The drawbacks of a passive only investment approach

By | Investments

First available to investors in 1975, a passive fund aims to offer a low-cost method of replicating the performance of a specific market index, rather than actively selecting individual assets within a particular market. Over the last decade, passives have grown substantially in popularity, with Morningstar research confirming that passive funds saw higher inflows than active funds during 2023.

The rise in the popularity of passive strategies is also evident from our own market analysis. Our Investment Committee regularly undertakes a comprehensive review of managed portfolio solutions offered by discretionary fund managers, to ensure that we can demonstrate that FAS clients receive good value for money. Our analysis clearly demonstrates an increasing bias towards passive investments, on which many of our competitors’ products and services are founded.

The rationale behind the increased use of passive investment funds is that the ongoing cost of a passive investment is usually cheaper than an actively managed fund. This helps passive only strategies maintain a competitive total cost of ownership. A key drawback of such an approach is that investors may be missing out on additional returns generated by strong active management. In our opinion, many portfolio managers are confusing “value for money” with “cheap”, with the focus on costs being the dominant factor.

Drawbacks of passives

Many investors fail to take account of two key disadvantages of a pure passive investment approach. The first is that, by definition, a passive investment will not outperform the representative index or market it is trying to replicate. Indeed, due to costs and potential tracking errors, most passives return just below the index return. As an investor, we contend that you should be seeking outperformance where possible, as long as the level of risk being taken remains commensurate with the prospects for superior returns.

A second key risk of a pure passive approach is that replicating an index will mean producing returns in line with that index. When market indices fall, the value of a passive investment tracking that index will fall by a similar amount. Unlike a fund with an active manager, who could potentially take avoiding action by reducing allocations, increasing the percentage of cash or possibly using derivatives, the passive fund will simply track the index on the way down.

Our approach

Within our investment strategies, we try to seek out good value for our clients, and our independent status allows us to take an unbiased approach as to the precise blend of funds we select. This allows us to select passive funds, where this is appropriate. We will, however, also look to use active funds if we feel this is likely to result in outperformance.

Our Investment Committee undertake considerable research on a sector and region basis when conducting the regular review of funds that we recommend to clients. This research, which has been carried out for many years, allows us to better understand areas where passive investment is likely to be sensible, and where selecting an active investment approach may produce superior returns.

The most commonly cited example of a sector where passive investments perform well is US Equities. Our own analysis has shown that index funds that track the S&P500 index of leading US companies tend to produce consistently strong returns when compared to actively managed US Equity funds. There will, of course, be active funds that do beat the market; however, the key is whether this can be achieved on a consistent basis.

One of the main reasons for the attractiveness of passive funds in US markets is the dominance of a small number of mega-cap stocks, where performance has been positive compared to the wider index for some time. Our analysis concurs with research carried out by S&P Dow Jones, who suggest in their recent SPIVA report that 60% of active large-cap US Equity funds failed to beat the representative S&P500 index during 2023.

A good example of an area where passive investment has shown historic weakness is in Fixed Income investment. Whilst many investors would associate passive funds with Equity investment, a wide range of passive bond funds are now available, which track a particular UK or Global bond index, and typically replicate hundreds or potentially thousands of individual bond positions. Bond investment is an area where adopting the correct strategy can yield significant outperformance, and an active bond fund manager can alter the duration of bonds held, the credit quality and sector or geographic allocation, to try and generate superior returns over the benchmark index. These additional levers available, which can adjust the allocation within the fund, can help a skilled fund manager generate superior performance to a passive fund, which simply holds the constituents of an index.

At FAS, we view ourselves as conviction investors, and therefore when selecting an active fund, we prefer to select an investment manager or team with a clear vision as to how their fund is to be positioned. This can often mean a concentrated portfolio, when compared to the representative region or universe of stocks available. All too often, we come across funds that employ an active manager or management team, who take an approach that allocates their portfolio closely to the benchmark index. In most instances, such funds fall between two stools, carrying high charges without the prospects for outperformance.


With the increased focus on costs across the industry, many portfolio management services are leaning towards a passive only investment approach, with the ultimate aim of highlighting a competitive pricing structure. We feel such an approach is highly inflexible and potentially means that opportunities for outperformance from active managers is being missed. We prefer adopting a hybrid strategy, using passive funds in areas where index tracking funds should perform well, combined with actively managed funds where we feel the prospects for outperformance justify the higher costs of active management.

If your investment manager is using a passive only approach, speak to one of our experienced advisers to discuss whether adopting a different strategy would be appropriate.

Scaling the wall of worry

By | Investments

Recent events in the Middle East have once again led to increased concerns about the impact that World events can exert on global financial markets. In such times, it is important to remain focused on the long-term trend, and to try and avoid taking short-term decisions that could prove detrimental, as history tells us that the initial knee-jerk reaction to global events is often short lived.

Why markets react to conflict

It is true to say that investment markets crave certainty at all times. Calm waters allow investors to focus on the prospects for the global economy and individual companies, without the need to consider the disruptive impact of global events, such as major conflict. One of the key reasons why recent conflicts have caused consternation from an investment perspective is the potential impact on commodity prices. For example, as Middle Eastern nations are key players in the global oil market, the recent heightened tension between Israel and Iran have forced oil prices higher. Likewise, the Russian invasion of Ukraine caused a significant spike in natural gas prices due to supply shortages.

What history tells us

Looking back through history provides clear evidence that investor pain following a global event is relatively short-lived. The Russian invasion of Ukraine in February 2022 led global markets lower, as inflationary pressure rapidly increased and caused investors to re-think economic projections. Despite reacting calmly to the initial outbreak of hostilities, the S&P500 index of leading US stocks moved decisively lower a few weeks later, and took just over one year to recover to a higher level than at the start of the Russian invasion. For those investors who correctly took the view that investment is a long-term process, this period of uncertainty will now be little more than a memory, as the S&P500 now sits relatively close to new all-time highs.

Other major conflicts and acts of terrorism have caused a sharper short-term market reaction,  which then quickly corrects once markets have had time to assess the impact. Following the suspension of global markets in the wake of 9/11 attacks in 2001, the S&P500 index fell over 11% in the space of seven trading sessions, as investors digested the US reaction and potential impact on economic prospects. The downturn was, however, very short-lived, as by October 12th 2001, the S&P500 had recovered the ground lost immediately following the terror attack and ended the year a further 5% higher.

It’s not just war

Of course, geopolitical risk does not necessarily increase as a result of conflict. The outbreak of the Covid-19 pandemic created the largest global economic crisis for a generation, as lockdowns caused significant damage to public finances and global commerce. Between April and June 2020, UK Gross Domestic Product fell by a record 19.4% during this period, only to rebound by 17.6% in the following three months, as the country slowly emerged from the first wave of lockdowns.

Investors had nowhere to hide during the early stages of the pandemic, with stock markets around the World moving rapidly lower during March and April 2020. The S&P500 index fell by 29% from 1st January 2020 to the low point on 23rd March 2020, but had recovered to stand higher than at the start of the year by the end of July, just four months later.

Many investors will vividly recall the unprecedented sense of concern at the time of the Covid-19 outbreak, and the economic damage to public finances around the World will take many years to repair. Global Equities markets, however, corrected rapidly once the initial panic had subsided and investors began looking at the fundamental recovery in business confidence and economic performance to follow.

Climate related events also have the potential to be a greater source of concern to investors over years to come. The changing weather patterns and increase in extreme weather events have the potential to reduce economic output and cause widespread damage, including disruption to supplies of raw materials, food and energy. Our view is that climate related risk may also prove to be an opportunity for those industries who are able to adapt, and the impact of such changes could be far more gradual over a number of years than the immediate impact of conflict or other global events.

Why markets bounce back

As demonstrated by recent precedents, global markets tend to be resilient and often shrug off an initial overreaction to unexpected global events. Once the initial shock of the event has subsided, investors are able to take a measured view of the impact on corporate earnings and economic growth, with markets often rebounding quickly following an initial sell-off. One of the primary reasons why this may be the case is that central banks can invoke a monetary policy response, and Governments can provide fiscal stimulus, which can boost investor confidence. It is also often the case that the global event will do little to damage future earnings, although of course depending on the nature of the event, some sectors of the economy may be more adversely affected than others.

Keep the long-term view in mind

When investing in Equities, it is vital to focus on the longer term objectives. Equity markets are volatile, and from time to time, global events push risk levels higher and can cause periods of underperformance. Whilst we cannot predict the future, we can learn from the market’s reaction to past events, and it is evident that markets often rebound shortly after the initial shock of a global event has passed. Even a once in a generation event (we hope…) such as the Covid-19 pandemic, only caused markets to retreat temporarily. Comparing index values today to the depressed levels seen in March 2020, is a potent reminder of the need to stay calm and stay invested through turbulent times.

It is at times of major concern that the ongoing advice of an independent financial adviser can prove invaluable, both to provide counsel on actions that need to be taken and reassure and aid you to focus on the longer term prospects. Our advisers at FAS are highly experienced, and through regular contact with clients, can provide ongoing advice in all market conditions. Speak to one of our friendly team to start a conversation about your financial planning requirements.

Going big in Japan?

By | Investments

For many years, Japan has been considered as “tomorrow’s story”, where there is much promise, but returns disappoint. That is until this year, where the Japanese Equities market has shown considerable strength. There is good evidence to support further outperformance; however, investors would be well advised to look to the past to understand why Japanese markets have struggled over an extended period, and the steps that policy makers need to take to avoid treading a similar path in the future.

Learning from history

The Japanese stock market has endured over 30 years of underperformance, following a significant economic bubble that formed in the late 1980s. At the time, Japan was growing more rapidly than many Western economies, and spurred on by lax monetary policy and growing investor appetite,  the Nikkei 225 – the most widely reported stock index in Japan – increased from an index value of 13,000 in 1985 to reach a high of 38,915 in December 1989. Across the board, asset prices rose, with the bubble spreading to other asset classes, such as real estate, where values of stocks and property reached overly optimistic levels of valuation.

Asset bubbles tend to end in a disorderly manner, and following the boom, the Nikkei 225 fell heavily in the early 1990’s. Following rapid acceleration during the previous decade, the Japanese economy moved into an extended period of low growth, due to the lingering effects of the asset bubble. The Bank of Japan moved to reduce interest rates to near zero, a level at which rates have broadly stayed ever since, in an attempt to reignite economic growth.

Economics and demographics

One of the reasons why Japan’s economic performance has been an outlier, when compared to other Western economies, are the demographics of the Japanese society. Population levels in Japan are in decline, and the World Economic Forum reports that more than 1 in 10 people in Japan is aged over 80. This has helped keep a lid on domestic consumer demand and there has been a tendency for the population to save, and not spend, despite receiving little in the way of interest. As the population ages, those in working age could see wages increase, leaving consumers with more money in their pockets to spend.

Deflation has been a constant threat that the Bank of Japan have had to deal with. Elevated inflation around the World has been seen as an enemy over the last two years, and whilst high levels of inflation generally harm economic prospects, extended periods of zero inflation, or deflation, have a similar negative effect.

The last year has, however, seen a change in fortune for the Japanese economy. Partly due to the global effects of the pandemic, Japan has seen the first significant bout of inflation for decades, with inflation rising from close to zero in early 2022 to reach 4.3% in January of this year. Whilst inflation has now moderated to stand at 3% in September, the return of meaningful inflation is welcome news and may see domestic demand increase and consumer confidence grow.

Regulatory reform

In addition to the welcome return of modest levels of inflation, Japan is embarking on a number of initiatives to boost investor demand. Traditionally, Japanese companies have been keen to hold large amounts of cash on their balance sheets, and regulators have announced measures to encourage these companies to return funds to shareholders, in the form of increased dividends or share buybacks. There have also been announcements improving the tax breaks offered to encourage Japanese households to move away from traditional cash savings and invest in their economy through share ownership.

Valuations are attractive

When using recognised metrics, Japanese Equities appear to be attractively valued when compared to most other global markets. This may well see a spark in overseas buyer interest, after many years where investors have been reluctant to hold significant allocations to Japan. Indeed, Wall Street veteran Warren Buffett’s announcement that he intends to increase allocations to Japan in April was seen by some as an endorsement of the value in Japanese Equities.

Artificial Intelligence and advanced manufacturing have been drivers of global markets over the last 12 months, and Japan is well placed to benefit from the quest to achieve further automation of human tasks, given the nation’s strong history in areas such as robotics. Japan also has a number of companies who provide solutions that can meet demand for a more energy-efficient and greener future, such as Toyota and Honda.

The importance of diversification

There are several reasons that support the view that Japanese Equities look attractive; however, risks do remain, and whilst the regulatory reforms may prove helpful, there is still significant pressure on central bankers to steer a successful course as inflation slows around the World. This is why we recommend allocations to Japan are held as part of a diversified investment portfolio, which is an important method of controlling investment risk. Allocating funds to different regions, where performance does not necessarily correlate, and to different asset classes – such as Government and Corporate Bonds and Alternative Investments – can help reduce overall portfolio volatility.

Speak to one of our experienced financial planners to discuss the asset allocation of your portfolio.

The quest for real income

By | Investments, Savings

Base interest rates have increased sharply over the last 18 months, as Central Banks aim to tackle high levels of inflation. As a result, interest rates on cash deposits have increased and those who look to produce an income from savings and investments can now generate relatively healthy levels of interest from deposit accounts.

On the face of it, cash is a risk-free investment, as the initial cash balance deposited does not fluctuate in value; however, the hidden risk in holding cash is the eroding impact of inflation. Let’s look at a typical savings account that is paying 4% annual interest before tax, which was opened one year ago. At face value, holding a deposit in this account will have earned 4% return and you will still hold your capital value. The hidden risk is that the real value of the cash deposited – i.e. adjusted for inflation – will have fallen. At the time of writing, the rate of UK inflation over the last 12 months has been 6.7%, which means that the amount deposited will be worth 2.7% less in real terms than when the account was opened. There are other risks of cash too, as the highest paying accounts restrict access to your money, and attention needs to be paid to the limits afforded by the Financial Services Compensation Scheme.

As we move into 2024, we expect interest rates to fall as inflationary pressure eases further, and the eye-catching rates on offer now may be a distant memory in twelve months’ time. This leaves investors who are holding cash needing to find another home as a way of generating income. This is where Equity Income investments have a real advantage over time, and as part of a diversified portfolio, can look to generate an attractive and rising income yield.

Look to dividend income

Part of the return from holding Equities are the regular distributions of excess profits, in the form of dividends. Most mature companies declare dividends to shareholders at regular intervals, and a company that enjoys a strong performance may well look to increase its’ dividend payments over time, which could potentially offset the effects of inflation.

There are a number of global stocks that have a track record of increasing dividends year on year, with the likes of Coca- Cola, IBM and Johnson and Johnson being prime examples of US listed global companies who have consistently raised their dividends each year for the last 25 consecutive years. The UK also has a smaller list of companies who have consistently raised their dividends, such as British American Tobacco and Diageo.

Dividend income is only one part of the potential return that can be achieved from holding Equities, as holding company shares can also offer scope for capital gains over time. Whilst Equities will introduce short-term volatility – which is not a feature of cash accounts – the long-term track record of returns generated by Equities markets highlights the capacity for Equities to significantly outperform returns achieved from cash deposits.

Spreading the risk

Dividends are, however, not guaranteed, and by holding individual Equities you introduce stock-specific risk. Changes in the fortunes of the company in which shares are held can not only impact the share price, but also the potential for dividend growth. Indeed, a company that begins to struggle may look to cut its’ dividends, or cancel it altogether.

As a way of mitigating this risk, we would suggest that holding Equity Income funds is a more appropriate way of gaining access to companies that pay an attractive dividend stream. This can help avoid the potential for issues with one particular company or sector having too great an impact on the overall fund value. Whilst there are a limited number of passive investments that specifically target stocks with increasing dividends, the majority of Equity Income funds are actively managed. This is where a manager or management team will look to select positions and build the portfolio, with a view to holding companies that offer an attractive and increasing dividend yield, and good prospects for capital growth over the longer term.

Equity Income funds cover most geographic areas of the World, providing access to dividend producing companies from the UK, US, Europe and Far East. There is also a wide range of Global Equity Income funds, where the fund manager can select the most appropriate positions from anywhere in the World.

As the performance of an actively-managed Equity Income fund relies on the skill of the manager, it is important to select the right fund – or blend of funds – to seek out the best performance. The level of income, and overall return, achieved from within the Global Equity Income sector can vary significantly from the best to worst performance over time, and this is where careful analysis of the fund, portfolio strategy and management style are crucial. The FAS Investment Committee regularly meets with leading fund managers from all sectors, including those who manage Equity Income funds. These regular meetings strengthen our quantitative approach to fund selection, so that we can truly understand the methods and rationale behind the portfolio selection process.

Equities as part of a diversified portfolio

It is important to point out that Equity Income funds are one of a range of different options for those seeking an income from their savings or investments. Cash deposits absolutely have a place in most sensible financial plans; however, the amount held in cash needs to be considered carefully, as the hidden eroding impact of inflation over time can easily eat into the real value of deposits.

Speak to one of our experienced advisers to discuss the options to generate an income.

Background illustrating bond market data

Time to revisit Bonds?

By | Investments

After the very difficult conditions for Bond investors seen last year, we are seeing growing evidence that a change in direction is now likely. This could herald an improved performance for an asset class that has struggled over the last 18 months and suggests that good opportunities exist in Fixed Interest markets at the present time. We take a closer look at Bonds as an asset class and why now may be a good time to consider Bonds as part of your portfolio.


What is a Bond?

Bonds are issued by governments and companies when they want to raise money. By buying a bond, you’re effectively loaning your capital to the government or company, and in return, they agree to pay you back the face value of the loan on a specific date, and pay you interest during the life of the Bond.

The characteristics of a known redemption date and a fixed rate of interest should mean that Bonds produce less volatility than Equities (shares) and are also more predictable. Other factors that influence the risk of a Bond include the financial strength of the government or company issuing the Bond. The more secure and financially stable the issuer, the more likely the Bond is to be repaid in full. The length of time before the Bond matures is also a key factor. Bonds that are due to be repaid in a relatively short period of time (say 5 years or less) are less volatile than those that redeem in 20 or 30 years’ time.


Why was 2022 so difficult?

Bond markets tend to do well in periods when interest rates are low, as the yield (the return offered by a Bond) looks attractive compared to the rate of interest you could obtain through a bank or building society. Last year was, of course, dominated by the sharp rise in inflation, which was caused by the aftermath of the Covid-19 pandemic and exacerbated by the Russian invasion of Ukraine. Central banks across the Western World began hiking rates from the end of 2021, in an attempt to slow the rate of inflation. Indeed, the speed at which rates increased caught many by surprise.

As interest rates rose sharply, the only way for Bonds to remain competitive with overnight money is for the price to fall, which in turn increases the yield. There was nowhere to hide within Fixed Interest markets, and whilst some protection could be found in shorter dated Bonds – in which we held good exposure throughout the last 18 months – the value of Government and Corporate Bonds fell. Whilst this led to disappointing returns last year, it does not mean that Bonds are attractively priced.


Why is the outlook brighter?

The Bank of England and US Federal Reserve have both now paused their rate hiking cycle, bringing to an end a run of successive rate increases. Whilst there remains a possibility that either or both could raise rates again, we feel this is unlikely. Firstly, we expect inflation to continue to fall over the remainder of this year and into 2024, and the speed at which inflation returns to more normal levels could be a surprise. UK inflation data in August was weaker than expected and in the US, inflation rests just above 3%.

Secondly, economic growth is likely to slow through the next 6-12 months in many Western economies. Ratings agency Fitch recently reduced the outlook for global growth next year, and the OECD projection is for the US economy to rise by only 1% during 2024. Consumer confidence is expected to weaken and the housing markets in both the US and UK are both under pressure given the impact of higher mortgage rates.

As a result, the next substantive move in interest rates may well be down. Economists and market participants are currently weighing up whether rates will be eased gradually or potentially more aggressively, depending on the pace of economic growth. Central banks are adopting a policy whereby their decisions are being led by inflation, unemployment and growth data. Should data remain strong, then there is a case to suggest that rates will only fall gradually, but in the event that data is weaker than expected, then calls will grow for central banks to take more rapid action. There is also discourse as to the timing of rate cuts, with some suggesting the first cuts could come in the first half of next year, whilst others seeing the easing cycle starting in the third or fourth quarters of 2024.

Just as increases in interest rates are generally negative for Bonds, cuts in base rates may well prove positive. At the time of writing, a 10 year US Treasury Bond is currently yielding 4.6%, which doesn’t appear overly attractive when compared to overnight interest rates available on cash deposit; however, a yield of 4.6% could look very attractive should base rates fall over the medium term, say to between 3% and 4%.


Time to revisit Bonds?

After a very difficult 18-month period, Bond prices are attractive, and we feel there is good reason to see value in Bonds at current levels. Investment Grade Corporate Bonds (i.e. those Bonds issued by companies who credit rating agencies deem to be financially stable) and Government Bonds may well see a slow re-rating, as the economic landscape changes over the coming year. Despite the fact that the default rate (that is to say the number of Bonds who fail to repay capital or interest to investors) remains low, a slowing economy could lead to an increase in defaults from more speculative Bonds.

Diversification is a key component of a successful investment strategy, and any allocation to Bonds should be balanced with other assets, according to your attitude to risk, objectives and time horizon. This is why taking advice on the correct asset allocation for your circumstances is an important step for most investors to take.

Speak to one of our experienced advisers here about the outlook for Bonds and Fixed Interest investments, and how they could fit into your investment portfolio.

Graphic of a hoodie covered with dark stormy skies being unzipped to reveal sunny blue skies, representing a brighter future.

The end of the cycle

By | Investments

As traders head back to their desks after the summer break, thoughts turn to the prospects for markets over the remainder of the year. What is apparent is that the conditions this Autumn appear to be calmer than one year ago. It is perhaps easy to forget that almost 12 months ago, then Chancellor Kwasi Kwarteng had just delivered a controversial budget that spooked markets. At the same time, inflation was climbing month on month and Equities and Bond investors took flight to safety, amidst high levels of volatility.

Looking back, it is no understatement that 2022 will be remembered as a tough year for investors. It was also highly unusual, as the impact was felt across all asset classes. Indeed, according to a study carried out by Blackrock, last year was one of only three years in history where both Equities and Bond markets returned a negative performance in the same calendar year.  It is important to remember that markets always look forward, and whilst we can ruminate on the difficult conditions of last year, the future prospects for corporate earnings and government and monetary policy will shape the performance of markets in the months ahead – and the prospects are certainly looking brighter.


The end of the cycle?

Much of the market’s attention since early last year has been focused on the actions of central banks in their attempts to curb inflation. As expected, inflation is now falling quite quickly in some parts of the World (i.e. the US) and a little more slowly in others (i.e. the UK). As inflationary pressure eases, so does the rationale for central banks to continue to raise rates. In addition to the fall in inflation, other important economic measures are adding weight to the suggestion that we are close to the peak of the cycle. Unemployment data, which has been resilient over the course of the last year, has softened over recent weeks in both the US and UK, and the outlook for the UK housing market is gloomy. These trends are likely to continue and as a result, economic growth may well slow in the next few months.

We have long argued that central banks may have been too aggressive in raising interest rates, given the lag between policy decisions being made, and the time taken for these decisions to impact on the economy. As a result, as inflationary pressure eases further, we feel markets will focus on the timing and speed of rate cuts as we head through 2024.

Both Bonds and Equities should benefit from easier monetary conditions. High inflation and rising interest rates work against Bonds and Fixed Income investments as they make the yield offered by the Bond less attractive when compared to cash rates. As expectations rise that monetary policy will pivot, Bonds should gain more attention, and many are currently priced attractively. Lower borrowing costs over time should also help ease the pressure on corporate borrowing, and help companies finance their operations.

As ever, risks remain. It is possible that inflation doesn’t fall as quickly as expected, which could lead to central banks delaying their expected pivot to lower rates. The recent jump in Crude Oil prices, for example, is one of a number of external shocks that could sway the course of interest rates. China’s debt-laden property market and slow recovery post-Covid could also have an impact. We do, however, feel markets have, to some extent, already priced in the “higher for longer” narrative.


Corporate Earnings remain positive

One of the key drivers of the improving outlook has been the strength of corporate earnings. The recent US reporting season saw over three quarters of companies announce profits ahead of expectations, confounding some predictions that earnings reports could be lower. Whilst there have been a handful of notable companies where earnings disappointed, many others have seen estimates for their future earnings increase.

Equities performance in the first half of 2023 was dominated by what we would identify as “growth” investments, which are often involved in technology and new industries. As the landscape changes, we would expect to see the focus shift in favour of companies with good levels of dividend yield and more value-based characteristics. Corporate balance sheets largely remain healthy and dividends are generally well covered. The contribution to overall investment returns achieved by dividends over time should not be underestimated.


Political risks and opportunities

As we move forward to next year, investors will need to consider the impact politics can have on market sentiment. There are, of course, key Elections in both the UK and US next year and the sitting administrations will be keen to see their economies in reasonable shape, as the electorate’s personal financial position is usually one of the key drivers of voter intention. History would suggest that election years tend to be broadly positive for markets; however, we need to be alert to the potential risks that a scenario such as that seen in the US in 2020/21, where no clear winner was apparent for some time, is not repeated, as this has the potential to cause a spike in volatility.


Brighter skies ahead?

Investors have had to negotiate rough seas over the last 18 months, but the end of the rate hiking cycle could well be in sight. A shift in monetary policy may well see calmer waters return over coming months, and evidence is building that 2024 will see us move to less volatile market conditions.

If your portfolio is not regularly reviewed, now is an opportune moment to consider your existing assets to see whether they are well positioned for the expected market conditions. Speak to one of our experienced advisers here to start a conversation.

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“Dog fund” report highlights benefits of independent advice

By | Investments

The latest Bestinvest “Spot the Dog” report has recently been published, and in addition to turning the spotlight on funds that have lagged behind fund performance within their sector, the most recent report also highlighted a trend of underperformance within funds offered by restricted wealth managers.


The list no-one wants to be on

The biannual “Spot the Dog” report lists funds investing in Equities, that have underperformed their relevant market index over three consecutive 12 month periods and also underperformed by a total of 5% or more over the last three years. By using these criteria, the report aims to exclude periods of short-term underperformance, which can happen from time to time to even the best long-term performing actively managed funds. Instead, the report attempts to highlight those funds that have consistently underperformed.

The latest study listed 56 funds that have met the criteria, with nine of the funds holding assets under management in excess of £1bn. The most interesting feature of the latest report is that it highlighted the inclusion of a high number of funds offered by restricted wealth managers. One particular restricted manager, St James’ Place, had a total of six entries in the Bestinvest Dog List, with three of St James Place’ Global Equities funds that appear on the list, holding combined assets under management of over £26bn. Another restricted provider, Scottish Widows (where funds are managed by Schroder), saw two of its funds make the list.


The limitations of restricted advice

We have regularly commented on the differences between independent and restricted financial advice, and why we believe the former to be superior. FAS is an independent practice, whereby we can recommend products, solutions, and investment funds from across the marketplace. This contrasts with a restricted advice proposition, which can only recommend products from certain providers and could mean that the advice provided is limited to a single range of products or funds.

We are passionate believers that independent, whole of market advice has distinct advantages over restricted advice propositions, and the Bestinvest report only serves to strengthen our belief that independent advice offers a significant advantage.

This is particularly the case if your investment portfolio is managed by a restricted adviser. By using a restricted wealth manager, it is likely that the adviser can only construct your portfolio by investing in their own brand funds. As a result, if one or more of the funds offered underperform consistently, your options will be few as the adviser will be limited in what they can offer as an alternative. In the case of St James’ Place, three of the six entries in the Bestinvest list are invested in Global Equities. For investors who take a medium to high level of investment risk, allocations to Global Equities are likely to feature heavily in any diversified investment portfolio, and holding consistently underperforming funds in this sector sets the foundation for poor overall portfolio performance, on a relative basis against other propositions.


Independent advisers have the advantage

Contrast the position of the restricted advice client with a client of an independent firm. As the whole of the market is available to an independent adviser, a skilled adviser can select the most appropriate fund from the very widest range of funds offered to retail investors, and if one of the funds underperforms, there are options to switch into an alternative fund which is managed by another fund house.

At FAS, we have a highly disciplined process when it comes to fund selection. Our in-house Investment Committee undertakes a comprehensive review of all funds available to investors each quarter, using quantitative research initially, and then engaging in rigorous analysis of those funds shortlisted, considering the style, approach and track record of the fund manager in question. As part of this process, we regularly meet with leading UK fund managers, so that we can fully understand their fund selection process and investment strategy.

The vast majority of the funds we recommend perform well when compared to sector peers. Where a fund underperforms on a consistent basis, we carefully analyse the reasons for the underperformance and if the Committee feels it appropriate, we remove that fund from our list of recommended funds. Given that most investment platforms can provide access to more than 3,000 investment funds, an alternative will always be available.


Conflict with FCA Consumer Duty

The recently introduced Financial Conduct Authority (FCA) Consumer Duty rules introduced a higher level of protection for clients of advice firms, as the rules now oblige firms to act to deliver good outcomes for retail customers. The FCA now requires all firms to apply the new principles to the areas of products and services, price and value, consumer understanding and consumer support.

Given the depth of the review we undertook in respect of our response to the introduction of Consumer Duty, we do wonder how restricted firms have been able to demonstrate value for money and good outcomes for clients. When reports such as “Spot the Dog” point the spotlight on underperforming fund performance, the restricted advice proposition is unlikely to be able to adapt, and therefore we feel it is difficult to see how such a service is compatible with the principles of the Consumer Duty rules.


Time to question restricted advice?

If your investments are managed by a firm that offers a restricted advice service, the “Spot the Dog” report makes for compelling reading. Any investor holding funds through a restricted adviser should consider the investment proposition carefully and consider the impact that a limited fund range could have in the event of underperformance.

Speak to one of our experienced independent advisers here, who would be pleased to analyse an existing restricted portfolio and review your current financial arrangements.

Graphic of symbols of four different currencies alongside eachother.

Do you need to consider currency risk?

By | Investments

Most investors understand the importance of diversification within an investment portfolio as a way of mitigating risk, and also appreciate the need to seek out funds that aim to produce strong returns. Some investors, however, fail to take currency risk into account, which has the potential to influence the investment returns achieved.

For UK investors, the exchange rate versus the Dollar carries high importance. The US Dollar has been the dominant reserve currency since the end of World War II, and according to the International Monetary Fund, 58% of global foreign exchange reserves are held in US Dollars.


Why currencies fluctuate against each other

The relative strength of a currency against another global currency can be influenced by a number of different factors, many of which we have seen play out over the last 18 months. Perhaps the most important factor is economic and political stability, as a nation with good economic prospects and a positive environment for business is likely to attract inflows of foreign investment. This can help drive demand for that currency.

Conversely a period of political instability, as we saw last Autumn during Liz Truss’ brief tenure as Prime Minister, can lead to sustained weakness in a currency. Almost a year ago, the Pound slid sharply against many other leading currencies, and indeed the Pound very nearly fell to parity against the US Dollar at one point. Political and economic instability can drive longer term trends, too. A good example of this is the weak performance of the Pound against most major global currencies in the period following the vote to leave the EU in 2016.

Other factors that can influence the direction of a currency are generally linked to the economic landscape, with factors such as the direction of domestic interest rate policy, and prevailing and expected rates of inflation, influencing the relative strength, or weakness, of a currency. During 2023, markets have continued to price in further hikes in UK base interest rates, whereas other developed nations, such as the US, now appear to be close to the peak of their rate hiking cycle. This has led to a rally in the Pound over the course of this year; however, with UK interest rate expectations moderating of late, the US Dollar has regained some of the ground lost earlier in the year.


Currency considerations for UK investors

Some investors who invest exclusively in UK listed assets, may incorrectly assume they are immune from currency risk. The reality is that over 80% of the earnings generated by companies listed on the FTSE100 are derived from overseas, in particular through US Dollars. Whether currency weakness has a positive impact depends on how a company derives its’ earnings and profits. A UK listed company that earns much of its’ income from overseas (such as HSBC or BP) will welcome a weak Pound, as those overseas earnings, when translated back to Sterling, will look more attractive. Weak Sterling, on the other hand, will hamper the prospects of companies that import components or products, as the weak exchange rate will mean the costs of importing goods increases.

One of the ways currency risk can be reduced is by hedging, and some funds actively choose to hedge their currency exposure back to Sterling. This can be seen as an insurance, as this removes the potential for currency movements to impact investment returns, and is achieved by holding complex financial instruments such as swaps or futures. Other globally diversified funds choose not to hedge, therefore aiming to generate additional returns through currency appreciation. Whilst such currency calls can amplify investment returns achieved from the portfolio, a wrong decision can lead to returns looking less attractive.


Diversification helps

Some argue that hedging is not important, and good levels of natural hedging can be achieved by building a portfolio of global Equities funds, as the investor will be exposed to a number of different currencies which will help offset some of the currency risk. Furthermore, as returns from Equities tend to be stronger over time, the impact of currency fluctuations will have less bearing on returns achieved. For a Bond investor, the impact of currency movements can be much more severe as returns are more predictable over time. For this reason, the majority of Sterling Bond funds that invest overseas in global Bonds, will hedge returns back to Sterling, thus reducing or eliminating the additional currency risk.


The prospects for Sterling

The FAS Investment Committee actively monitors currency movements and the impact these will have on our investment decisions. For example, returns achieved from our unhedged allocations to US Equities were boosted by the weak Pound during 2022. Whilst the Pound has regained some of the lost ground during the first half of this year, we have seen the US Dollar strengthen once again over the last month, and we feel this trend could continue. Should the US Dollar find further strength, this is likely to boost returns from global Equities and reinforces our view that holding a portfolio of global Equities could achieve strong returns as we move towards the end of this year and into 2024.

Currency risk is an area that many investors overlook, although good levels of global diversification can help reduce the need to actively hedge currency exposure in a portfolio.

Speak to one of our experienced planners here if you would like to review your current investment portfolio.

Graphic of a globe resting on a grassy ledge representing socially responsible investments

ESG risks cannot be ignored

By | Investments

According to scientists, July may well have been the warmest month on record, when measuring global temperatures. Scorching heat in Southern Europe and North America has led to the United Nations issuing dire warnings on the impact of climate change. As awareness of the issue becomes more widespread, an increasing number of investors are keen to adopt an investment approach that includes non-financial considerations, such as the ability for their portfolio to make a positive contribution to society and the environment.


What is Socially Responsible Investment?

Socially Responsible Investment (SRI) strategies have become increasingly popular since they were first developed in the 1970s. According to the Sustainable Investment Forum, of the USD $66.6 trillion of investment assets managed in the US at the end of 2021, USD $8.4 trillion – or just under 13% – were invested through a sustainable investment strategy. Over time, the range of options open to investors who are keen to take a socially responsible approach has increased, with both active and passive strategies covering Equities and fixed income investments now available.

SRI investment can take many forms, depending on how strict an approach an investor wishes to take. It is, however, important to bear in mind that considering a very limited investment universe, will reduce the ability to diversify the portfolio appropriately. One investment approach is to look at including investments that aim to make a positive impact, and tries to include, rather than exclude, companies that meet this criterion. Alternatively, an investor who wants to take a more rigorous approach may look to set high standards for inclusion and disregard many opportunities on SRI grounds.


Our approach to SRI

At FAS, we are well-placed to cater for investors who wish to incorporate ethical considerations into their investment approach. Through our discretionary managed portfolio service, we offer two SRI portfolios that take a common-sense approach to SRI investment, by building portfolios designed to meet suitable screening criteria (which limits exposure to areas such as fossil fuels, gambling, animal testing and weaponry) whilst being as inclusive as possible. By way of example, a key position in our SRI strategies includes a fund that only holds companies that make a positive contribution to the Paris Agreement Climate Change goal.

We also appreciate some investors would prefer a sharper focus, and within their investment portfolio are keen to strictly limit any allocation to areas that could be harmful to the environment or society. We can build bespoke advisory investment portfolios for these clients, using rigorous quantitative screening processes and active engagement with leading fund managers, to meet a client’s ethical preferences.


What about mainstream investments?

Whilst SRI investment is a growing trend, most investors still wish to invest in a traditional strategy that does not take these further factors into account when making investment decisions. Adopting a mainstream investment approach does not, however, mean that the investment fund managers will ignore the impact of the actions that investee companies take, when it comes to environmental issues, or how they treat their employees. Indeed, Environmental, Social and Governance (ESG) factors are a critical risk for any business, and fund managers – whether adopting a socially responsible investment approach or not – will look to take these risks into consideration when building their portfolio.

ESG criteria will assess how a company safeguards the environment, including corporate policies addressing climate change.  Social factors look to examine the company’s relationships with their employees, customers and suppliers. Governance issues cover areas such as a company’s leadership, executive pay and shareholder rights.


Avoiding controversies

The reason ESG factors are now a mainstream investment consideration when looking at the prospects for growth is that investors, consumers, and the companies with whom they do business, are looking at the way a business conducts itself. The risk that a business overlooks these key considerations, can lead to the potential for reputational and financial damage. These so-called “ESG controversies” can have a significant impact on the value of a company and lead to underperformance.

A good example of such an ESG controversy was the Volkswagen emissions scandal in 2015, when the company admitted installing defective devices to beat emissions tests. This led to significant reputational damage, financial penalties, and the cost of recalling millions of vehicles. Looking further back in time, the environmental impact of the Deepwater Horizon disaster caused BP’s shares to plunge in 2010. Other more recent examples of ESG controversies are Boohoo, who faced accusations of ill-treatment of employees, and both Alphabet (Google) and Meta (Facebook) have been fined by regulators for anti-competition and privacy concerns, respectively.


A change for good?

The increased potential for an ESG controversy to damage the financial prospects of a company is driving a change in culture within businesses across the World, and therefore any investor can take comfort in the fact that good business governance will take ESG considerations into account when formulating their strategy and approach. The same is true for investment managers. Sound investment planning is about assessing risk, and whilst active fund managers will routinely consider potential threats to a business from increased market competition, changes in trends and customer habits and new technology, it is clear that ESG factors cannot be ignored.

Adopting a socially responsible investment approach can aim to make a positive impact through investment choices made, but that does not necessarily mean that the risks associated with environmental, social and governance factors can be ignored by other investors, too.

Speak to one of our experienced financial planners here if you would like to discuss how your portfolio is positioned in respect of its’ social responsibility and how this aligns with your values.

benefits of active fund management - active and passive on blackboard

The benefits of active fund management

By | Investments

One factor to consider when choosing an investment approach, is to decide whether you are looking to follow an active or passive investment style. Active management involves the research and analysis of a target market by a team of analysts, and the decisions of management teams who build a portfolio of best ideas. The alternative approach is to invest passively, which aims to simply track the performance of an index.

Our view is that both investment management styles have features that make them attractive to investors. At face value, a passive investment approach is the most cost effective method, and also potentially offers greater diversification. There is, however, a cost to using only passive investments, 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 achieve downside control through asset allocation, this makes quality active funds an attractive proposition.


A tale of two halves

The first half of 2023 sprang a surprise on many analysts, as passive investment strategies broadly performed well compared to active managed funds. Many were expecting 2023 to be a year when active managers could carve out additional returns by allocating their portfolios in the most appropriate positions; however, index investing, in particular in the US and Global markets, has seen positive returns so far this year.

The performance of a handful of global technology giants, including Apple, Microsoft, Amazon and Nvidia have largely been responsible for much of the Equities gains this year. The S&P500 index is a weighted index, where a greater proportion of the index is allocated to the largest companies, measured by their market capitalisation. Apple currently holds a 7.5% weight in the index, closely followed by Microsoft, at 6.8%. The next three largest, Amazon, Nvidia and Alphabet, represent a combined allocation of almost 10%, and as a result, close on a quarter of the index is made up of these five companies.

Given these facts, it is easy to see the reason for the strong performance in passive strategies. By simply holding a US index fund, you are allocating a quarter of your investment to the largest five stocks, which have all performed well so far this year. Indeed, the S&P “Equal Weighted” index, which assigns an equal proportion to each component of the index, has underperformed the headline weighted index by 10% over the year to date.

The strong performance of the tech giants has also influenced the performance of Global passive funds, as the US dominates the MSCI World Index (the broadest index of the largest global companies), representing 69% of the global index by weight.

The second half of 2023 could see a resurgence from active managers. There is much uncertainty about the trajectory of the US economy over coming months, with many economists expecting a mild recession. Much will depend on the actions of the Federal Reserve, who have performed admirably in the fight against inflation (indeed, with much more success than the Bank of England). US inflation has now fallen back to a 3% annualised rate, and economic data has been surprisingly resilient. Corporate earnings have also largely continued to beat expectations. This strength could, in turn, mean that the long awaited “pivot” from the Federal Reserve, that is to say, the point at which interest rates are cut, may be pushed back.

In these conditions, active managers, who have freedom to allocate their portfolio, can take a high conviction position in areas that are undervalued, potentially reaping rewards from this investment approach. If indices fail to make headway, there is no reason why a skilled manager or management team cannot generate additional returns by selecting the most appropriate portfolio of assets.


Our approach

Our investment approach has always been to blend passive and active management when building our portfolios. Passive funds provide good diversification across the widest range of positions, and given the lack of fund manager at the controls, tend to be cheaper. Active managers, on the other hand, can outperform through the selection of their portfolio of assets. Our Investment Committee regularly undertakes comprehensive due diligence on the performance of actively managed funds, and meets with leading fund managers across the industry. Through these focused sessions, we can gain a clear understanding of a manager’s strategy, style and approach, and how they have aligned their portfolio for the expected conditions.

Through our active fund management selections, we also look to select different investment approaches that complement each other. For example, some managers have a clear value bias, seeking out positions in mature companies that pay attractive levels of dividend income. Other managers are biased towards growth stocks, where managers often take a high conviction approach and construct a focused portfolio of relatively few positions. By combining these different styles, we add a further element of diversification and risk management.


Time to take stock

The first half of 2023 has seen passive strategies outperform; however, the remainder of the year could see active management styles back in favour. We suggest this is an ideal opportunity to take stock of an existing investment portfolio, or pension investment strategy, to see whether any changes are needed.

Speak to one of our experienced financial planners here to start a conversation.