Investments

The profit announcements from BP, Shell and others have made headline news over recent weeks, due to concerns over the raising of the energy price cap and hikes in gas and electricity prices to follow in the Autumn. Given the size of the profits generated, and dividends declared to shareholders, it is of little surprise that the Energy sector has been the best performing sector within the UK Equities market over the year to date.

In the first half of 2022, the Energy sector returned 28.2%, a comfortable lead over the next best performing sector, Healthcare, which returned 16.5%. This performance is in stark contrast to the worst performing sectors, Consumer Discretionary (which fell by -21.2%), Industrials (which recorded a 21.9% fall), and Technology which returned -28%.

How an investment fund responds to such disparity of performance across sectors depends on whether an passive or active investment approach is being adopted, and where an active manager is employed, whether a high conviction strategy is used.

The Passive v Active debate

Within a Passive Index fund, which tracks the return of a particular market index, the fund will allocate the portfolio to broadly match the composition of the index. This means that the fund holds representative weights in each sector in line with the weight in the index. So a FTSE100 index fund could hold around 8% of the portfolio in Shell and 3.5% in BP.

The opposite of a passive investment approach is an actively managed fund. When a fund is actively managed, it employs a professional portfolio manager, or team of managers, to decide which underlying investments to choose for its portfolio.

Being actively managed, this would permit the fund management team to allocate funds across different sectors of the index, and depending on the style of the fund, the sector allocation could differ a great deal from the percentage allocations of the benchmark index. These decisions can have a significant impact on fund performance, depending on the level of variance compared to the index composition. For example, an actively managed fund with a lower allocation to the Energy sector during this year would have struggled to keep pace with the index over the course of the year. Similarly, holding too much in Technology, the worst performing sector in the UK over the last year, would also weigh on returns.

Holding the right stocks at the right time

Of course, market conditions continue to evolve and the performance of different sectors of the economy will swing from period to period. Comparing the period from March 2020 to March 2021, to the last year, illustrates this very well. Over the lockdown period, Healthcare was the best performing sector, followed by Basic Materials and Technology, with the Energy sector – which has performed so well recently – lagging the leading sectors by some margin.

The ability of a fund manager to allocate the fund correctly, and make decisions to alter the structure of the portfolio over time, will make a sizeable contribution towards the overall performance. Looking at the Energy sector over the longer term, for example, paints a very different picture to the significant outperformance seen this year. Over the last 10 years, both BP and Shell shares have each lagged the benchmark FTSE100 index by over 30% over this 10 year period. Holding the correct stocks, at the right time, is therefore key to effective active management.

Research is key

When we research investment funds, through data analysis and meetings with leading fund houses, we often come across fund managers and management teams that look to take a so-called “conviction” based approach. This involves constructing a concentrated portfolio of a smaller number of holdings than an average fund would hold, perhaps holding as little as 30 stocks. Holding this number is likely to mean that the manager will be taking a considerable position in certain sectors and holding very little in other sectors of the economy. As demonstrated by the sector data over the course of this year, correctly allocating the portfolio to the right sectors and positions could yield significant outperformance.

Taking the opposite approach, we often review actively managed Equities funds that positions the portfolio with only subtle variance to the representative index. As a result, the performance of these funds tends to hug the index return, and lends predictability to the performance achieved. However, holding this type of fund begs the question whether the investor is getting good value for money from investing in an actively managed fund, when a passive tracker fund could do a similar job for the investor typically at much lower cost.

The average actively managed UK Equity fund will charge an annual management fee of between 0.50% and 1% per annum, which will eat into returns, unless the active manager can generate outperformance that justifies the cost. Compare this to a UK index fund, which can cost as little as 0.06% per annum, and will achieve returns close to those achieved by the benchmark index.

Both passive and actively managed funds do very different jobs in a diversified portfolio of funds, and there are advantages to each approach that merit their inclusion in a chosen strategy. Where fund managers show high conviction, with a good deal of success, this can often easily justify the higher costs due to the outperformance achieved. We are often less impressed with actively managed funds that offer a very similar strategy to a passive approach, but offer the investor poor value for money.

With over 3000 funds available to UK investors, blending funds to achieve good levels of diversification, lower volatility and strong performance can be daunting for private investors. At FAS, we have a disciplined investment selection process, which is designed to select funds with good prospects for outperformance over the longer term. If you hold an investment portfolio currently, speak to one of our experienced Financial Planners to review the performance, risk and value you are receiving.

If you would like to discuss the above with one of our experienced advisers, please get in touch here.

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

Most of us will be familiar with the concept of regular investing, through pension saving for retirement. Each month, contributions are deducted from salary or earnings and under a Defined Contribution arrangement, are invested into a stock market fund. The monetary contribution buys a number of units based on the prevailing price of the fund on the day the contribution is received by the pension provider. At each monthly contribution point, the number of shares the contribution buys is different, as the price of the units will fluctuate from month to month.

When markets are buoyant, and performing well, the monthly contribution is likely to buy less shares, as the price of the fund is likely to be higher. Conversely, when markets are under pressure, the monthly contribution is likely to buy a greater number of shares as the price will be lower. By saving regularly and investing at different entry points, this provides the benefit of “Pound Cost Averaging”, which is an effective way of smoothing out the peaks and troughs that markets experience over a period of time.

Under a pension arrangement, or any other regular saving approach, regular savings of this manner are often the only way that an individual can effectively save over the longer term. As the regular savings are deducted from salary, this leads to a disciplined saving regime month after month. But what if the investor has a lump sum to invest? Should regular savings still be employed, or should the investment be made in a single transaction? This is a more complex decision, where a series of factors need to be considered before reaching a decision.

Don’t try and time the investment

Conventional investment wisdom would dictate that investors should maximise the time that investments are held, and therefore the simple answer would be that a rational investor would make a lump sum investment at the earliest opportunity in order for the investment to begin working for them. In periods when markets are stable or rising, this is often sound advice, as not being invested comes with an opportunity cost.

Missing out on just a few of the best performing days that investment markets have witnessed can have a dramatic impact on long term performance. For example, the annualised return achieved on an investment made in 1990, invested in the S&P500 index of US Equities, would fall from 10.4% per annum to 7.7% per annum if just the 10 best days, when markets gained the most, were missed. This is, perhaps, the best illustration of the importance of being invested in markets, and staying invested for the long term, rather than trying to time the entry point into an investment position.

A phased approach

When markets are more volatile, however, a case can be made to drip feed the investment in over a number of months. When a lump sum investment is split into a number of smaller investments that are made over a period of time, this is known as “Phasing”. A phased investment approach effectively converts the lump sum investment into a series of smaller amounts, which are then invested over a period of months. The investment is normally established so that the same amount is invested at each point in the phasing process, and as prices and values will be different from month to month, each purchase buys a different number of shares in a fund or series of funds, thus smoothing the entry into markets.

Phasing can work in an investor’s favour, if markets fall during the phasing process. At each investment point, the phased investment would buy a greater number of shares if prices are falling, leading to a better outcome than if the lump sum was invested in a single transaction. On the other hand, rising markets will mean that each phased purchase will buy less shares, if prices are rising, leading to a worse outcome than would be the case using a single purchase point.

An individual decision

Other factors need to be considered when deciding on whether to invest a lump sum immediately, or phase an investment over a series of smaller transactions. For example, investment experience is an important consideration. If an investor is making a lump sum investment for the first time, drip feeding funds in over a period of time can be helpful in reassuring a nervous investor.

The opportunity cost of not investing in a single lump sum also needs to be considered. If funds are held in cash during a phasing process, and are not invested, the cash funds are likely to earn a negligible rate of interest, and if the investor is seeking to generate income from the investments, the income stream will take longer to develop, as only a small investment would be made initially.

Lastly, the size of the investment, in relation to value of an individual’s wealth, may also be a contributory factor in the decision making process. If a large lump sum is being invested, the investor may be more keen to invest over a number of months, rather than investing in a single transaction.

Deciding on an appropriate strategy for entry into an investment position is an area where independent advice from a professional can add significant value. At FAS, we employ Phasing where appropriate and always consider an individual’s circumstances in a holistic manner when advising whether to invest a lump sum using a phased approach or not. As each individual’s needs and objectives are different, we take the time to talk to our clients about risk and volatility, enabling clients to reach a decision with which they are comfortable.

If you would like to discuss the benefits and drawbacks of phasing with one of our experienced advisers, please get in touch here.

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

Since March 2020, investors have been exposed to volatile market conditions, with markets falling heavily at the height of the Covid-19 pandemic, only to be followed by a rapid recovery, and then weaker market conditions again this year, due to higher inflation and the conflict in Ukraine. Whilst volatile conditions lead to opportunities, there are a range of funds that aim to generate profit irrespective of whether markets are positive or weak.

These funds are known as Absolute Return funds, and as the name suggests, they aim to generate positive returns in all market conditions, by adopting a different strategy than is used in more traditional investment funds that tend to invest in a single type of asset (e.g. Equities or Corporate Bonds) or a mix of asset classes.

Absolute Return funds often use “long” and “short” strategies, and are designed to make money from shares in companies that go down as well as up, thus aiming to  deliver a positive return for investors regardless of whether the market is rising or falling. They also aim to achieve returns that are smoother, reducing some of the volatility that has been so apparent for investors over recent years. This is also reflected in the choice of benchmark, or performance measure, used by Absolute Return funds, which is more often a return based on cash, or inflation, plus a percentage margin, rather than broader market movements.

A combination of strategies

The primary feature of Absolute Return funds is that the fund manager is not usually constrained by investing the fund in a rigid asset allocation, and has the flexibility to choose where the fund is invested across a range of different asset classes and strategies. In many Absolute Return funds, the manager will look to employ strategies that hold both “long” and “short” positions.

“Long” strategies are traditional investments into assets that the fund manager believes will rise in value over time and involves buying and holding the shares of companies or other assets. A “short” position can be adopted on any investment that the manager believes will fare less well, or fall in value. These positions make use of derivatives, which are complex financial instruments that typically allow the manager to sell shares they do not own, with the aim of buying them back at a lower price to make a profit.

In addition to these strategies, Absolute Return funds also invest in other assets depending on market conditions. Some use cash and short dated loans/bonds as a way of protecting the portfolio in more difficult market conditions, and use alternative assets and commodities as hedging tools.

What is the attraction?

Looking at historic returns from the sector, it is clear that a well managed Absolute Return fund can limit volatility and risk, whilst achieving good returns over the medium to longer term. The fact that the fund manager is not limited by strict guidelines can help tailor the portfolio to match the underlying and expected conditions more closely than when the fund manager is constrained by the fund guidelines. This flexibility can also mean that a strong performing Absolute Return fund can aim to deliver returns when other asset classes struggle.

And the drawbacks?

This type of investment is more heavily dependent on the skill set of the manager or management team than perhaps any other type of investment. As the investment strategies used often involve derivatives, these can amplify performance in both directions, and lead to greater losses if the wrong asset is held at the wrong time.

In addition, Absolute Return funds tend to be expensive in terms of their annual charges, and some funds charge a performance fee, which is charged in addition to the standard fund charge when certain performance targets are reached.

In addition to the added complexity of Absolute Return funds, in certain circumstances, positions taken within an Absolute Return fund can be less easily realisable than mainstream assets, which could lead to delays or difficulties if investors wish to sell or encash their investment.

Does flexibility translate into returns?

Absolute Return funds started becoming more popular immediately after the financial crisis of 2008, and by 2015, they represented the most popular type of fund by volume of sales. However, this popularity has waned over recent years, with outflows of £3bn from the sector seen during 2021.

Performance across the sector has been mixed. A number of funds have shown consistently strong performance over a range of different market conditions, and merit consideration. In a diverse sector, however, there have been a number of funds that have performed less well, with a wide divergence of returns seen over the medium term.

Given this variance in performance, increased due diligence is required when considering Absolute Return funds, and careful analysis of the strategy, track record of performance of the management team, and risks, is key to making the right selection within the sector. At FAS, we maintain a limited exposure within our portfolios to a small, select group of Absolute Return funds that we feel have good prospects for outperformance over the medium to longer term. However, we use these funds where appropriate as part of a much wider, diversified portfolio of assets.

If you would like to discuss Absolute Return funds or would like to review your portfolio strategy with one of our experienced advisers, please get in touch here.

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

Anyone heading off abroad at the moment will be facing the prospect of the Pound not stretching as far, as Sterling continues to weaken when compared to other global currencies. The implications of a weak Pound go much further than making holidays more expensive as it has a major impact on the UK economic outlook and for investors in UK assets.

Interest rates are key

Whether a currency is strong or weak against a basket of other currencies, and notably the US Dollar depends on a number of factors. The prevailing interest rate, and expected interest rates in the medium term, can help promote a strong currency, as investors will be more keen to hold cash in a currency where interest rates are higher than in a currency with lower interest rates.

The Bank of England, whilst raising interest rates on five occasions since December 2021 are still lagging behind the US and Canada, with the US Base Rate standing at 1.75% and the Canadian Base Rate at 1.50%, compared to 1.25% in the UK. However, the Base Rate is still some way above the Eurozone, where Base Rates are effectively still at zero. Interestingly, the Euro has been just as weak against the Dollar as Sterling, and is close to reaching parity with the US Dollar.

The importance of stability

Financial stability is another important consideration, as investors would, unsurprisingly, be more willing to hold reserves in a country that has sound economic prospects and good governance. It is quite evident the political turmoil and uncertainty we have seen over recent months has impacted on Sterling’s performance. Looking at the longer term, Sterling has been on a broadly downward trajectory against the Dollar ever since the Brexit vote was announced in 2016, and given the uncertainty that was introduced by the vote to leave the EU, again, it is perhaps not a surprise that Sterling has found itself on the backfoot.

Inflationary pressure

Lastly, levels of inflation that exist in the location where reserves are held is also important, as higher levels of inflation can hinder real returns achieved on deposits. Inflation in the UK is also higher than most other developed nations, with the Consumer Price Inflation (CPI) measuring 9.1% in May and standing higher than both the US and Eurozone, at 8.6%.

The higher levels of inflation are, to some extent, not only a disincentive to holding Sterling, but a direct result of Sterling’s weakness. The UK has a negative trade balance, in that it imports significantly more than it exports. Imported goods that are priced in Dollars can potentially cost more when passed on to end consumers, once the Dollar price is converted to Sterling.

The impact on the UK economy

Considering these factors, there is plenty of evidence that confirms why Sterling is under pressure at the current time. But how does this impact on UK businesses, and in turn on the prospects for investors in UK assets?

We have already alluded to the fact that importing goods in Dollars will become more expensive as Sterling weakens. Businesses have a choice whether to absorb these higher costs, at a risk to their margin, or pass on the cost increases, which runs the potential risk that customers may turn to alternatives or simply reduce or stop buying the product altogether. This is the reason why we favour funds that invest in businesses with strong market share, good cash flow and brand loyalty, that can look to pass on increased costs without affecting their market position.

Sterling weakness can provide a positive impact on companies that earn a good proportion of their income from outside of the UK. Within the FTSE100, around three quarters of revenue earned by the largest UK companies are generated overseas, and once these earnings are converted back into Sterling, a falling Pound can amplify the profits of these companies. This effect is less prominent in mid-sized companies, and in particular, far less apparent in smaller companies, that tend to be more domestically focused. For those companies that primarily export their goods, a weak Pound is a barrier to profits, as goods and services priced in Sterling can look more expensive to overseas buyers.

Should investors be concerned about currency risk?

We live in a global economy, and it is only correct that investors should look to hold a diversified investment portfolio, with assets spread across the globe. As we have commented in previous articles, the UK market is relatively tiny compared to the influence of the US, and by simply focusing on UK positions, many of the World’s largest and by definition successful companies will be out of reach. That does, of course, lead to currency risk.

As we have seen over the course of this year, Sterling’s weakness has helped overseas investments held in UK funds. The S&P500 index of leading US shares is down over 17% over the year to date in Dollar terms, but due to Sterling’s weakness, the fall is just 8% when converted back to local currency.

The reverse effect would, of course, be apparent in periods when Sterling strengthens. In these conditions, one option is to blend funds that aim to hedge their portfolio against currency movements.

Where next for Sterling?

The Pound has drifted down a slippery slope this year, due to higher inflation, political upheaval and weak economic prospects. Given our expectations for the coming months, it is difficult to see the position changing significantly in the short term.

If you would like to review your portfolio to consider aspects such as currency risk with one of our experienced advisers, please get in touch here.

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

Making sure an investment portfolio has sufficient diversification can help mitigate risk, and one way that a portfolio can effectively be diversified is to allocate funds globally. By investing funds across a range of different geographic areas of the world, the impact on the overall portfolio, if a particular region suffers a downturn, is reduced.

Investing in a global investment fund may be a sensible way of obtaining this diversification, and you may be forgiven for thinking that such a fund would invest a reasonable proportion of the portfolio in each region. The reality is that a significant proportion of the portfolio, perhaps up to two-thirds, is highly likely to be invested in the US market. The MSCI World Index, perhaps the most recognised global market index which comprises the largest 1,540 global companies from 23 developed nations, allocates 68.3% to the US market, with the next largest component being Japan at just 6.2% and the UK at a mere 4.4%.

Size that can’t be ignored

The reason US markets command such a weight in global indices is a result of the sheer size of the largest components of the US S&P500 and Nasdaq indices. The relative size of companies value on the market is calculated by multiplying the number of shares in issue by the price of each share, and is known as the market capitalisation (or market cap). Currently, US tech giant Apple and Saudi energy company Saudi Aramco are swapping places as the largest global stock by market cap, with both companies valued at over $2 trillion. To put this in perspective, both companies are individually over 10 times bigger than Shell, which is the largest component in the FTSE100 index of leading UK shares.

Of the remaining 8 companies in the top 10 global stocks ranked by market cap, 7 are based in the US, with Chinese conglomerate Tencent being the only other non-US company to feature in the top 10.

To reinforce the scale of these mega cap stocks, it was interesting to note that at one point in 2020, the market cap of Apple was bigger than the combined market cap of all 100 constituents of the FTSE100, and whilst Apple shares have fallen back this year, the value of the company continues to stand just below the combined market cap of the UK index.

Given the sheer magnitude of the largest US stocks, active managers of Global Equities funds would have to make a very bold decision to ignore the largest positions, as doing so would be increasing the chance that the fund would perform very differently from the market as a whole.

When America sneezes

It is clear to see the dominance of US companies in global terms, and why US stocks really can’t be ignored when considering geographic asset allocation within a portfolio. But this doesn’t necessarily explain why the fortunes of the US economy are key to how global markets perform.

Whilst the origins of the saying are open to debate, the phrase “when America sneezes, the world catches a cold” is often used to describe the influence the US economy has over the rest of the world. Perhaps the most striking example would be the Great Depression in the 1930s, which started following the infamous Wall Street Crash of 1929.

Despite only being home to less than 5% of the world’s population, according to the World Bank, the total Global Gross Domestic Product in 2020 was $84.5 trillion, with the US contributing almost $21 trillion or 25% of the world’s economic output. Any shift in performance of the US economy, by virtue of the global marketplace, will therefore have a disproportionate impact on the economic prospects for many other countries.

The confidence of US consumers will have a truly global impact, as it is the most important export destination for one fifth of countries around the world. Increasing US consumer confidence can lift the fortunes of many trading partners through an increase in demand for imported goods, and this is why the prospects for Emerging Markets are, in particular, linked to the performance of the US economy.

Another key reason is the importance of the US Dollar, which is the most commonly used currency both in trade, and also financial markets. The Dollar is seen by many as the world’s reserve currency, and according to the International Monetary Fund, just under 60% of Global central banks reserves are held in US Dollars. Monetary policy decisions by the Federal Reserve, the US central bank, are so carefully watched due to the impact these can have on the strength of the US Dollar, which in turn affects the financial stability of countries that rely on Dollar reserves.

Finally, global commodity markets are intrinsically linked to US economic prospects. As the US is the largest producer, and consumer, of both Oil and Gas, the output from US production of energy supplies, and the demand for those supplies around the world, will weigh on global commodity prices.

The US is key to the global economy

As these factors demonstrate, the US economy and stock market have a defining role to play in the fortunes of the global economy, and in our opinion, any portfolio strategy should have exposure to the US as part of a global approach.

We see many investment portfolios managed by others that are too focused on UK stocks and funds, and significantly underweight in their allocation to US Equities. Since 2016, this would have led to underperformance as UK Equities have consistently lagged US stocks over this period. Whilst we advocate good exposure to the UK within any strategy, given the importance of holding domestically focused positions, not having a sufficient allocation to the US means missing out on the prospects for the world’s largest firms, and the most influential economy.

If you would like to discuss the geographic diversification in your investment portfolio with one of our experienced financial planners, please get in touch here.

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

A common theme underpinning all investments, the notion of risk and reward, is a general trade off that affects almost anything from which a return can be generated. Anytime you invest money, there is a risk, whether large or small, that you might not get all of your money back, or in the worst case scenario, that the investment may fail. For bearing that risk, you expect to receive a return that compensates you for potential losses. In theory, the higher the risk the greater return you should receive for holding the investment, whereas if lower levels of risk are taken, lower returns should be expected.

This definition is, of course, simplistic; however, over a period of time, an investor should rightly receive greater compensation for taking greater risk. If this was not the case, why would an investor choose an investment where higher levels of risk were inherent, if they could expect to receive a similar return from an investment that displayed lower levels of risk? This introduces the notion of risk adjusted returns, whereby the return achieved by the investment over time is considered in conjunction with the level of risk experienced.

Assessing investment risk

Assessing the risk of any investment relies on subjective assessment of the potential for the investment to fail, amidst a whole host of other factors. For example, placing money in a UK deposit account carries low levels of investment risk. The nominal value of the deposit cannot fall in value, and if the bank or building society were to fail, then assuming the deposit meets the qualifying criteria, the deposit of up to £85,000 would be protected by the Financial Services Compensation Scheme. However, other risks, such as inflation risk, need to be carefully considered to assess the potential “real” return of the funds held in savings, which is expressed as the return less the then prevailing rate of inflation.

Examples of other risks that investors need to consider are liquidity risk, which is the risk that you will not be able to access your money quickly and easily at a time of your choosing, and currency risk, which applies when investments in foreign assets are made, which exposes the investor to the risk of losing money due to movements in the exchange rate.

By undertaking a similar assessment of the risks associated with each asset class, investors can make a judgement as to the level of risk that applies to each investment and by reviewing long term historic returns and projected returns, can begin to assess the balance between risk and reward that applies to any asset class.

Time horizon is also key

The length of time an investor is willing to invest for is also a key risk factor. Given that economic growth (and therefore market performance) is generally cyclical in nature, investing for less than the medium to long term (which we would normally express as being a period five years or more) would introduce Time Horizon risk, whereby the point at which an investment is bought and sold may be less likely to produce a positive outcome.

When investors look beyond asset classes to individual investments, volatility measures are used to determine how much the price of an individual investment will move up or down over time. If an asset rises and falls considerably, it is seen as displaying high levels of volatility. On the other hand, if the price of an asset is relatively stable and predictable, then this is seen as being low volatility.

Volatility measures are also useful when considering the risks associated with broad market conditions. The widely reported Chicago Board Options Exchange Volatility Index (or “VIX” for short) measures the expected volatility of the S&P500 index of leading US shares and can be a helpful indicator of how much markets are likely to move, in either direction, over the next trading periods.

Deviation from the average

The most common way to measure volatility is through standard deviation. This measures how much the returns of an investment move away (or deviate) from average returns. More volatile investments deviate further and more frequently from their average return, whereas less volatile investments are more likely to track the long term average returns more closely.

The value of investments with very high levels of volatility tends to be dependent on overall market confidence, and sentiment towards riskier assets can be weak during periods of economic uncertainty. In periods when market confidence is lower, investments displaying lower levels of volatility may be less likely to experience poor performance.

When we construct investment portfolios, volatility is a key component we consider when determining which assets are included in the portfolio, and the percentage of the portfolio that is allocated to that position. As each investment has its own volatility measure, when these are combined within a portfolio of different assets, an overall portfolio risk can be determined. The portfolio volatility measure can then be compared to the volatility displayed by similar portfolios, or to recognised benchmarks, to determine whether the strategy is of lower or higher volatility than its peers.

Review your risk adjusted return

Risk is always a key component of our research and analysis when we assess investments, and as explored above, risk can come in many guises, all of which need to be considered. We use advanced technical tools to review volatility and standard deviations of investments with the aim of achieving returns that are commensurate with the level of risk being taken. We often come across investment portfolios managed by other fund managers that carry substantial levels of volatility and risk, that the investor is unwittingly exposed to. 

If you are concerned about risk levels within your portfolio, then please get in touch with one of our experienced advisers here.

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

Inflation is the key

Following a very positive year in 2021, investment markets have faced significant challenges over the first six months of this year. Inflationary pressure, that was starting to build following the emergency monetary policies employed by Central Banks at the start of the pandemic, has rapidly increased due to higher energy costs, and increases in the price of food and oil. Much of this is due to the Russian invasion of Ukraine, and the combined impact of sanctions on Russian supplies of energy and lack of exports from Ukraine. Further pressure has been exerted by supply chains, which were damaged by the pandemic, failing to keep up with increased demand, and further lockdowns in China, which have exacerbated the supply side constraints.

To combat higher inflation, central banks in the US and UK have increased interest rates over the course of the year. It is the job of Central Banks to try and navigate a course that reduces inflation (the anticipated consequence of the base rate increases) whilst avoiding recession, which may well arise as consumer confidence falters amidst the higher costs of living. Global economic growth was strong in the second half of last year as economies emerged from the pandemic; however growth is slowing in many Western economies once again, with recession a real possibility in the UK, US and Eurozone.

The latest round of base rate increases saw the Federal Reserve increase rates by 0.75% and the Bank of England by 0.25%. Since December 2021, the Federal Reserve has now increased rates by 1.5% and the Bank of England by 1.15%, and further substantive rate increases are anticipated over coming months.

Bear Market in Equities

Global Equities markets have struggled amidst the higher inflation and slower growth. US markets have already moved into correction territory, with falls in the S&P500 and Nasdaq of over 20%. Despite the market reaction, corporate earnings have continued to hold up well in many sectors, and companies with strong balance sheets and cash flow should be able to navigate through these conditions effectively.

Bond markets have not provided a safe haven, with yields increasing over recent months in anticipation of higher interest rates and persistent inflation. Bond markets have now, in our opinion, priced in much of the expected monetary policy decisions, and now offer investors much better value than they did at the start of the year.

What should investors expect over coming months

Given the weak performance seen so far this year, investors are questioning what they may expect to see during the second half of the year. It is important to bear in mind that stock markets are a discounting mechanism, and as such, have factored in the expected course of interest rates and slowdown in economic growth. The forward guidance provided by central banks, in particular the Federal Reserve, has outlined the expected path of interest rates that we expect to see as we head through the remainder of the year. Without any further surprises seen from economic data over coming months, it is likely that the rate hike cycle may begin to slow as we move towards the end of the year.

It is evident that higher volatility will persist during the remainder of 2022; however, we contend that price action over the course of recent months has already discounted higher interest rates and slower growth to come, and market participants are looking beyond this period, when inflation begins to gravitate back towards stated targets, and central banks can ease off the brake pedal.

In any given market, opportunities will present themselves. We are watching the so-called “Price Earnings Ratio” of the S&P500 index of US shares, which measures the stock price relative to earnings for each component in the index. The forward Price Earnings Ratio now stands below 16, compared to the 10 year average for the index of 16.9 and 25 year average of 16.3. Assuming earnings hold up reasonably well over coming months, equities markets – by this measure at least – offer value over the medium term.

The importance of staying invested

In these difficult conditions, it is important to remember the advantage of staying invested and the risks inherent in trying to time an exit and re-entry to an invested position. Trying to trade these conditions is certainly not advisable for any long term investor. Take the example of an investor in the S&P500 index from March 1990 to April 2022, who would have achieved a return of 10.4% per annum over this period, with all income reinvested. However, by missing the 10 best days over this period, this return would fall to 7.7% per annum, and missing the 30 best days would see the return fall to just 4.5% per annum. It is interesting to note that the 10 best performing days all occurred in 2008-9 and 2020, when markets recovered sharply from heavy falls.

A better second half?

The first half of 2022 has seen investment markets struggle, and whilst it is apparent that the volatile and weak conditions may persist over the near term, we are starting to see real value emerge in a number of areas, including Equities and Bonds.

If you wish to discuss your investments and how they are positioned in these conditions, then please get in touch with one of our experienced advisers here.

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

The private rental sector has grown significantly over recent years, with over 4.5m tenants now renting from private landlords in the UK. Propertymark  – the professional body for the lettings industry – reported in April that their agents continue to see strong demand, with 10 new registrants for each available property to rent in their member’s branches. In light of the increased demand, it would, perhaps, be easy to conclude that buying a property to let would be a good decision at the current time; however, tenants’ requirements are also shifting, and with many now working from home on a part or full time basis, having the right property, in the right location, is key.

Introducing our Taxation of Property brochure

Whether you are looking to buy, sell, or rent a property a thorough understanding of the tax implications is essential. For up-to-date information and expert advice please access our latest Taxation of Property brochure here.

Growth about to stall?

Landlords have enjoyed the benefits of house price growth in addition to rental income over recent years. Despite the effects of the pandemic that were felt across much of the wider economy, house prices have continued to climb (although the Stamp Duty holiday which ran until 30^th June 2021 certainly gave prices a helping hand).

Recent surveys and reports have, however, suggested that price growth may finally be slowing. The Office for National Statistics reported annualised house price growth slowed from 11.3% to 9.8% in March, although behind the headline numbers, the rate of growth is variable depending on location. For example, annual price growth in London is only 4.8%, compared to the East Midlands region, where growth has exceeded 12% over the last year.

Given the economic shock of higher inflation and consecutive interest rate increases, it is highly likely that this downward trend will continue, and may well accelerate, as higher costs of living and increased borrowing costs limit affordability for house buyers.

Potential changes in legislation

There have been increasing calls for further legislation of the private rental sector, which may well have cost implications for landlords over coming years.

Legislation may be introduced by the end of 2022 to prevent landlords from evicting tenants without giving a specific reason. This could lead to serious implications,  as under the proposed legislation, the likely route to remove tenants would be through the court system or specialist tribunals. One option to protect landlords may be to consider asking for several months’ rent paid upfront or for a guarantor to be provided.

A compulsory energy performance certificate rating of ‘C’ has been proposed, for new tenancies by December 2025, and on all rented properties by December 2028. This could be a major issue for landlords with older properties, as the cost of remedial works may make the financial decision to continue letting an older property unviable. As ever, the proposed legislation is subject to change and carrying out expensive improvement work is not recommended until definite rules are in place.

New rules for holiday lets

Holiday lets have become increasingly popular, in particular given the boom in UK holidays seen during the pandemic. However, if you are a second homeowner with a holiday let, you have a year to ensure you won’t be caught by the closure of a tax loophole used by some to avoid council tax bills on their holiday homes.

Currently, those with second homes in England can avoid paying council tax and can access small business rates relief if they state they are planning to use their property as a holiday let.

Until now, homeowners have not had to provide any evidence that this home has in fact been rented out to holidaymakers, allowing some to gain a tax advantage, despite the property being occupied solely or primarily for private use and standing empty for much of the year.

From April 2023 new rules stipulate that holiday rentals must have been let for a minimum of 70 days in the previous year to qualify for the council tax exemption and small business rates. In addition the property must be available to let for 140 days a year. Property owners will have to provide letting receipts and details of where the property is advertised to holidaymakers, e.g. online or via brochures. Those that fail to let out their property for the required period will have to pay council tax the following year.

Business rates are paid to the local authority. Like council tax, the amount paid will depend on the ‘rateable value’ of the business property. However, as many holiday lets are effectively small-scale businesses, many will qualify for small business rate relief, which will effectively mean no charge at all. Government figures show that around 65,000 holiday lets in England are liable for business rates, but around 97% have rateable values of up to £12,000. If the rateable value is less than £12,000 then there will be no business rates to pay. These rates are also reduced, on a sliding scale, if the rateable value is between £12,000 and £15,000.

Landlords running commercial holiday let businesses, which encourage tourism and provide jobs and local revenue across the country, will, however, not be penalised.

A more balanced decision?

The property rental market has been buoyant for some time, although we feel the decision to take on a new rental property is more finely balanced than it has been for some time. With a slowing economy, higher interest rates and inflation, and legislative changes proceeding through Parliament, landlords have plenty to consider. It could be the case that other forms of investment, such as a diversified investment portfolio of equities and fixed interest securities could produce an attractive income yield to match rental income, in a more tax efficient manner, and without the potential legislative headaches.

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

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

Whenever clients talk about cryptocurrencies, our response has always been the same – the investments are unregulated and carry significant risk of total loss of the investment. Recent price action in cryptocurrencies, together with warnings issued by leading crypto exchange Coinbase, have only reinforced our view.

Making headline news

Cryptocurrencies have made headline news over recent days as a severe bout of turbulence has knocked the value of the largest coins available, including Bitcoin and Ethereum. The catalyst has been the collapse of the Terra Luna currency, which is supposedly pegged to the US Dollar as a so-called “stablecoin”. The Terra currency lost its peg to the Dollar last week, apparently due to issues in the algorithm that links the price of the digital currency to the US Dollar. The peg was not backed by currency or government bonds, but in other cryptocurrencies, and as the price began to fall, investors rushed to sell the coins, effectively creating a digital bank run. The price of Luna fell over 99% in the space of a week, effectively wiping out investors.

No safe haven

Following the collapse in Terra Luna, contagion has spread to other leading cryptocurrencies. Bitcoin fell below $30,000, to stand over 50% lower than the previous peak of $69,000 seen in November 2021. Ethereum, Ripple, and Cardano also suffered similar heavy falls.

Supporters of cryptocurrencies have often cited the decentralised nature of the currencies as offering protection against inflation and wider economic uncertainty. Given the underlying economic conditions we are experiencing, the recent price action is a clear indication that cryptocurrencies are, in fact, a poor hedge against rising prices.

Quite surprisingly, cryptocurrencies appear to be moving more in line with Equities markets, contrary to supporter’s claims that Bitcoin and others provide diversification away from more traditional investments. A study by the International Monetary Fund (IMF) in January of this year highlighted the much closer correlation between cryptocurrencies and the S&P500 index of US shares since 2020. What has become increasingly apparent is that the cryptocurrencies are just as susceptible to broader weakness in market sentiment as other assets, such as Equities, only accompanied with significantly higher levels of volatility.

Unregulated assets

In addition to the risks of falling prices and contagion from failing currencies, concerns over how safe investor’s crypto assets held on exchanges are, have added to the negative sentiment.

Coinbase, a leading US-based crypto exchange, announced a very poor set of financial results on Tuesday, which showed widening losses and a 19% drop in users over the last quarter. The most important part of the announcement, however, was the admission that should Coinbase declare bankruptcy, the assets held in custody on behalf of customers could become subject to bankruptcy proceedings. In other words, customer’s assets would not be segregated and the customers would become general unsecured creditors of the business.

Unlike UK regulated investments, where investors do have some protection offered under the Financial Services Compensation Scheme in the event that something goes wrong, cryptocurrencies are unregulated, potentially leaving investors without recourse if an investment fails.

Invest in what you understand

As famous US investor Warren Buffett quoted “never invest in a business you cannot understand”. We feel this sage advice is true of cryptocurrencies generally. The premise of Bitcoin and its peers was to create new valid currencies, free from intervention from central banks and governments, that would be accepted more frequently as a currency over time. A limited number of organisations do accept Bitcoin as payment for goods and services, although the use of the currency is hardly becoming mainstream. Furthermore, the high levels of volatility seen in Bitcoin and other cryptocurrencies would make their use for transactions almost impossible.

A move towards regulation

There has been growing calls for the cryptocurrency market to be regulated over recent years, and the recent volatility is likely to increase the volume of calls for more intervention in this market. Some may see this as a positive move, potentially increasing the mainstream appeal of the investment. However, others see increased regulation as a negative, and totally at odds to the premise of decentralised currencies, which could stifle innovation.

Cryptocurrencies have also long been associated with criminal activity, such as scams, malware and ransomware attacks and money laundering, and regulation would aim to reduce the amount of illegal activity that takes place. Another key consideration is the amount of energy expended in mining tokens, with any move towards regulation likely to focus on the industry’s environmental impact.

FCA warning

The Financial Conduct Authority (FCA) produced the clearest assessment of the risks associated in January 2021 when stating “the FCA is aware that some firms are offering investments in cryptoassets, or lending or investments linked to cryptoassets, that promise high returns. If consumers invest in these types of product, they should be prepared to lose all their money.”

Despite warnings such as this, the cryptocurrency market has continued to gain in popularity over recent years; however the gyrations seen over the last week may well serve as a timely reminder of the inherent risks of these unregulated investments.

If you would like to discuss the above with one of our experienced financial planners, please get in touch here.

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

Central Banks on both sides of the Atlantic made headline news last week, as the US Federal Reserve and UK Monetary Policy Committee both raised interest rates. In a much anticipated move, US interest rates were increased by 0.50%, and in the UK, interest rates were increased by 0.25% to 1%, the first time UK interest rates have hit this level since 2009.

Why have rates increased?

Focusing on domestic interest rate policy, the Bank of England’s UK Monetary Policy Committee is tasked to support the Government’s economic aims for growth and employment, as well as hit an inflation target (measured by Consumer Price Inflation or CPI) of 2% per annum.

As widely reported over recent months, inflation has surged across the world, as a result of supply issues caused by lockdowns during the Covid-19 pandemic, increases in energy and commodity prices, and more recently by the Russian invasion of Ukraine. This has driven inflation far beyond market expectations, with UK CPI standing at 7% over the 12 months to March 2022, over three times the Bank’s 2% target. Furthermore, most economists believe UK inflation will increase further over coming months, with Bank of England Governor Andrew Bailey indicating the Bank’s belief that CPI will hit 9% in the third quarter and go beyond 10% by the end of the year. The anticipated increase in energy prices, as a result of the OFGEM price cap adjustment, in October, may well be the catalyst for UK inflation hitting double digits.

The impact of higher rates

Higher interest rates have a dampening effect on the economy generally, and affect households and businesses alike. The higher cost of borrowing impacts the ability of households to take out larger mortgages, and also increases the cost of loans and credit cards. A likely outcome of a sustained period of higher rates is that house price growth may well be limited, or indeed, could be the catalyst for house prices to fall.

Businesses need to access cheap finance to aid expansion, and if borrowing costs are higher, this could limit business plans to expand, including taking on new staff or premises.

Will the Bank keep on raising rates?

In light of the Bank’s forecast that inflation will rise further over the course of the year, it is likely that the Bank will raise interest rates further to try and bring inflation under control. Indeed, 3 of the 9 members of the Monetary Policy Committee voted for an increase of 0.50% rather than 0.25% last week, such was their concern that more aggressive action was needed immediately.

At present, economists are predicting UK Base Rates will reach between 1.75% and 2.25% by the end of the year, a further increase of 0.75% to 1.25% over and above the current level.

The Bank forecasts are always forward looking and they will be considering the longer term inflation forecasts before taking action. Given that CPI measures price growth over the previous 12 months, unless prices continue to rise at the same rate, the current elevated rate of inflation should begin to ease during 2023.

The Bank of England will, however, be acutely aware of the impact of higher interest rates on economic growth. Raising interest rates generally causes an economy to slow down, and with the UK economy already decelerating from a more promising position last year, the Bank will undoubtedly be considering the impact of their actions on the UK economy, which could be heading back towards recession.

Recent numbers for UK PLC have not been encouraging. UK growth stalled from 0.8% in January to just 0.1% in February, and the April 2022 consumer confidence report (as measured by GfK) showed consumers felt less confident than at any time since 2008. Services and Manufacturing surveys carried out last month also showed a drop in optimism.

Whilst the ongoing conflict in Ukraine underpins the increase in the price of food, energy and other supplies, and the continued Covid-19 lockdowns in China threaten to slow supply chains of key goods for manufacturing, it is difficult to see the current economic situation improving over the next few months.

We therefore feel that the market and economists may be off-target with their projections for UK Base Rates to hit 2% by the end of the year. Should the economic slowdown worsen, and the UK economy contracts, this may well weigh on the central bank’s decisions, and could lessen the need for the Bank to raise rates aggressively over the second half of the year.

What does this mean for investors and savers?

Savers should expect some respite from the very low interest rates that have persisted now for more than a decade. Whilst some banks and building societies have been slow to pass on the base rate increases in their savings products, others have been more reactive, and as always is the case nowadays, savers should look across the market for competitive rates. The bad news for savers is that the increase in savings rates is not likely to keep up with the expected increase in inflation over the remainder of this year. The “real return” (i.e. the return after the effects of inflation are taken into account) from cash savings may well shrink, leaving savers worse off.

Investors can access a wider range of assets that could look to take advantage of the prevailing conditions. Within lower risk assets, inflation linked bonds and alternative investments such as infrastructure could continue to do well, and in terms of equities, taking a global approach, and focusing on companies with strong earnings and attractive dividend yields could produce outperformance.

If you would like to review your existing savings and investments with one of our experienced financial planners, please get in touch here.

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