rathbones head of collectives research, investment management, discusses how to get two opposites to work together in one portfolio
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t’s not uncommon for an investment strategy to be followed to such an extent that it becomes almost tribal. Dedicated followers of either value or growth investing are one example. Another is the active versus passive camps, where fans of index funds argue about the virtues of simple, low-cost investing which, after fees, has outperformed many active managers. Unlike value and growth-focused investing, which should provide contrasting exposures if executed correctly, multi-asset portfolios can benefit from holding a blend of active and passive funds. The advantages of both approaches are nuanced and the choice depends on the opportunity the market presents. Passive funds have advantages. The biggest and almost indisputable benefit is lower cost. For instance, a FTSE 100 exchange traded fund (ETF) can cost as little as five or six basis points, while some S&P 500 ETFs are even free. They provide cheap and efficient exposure to a stock market index (also called equity beta). Through an ETF it’s also possible to gain exposure to asset classes that are difficult to buy directly, but have strong portfoliodiversifying qualities. Physically backed gold ETFs are a great example of an asset that has added a diversified source of returns to portfolios in 2020.
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Far from infallible However, when markets are particularly volatile and less liquid, ETFs can be far from infallible. Understanding these shortfalls is crucial, and can not only give active managers an edge, but also help investors make better decisions. This situation has been more evident in 2020 with corporate bond ETFs. With more sellers than buyers during the stomachchurning falls triggered by COVID-19, and the underlying market liquidity drying up quickly, some ETFs not only fell in value, but at a quicker rate than the indices they are following (figure 1). By taking into consideration various factors such as a bond’s liquidity (how big the pool of buyers and sellers is), duration (a bond or portfolio’s sensitivity to changes in interest rates), the underlying financial health of the issuers and portfolio cash management, active managers can have an advantage over ETFs. Lower costs are important but could prove poor value for money if an ETF is structurally flawed, or blindsided by one or more of these factors.
Under greater scrutiny As for their equity counterparts, there are other issues to consider beyond beating an index. An income fund generally targets a
yield that is greater than the market, or can grow its dividend at a greater rate. Some active managers are trying to ensure a return with a greater degree of capital preservation in down markets. With more scrutiny on qualitative attributes such as governance and environmental considerations, these can also be factored into an active strategy. Since the start of 2020, many UK equity funds, whether open-ended or investment trusts, large or small-cap focused, income or total-return orientated, have performed well through the extraordinary turbulence on a relative and risk-adjusted basis. The decision to allocate to various asset classes depends on your financial objectives and goals. However, there are many advantages to building a portfolio that blends both active and passive vehicles rather than sticking with one or the other. Understanding the trade-offs between costs, asset exposure and flexibility of execution by active and passive providers can help investors reach their desired outcome. n l This is the first instalment in our series of articles about passive and active investing — catch the second instalment in next quarter’s InvestmentInsights.
About Rathbones Rathbone Brothers Plc, through its subsidiaries, is a leading provider of high-quality, personalised investment and wealth management services for private clients, charities and trustees. This includes discretionary investment management, unit trusts, financial planning, trust and company management and banking services. As at 30 March 2020, the Rathbones group managed £42.6 billion of client funds, of which £6.8 billion were managed by Rathbone Unit Trust Management Limited. rathbones.com
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COVID-19 POSES TEMPORARY SETBACK TO THE ENERGY TRANSITION
Mark Lacey, Head of Commodities, Schroders
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he Covid-19 crisis and oil price plunge may slow consumer appetite for the energy transition but this effect will be short-lived.
Like almost all sectors globally, the spread of Covid-19 and ensuing lockdowns have taken their toll on activity in the energy transition sector. 2020 was expected to be a record year for wind and solar power installations. That is now unlikely given the difficulties in moving the necessary component parts around the world. Some projects are still ongoing, but many others will be delayed. The good news from the point of view of the energy transition is that such projects will simply slip into next year with activity expected to recover strongly in 2021. Where we are cautious, and might not see such a quick recovery, is in the consumerfacing aspects of the energy transition.
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Recent economic data from the US and in Europe continues to show significant job losses. Clearly, such a difficult employment backdrop will have an impact on consumer spending, especially discretionary spending. There are two parts of the energy transition that we think will be particularly affected: electric vehicles and rooftop solar. This is different to structural spending, as buying an electric car or installing solar panels on the roof are discretionary spending decisions that are unlikely to be top priorities for households given the difficult jobs picture.
Energy transition commands policy support However, while household budgets may be tighter, the underlying demand for action on climate change is still there. That demand comes both from the public and from policymakers. Many countries, with Europe
leading the way, are due to phase out cars with internal combustion engines in the coming years. What’s more, the bigger targets still remain in place. While the Covid-19 crisis has understandably taken the spotlight, the climate crisis hasn’t disappeared. Countries around the world remain committed to limiting warming from pre-industrial levels to 2 degrees or less, as per the 2015 Paris Accord. Although there has been little concrete action so far, we note calls for economic stimulus in the wake of Covid-19 to focus on energy transition measures. Europe, for example, had already proposed its Green New Deal before Covid-19 spread across the continent. Calls for recovery measures to be designed to help build a climate neutral economy are gaining momentum, with a think tank in Germany proposing a €100 billion package.
Business continues to support energy transition As well as public demand and policy support, the third pillar supporting the energy transition is the cost competitiveness of clean power. Demand for electricity has obviously fallen during the lockdowns but looks set to rebound as economies reopen. Clean energy will remain a high and growing percentage of demand as it has become cost competitive with conventional fuels. Even in the midst of the Covid-19 crisis, businesses are still investing in renewable energy and technologies. For example the utility firm Southern California Edison is ordering a huge storage portfolio to replace gas plants and enhance the reliability of its grid.
The combination of cost-competitiveness, policy support and public demand are the three factors driving the energy transition. All three remain in place, despite the temporary impact we are likely to see in terms of household spending as a result of Covid-19. The energy transition covers a broad range of areas, not only clean power generation and supply, or electric vehicles, but also storage, transmission and electrical equipment. The long-term structural investment opportunity remains very much intact. n l This article is issued by Cazenove Capital which is part of the Schroder Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. www.cazenovecapital.com/uk/financialadviser/
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Cheaper oil has limited impact on energy transition The falling oil price has been a feature of recent volatile markets. We would stress that oil prices have less crossover to the energy transition than one might expect. Around 65% of all oil consumed is in transportation. Again, falling petrol prices could be another short-term factor limiting consumer appetite for electric cars, and this may particularly be the case in the US where people are accustomed to driving long distances. However, we see it as having less impact elsewhere, especially in Europe where a significant part of the petrol price is tax and where the internal combustion engine phaseout is a much bigger part of the decisionmaking process. It’s also notable that even the major oil companies are responding to the oil crisis by protecting their investments in the energy transition space, while cutting aggressively their conventional energy capital expenditure. The falling oil price saw Royal Dutch Shell recently cut its dividend for the first time since the Second World War. That was to ensure that it can still make the investments it has planned in the green energy space.
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AHEAD OF THE CURVE? Guy Foster, Head of Research Guy leads Brewin Dolphin’s Research team, providing recommendations on tactical investment strategy to Brewin Dolphin’s investment managers and strategic recommendations to the group’s Asset Allocation Committee. He is a CFA charterholder, holds the CISI Diploma, and is a member of the Society of Business Economists. Guy frequently discusses financial issues with the written and televised media as well as presenting to the staff and clients of Brewin Dolphin.
China was the first country to feel the effects of Covid-19, and has been first to relax lockdown. Guy Foster, Head of Research at Brewin Dolphin looks at what the world can learn.
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hina specifically, and Asia, in general are interesting for a few reasons. Most obviously it was China that suffered the first wave of coronavirus cases and so offers the first case study for how to contain the virus and how to re-start the economy.
China is also likely to be at the vanguard of any feared second wave of cases. It will also therefore offer the first opportunity for businesses and the authorities to show how they have evolved their practises to be more resilient and active if a second wave of infections hits.
Step by step At the start of April, the lockdown in Wuhan started to be relaxed, 76 days after restrictions were imposed. The relaxation of rules has been approached regionally – so Beijing and Shanghai reopened schools ahead of Wuhan – and sector by sector. The Government has also recently announced plans to gradually reopen cinemas, museums and other recreational venues. The process has been carefully managed. Initially, those who had a green clearance code on a smartphone app were free to leave the city, with travel on public transport restricted in a similar way. However, it has not been a quick reopening. Many restaurants and shops have remained shut. Wuhan’s senior schools reopened on 8 May, and then not for all age groups. As well as distancing between desks, thermal scanners were in place, and anyone with a high temperature was not allowed in. Now, with news of fresh cases in Wuhan,
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concerns over a second wave following the easing of restrictions seem pertinent.
Consumer confidence Weeks after restrictions were eased, the streets have remained quieter than normal. Consumers appear wary and seemingly reluctant to venture out and spend. A recent broker survey of large services firms shows that while 75% to 85% of supply has been restored, demand is only running at 50% to 55% of normal levels. Many companies don't expect full normality at home to return until the second half of the year¹. This question of demand is significant because while exports remain important for the Chinese economy, (and will therefore feel any drop in international demand caused by lockdowns elsewhere around the globe), they are not as meaningful in terms of growth as they once were. Domestic consumption accounted for 80% of last year’s growth, which is why getting consumers back out and spending could be so crucial. Such is the concern, that billions of yuan in shopping vouchers have been given away to encourage consumers to start spending again. How long this drop in consumer confidence lasts is something that leaders in the west will be watching with interest.
Further intervention opportunities Despite consumer caution, the economic data has shown that the reopening is certainly making a difference. Construction and manufacturing activity has been returning. After the shock 1 https://www.bbc.co.uk/news/business-52305259
contraction in the first quarter of the year when GDP shrank 6.8%, China’s first year on year quarterly decline since 1976, March and April's monthly data show that activity is picking up. Nevertheless, the economy still has a long way to go to get back to where it was pre-crisis, putting pressure on the authorities to do more. However, the authority’s dilemma is that they are trying to juggle competing objectives. On the one hand, they want to boost spending and encourage new borrowing to boost growth. On the other hand, they are reluctant to abandon their longer-term goals to reduce debt and risk. There has been a very large increase in debt in China across all sectors, with the stock of debt expanding from 140% of GDP prefinancial crisis to almost 260% of GDP as of Q3 last year. There have been interventions already. Loan activity is picking up. Data last month showed that bank loan and total social financing growth accelerated, as did M1 and M2 money supply. This signals that the authorities are leaning on its state-owned banks and reducing constraints around shadow bank lending to boost credit creation. There is scope to do more – and compared to other governments around the world, they have been quite meek so far. The question will be around how much more and where it will be targeted. The annual National People’s Congress, which was initially scheduled for 5 March, will now be held on 22 May. Major legislation, policy initiatives as well as economic targets are unveiled at this event, so this is something that will be watched closely.
Economic scarring Looking at the experience in China, it is important to remember that suppression measures of some form will remain in place in countries around the world until there is a vaccine or herd immunity. Hospitality businesses may struggle to cover their operating costs with strict social distancing measures in place, which suggests there will be additional job losses once governments start to scale back support for furloughed staff.
The Chinese experience has relevance for what the rest of the world can expect from life immediately after lockdown. Businesses and households will emerge from strict lockdowns cautiously, and investment and consumer spending will not fully snap back. There will also be defaults, which will impact banks' willingness to lend, and result in more job losses. The bottom line is that this crisis will leave the economy with scars. The Chinese experience has relevance for what the rest of the world can expect from life immediately after lockdown, although it seems
as if cultural differences have meaningful implications. Chinese data are notoriously unreliable but even assuming under-reporting, China appears to have restricted cases and mortalities far better than the western world. That is the advantage of an authoritarian system and a largely compliant population. This is generally true of the developed Asian countries which have also typically taken a cautious approach to lifting lockdown. It means that if we see a meaningful pick up in Asian cases then we should be steeled for even more disruption in Europe and particularly the US, where reopening the economy has been given a higher priority than in other regions. More recently several western countries have accused China of everything from secrecy to negligence over their management of the virus. President Trump has threatened tariffs once more and so the previously receding threat of a trade war may now be in the ascendancy again. Neither party would benefit from pushing this issue too far, with their economies pretty well-integrated and dependent upon each other. But facing an election in November and an economic challenge of historical proportions we can expect the US to continue to talk tough. While markets have rallied significantly from their lows, most remain some distance from this year’s highs. We expect them to continue to make progress over the next twelve months, but, amidst coronavirus uncertainty and tense foreign relations, the near-term outlook warrants a slightly more cautiously optimistic stance. n
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Chris Beckett, Head of Equity Research, Quilter Cheviot
Matt Ennion, Fund Research Analyst, Quilter Cheviot
OUTLOOK FOR UK DIVIDENDS: STILL A RELIABLE INCOME?
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tock markets have rebounded quickly from their lows this year, but the outlook for UK dividend investors remains mixed. Many companies have cut or suspended their dividends in response to the coronavirus crisis and given an impending global recession, these look unlikely to be reinstated in the short term. Nevertheless, we expect the UK and global economy to recover in 2021, with dividends rebounding too. The picture will vary sector by sector and company by company. Food retailers and consumers goods companies have maintained their dividends, for example, with these sectors tending to either be unaffected by the pandemic or beneficiaries of it. Pay-outs from the oil and gas sector, a highly cyclical part of the market, are likely to remain at a permanently lower level. However, dividends will remain an important source of income for many investors, even in the short term. Dividend income is likely to be more concentrated amongst sectors, but there are ways to diversify your income sources and wider merits to sticking with UK dividends.
UK shares still offer a relatively high level of income In both absolute and relative terms, UK shares still offer a high level of income. As of the end of May 2020, the FTSE 100 offered a yield of slightly more than 4%, significantly higher than the yield on ten-year UK government bonds, which stood at just under 0.2% at the end of the month.
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Furthermore, this ‘income premium’ is unlikely to change in the short term. UK dividends have already fallen by around a third, including a total suspension of dividends by the banking sector as the regulator demanded the banks display prudence with their balance sheets. While we could see UK dividends fall by 50% in total from their 2019 peak in a worst case scenario, this would still leave the market trading on a yield of round 3%. Bond yields are likely to remain low for the foreseeable future, helping to sustain the attractiveness of the stock market even in the face of dividends cuts or suspensions.
Dividend resilience: not all sectors are created equal Dividend cuts have been highly concentrated by sector. There are those who simply cannot pay, including businesses in the travel or retail sector, many of which have been directly affected by lockdown measures. There are others who believe it is prudent not to pay, such as the housebuilders, which now looks like a case of excessive prudence. Many housebuilders have net cash positions with some encouraging signs that at least some in the sector are coping well with the crisis. There are some companies, such as BP in the oil sector, which have not yet adjusted their dividends. We do not expect a cut in the dividend in the second quarter, with the longer-term outlook contingent on oil prices. Overall, we expect the dividend yield on our UK 40 stock model to fall to around 4.1% in our base case, with a worst-case scenario seeing a dividend yield of 3.2%. This would still be an attractive yield compared to other
asset classes, however. Fundamentally, many UK businesses remain well run, high quality names, and while a dividend suspension will hurt in the short term, offer good long-term income potential.
How to adapt a portfolio Of course, there may still be some actions investors might want to consider, especially if they are specifically in the market for an income. Diversifying your UK exposure into smaller UK companies could be one option if you do not already have small cap exposure, with UK smaller companies offering their highest yields since the Global Financial Crisis on some measures. With Brexit on the horizon, however, you need to pay due consideration to your overall UK exposure. Income investors may also want to consider income-focused investment trusts, in addition to direct stocks or open-ended
funds. Investments trusts are allowed to hold back a proportion of the dividends they receive each year as reserves, releasing this surplus to investors in leaner years. Several UK investment trusts have sufficient reserves for their pay-outs to be unaffected by the coronavirus crisis, even assuming their holdings stop paying dividends entirely.
Conclusion While Covid-19 may have badly shaken confidence in dividends as a source of income, there are still strong grounds for considering equity income as an asset class, not least the higher yields and potential for income growth over time. Furthermore, investors have continued to put money into income funds during the coronavirus crisis, suggesting that long-term demand remains strong. Dividends may have suffered in 2020, but the case for equity income remains intact. n
l Quilter Cheviot One Kingsway London, WC2B 6AN contact: Marketing e: marketing@quiltercheviot.com t: +44 (0)20 7150 4000 w: www.quiltercheviot.com
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