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Index funds are useful, but they shouldn’t dominate your investment portfolio

By | Investments

Ever since index tracking funds overtook active funds in popularity with UK investors more than two decades ago, there has been a continuous debate over which approach is better. But while index funds are an essential investment tool, we don’t believe they should be replacing active funds just yet.

 

What is an index fund?

As the name suggests, an index fund is an investment created with one objective in mind – to track the performance of an index. An index fund is also known as a passive investment because there are no active investment decisions to be made. For example, a FTSE 100 index tracking fund will feature the same 100 companies as are listed at any given time on the FTSE 100 index. Should the companies featured in the FTSE 100 change, so too will the companies featured in the index fund.

 

Why choose an index fund?

There are several reasons why it makes sense to invest in an index fund. Firstly, an index fund is a relatively inexpensive way for an investor to gain exposure to a particular asset class or market. Because there are no fund manager salaries to pay, the cost of owning an index fund is considerably less expensive than the management fees you would expect to pay for owning an actively managed fund.

Second, an index fund will invariably cost less in transaction charges. While an active fund manager is free to buy and sell investments as often as they think is suitable for their portfolio, an index tracking fund will only buy and sell when index constituents are reshuffled (as an example, the companies in the FTSE 100 are reviewed every quarter to determine whether they still merit a place in the index).

Finally, investing in an index fund is a good way to invest if you plan on staying invested for the long term, or if you don’t want to keep actively monitoring your investments regularly. You can simply buy shares in the index fund and hold them for as long as you choose to.

 

What are the disadvantages of index funds?

While index funds definitely have their advantages, there are some important disadvantages that investors should also be aware of.

 

Underperformance

The first is that index funds – by their very nature – will only ever deliver an underperformance. That’s because passive investments are not designed to beat the performance of the market they focus on, they can only track it. And, when you add in the cost of investing in an index fund, this means it will always fall slightly short of the market’s returns once those fees are paid. The advantage of an active manager is that their goal is to outperform the market they invest in, by making decisions – but of course, attempting to achieve greater rewards carries greater risk too.

 

Lack of protection during the bad times

If you’re invested in an index fund, your investment is heavily dependent on the fortunes of the market your fund is invested in. While stock markets have proven to be a good investment over the long term (by this we mean at least ten years), they can be much more volatile over shorter periods. Investing in an index fund means that your investment will do well when the market is doing well, but will invariably suffer when markets are facing difficult conditions.

 

Lack of choice or control over the investments you hold

An index fund is a ready-built portfolio featuring all of the constituents of a particular market or index. So, if you own a FTSE 100 index fund, this means you own a small percentage in 100 different companies. You have no control over the companies you ‘own’, and you do not get a say on whether you believe those companies are in line with your personal principles or not (tobacco companies, oil companies, or weapons manufacturers, for example). The components of any index fund are effectively out of your hands.

 

Lack of flexibility

Another point worth mentioning is that investing in an index removes the opportunity for ‘advantageous behaviour’ or what is known as “buy low, sell high”. The downside of owning an index fund is that if a stock within the index becomes overvalued, it starts to carry more weight within the index, and your fund will be forced to purchase more of it, at the higher price. So, even if you have a personal view that a particular stock is overvalued or undervalued, by investing solely through an index fund, you do not have the ability to act on that knowledge, and nor can a fund manager do so on your behalf.

Here is an interesting example of how index investments can sometimes work against investors. When Tesla was admitted into the S&P 500 index in November 2020, within a matter of weeks it had already overtaken Facebook to become the fifth-largest company in the index. Once it gained entry into the S&P 500 index, every S&P 500 Index tracker automatically had to include Tesla as a new constituent, and this ‘forced buying’ helped to propel the Tesla share price upwards.

Why is this important? Well, Tesla had been close to gaining entry to the S&P 500 previously, meaning that many active fund managers made big profits by owning Tesla shares bought in advance knowing that once it entered the S&P 500, index tracking funds would have to start buying the shares at inflated prices. In the case of a company like Tesla, active fund managers had the maneuverability to make a smart rational decision, and this left them able to make a profit at the expense of index funds and, ultimately, their investors.

 

Overview

The debate over whether active or passive funds offer the best value for investors will no doubt rumble on. But investors do not need to see it is a decision to adopt either one approach or the other. A better way is to consider them both as valuable tools that deserve their place within a well-built investment portfolio. We believe that holding a blend of both actively managed funds as well as a carefully chosen selection of index tracking funds, is the best way to build a well-balanced, cost-effective, and risk-managed investment portfolio.

 

If you are interested in discussing your investment portfolio with one of the experienced financial planners here at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Bird and worm next to a clock representing early bird catches the worm

Why early-bird ISA investors may catch the best returns

By | Investments

Now that the new tax year has started, people often ask us whether they should use their Individual Savings Account (ISA) tax allowance early, or wait until the end of the year? While many people leave it to the last minute, there are several reasons why it makes sense to invest early instead.

 

There is nothing like a hard deadline to focus the mind. It’s why tax year-end has traditionally been the busiest time of year for financial planners, as we work with clients to ensure they make the most of any available tax allowances. One area that is always busy for us is helping people with their ISA subscriptions.

 

ISAs remain popular with savers and investors

ISAs have become one of the most important building blocks for anyone looking to invest for their future. After all, ISAs allow you to shelter any investment gains or interest earned from the taxman, which means any money held within the ISA wrapper has the potential to grow more quickly.

As a reminder, you can save up to £20,000 annually into an ISA in each tax year. This limit applies to Stocks and Shares ISAs, Cash ISAs, and Innovative Finance (also known as peer-to-peer) ISAs, so there are plenty of options to choose from, and you can spread your ISA allowance between different ISA types. But ISA allowances operate on a ‘use it or lose it’ basis. In other words, if you do not make an ISA investment during a particular tax year, you cannot ‘roll-over’ the allowance to the next one. So, it makes sense to leave using up your ISA allowance at the very last minute, rather than to not use it at all.

 

Making the best use of your annual ISA allowance

Human nature being what it is, lots of people leave it until the last minute (11.59 on 5 April, to be precise) to get their ISA application completed. And then they tend to forget about their ISA for 12 months before repeating the process all over again.

Many people make the mistake of leaving their ISA investment until the end of March, perhaps because they are focused more on the tax benefits associated with an ISA, instead of thinking about it as an investment vehicle. While there is a strong temptation to wait, knowing that you have a full year to make the most of your ISA allowances, it is important to remember that investments need time to grow, so the more time you give them, the better the potential outcome.

 

Investing for income and growth

As an example, this year the FTSE 100 index is expected to generate an average dividend yield of 3.8%, which is an improvement on last year’s historic yield of 3.2%. If you hold off investing until close to the end of the tax year, your investment has missed out on a whole year of tax-free income. More importantly, your ISA will also be missing out on the potential of tax-free growth on the value of the shares in your ISA portfolio. Growth cannot be guaranteed, of course, but the theory is that the more time you leave your ISA invested, the longer it has to potentially grow, and the larger your investment pot will ultimately be.

 

‘Averaging in’ with regular investments

Starting your investment sooner means you could boost your overall ISA pot in the longer term, but not everyone is able to invest the full £20,000 ISA allowance at the beginning of every new tax year. So, instead of investing the whole amount into your ISA at the last possible minute, you might want to consider spreading regular amounts across the 12 month-period instead. Investors call this ‘pound-cost averaging’ because paying in regular amounts reduces the overall volatility of your investment.

How does pound-cost averaging work? Well, imagine if you pay £20,000 into your ISA in March, just before the tax year end. That money will be used to invest in different funds or stocks and shares at a set date in March when your investment will be subject to how overall stock markets are performing at that point in time. If valuations are high at that point, you will end up paying more for your investments than you would have had you invested at a different time.

It can be particularly painful to invest a large amount into your ISA, only to see stock markets take a tumble soon after, which means your investment is already in negative territory. ‘Timing the market’ is very difficult to get right. But by paying into your ISA regularly, using your regular amounts to purchase assets at different times and at different prices, you eliminate the possibility that the whole value of the ISA subscription will be bought when markets are at their peak. It is a simple way of taking the guesswork out of investing, avoiding uncomfortable market highs and lows, and spreading the risk out over a full year instead.

One final point to remember is that using your ISA allowance at the beginning of the tax year, instead of at the end, gives you the advantage of time, which is always the most precious commodity. Using your ISA allowance early can make a real difference to the returns on your investment, and give you the best possible chance to grow your wealth over the longer term.

 

If you are interested in discussing your ISA or investment portfolio with one of our experienced financial planners here at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Silhouette of man's head with brain highlighted in white with a pound symbol

The psychology of investing – knowing when to cut your losses

By | Investments

Sometimes, investors can be their own worst enemies. As Warren Buffett once said: “If you cannot control your emotions, you cannot control your money”. We explore the emotional side of investing, identify some of the negative behaviours that frequently trip people up, and we also give some advice on keeping emotion out of your investments.

 

Recognising and understanding investor behaviour

It is worth remembering that money is an incredibly emotional subject for people. People’s relationship with money usually begins at a very early age, and emotional responses can often overpower rational thinking when things are not going as well as a person had hoped.

Perhaps the biggest challenge investors must come to terms with is their own attitude towards investing. Studies have shown that it is more painful to lose money than it is pleasurable to win money – even when the amount is the same. Many investors find this aspect about themselves hard to come to terms with. Ingrained attitudes often make people too risk-averse when it comes to investing, which can often mean they miss out on significant returns over the longer term. To avoid this, you should think about some of your own personal psychological biases before deciding whether to buy or sell any investment.

 

Pride and prejudice

It is also common for investors to feel unable to admit when they’ve made a mistake. One of the most frequent examples of this we see is where investors continue to hold on to the shares in a failing company, in the hope that it will eventually recover. The old investment wisdom is to “run your profits and cut your losses”, but most people tend to do the opposite. They sell their profitable investments too soon and they let their loss-making investments keep going while they wait for a change in fortune.

People often let emotions sway their investment decisions because they have a personal attachment to the investments they own. Perhaps these investments were left to you by a relative, or they did particularly well in the early years after you first bought them. We often make the point that investments or companies don’t have feelings or attachments to you, so why have feelings or attachments to them? Taking a personally detached view from your investments is a good way to start making better investment decisions overall.

 

Forgetting that past performance is no guide to the future

Every investment comes with the warning that past performance is no guide to the future, but it remains a warning that most people struggle to heed. It’s far too easy to fall into the trap of ‘outcome bias’, which is the tendency to evaluate a decision based on the outcome of previous events, without giving enough consideration to how those past events developed.

To put it another way, you may decide to back the same horse in the Grand National that won last year’s race. But all of the factors that resulted in that horse winning (the condition of the horse on the day, the ground conditions, the weather, how competitor horses fared, and on and on) are not going to be replicated identically this year. Even if the same horse does in fact win again, it will have faced different conditions when achieving victory this time around.

Simply relying on the past to do the hard work for you, instead of carrying out helpful research and finding the right investment for right now, is unlikely to lead to positive investment results over the longer term.

 

Poor timing

Emotional investing is often an exercise in bad market timing. Greed and fear are powerful motivators, and one of the main reasons why investors lose money is they execute an investment decision out of greed or fear (or both), at a time when it is not in their best interest to do so. Examples of the greed/fear dynamic at work include:

  • Seeing others making large profits on an investment and jumping in without thinking about the risks involved. This is also the “fear of missing out” (Bitcoin is a good example of this).
  • During periods of market volatility, investors often sell their investments while values are falling, thereby crystalising their losses and potentially missing out on any recovery.
  • Following the herd, and simply doing whatever the rest of the market is doing.

 

So how can you stop being emotional with your investments?

Emotional investing usually takes place when events trigger our own individual responses to money and convince us that we should behave differently because the stakes are higher than we had expected. Sadly, there is not much that any of us can do about human behaviour, apart from being aware of it and learning to control it, rather have it control us.

But there are two ways to invest that help to lower the emotional stakes and reduce the risk of getting the timing of the investment wrong. The first of these is pound-cost averaging.

 

Pound-cost averaging

One of the most effective ways to remove emotion from investment decisions is to use pound-cost averaging. This is a strategy where you plan your investments in advance, and then invest regular amounts at set intervals. The benefit of this approach is that it removes the risk of regretting your investment. Instead, investing smaller amounts means that you get to buy fewer shares while the price is high, but more shares when the price is lower.

The key to the pound-cost averaging strategy is to stay the course and recognising that those periods when the value of your investment is lower can actually work in your favour over the longer term.

 

Diversification

The second most effective way to reduce the impact of emotion on your investments is through diversification. Holding a larger number of investments means that the impact of market volatility on your overall returns is more likely to diminish (as not all of your investments will behave in the same way). In normal market conditions, a well-diversified investment portfolio should offer some comfort that the losses suffered by some of your investments are offset by gains made in others.

However, it is important to understand what counts as true diversification. It’s not just about owning shares in a few different companies, or investment funds from different providers. At FAS, we can help you to create a diversified portfolio that invests across a wide range of different asset classes, geographical regions and industry sectors, as well as investments that invest for income or capital growth. An investment portfolio made up of all these various types of investments should offer increased protection that leaves your investments well-placed to cope with a range of different market conditions, and leaves you feeling much less stressed about what could go wrong.

 

Final thought

Investing without emotion is easier said than done. If it was easy, there would be far fewer headlines of stock market tumbles. But just because other investors struggle to keep their emotions in check, this doesn’t mean you have to follow them. An understanding of your own attitude towards money, and personal risk tolerance, is a good starting point.

It helps to be able to take a step back to see what is driving current market conditions and valuations. Once you can recognise that others are acting irrationally, you stand a better chance of leaving them to get on with it. Or, to use another Warren Buffet pearl of wisdom: “Outstanding long-term results are produced primarily by avoiding dumb decisions, rather than by making brilliant ones.”

 

If you are interested in discussing your investment portfolio with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Senior woman in a wheelchair being cared for by nurse

Counting the cost of care: don’t leave it too late

By | Investments

With care home costs continuing to increase, and pensions struggling to keep up, it is essential to come up with a long-term investment strategy that aims to match the cost of long-term care to reduce the risk of you – or someone you love – running out of money during retirement.

A worrying number of British pensioners are struggling to pay for care during retirement, according to recent statistics. Analysis from Age UK published in 2020 revealed that, in just one year, the number of pensioners whose assets have been effectively ‘wiped out’ due to the cost of paying care home fees has risen by more than one-third. Putting it another way, care bills are wiping out the finances of 100 people in the UK every week of the year.

 

Care costs are rising

Anyone who has looked into the costs of long-term care, perhaps on behalf of a parent, knows just how expensive those costs can be. According to health data provider Laing Buisson, in 2019-20, the average cost of a residential care home for an older person in the UK increased to £672 a week. Or, put another way, that’s an average annual expense of £34,944. In most instances, a person’s pension will be just a fraction of that amount.

 And, for those who are in urgent need of being placed into a nursing home – offering round-the-clock care – the costs of care are even greater. Between 2019 and 2020, the UK average nursing home cost increased by 5% to £937 a week, or £48,724 a year. The fees a person can expect to pay for nursing home care are significantly higher in London and the South East.

 

Will you have to pay for your own care?

While healthcare is provided free by the NHS, most of us will be required to pay some or all of the costs of our own social care in later life. Local authorities will provide financial support for people whose assets and income are below a set amount, but broadly speaking, anyone with savings or assets worth more than £23,250 can expect to pay for their own care costs. Most people hope to pay for care by using income from their pension, savings, and investments or income generated by other assets, such as the sale proceeds from their main residence, or rental properties. But it’s important to make plans that determine the most cost-effective way to pay for care, which is where we can definitely help.

 

Optimising capital and income to pay for care home fees

At FAS, we often talk to families looking for advice on what to do when a parent or loved one needs to go into care. The first thing we point out is that when large fixed costs are being paid every month (such as care home costs of £5,000 per month), cash in the bank usually doesn’t last very long. So, instead of thinking about relying on savings or a pension to pay for care, we usually tell families that it’s a much better idea for us to help devise an investment strategy that will help to ensure all known fixed monthly costs can be covered for as long as possible.

 

How can an investment strategy help with care costs?

From our perspective, we know that good financial planning can make it possible to plan for care without fully eroding a person’s capital, whilst also effectively ring-fencing the family’s future inheritance. It starts with calculating the costs of care over the longer term and identifying suitable investments that have the right risk and return objectives.

By matching liabilities with income, we are able to find and recommend investments capable of growing at a rate of return that will aim to ensure the rising costs of care continue to be met. This really emphasises the importance of investing your money with the aim of generating a meaningful return, rather than leaving it sitting idle in cash. This is particularly relevant given that care costs have a tendency to rise by more than inflation each year, which means you need the income you generate from your investments to be able to do the same.

 

Buying care insurance

As a last resort, another area where we might be able to help is with arranging care insurance. This insurance (also known as an ‘immediate needs annuity’ or ‘immediate care plan’) will automatically cover the cost of care fees for the rest of a person’s life, in exchange for a one-off lump sum payment. Just as with pension annuities, care insurance payments can be set to provide a flat payment monthly, or arranged to rise in line with inflation. However, these types of policies are only available to those with a restricted life expectancy.

 

Summary

No one should be left to worry about how to pay for a loved one’s long-term care. And, with careful planning, it should be possible to structure someone’s finances to ensure care fees can be paid for as long as required, without the money running out. If you’re in this position, talk to us. Our knowledge of this complex market means we have considerable experience of coming up with tailored care funding strategies designed to suit individual needs. The sooner you get in touch, the more peace of mind you will have.

 

If you are interested in discussing the above with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Bitcoin on motherboard

Beware the ‘irrational exuberance’ behind Bitcoin

By | Investments

The spectacular rise in the value of Bitcoin is prompting more investors to get involved. But as with any investment, would-be investors need to delve a bit deeper into why these assets are attracting attention, as well as understanding the significant risks involved.

 

After a strong performance over the second half of 2020, global investment markets have been treading water for the last couple of months. In investors’ minds, a tug of war is developing between the much-anticipated post-coronavirus economic recovery and the need for central banks worldwide to keep financial conditions loose. The fear among investors is that inflation is poised to make a big comeback, and this has resulted in the share price of many of 2020’s biggest winners, technology stocks in particular, seeing bouts of profit-taking.

At the same time, Bitcoin seems to be going from strength to strength, raising speculation that the “Bitcoin bubble” shows no sign of bursting just yet. The value of an individual Bitcoin hit an all-time high of $57,489 on 21 February (around £41,000 in sterling), but how much a Bitcoin is worth by the time you read this is anyone’s guess. Bitcoin is an incredibly volatile asset, underlined by the fact that it was valued at just $9,668 (£7,462) on the same day last year.

 

Why has the value of Bitcoin risen so dramatically?

After many years of being treated with distrust and disdain by the financial world, Bitcoin is becoming an accepted part of the modern world. This year, major financial institutions such as BNY Mellon and Mastercard announced they would begin integrating Bitcoin into their payment systems. The reputation of the most well-known cryptocurrency was given another almighty boost after electric car manufacturer Tesla announced it had bought $1.5 billion of Bitcoin for its corporate treasury and would accept Bitcoin as payment for its cars. These announcements helped drive up the price of a single Bitcoin to record levels, and the value of Bitcoin has remained fairly strong even while equity market values have taken a hit.

The complication of Bitcoin is that it is not just a method of payment; it is also an asset class. So, somewhat unsurprisingly, the runaway rise of Bitcoin is leading to more talk of an asset ‘bubble’, drawing comparisons to the famous tulip mania of the 17th century. As with all asset bubbles, the value of the asset reaches unrealistic, even extraordinary, levels because people think it is going to be worth more tomorrow than they were prepared to pay for it today. Once that ‘FOMO’ (fear of missing out) dries up, the value comes crashing back down.

One of the biggest challenges around Bitcoin is that it is supposed to be considered as a valid currency, one that will soon become more mainstream, rather than as purely a speculative asset class or investment. But the volatility associated with Bitcoin makes it almost impossible to use as a currency. Nobody wants to be that unfortunate person who, in 2010, spent $30 worth of Bitcoin to buy a pizza, who would have been sitting on a $350 million fortune today if he had used cash instead.

 

Bitcoin is a huge energy drain

One of the biggest issues is that the process of mining Bitcoins consumes vast amounts of energy. This is because blockchain technology requires a vast network of computers and, as Bitcoin gets more valuable, the sheer effort expended on creating and maintaining it – as well as the amount of energy consumed – also increases. According to research from the University of Cambridge, Bitcoin uses more electricity annually than the whole of Argentina. Bitcoin’s annual total energy consumption is somewhere between 40 and 445 annualised terawatt-hours (TWh).

By comparison, here in the UK, our total electricity consumption is a little over 300 TWh a year. This also brings into question Tesla’s decision to back Bitcoin so heavily, and so publicly, as doing so appears to fly in the face of its environmentally green credentials.

So, taken in total, Bitcoin is a mass of contradictions. It is an investment that is highly volatile, a currency that you would be very fearful of spending, it is burning up fossil fuels at a very troubling rate, and its value is only whatever the market says it is on any given day. In other words, the value of Bitcoin appears to be maintained almost purely on speculation, meaning the bubble could burst any time.

 

An unregulated minefield

It is crucial to bear in mind that cryptocurrency is an unregulated investment. As with all high-risk, speculative investments, it is vital that investors fully understand what they are investing in, the risks associated with investing, and any regulatory protections that apply.

For crypto-asset-related investments, consumers are unlikely to have access to the Financial Ombudsman Service (FOS) or the Financial Services Compensation Scheme (FSCS) if something goes wrong, potentially leaving investors without recourse if an investment were to fail.

Furthermore, increased dangers of criminal activity have been associated with cryptocurrency, such as ransomware and other attacks, which appear to have increased during the Covid-19 pandemic.

 

Importance of diversification

When clients talk to us about Bitcoin, we always start by reminding them of the risks that we have outlined above. But it is also important to recognise that cryptocurrencies are a very new (and very volatile) asset class, and it is impossible to know where it could go from here.

Our suggestion is that if you are aware of the risks and the contradictions surrounding Bitcoin, and you still believe they are an asset that is worth holding, then only put in what you can absolutely afford to lose, bearing in mind that trends wear out and most bubbles do eventually burst.


If you are interested in discussing your investment portfolio with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.

Pug dog wearing glasses pointing to graphs on whiteboard

How investment reviews can help to spot the ‘dog’ funds

By | Investments

What is a ‘dog fund’ and what should you do if you hold one in your portfolio? We look at some of the facts behind the ‘dog fund’ label, highlight the big names in the doghouse, and explain how fund reviews can keep your investments on track.

 

What is a dog fund?

Every year, Bestinvest publishes its ‘Spot the Dog’ research. In the September 2020 update, the investment firm identified 150 funds officially in the doghouse, the highest number for 25 years.

To earn the notorious ‘dog’ tag, a fund must deliver a worse return than the market it invests in over three consecutive 12-month periods, and must also have underperformed that market by 5% or more over a full three-year period. The research focuses on unit trusts and open-ended investment companies (OEICs) listed in the equity sectors covered by the Investment Association.

This performance criteria is used to help identify those funds that are consistently poor performers, rather than those that have simply suffered a difficult year. It also filters out tracker funds that aim to replicate the return of a market index (minus running costs). What this means is that behind every dog fund, there’s a fund manager looking very sheepish.

 

What characteristics do dog funds share?

Just as with most other facets of life, there are often lots of reasons behind the disappointing performance of a dog fund. The most recent list of 150 offenders features a number of former high-flying equity funds that did really well for a few years, before crashing back down to earth. Other funds have just continued to plod along, falling further behind their peers and the returns of the market, while still charging high fees for the privilege. Sometimes, things can go horribly wrong for so-called ‘star’ fund managers and for fund management companies.

Perhaps the greatest example of spectacular dog fund fails is the story of the rise and fall of Neil Woodford. When he was at Invesco Perpetual, Woodford ran the Invesco Perpetual Income and High Income funds and was the UK’s most famous and respected fund manager. After Woodford left Invesco in 2014 to start his own fund management company, Invesco never really recovered. Its funds have earned it the unenviable reputation of having the most dog funds in the research for five years in a row.

But after striking out on his own, Neil Woodford hasn’t fared any better either – instead he has ended up ruining his reputation and his legacy. His LF Woodford Equity Income fund became a regular in dog fund tables until it was forced to suspend dealing and ultimately close down in 2019, with investors bearing the brunt of heavy losses.

 

Repeat offenders in the doghouse

One of the most troubling aspects of the most recent Spot the Dog report is the sheer size of the investments within these dog funds. According to Bestinvest, the 150 worst performers hold a staggering £54.4 billion in assets from long-suffering investors. And 18 of these funds manage more than £1 billion each in assets.

 

Which sectors feature the most dogs?

The UK Equity and Global Equity Income sectors have the highest proportion of dog funds (26% in UK Equity Income, and 25% in Global Equity Income, respectively). However, it’s only fair to point out that this poor performance has been added to by the sudden suspension of dividend payments from traditional high-dividend paying companies during the pandemic months of 2020.

 

Why are dog funds dangerous?

As Bestinvest noted in their most recent report, the average fund in the Investment Association UK All Companies sector posted a loss of 5.1% over its three-year period. But the worst dog fund in the same sector fell by 51%, whereas the best performer achieved a positive return of 34%. That kind of underperformance is just not acceptable, and really demonstrates why it is so important sometimes to cut your losses.

 

Which fund providers have the most dogs?

Keeping a watchful eye over the performance of the funds you hold is important. Not only does it ensure that you hold a healthy balance of good performers, but it can help to identify any red flags that you might want to take notice of, such as when an investment company has an unhealthy number of consistently poor performers.

As already highlighted, Invesco has become highly synonymous with the dog fund reputation – proving that old saying about “giving a dog a bad name”. Across all sectors, Invesco currently has 13 funds classed as ‘dogs’ (although two of these funds have since merged). Together, these funds have a total value of £11.4 billion – which means Invesco is responsible for managing just over one-fifth of all assets held within dog funds.

Snapping at Invesco’s heels is St James’ Place, which features eight dog funds across all sectors, with £6.9 billion invested. Fidelity has four dog funds, holding a combined total of £3.9 billion. And Schroders also deserves a dishonourable mention, with a total of ten dog funds featured for a combined value of £2.7 billion. When you think about it, this is an awful lot of money that’s failing to deliver a respectable return for investors.

 

Putting things into perspective

But just because a fund has made an appearance in the dog fund tables doesn’t necessarily mean it should be immediately sold. After all – as we are often quick to point out – past performance really is no guide to the future. Fund management companies could already be taking action behind the scenes to improve the performance of some of their repeat offenders, either by changing fund managers, merging underperforming funds, or redesigning the fund’s investment strategy and approach. Sometimes it’s well worth sticking with a fund while they go through this process.

But knowledge is power, and knowing whether a fund is suffering from just a short-term blip, or whether the fund management company has a lot of poorly performing funds can really help when it comes to asking the right questions and making informed investment decisions.

 

Talk to us for a comprehensive fund review

If you haven’t reviewed your investments for a few months, now might be a good time to come to us for a review of your holdings. We can help you to identify any poor performers, and help you to decide whether it’s worth sticking with those funds for the time being, or whether it’s time to look for better opportunities elsewhere. But it’s always worth having a discussion with us before making any investment decisions.

Dogs have many attractive qualities, loyalty being one of them. But holding onto poorly performing dog funds for too long can have a damaging impact on your long-term wealth.

 

If you are interested in discussing your investment portfolio with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Red and yellow paint being mixed with a paintbrush

Passive funds or active funds? Here’s why you need a blend of both

By | Investments

Active fund managers outshone passive equivalents during 2020. Here, we look at the pros and cons of active and passive investing and explain why a well-diversified investment portfolio should contain elements of both.

 

The reputation of the active fund management industry has taken a bit of a pasting in recent years, although active fund managers fought back strongly in 2020. According to research carried out by Quilter, active funds outperformed their respective markets in seven out of the ten major investment sectors, including the UK Smaller Companies and UK All Companies sectors, as well as the indices for Japan, Emerging Market Equities and Global Equities.

 

What are ‘active funds’?

As a quick reminder, ‘active fund management’ is when a fund manager, or a fund management team, is in control over the investment and takes responsibility for the performance of the portfolio overall. Active funds usually aim to outperform a benchmark such as the FTSE All Share Index and will build a portfolio comprising those companies it thinks are worth holding.

Active fund management is all about decision-making. We are talking about real human beings, making real-time investment assessments, and changing their portfolios accordingly. Active fund management, as the name suggests, is a full-time, 24-7 job. And it is expensive, with all those costs reflected in the charges that investors can expect to pay in management fees. Therefore, it comes as no surprise that active fund managers face heavy criticism when they fail to outperform their benchmarks. Because even with the best available fund managers, there is no guarantee that the fund itself will deliver a better return.

 

And what about ‘passive funds’?

As the name also suggests, a passive fund does not have a decision-maker at the helm. Instead, passive funds usually aim to match the performance of an index or a particular sector of the market. The most common types of passive funds are index trackers or exchange traded funds (ETFs). In the case of a FTSE All Share tracker, for example, the fund will hold shares in every single company listed in that index, and its performance will fall or rise in line with the entire market.

Because there are no fund manager salaries to pay, and no research or trading expenses, it means that passives are much cheaper to invest in over the long term. Furthermore, you are achieving the same level of performance as the index, which is great news when markets are in positive territory, but less welcome when markets are experiencing periods of heavy volatility.

 

Active managers responded well to coronavirus

That is precisely what happened in 2020. In the early weeks of the coronavirus pandemic, stock markets across the world fell dramatically, as the potential implications of extended lockdown started to be felt. But over the course of the year, it soon became clear that the pandemic would lead to some companies emerging as ‘winners’ and other less-fortunate companies would be ‘losers’. This resulted in a sharp recovery in equity markets, with tech companies doing particularly well.

Successful active managers were able to react to the stock market falls and move their portfolios away from owning those stocks less likely to do well during lockdown, and at the same time increase their investments in those companies capable of making big profits – in some instances buying them up at bargain prices. Passive funds, on the other hand, had no such opportunity. In a market sell-off, passive funds will simply follow the market lower, unable to get rid of those unfortunate ‘losers’ that are dragging overall returns down.

 

So, which is better?

Of course, one poor year doesn’t make passive funds a bad investment, just as one good year doesn’t necessarily mean you should only own active funds from now on. At FAS, we believe well-diversified investment portfolios should feature a blend of both active and passive funds. But it’s important to look for those funds that offer value for money.

For example, passive investments offer the potential for better returns when shares are generally moving together in the same direction. So, they can be used as a cost-effective way to gain broad investment exposure to particular markets, acting as essential long-term building blocks in a portfolio.

However, sometimes the stock-picking skills of an experienced and well-researched fund manager can give the fund a definite edge over its competitors – helping to generate valuable risk-adjusted returns. Plus, the ability for these fund managers to adapt to changing events and swiftly ‘change course’ can prove invaluable during periods of market turbulence. In these instances, additional returns achieved by the best fund managers can more than justify the fees they charge.

 

Conclusion

Low-cost investments might seem like a sensible choice, but good investments are usually worth paying that bit extra for. The good news is that you do not need to make a choice between active or passive funds, and we can help you to decide on the best way to capture the benefits of both within your portfolio.

If you think now might be a good time to review your investment holdings, and to take a more ‘blended’ approach, please get in touch with one of our advisers who’d be happy to discuss some investment options with you.

 

If you are interested in discussing your investment portfolio with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Man and woman in hard hats pointing towards wind turbines

Building back better: why everyone’s talking about infrastructure investing

By | Investments

With countries all over the world determined to recover from the pandemic, infrastructure looks likely to be a prominent investment theme over the next few years. We look at some of the biggest areas of infrastructure investing and assess the positives and negatives for investors.

 

The building of bridges, railways, and motorways are all examples of high-profile infrastructure developments, while schools, prisons, and hospitals are all just as essential to a functioning society, and the demand for infrastructure spending may well increase as a result of Coronavirus. Governments in developed markets, including the UK and the US, have promised to “build back better”, and see infrastructure projects as a way to create more jobs and boost long-term economic growth. As a result of this, we can expect more announcements of projects that move away from ‘traditional’ concepts of infrastructure, and towards next-generation projects, such as smart motorways and intercity transit, 5G base stations and renewable energy installations, and electric vehicle charging points.

 

Infrastructure as an investment

It’s no surprise then, that there has been growing interest from investors who see infrastructure as an excellent long-term investment opportunity. But there are other benefits too. Just like property, infrastructure is a tangible asset to hold, which makes it altogether easier to understand, and therefore easier to invest in.

It is also worth noting that the infrastructure sector has also proven to be a reliable source of investment returns. Again, the tangible nature of infrastructure means it can provide investors with a predictable and regular stream of cashflows over several years – often linked to inflation. And, because infrastructure projects are backed by government public sector spending, the project risk is usually shared.

Investments that offer a reliable repeatable cashflow are very appealing, but many investors are only starting to recognise the role that infrastructure investments could play as part of a diversified mix of portfolio investments.

Within the investment universe, infrastructure is considered as part of the ‘alternatives’ sector, sitting alongside property investment, renewable energy, bonds, debt, and specialist finance, as well as the less accessible but well-established areas of private equity and hedge funds. All of these are considered ‘alternative’, as they are expected to produce returns with very little in common with the returns available from equity investments. Because of this, a ‘diversified’ portfolio is likely to feature an allocation towards alternatives that aim to achieve returns in periods when equity markets perform less strongly.

 

A move away from traditional investments

Alternatives have surged in popularity as more investors (of all shapes and sizes) have grown frustrated with the old-fashioned ‘balanced’ model of investing, where the belief is that holding both higher return/higher-risk equities and lower return/lower-risk investments in bonds effectively gives investors lower volatility and smoother returns throughout the investment journey – regardless of any stock market ups and downs.

The biggest problem with that approach is that with government bond yields stuck at historic lows, bonds are offering little or no return for investors, and are therefore not really justifying their place within portfolios. So, at a time when we are all questioning the old ways of doing things, it might be time to rethink those traditional labels of ‘mainstream’ and ‘alternatives’. Infrastructure could then be viewed as overtaking bonds as an asset class capable of providing useful portfolio diversification – with little correlation to riskier equities, but capable of providing inflation-linked returns and a steady stream of positive income.

 

Infrastructure trends to think about

So, if you are considering investing in infrastructure, are there any specific areas worth focusing on? You might want to start with infrastructure investments that focus on renewable energy. Back in 2015, 193 countries signed up to the United Nations General Assembly’s Sustainable Development Goals (SDGs). If governments across the globe are serious about achieving some or all of these goals, they will need to implement infrastructure spending covering areas such as solar and wind projects designed to help accelerate the transition towards a low-carbon future.

 

Digital infrastructure

Another fast-growing area involves digital infrastructure. If 2020 has taught us anything, it is that people have become increasingly dependent on digital access. Working remotely, shopping through e-commerce, and spending more of our leisure time at home (and in front of our computer or TV screens) has accelerated the global demand for fibre-optic networks, telecommunication towers, and data centres.

You may think that internet activity – whether that means using emails or streaming films on Netflix – is these days mostly carried out ‘in the cloud’. But data centres are the buildings used to house computer systems, servers, and storage. These data centres and exchanges rely on a largely unseen network that requires millions of miles of fibreoptic cable, cellular base stations, towers, and countless signal transmitters. Demand for data centres and associated components has increased dramatically over the last 12 months, and this demand only looks like increasing in the future.

 

How to invest in infrastructure

As an asset class, infrastructure used to be the preserve of big money institutional investors. But today there is a range of different investment vehicles that offer infrastructure exposure to individual UK investors, either in the form of open-ended funds or investment trusts. Investment trusts tend to own the physical assets (such as wind turbines, data centres, or toll roads), whereas open-ended funds invest in the equities of the companies that operate in these sectors. These include the major engineering and construction firms that are contracted to plan and deliver on large infrastructure projects, as well as companies that supply the tools and equipment.

As a result, we expect the number of funds – focusing on all different aspects of infrastructure – to increase from here. But as with any type of investment, it is important to understand the structure of the investment (particularly whether it is an investment trust or an open-ended investment), where it expects returns to come from, and to determine whether the risk is appropriate for the available reward. We would also argue that now infrastructure investing is becoming more fashionable, it is even more important to choose those investments managed by companies with a good track record, who manage risks appropriately, and who do not promise returns that are too good to be true.

 

Outlook

The coronavirus pandemic may well present an opportunity to “build back better”, and to replace old ways of living with new ones. As a result, infrastructure looks like becoming an important investment trend for years to come, and we expect it to play an increasingly prominent role within investment portfolios.

 

If you are interested in discussing your financial plan or investment strategy with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Man jumping on trampoline

A (brief) history lesson on the resilience of stock markets

By | Investments

We’ve grown accustomed to a regular diet of bad news in recent years, and how negative headlines have wreaked havoc on stock markets. But investors should feel encouraged that stock markets often bounce back far sooner than you might expect.

Anyone who expected 2021 to begin in a more positive and optimistic fashion has probably been brought crashing back down to earth after the events of the year so far. But while the world is full of worries at the moment, it’s important to remember that the investment world approaches things very differently. In fact, stock markets have a long history of recovering strongly after big shocks, which makes it even more important for investors to hold their nerve during tough times.

 

‘Climbing the wall of worry’

Climbing the wall of worry was an investment phrase that originated in the 1950s. It means that during periods of economic or financial shock or stress, investors will continue to trade, and stock markets will keep rising as a result. The history books tell us that global stock markets have not only managed to survive negative events but have ultimately thrived.

However, what’s noticeably different now compared to previous periods of crisis is the shorter timeframe it takes for stock markets to absorb shocks and regain their composure again. This is due, in a large part, to the determination of governments and central bankers to take significant steps to prevent a crisis from turning into a depression.

 

The Wall Street Crash

The ‘Great Depression’ that took place during the 1930s began with the Wall Street Crash in October 1929. Throughout the 1920s, US stock markets enjoyed rapid expansion, but this started to slow down markedly towards the end of the decade. As production began to fall back, unemployment started to rise, and prices began falling. On 29 October 1929, the Dow Jones stock market fell 12%. But the aftershocks of ‘Black Tuesday’ continued to be felt for years after. By 1933, unemployment in the US had risen to 25% of the total workforce.

The lessons learned from the Wall Street Crash – and the Great Depression that followed – remain applicable today: the best way to stave off years of economic depression and hardship for millions is to provide emergency measures designed to stimulate the economy, prevent mass unemployment, and keep things moving. Even so, despite US President Franklin Roosevelt launching the historic ‘New Deal’ stimulus measures, it took stock markets a full 25 years before they returned to their pre-crash peak.

 

Black Monday

The experience gained after the Wall Street Crash managed to help stock markets to recover from the ‘Black Monday’ crash that took place in October 1987. This time, a number of events – such as the slowdown of the US economy, oil price fears, and automatic selling from newly computerised trading systems – converged to create an overwhelming sense of panic among investors. Back then, using computers to conduct large scale stock market trades was a relatively new concept, and the rules that meant systems would sell stocks when they fell to specified levels created a “death spiral” of selling. By the end of the day, 22% had been wiped off the value of the Dow Jones, and stock markets across the world were also badly affected.

Even so, this time the stock market recovered very quickly, boosted by the decision taken by central banks to reduce interest rates to help keep money circulating in the financial system. Investors soon regained their appetite, and just five years later (and after some measures were introduced to prevent a repeat of the computerised selling) stock markets were rising again by around 15% per year.

 

The tech bubble

The next big test for investors came with the commercialisation of the Internet in the 1990s, which led to the dramatic ‘dotcom’ boom and bust at the turn of the century. Back then, investors were almost euphoric about the possibilities of internet-based companies, and the value of shares in vastly-hyped companies – most of which had never made a profit – reached ridiculous levels.

This time, central bankers had tried to intervene and rein-in excessive speculation in tech companies by raising interest rates – the US Federal Reserve raised rates three times in 1999 and twice more early in 2000. But there was little they could do to prevent the dotcom mania. In March 2000, the bubble began to burst. The Nasdaq index that lists US tech companies fell by more than 20%, and by October 2002, the Nasdaq was down 80% from its March 2000 peak. This meant that trillions of dollars in paper wealth disappeared almost overnight. It took another 13 years before the Nasdaq fully recovered to surpass its previous high point.

 

Global Financial Crisis

But the biggest test for investment markets, the broader impacts of which are still being felt many years later, came with the ‘Global Financial Crisis’ of 2007/2008. This time, stock market crashes became a full-blown economic crisis after the collapse (and subsequent rescue) of banks that had invested in bad loans and toxic assets – it created shockwaves throughout the world. According to the International Monetary Fund, large US and European banks lost more than one trillion dollars, forcing bailouts that would lead to economic austerity for a decade.

In the UK, the FTSE 100 fell 31% in 2008. In the following year, UK gross domestic product (GDP) shrunk to -4.2%, and the unemployment rate rose to 7.9%, before reaching an all-time high of 8.1% in 2011. Perhaps you may recall this difficult period. But while the negative effects of the Global Financial Crisis lived on for many years, investment markets recovered quickly. The Bank of England acted decisively to lower interest rates to record levels and offered previously unheard-of levels of financial support. The measures worked, and in 2009, the FTSE 100 recovered by 22%.

 

The COVID pandemic

A similar pattern – crisis followed by rapid recovery – has taken place since the coronavirus pandemic caused economies across the world to enter hibernation in the early months of 2020. The initial shock prompted panic selling among investors. Global equity markets fell more than 35% in March 2020 and falls continued throughout April. But investors regained their composure when it became clear that governments and central banks would act to do whatever it took to prevent another Great Depression.

Another important factor was also noticeable during the early months of the pandemic. The reality is that companies are adept at adapting and evolving, and entrepreneurship is about thriving in testing times. Investors were, therefore, able to identify those companies that would do well during lockdown, tech companies for example, and these companies performed well throughout 2020.

 

What should investors do?

Let’s be clear – we’re still in the middle of the global pandemic, so it’s too early to chalk this one up to experience. And while it’s important to recognise that investment markets have shown great resilience in recovering so quickly, there’s clearly a disconnect between the performance of companies and the economic hardship that so many people faced during 2020 and are still likely to face in the months – perhaps years – ahead.

But from an investment perspective, it’s encouraging for our investors to feel reassured that negative economic and life circumstances don’t necessarily lead to negative returns. As history tells us, equities have always been a volatile investment, but that definitely does not mean they are a bad investment. People often make the mistake of selling when markets fall heavily, and only start investing again when markets have rebounded. But even during times of crisis, when people have experienced dramatic falls in the value of their investments, we’ve seen time and again that those losses can be recovered within a few years, provided you stay the course. Because the longer you remain invested, the more likely you are to make a gain.

There’s no doubt that the current climate remains a difficult one for investors. But decade after decade, the market has demonstrated its ability to climb the ‘wall of worry’ and to focus on finding investments with a good chance of future success. That’s as true now as it has always been.

 

If you are interested in discussing your financial plan or investment strategy with one of our experienced financial planners at FAS, please get in touch here.

 

This content is for information purposes only. It does not constitute investment advice or financial advice.

Businessman using laptop to look at dividends

What are the prospects for dividend income in 2021?

By | Investments

After a traumatic 2020 for dividend-paying companies, when a number of traditional stalwarts were forced to cut or suspend their dividends, we look at whether we can expect a return to dividend payments in the year ahead.

 

Why are dividends important?

UK investors have always had a love-affair with dividend-paying companies. For example, many retirees invest in companies known for their dividend payments because they can be relied on to pay a consistent and strong level of income, year in, year out.

But it is not just the man in the street who is attracted to income-paying companies. Most pension funds own large quantities of dividend payers for the same reasons. One of the reasons the FTSE 100 index has been historically popular with investors is that its average dividend yield is usually between 4% and 4.5%. During an extended period of low interest rates, this makes dividend-paying companies very attractive within any investment portfolio.

What’s more, earning a regular income through dividend-paying companies can help you to grow the value of your investment pot significantly over the years, especially if you use the income payments to purchase additional shares – which in turn also pay out future dividends.

So, it is no surprise that investing for dividends is important to UK investors, and no coincidence that the UK has long stood out as offering a higher dividend yield (how much a company pays out compared to its stock price) than most other countries.

 

A difficult period for companies

Dividends are usually considered to be a good sign that a company is doing well, and has plenty of spare cash in the bank. But the UK’s reputation for dividend payments took a battering during 2020.

The coronavirus pandemic caused a global shutdown during the first few months of last year, forcing companies to take widespread, and often drastic, measures to keep operating during a period of uncertainty.

Dividends were an obvious place to start, and according to research carried out by GraniteShares, almost 500 companies listed on the FTSE 100, FTSE 250, and AIM stock markets either cut, cancelled, or suspended their dividend payments during 2020. As a result, the FTSE 100 average dividend yield for 2020 overall ended up at a significantly lower 2.98%.

 

Which companies were affected?

Some of the biggest dividend payers come from the oil, banking, and property sectors. Within the oil sector, after a year when travel became a non-starter for millions of people, BP cut its dividend by half after reporting a $6.7 billion loss in the second quarter of 2020, while Shell reduced its dividend by two-thirds – the first time it cut its dividend since World War Two. After the shock of 2020, and the increased pressure on oil producers to invest in the transition towards renewable energy, the prospects for a return to past dividend highs looks uncertain for now.

However, a return to normality looks more promising in those two other sectors. Companies operating within the UK banking sector – including HSBC, NatWest, Lloyds, and Barclays – stopped paying dividends in March, following recommendations from their regulator. The concern was that banks needed to keep more capital on hand in order to absorb financial losses from non-payment of loans. This concern appears to have been overstated, and following upbeat reports in the third quarter of 2020, the Bank of England has said banks are cleared to announce dividends as part of their next financial results in 2021.

Within the property sector, companies such as Land Securities and British Land cancelled their dividend pay-outs to conserve cash early during the pandemic, after heightened fears that their tenants would fail to keep up with rent repayments. But both have announced they intend to restart dividend payments in 2021.

 

What’s likely to happen now?

A return of companies paying dividends would be an important and positive development in 2021, and with banks and property companies expected to return to making payments soon, the signs are encouraging.

That said, expecting a return to previous levels of dividend payments seems optimistic. The coronavirus has made life difficult and even accelerated the decline of companies in certain industries – which is likely to reduce the average dividend yield in the UK market for some time to come. Most companies are likely to start paying dividends at more sensible levels to protect their business in the long run, which is no bad thing.

 

What should investors be thinking about?

Stocks with a good history of paying consistent and growing dividends will always be appealing to investors. But you should avoid investing for the promise of a dividend alone – it is just one of many factors to bear in mind, and companies can change their dividend policies at short notice, as seen during 2020.

If you hold some UK shares that are there solely for their dividend-paying prospects, now might be a good time to reassess their place in your portfolio, and consider some of the other investment options available to you. For example, the UK is no longer the only place to find great dividend-paying companies. You might be better off switching your investment into a fund that looks at other countries, such as the US, Japan, and the Asia-Pacific region. There are other income-generating investment options available too, so this might be a good time to refresh and refocus your portfolio.

 

If you are interested in discussing your investment strategy with us, please get in touch with one of our experienced financial planners here.

 

The value of your investment and income from it can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long-term investment and should fit in with your overall attitude to risk and financial circumstances.