FAS

The events since Friday

Much has happened in markets since Kwasi Kwarteng began his statement to the Commons on Friday morning. Currency markets reacted first, with the Pound slipping further against a strong Dollar, reaching an all-time low (at the time of writing) of $1.05, and also losing ground against the Euro. The price of Gilts – loans issued by the UK Government to fund its liabilities – also fell heavily, as investors sold off the bonds, leaving the Government with a higher interest bill on existing debt.

The perception from global investors appears to be that UK economic policy is heading in the wrong direction. Announcements from the Chancellor that a spending review and full statement would follow in late November did little to improve the mood of Sterling or Gilt markets, and following a fall in Gilt prices on Tuesday, the Bank of England announced a return to Quantitative Easing, by starting to purchase longer dated Gilts in unlimited quantities, albeit for a limited period, which has helped stabilise long dated Gilt prices. This move came after concerns were raised by defined benefit pension trustees, where final salary pension liabilities, which are largely linked to Gilts, came under financial pressure.

There have been calls for the Bank of England to raise interest rates ahead of the next scheduled meeting on 3^rd November; however, the Bank has resisted these calls, for now at least, but a large increase in base rates is expected at this meeting. As a result of the expected higher interest rates, mortgage lenders have been pulling fixed rate deals from the market and relaunching the same deals with higher rates. This is likely to have a dampening effect on the UK housing market.

We wait to see what effect the Bank of England’s actions will have, although we see the intervention in Gilt markets as being necessary given the weakened sentiment. The International Monetary Fund and currency markets have given their initial opinion on the fiscal announcements made by the new Government, and we would anticipate further moves will be made by both the Treasury and Bank of England to calm markets over the coming days and weeks.

The impact for UK investors

Sterling’s weakness is something of a double-edged sword for UK investors. As the UK are net importers of goods and services, a weak currency pushes up the price of these imported goods and stokes the inflationary fire already ablaze. This, together with the general market perception of the strength of the UK economy, will likely lead to higher interest rates as the central bank tackles inflation.

For holders of UK shares, however, a weak Pound may be beneficial, particularly if the company generates profits overseas. And holders of Global Equities have seen losses largely cushioned by Sterling’s weakness. This underlines the importance of holding a globally diversified portfolio – a key component of our investment strategies – in these conditions.

For investors in Fixed Interest securities, this has been an uncomfortable period. Bonds tend to be assets that provide stability in times when Equities markets are volatile; however, the rapidly increasing inflation and higher interest rate expectations have sent Bond prices lower over the course of the year. As a result, Bond yields have now risen to attractive levels and both Investment Grade and High Yield Bonds are offering good value to investors who are happy to take a medium to long term view.

Markets always look forward

In conditions such as those we are experiencing at the present time, it is important to remember that markets are a discounting mechanism, reflecting future earnings that companies will generate. As such, the difficult market conditions seen over the course of this year will, to some extent, have already discounted the impact of higher inflation and interest rates on the global economy. This discounting of future earnings can provide opportunities for investors. This is a view shared by leading Fidelity fund manager Aruna Karunathilake who commented earlier this week “We are getting excited by the opportunities in the market – not because the outlook is improving, in fact the opposite is true, but because this very negative outlook is now being reflected in share prices in selected areas of the market.”

Looking a little further ahead, we continue to expect inflationary pressures to abate over the course of the next 12 months. The expected slowdown in the global economy, together with the monetary policy decisions taken by central banks, should bring inflation back down to more modest levels, and, indeed, inflationary pressures could ease significantly should progress be made towards a resolution in the conflict between Russia and Ukraine.

On the assumption that inflation falls back next year, the focus will then shift to see whether central banks can begin to unwind the base interest rate increases seen over the course of this year, and provide monetary stimulus to kick-start growth.

The importance of diversification

Clearly the events of the last few days have rattled Bond and Currency markets, and time will tell whether further intervention or policy change will be forthcoming. However, for investors willing to take a medium to long term view, these conditions present a number of interesting opportunities. As renowned investor Warren Buffett famously quipped, “be greedy when others are fearful”.

Market performance over this year has only served to reinforce our conviction in global investing. Holding assets in a diversified portfolio, with money allocated across western economies, can provide shelter when specific localised concerns arise, such as we are seeing in the UK at the current time.

Given the slowing economy, it is also apparent that investors should look to focus on the strongest companies through this period, be they through Equity or Bond investment. Companies with good levels of cash flow, resilient earnings and the ability to pass on price increases to their customers should be able to withstand the testing conditions.

At FAS, our Investment Committee will continue to stay in close contact with fund managers and we will remain watchful for opportunities in the current conditions.

If you would like to discuss markets further then speak to one of our experienced advisers here.

Fidelity Risk Warning
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

The retail fund management industry, which was established in the 1920s, was built on the creation of actively managed pooled investment funds, where fund managers and management teams take frequent investment decisions to their portfolios, with the aim of beating a particular benchmark or target index return. The 1970s saw the creation of a challenger to the fund management industry, when the first index tracking funds were launched. These are funds that operate with far less human interaction and decision making, and manage funds by looking to mirror or track the performance of a particular index or set of indices.

Index tracking funds have steadily gained popularity as the decades have passed, so much so that the amount of new money invested in passive investments now outstrips actively managed funds. However, despite the rise in passive usage across the world, the debate still rages as to which approach can yield the best returns for investors. As we will demonstrate below, we feel that both approaches have merit, and combining the two distinct investment styles can often be an appropriate solution.

Active can outperform

The key difference between the potential returns from an active approach is that the fund can beat returns achieved by the market generally, if the fund manager or team get the investment calls right and hold more in positions that perform well. This is simply not possible through a strict passive approach, where the returns can only mirror (or usually lag slightly behind) the returns achieved by the representative index. As the main driver for most investors is to seek outperformance, this places active funds at a distinct advantage; however, this is only the case if the active manager or team can consistently beat their benchmark.

Another potential positive is that active managers have the flexibility to adjust their portfolios in periods when markets perform less well, therefore potentially reducing the impact of a period of weakness on the fund’s performance.

However, the success of the strategy will largely be dependent on the skills of the manager or management team, and the analysts they employ. Some active fund managers have built up a strong track record of outperformance over many years, and have proven themselves over a range of different market conditions. There are others, however, where performance has lagged benchmarks consistently, and therefore careful analysis of the approach, style and past performance of the fund manager are factors investors need to consider when selecting actively managed funds.

The teams of analysts and fund managers employed to manage an actively managed fund do, naturally, increase the running costs of the fund. This is passed on to investors through higher charges than are typically charged when holding a passively managed fund. For this reason, it is important to achieve good value for money when considering active funds.

The positives of passives

When investing in a passive fund, the first important point to consider is that you are highly unlikely to outperform the representative index that the passive fund aims to track. Even passive funds that fully replicate an index are likely to underperform the index slightly due to charges and tracking error.

It is also important to note that the very nature of passive funds means that the performance is purely driven by that of the underlying index. There is no ability for a human fund manager to take decisions to protect a portfolio in periods when markets perform less well. For example, a fund manager of an active fund could look to increase cash positions within the portfolio, or reallocate the balance of the portfolio to take advantage of underlying conditions.

That being said, there are distinct advantages that a passive fund can provide. Firstly, as the fund tracks an index, the investment will provide exposure to a good proportion, or indeed all of the constituent holdings within the index. This provides good levels of diversification across a range of different sectors, which is difficult to achieve from an actively managed approach. That being said, we often review actively managed funds where the portfolio does not deviate significantly from the composition of the underlying index. If an active manager was closely replicating an index, it begs the question what are you, as the investor, paying for?

Low charges are the other area that passives have an advantage. Given the lack of a human manager, passive fund management charges are generally much lower than active funds.

No winner, but plenty to consider when asking ‘Do Active Managers add value?’

As you can deduce from our analysis above, both active and passive investment management styles have features that make them attractive to investors. At face value, a passive investment approach is the most cost effective method of investment, and also potentially offers greater diversification over an active approach.

However, there may be a cost to using passives, which is the potential underperformance compared to an actively managed fund which outperforms the representative market and its’ peers. Given that active managers can often outperform the benchmark by several percentage points of performance each year, and potentially often downside control through asset allocation, this makes quality active funds an attractive proposition. But what if an active manager runs into a rut, where performance disappoints and lags the performance of similar funds? This is a situation avoided by a passive fund, and therefore when selecting active funds, there is heavy reliance on choosing the right fund from thousands of funds available to UK investors.

Our Investment Committee at FAS undertake regular and comprehensive due diligence across a very wide range of funds available to UK investors, to seek out strong performing active funds. We also regularly review passive investment approaches and look to select the right approach for each sector and asset. Speak to one of our experienced financial planners if you would like to review an existing portfolio, or invest funds using a blend of cost effective passive funds and attractive actively managed funds.

If you would like to discuss the above further then speak to one of our advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

As the A-level results are announced, students up and down the country are busy securing their place at University. The future funding of further education is a growing concern, highlighted by press reports at the weekend that tuition fees will need to rise considerably above the current level of £9,250 per annum over coming years. Add on top all of the other costs of living in student accommodation, it is little wonder that further education funding is a common topic of conversation when advising parents and grandparents.

The Student Loan system is designed to provide support for tuition fees, and as a result, finding the money up front to pay for learning costs is often not an issue. This system does, however, saddle young people with significant debts, which are only repayable once earnings exceed a certain threshold. Maintenance costs are, however, means tested, and given the cost of accommodation, living expenses, food, study materials and socialising, this can run into several thousand pounds a term.

This is why we are often called to advise families on the best way to fund these expenses for their children. We will explore a number of ways this can be achieved.

Regular saving

Most of us are familiar with the notion of regular saving for retirement through a pension, which aims to provide an income in later life. We can look to take the same approach, but with a much shorter time horizon, by setting up a regular savings investment plan. Whilst using cash is an option, it is rarely sensible to use cash for an investment of this type as returns are generally low and inflation can eat away at the real value of the sum saved. By using investments into other assets – such as Equities (Company Shares), Fixed Interest Securities (Bonds and Gilts), Property or Infrastructure – returns in excess of those generated by cash can normally be achieved over the longer term.

The investment can be held in the name of a parent, which retains control over the investment fund, or potentially could be invested through a Junior Individual Savings Account (ISA) in the hands of the child. The latter option does provide immediate access to the funds when the child is 18, which could be a consideration if a parent has concerns that the child may use the funds for other purposes than intended.

An additional benefit of investing regularly is that the monthly contributions will purchase investment fund units at different values, and therefore a smoothed investment effect known as “pound cost averaging” can be achieved.

The earlier a regular savings plan is commenced, the greater the time horizon for investment. This can lower the risk of the investment plan as investments in assets other than cash should really only be considered when the investment can be left in place for five years or more.

Lump sums and gifting

Grandparents in particular are often keen to help future generations, by helping them fund their grandchildren’s study costs. This can potentially have a dual benefit, as making gifts at an earlier point can also ease concerns over Inheritance Tax liabilities that Estates may be burdened with in the future.

As with regular savings, a lump sum gift could be placed in a cash savings account; however, as described above, returns on cash over time are generally poor, and investing the lump sum into a suitable investment plan can often yield better returns.

When establishing an investment of this type, there are options to consider as to how the investment is structured. To also be effective for Inheritance Tax planning, the gift needs to be absolute, which means either passing funds to the parents of the child to hold for the benefit of the child, or establishing a Bare Trust.

Bare Trusts and tax efficiency

Assets in a Bare Trust are held in the name of a trustee. However, the beneficiary has the right to all of the capital and income of the trust once they reach the age of 18. This means the assets set aside by the settlor in Trust will always go directly to the intended beneficiary and there is no discretion as to who receives the benefit.

The advantage of using a Bare Trust set up by a Grandparent is that whilst the assets are held by the trustee, any income generated by the investments are taxed on the beneficiary, i.e. the child. As children are entitled to the Personal Allowance before Income Tax is paid, this effectively means that no Income Tax charge will arise. It is important to distinguish this tax advantage from the situation that occurs when a Bare Trust is set up by a Parent, rather than a Grandparent. In this instance, the Parent is deemed to be the “settlor” and if income of more than £100 per Tax Year is produced, the entire income is taxed on the Parent, and not the Child.

Success is down to careful planning

Whether a regular savings approach is adopted, or a lump sum invested, the success of any plan to save for University costs will rest on the performance of the investment strategy and funds selected. FAS can provide independent advice as to the type of strategy that should be adopted, and discuss aspects such as investment risk and volatility and also address any ethical considerations.

As with any investment plan, regular reviews should be carried out to ensure the investments are performing as expected and given that funds will be needed at a known point in time, it may well be appropriate to consider reducing investment risk as the child nears the point that the funds are needed. This can help avoid the potential for markets to suffer a downturn at the time that funds are to be withdrawn. At FAS, we provide ongoing advice and regular reviews to consider whether the underlying strategy should be altered during the life of the investment.

If you would like to plan ahead to fund further education costs, or are considering gifting funds for this purpose, then speak to one of our advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.