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| MoneySense - Autumn 05
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| Financial markets have performed well over recent months. Strong growth, rising corporate profitability and reasonable valuations have helped drive equity indices higher in most markets except the US where interest rates were raised by another 0.25% to 3.75%. Bond markets have also held up despite a steady rise in inflation, albeit from very low levels, in most developed markets. The oil price continues to make headline news touching $70 and it is difficult to see an early respite. Until very recently figures from the International Energy Agency supported the view that the rising price was mainly a function of excessive demand (predominately China) but the hurricanes in the Gulf of Mexico raise the possibility of it becoming more of a supply issue with long lasting and more widespread consequences. As a result analysts are now revising forecasts for 2006 to $64 per barrel, a 40% increase on previous assumptions. Global GDP forecasts have also edged down slightly to 4%. The US could be one of the worst affected and we expect US GDP to weaken by up to 1% in Q4 although some of this will be recouped in 2006 as a result of the $67bn Federal relief package. The impact on inflation is an unknown quantity but critical for the pricing of credit and bond markets - the pre-hurricane US core consumer price inflation was only 1.8% which is why bond markets are relatively sanguine about the situation. Financial markets are assuming the oil shock will be deflationary, not inflationary, and so any evidence to the contrary would pose a serious threat to the current stability in bond markets. In these circumstances, index-linked bonds would provide a useful insurance policy. While global economic growth remains relatively resilient the same cannot be said for the UK which has deteriorated faster than expected in recent months. Our expectation at the start of the year was for 2% GDP in 2005 but the Q2 downward revision showed that the growth rate had fallen to 1.5%, the lowest level for 12 years. The lagged impact of last year’s interest rate rises and the ending of exceptionally cheap mortgage finance have finally taken their toll on the residential housing market where the annual rate of price increases more or less ground to a halt in August from over 20% this time last year. The lack of supply of new housing should provide some support but, given the reduced scope for mortgage equity withdrawal and rising energy costs, weak retail sales may continue for several months. The consumer price index rose again in August to 2.4% and, with the likelihood of worse news to come, interest rates will probably remain on hold at 4.5% after the recent 0.25% cut. Lower economic activity will have a knock-on effect on tax revenues as the government’s spending plans were predicated on rather more optimistic growth forecasts. The net result of a deterioration in government finances could be further weakness in sterling. It has been a dramatic few months for investors in Europe and Japan. Just as growth was starting to pick up in ‘old’ Europe on the back of exports to Asia an indecisive election result in Germany raised the question of the sustainability of the restructuring programme. Perhaps it was proximity to China that persuaded the Japanese electorate to return Prime Minister Koizumi to power in a landslide victory emphasising their determination to continue and even accelerate the programme of reforms. This will complete the restructuring of the banking system and the privatisation of key public institutions. The process will take years and in the meantime Japan has one of the worst demographic profiles with an aging population which is unproductive in economic terms. But fortuitously it is a major beneficiary of the industrialisation of China and India and this will help absorb some of the excess capacity as well as acting as an incentive to improve returns and dividends to shareholders. Equity values have risen dramatically as the international investment community recognised this turning point although domestic investors are more reticent. Nevertheless, the changes taking place mean that Japan provides one of the most interesting restructuring opportunities over the next decade with the added attraction that its economy is not overly sensitive to high oil prices or heavily dependent on the US consumer. Growth remains very strong in Asia and the emerging economies despite central banks raising interest rates in response to inflationary pressures from rising energy costs. Asia is closely linked to the US consumer but is now more attractively valued than the resource dependent emerging economies. The 50% increase in the oil price since this time last year clouds the outlook for global markets. We expect slower economic growth and modestly higher inflation but nothing like a repeat of the deep recessions which have resulted from previous oil shocks. Energy usage is more efficient and globalisation will facilitate a more efficient rebalancing of trade. Oil exporters such as Saudi Arabia and Russia are also under more internal pressure not to hoard their unexpected increase in wealth. For companies in the developed world profits growth is getting harder as a result of rising real interest rates and higher energy prices as well as international competitive pressures. Overall earnings estimates are being revised up but this is because strong upgrades in mining and oil are offsetting mild downgrades across many other sectors. Equities are not priced expensively and certainly not in relation to either bonds or property. It is reasonable to expect some consolidation in the coming months on growth or inflation scares but the background is still generally favourable. A continuing theme is mergers and acquisitions, especially leveraged buyouts of quoted companies by private equity investors seeking to take advantage of the low cost of debt. Morgan Stanley Quilter Sept05 ms/Autumn-05-01
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| Commodity
Index Review 1.
Buy the physical 2.
Buy commodity futures 3.
Buy commodity stocks 4.
Commodity indices
Many investors ask how investing into commodity futures makes money for them. If it is via investment into a fund that invests exclusively on the “long side“ of the market, this is achieved in the following ways: Spot Return: the return generated from changes in commodity prices over time. Backwardation/Roll Yield: the return earned by buying shorter dated futures that are rolled into longer-dated contracts as delivery dates approach. Interest: the return (usually close the US T-bills) from margins held for futures contracts. Monthly rebalancing yield: where the fund will “profit take” from those components that might have risen, to reinvest in those that have fallen in value, by the fixed proportion each represents in the portfolio/index. Clearly it is important to select an index that is best suited to achieving the desired returns objective being set. For this it is essential to discuss your requirements with a financial adviser familiar with the choices and opportunities available.
Noble Investments ms/Autumn-05-02 |
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Introducing
BlueCrest Capital Management BlueCrest was established in 2000 by Michael Platt and William Reeves, who were both Managing Directors and senior proprietary traders at JP Morgan before leaving. Their objective was to construct a trading infrastructure of investment bank quality from which they could build trading teams and manage new funds. At the core of the BlueCrest vision was heavy investment in technology and information. To achieve this Platt and Reeves developed a significant in house quantitative research team. This team brings together researchers with backgrounds in statistics, stochastic calculus and control and is able to leverage the market expertise of more than 40 ‘human traders’ who include numerous market specialists. A key focus for BlueCrest when building its sizeable team of proprietary trading specialists has been to acquire specialist knowledge and skills and effectively increase capacity, rather than solely seeking profit creation. The trading floor culture, with no separate offices and an open architecture structure rich in information flow, has produced a unique platform for extensive cross fertilisation of ideas and acumen at all levels of the market.A return driver Risk control is a vital part of the BlueCrest investment process but the manager’s strategy is centred on the optimisation of risk-adjusted returns. Its strategies,focus on asymmetric returns meaning that while they are heavily weighted towards generating large, positive returns, there is also significant management of drawdowns. As a result, the BlueCrest strategies, will largely favour investors seeking to bolster investment returns or inject alpha into their portfolio. MAN Investments Limited IMPORTANT
INFORMATION ms/Autumn-05-03
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A radical overhaul is happening to UK pensions and is likely to affect UK expatriates that have UK pensions. All the existing tax regimes are being moulded into one, simplified regime. As you can imagine the legislation is extremely extensive and below is a brief snapshot of some of the main rule changes: • A Day will commence on 6 April 2005 • A limit on the fund value that is tax exempt (Lifetime Limit of £1.5m) increasing to £1.8m by 2010. The Fund value is only tested when benefits are taken. • Contributions can be 100% of salary or up to £3600 if no earnings but will be subject to an annual input limit of £215,000. • Any benefits taken that exceed the lifetime allowance will be subject to a Recovery charge of 55% if taken as a lump sum, or if taken as a pension then 25% of the fund is taxed as income and then if a higher rate payer at an additional 40% which means an effective tax charge of 55%. For example: Client reaches retirement in October 2009 with a fund of £2M. Lifetime limit will be £1,750,000 so Recovery charge will apply to £250,000. £250,000 X 55% = £137,000 Recovery tax charge with balance £112,500 taken as cash. • 25% of fund allowed as a Tax Free Cash Sum up to lifetime limit and includes AVC’s and Protected Rights • Non UK residents will be allowed to contribute to their UK pension schemes but will not receive tax relief. • Retirement age being raised to 55 from 2010 unless individual has a contractual right to take benefits from 50 if granted before 10 December 2003 • Death benefit tax free up to life time limit of £1.5m • Retirement income can be taken before aged 75 via annuity or drawdown subject to a minimum amount of nil and a maximum amount of 120% of single life annuity. After 75 can be via annuity or “alternatively secured income” subject to a minimum amount of nil and maximum amount of 70% of single life annuity. • Residential property available as a pension asset for the first time! What
are the advantages of contributing to a UK pension? Potential
Disadvantages: • Any contributions made when UK resident will contribute towards the lifetime allowance • No tax relief available on contributions whilst outside of the UK • Original capital is turned into taxable income if placed into a UK pension fund. Alternatives • The tax treatment of offshore policies is exactly the same for a UK pension after tax relief on contributions. All income and gains are free of tax apart from the dividend tax credit on UK shares which cannot be reclaimed. • There is no restriction on when benefits are taken • 5% tax deferred withdrawals available at any time • Life policies are freely assignable-for example, ability to split tax bill between husband and wife. • On surrender 100% of capital deducted from the proceeds • The fund can be left to heirs via IHT planning • Open architecture structure and ability to appoint investment manager similar to SIPP • Gains from offshore policies should attract non-residents relief for any expatriates returning to the UK and top slicing relief for those individuals within the basic rate tax band. Use
of all planning tools
WHAT IS YOUR MOST VALUABLE ASSET? STOP for a moment and ask yourself this question: “What is your most valuable asset?” Often the first thing that springs to mind is your property or share portfolio. Maybe it’s the stake in your own business or your cherished items of jewelry? For many people it is actually none of the above. In reality, it is your ability to earn an income both now and in the future. It’s easy to underestimate the worth of your future earnings until it’s put in perspective. Take a look at the following example:
The
Unexpected Does Happen!
Are
You Exposing Your Family to Unnecessary Risk? Strangely, most people wouldn’t think twice about insuring their car ahead of insuring their life!! Ask yourself…which is more important, your car or your family’s standard of living? What
would be the impact of your death on your business? To meet the needs of families and companies, Aviva has developed a new insurance policy for expatriate passport holders called Aviva Global Protection. Aviva is the UK’s largest insurance company and 6th largest in the world. The aim of the policy is to minimise the impact of premature death by providing a lump sum on death or terminal illness (refer to product brochure). This is a multi-currency policy and is unaffected by future changes in your country of residence. There are a range of premium options, and policies can be written in trust to ensure that beneficiaries are provided for and paid out without delay. To put it simply, Aviva makes protection easier. Speak to your TTG financial planner for more details Trevor
Smith, Certified Financial Planner |
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Within an hour of stock markets closing around the world the “talking heads” are busy explaining on the TV, radio and newspapers the reasons for the markets’ reaction. Given their plausible explanations, it often seems that what happened was so utterly logical that it could have been predicted much earlier in the day. If only we’d been more alert to the opportunity we could have bought or sold and made a killing in the markets! But if it’s really that easy then why aren’t we all successful investors? The reality is that people are not always rational and stockmarkets are not always as predictable as we might think. When emotions such as greed and fear meet head on, fuelled with large amounts of money and expectation, the results are never predictable, no matter how obvious they may seem with the benefit of considered hindsight. Nevertheless, many people still try to second-guess markets for short term gains and many others make a good living disseminating information and opinion (both good and bad) on market behaviour. The
Perils of Active Trading As an example of the risks of active buying and selling of stocks or funds, some recent research carried out by the fund management group Schroder, emphasized the potential pitfalls. It showed that the best gains tend to be concentrated in short periods and tend to follow hard on the heels of a correction. This means that active traders run a great risk of missing out on the best gains as they try to avoid the losses. In a separate survey conducted by Fidelity, analysis demonstrated that between 1990 and 2005, missing just the 10 best performing days reduced returns from major stock markets by over 30%. Missing the best 40 days (just 3 or 4 days a year) would have seen returns cut by over 90%. Far from minimizing risk, therefore, trying to pre-empt the ups and downs of the markets is, in fact, a high risk strategy. All figures show annualised, total returns, from 31 December 1989 to 31 December 2004, in local currency terms. Source: Fidelity Investments
The other aspect of active trading which is often overlooked is that dealing expenses moving in and out of the market can be as much as 5-7% per deal, charges that can substantially erode or eradicate potential gains. Further research by Fidelity looked at the possible benefits if an investor was to get market timing right every time and invest on the lowest day of the year every year for over 30 years. They then compared this with investing on the highest day of the year and then, as most investors usually do, on a “random” date each year, in this case the 1st day of every new year.
All figures show annualised, total returns, 32 years to 1st December 2004, in local currency terms. Calculated using MSCI country indices. Source: Fidelity Investments. Whilst the best returns are achieved by picking the best, or lowest, day, the difference between investing on the best possible day every year for 32 years compared to the “random” date is only around 0.5% on an annualised basis. These results suggest investors do not need to be timing experts to benefit from stockmarket investment. To reduce the risk and the research (or the guesswork!) of investment decisions, simply investing in a regular and disciplined fashion could produce the right results. Investor
Psychology Recent Nobel Prize-winning research has demonstrated that people tend to perceive patterns where none exist and in particular people tend to react more positively to low probabilities but less enthusiastically to moderate and, particularly, high probabilities. This explains why people favour the ‘long shots’ at Happy Valley and buy tickets for the Mark Six – the low probability of winning is greatly overweighed and patterns are invented which are not statistically accurate. Those of us who tend to be optimists tend to underestimate the likelihood of bad outcomes over which we know we have no control. Hindsight tends to further promote a sense of confidence by creating the illusion that the world is more predictable than it really is. In reality, it has been shown that when individual investors sold one stock and quickly bought another, the stock they sold outperformed the stock they bought by 3.4% in the first year on average. And this excludes the costs of dealing transactions. (“Do Investors Trade Too Much? Odean,1998) So, this combination of overconfidence and natural optimism can cause people to overestimate their knowledge, underestimate risks and exaggerate their ability to control events. It leaves them very vulnerable to surprises and - if they then decide to cut their losses - missing out on the best gains, and then compounding their error by choosing the wrong alternative. Nevertheless, according to a BZW Equity Gilt Study published in 1997 there is a 97% chance of equities outperforming cash over 10 years. This was in the same year that Warren Buffett was quoted saying,” We make more money when snoring than when active”. Both point to a long-term investment strategy being the most effective for solid gains. Modern
Portfolio Theory Harry Markowitz won a Nobel Prize for his thesis on the relationship between risk and reward and the benefits of diversification across different markets and asset classes. He demonstrated that there are not only inherent risks in selecting individual shares, but also that there are dangers in restricting oneself to one stockmarket or even one asset class, such as shares, bonds, property, cash or commodities. His message was to invest globally and to diversify your asset allocation to create a balanced portfolio appropriate to your risk profile. Because uncorrelated asset classes don’t move in tandem, this approach can demonstrably reduce volatility, flatten out the peaks and troughs in performance and improve the whole experience of investing. It is important to recognise however, that the message is not simply to “buy and hold”. If certain assets grow at a faster pace than others, these assets will naturally represent a larger percentage of the original asset allocation, changing the risk profile of the portfolio as a result. Therefore regular review and re-balancing, by taking profits and re-assessing the investments held, is an important aspect. The advice that an Independent Financial Adviser (IFA) can provide could prove invaluable. Sorting through the options yourself can be confusing and time-consuming and an IFA can help you put together an appropriate financial plan to help identify your financial priorities and achieve your goals. The key is to block out the noise of speculators, be aware of the role played by emotions and take into account the risks and additional costs of active trading. Simply get a solid long-term strategy based on your needs and stick to it rather than trying to second-guess the markets or over-reacting to short-term movements. In
other words time, rather than timing, is the key to investing. It
should be noted that past performance is not necessarily a guide
to the future and that the value of investments can fall as well
as rise.
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In the past, these articles have looked at topics such as property, hedge funds, stock markets and precious metals. For this piece we will be dipping our toes into the murky waters of economics, in the hope that there is nothing nasty under the surface ready to bite off our tarsals. We will take a look at what is known as the Multiplier effect where a minor change in one area can have a major domino effect elsewhere. Our personal planning and that of many large financial institutions is full of broad assumptions. Time and again we are caught out by widely held beliefs that are subject to small print that no one reads until after the event. One classic example was in 1998 where everyone assumed that Russia’s burgeoning levels of debt were guaranteed by the International Monetary Fund. This proved not be the case and shell shocked investors woke up one day to find that government bonds with a face value of $100 a few weeks before were suddenly worth less than $30. It is worth repeating the word assume with a few phonetics thrown in. We soon discover that it breaks down into ass-you-me. In other words, an assumption will make a fool of everyone involved, after which the finger of blame is thrust forward by all parties concerned, in all directions but their own. It would be easy to extrapolate this into an article of the myth which is often repeated like a religious mantra that ‘my house is my pension’. But that can wait. Instead we will look at the assumption that once consumers have spent their very last (borrowed) Dollar that miraculously, the multinational cash rich companies will come and fill the spending void to keep the world economy bubbling away. Unfortunately, these organisations are not charities, nor are they the 7th Cavalry coming over the hill to save the damsel in distress. It is fair to say that consumers, governments and many investment funds have had a great party on the back of borrowed money. Sadly, the intoxicating flow of ready cash is coming to an end through higher interest rates and the hangover is as inevitable as the dawn of the following day. However, there has been one group of party poopers during this orgy of debt. They come in the form of finance directors who hold the corporate coffers of large companies. A good example of the difference in their behaviour compared to consumers can be seen with Telecom companies since 2000. When the Internet boom was in full swing third generation mobile telephone licenses were being sold by European governments to Telecom companies for many billions of Pounds or Euros. A few research reports at the time pointed out the ridiculous mathematics required to break even on these licenses but the companies still went ahead. In some cases, they paid more money for these licenses than their own stock market value just two years later once their shares had collapsed. This topic has not been raised to gloat over the folly of fantastically paid executives as they are human beings and subject to the same emotions that we all fall prey to during a bubble. The reason for bringing it up is to give the reader a picture of the psyche of many large institutions since the peak of the boom. Having got themselves swamped in debt, they were in no mood to join in the easy money party hosted by American Central Bankers. The last five years have been a period of healing for many organisations that took on too many staff and bought too much worthless technology at just the wrong time. Such is the nature of herd following behaviour. Once bitten, twice shy has become their motto having been caught once too often in the collective madness of a fake gold strike. They have since been encouraged to invest and to create more jobs. They have also been given tax breaks to do so. However, all of these inducements to let loose the purse strings have once again been in vain. Companies have been using better conditions and earnings to pay down and reduce their debt. Much like the balance sheet repairs carried out by banks in the aftermath of the Savings & Loans crisis, mainstream companies have carried out the same exercise. One piece of evidence for this is that yields on corporate bonds have been falling such that there is little differentiation in return between a top quality government bond and a large company. Yields are of course a collective expression for the risk of an investment such that higher yields reflect the higher risk nature of the company or investment vehicle. While governments can (and do) print money, this can never be the case for companies, and therein lies the difference. The fall in corporate bond yields is a sign of two things. First, investors have become very laissez-faire when it comes to risk and this can be seen by looking at surveys of bond-related investment advisers. They show the majority to be optimistic, which is a classic contrarian signal that you should act in the opposite manner. Second, it is becoming clear that companies are borrowing less and have been paying off existing debt. This means that the supply of higher yielding corporate bonds is dwindling when demand is increasing. Like anything else in life, a limited supply coupled with an increase in demand leads to higher prices. For bonds, if the price has gone up then the annual yield you receive will decrease. The ‘so what’ of this conservative corporate approach is that anyone expecting them to launch into an investment binge like that seen in the late ‘90s is likely to be disappointed. And yet it has never been easier for them to raise money as borrowing costs are low and investors are begging them to issue more debt to satisfy their hunger for yield. However, this reluctance to borrow is entirely logical as companies understand that much like property price rises, the consumer binge is likewise unsustainable. There is therefore no point in investing to produce more capacity in a declining economy because the return on investment will dwindle. In any case, business investment only accounts for 10% of US Gross Domestic Product so it would require a massive spending spree to take over the baton in the economic relay race. The steroid induced consumer has sprinted magnificently but is gasping at the handover point of the baton, as evidenced by the savings ratio which has now turned negative. This is where the Multiplier effect turns mean. Corporate planners will be scaling back their investment plans and therefore do not require more employees. However, employment growth is the prop for income and hence ongoing consumption. This looks hideously like a vicious circle in the making where one negative factor begets another. If you need a worked example then all one need do is look at the state of the Japanese economy since the stock market peaked back in 1989. In
summary we should make no assumptions about the well-being of our
finances or financial markets, especially where they involve a large
dollop of debt. Most major recessions since the dawn of the industrial
revolution are heralded by a similar theme of a debt bubble followed
by a surge in commodity prices, usually during a time of War. All
of these boxes can now be ticked. It is therefore down to you whether
you follow the example of large multinationals by paying off your
debts and reducing your risk profile. |
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For more information please contact TTG
