John Townsend’s Investment Opinions – Mid June 2016
There ain’t no answer. There ain’t gonna be any answer. There never has been an answer. That’s the answer.
Gertrude Stein American writer 1874-1946
The panic that gripped the equity markets at the end of 2015, reached its low point on 11th February 2016. No-one noticed, because the fear affecting the markets was still so clear that it took a while for the memory of the pain to subside. There was no logic to the panic, just a number of seemingly dislocated events, such as the low oil price (which should have been seen as positive), China’s slowing economic data, terrorist acts, the EU refugee crisis, the unrest in the Ukraine, the fact that the Syrian war has de facto turned into Sunni versus Shia, and the weaker employment figures in the US all played their part. The MSCI in Euros dropped 12%, the DAX some 16%. The doom mongers who perhaps once guessed the markets decline, are now deemed to be expert prophets. I don’t believe the markets are in decline, but are instead vulnerable to volatility, especially as the downward movements in prices had no intrinsic logic, based as they were almost entirely on emotion and fear. It is also important not to confuse the national economies with the equity markets and well managed Funds. A good fund manager will find opportunities even in poor economies.
China floated its currency, the Renminbi Yuan (RMBY) last year. At the same time the Chinese central committee’s decision to turn the Chinese economy from an investment in infrastructure driven economy to a consumer demand driven one has inevitably caused a change in the rate of economic growth, but as the Chinese growth figures were largely artificial anyway, the effect should have been minimal and an encouragement of the view that the world outside China would one day see real figures. The fact remains that the Chinese economy is still very large and is showing growth; the demand for consumer products from domestic as well as foreign sources is growing. A weaker RMBY also makes imports more expensive which encourages domestic suppliers to grow.
In Europe the crises bumble on unabated. The possibility of Britain leaving the European Union (known as Brexit) has caused and is causing turmoil. Once again experts and pollsters are having a wonderful time making predictions, some for a British exit, some against. The British government has not helped their cause with the ruling conservative party being deeply split. The opposition Labour party, under its new and ineffectual leader, is effectively rudderless, though theoretically in favour of remaining within the European Economic Community, but unable to provide any consistent lead. Bookmakers and betting shops still suggest (just) that Britain will remain within the fold, but the 23rd June is the deciding date and the expert opinions will then have to be tempered by reality. It is the older generations from the comfort of their armchairs who are demanding a Brexit; the younger generation is much more pro-European and will benefit most from Britain remaining within the EU, but many either do not yet have the vote or won’t vote for whatever reason. In the meantime, the investment markets will continue to be volatile but post-election markets will show investment opportunities both in the UK and in a more stable Europe.
The ECB’s policies have caused interest rates and bond yields to drop to never before seen depths. 10 year German government bonds are now much sought after, despite the fact that yields are now firmly in negative territory. The argument is that the institutions do not expect to hold the paper to maturity anyway, but need a safe haven until the ever present uncertainty prevails. Bond fund managers have taken to increasing their returns by taking more risk, though still within the BBB investment grade boundary. By investing in corporate bonds, many of which are in any event more highly rated than some European governments, as well as selecting different maturities within their portfolios, the fund managers can protect the stability of their yields.
In the US, the Federal Reserve has begun to raise interest rates. It was at first only a token gesture but a signaled intention and more is certain to come. Europe is inevitably some way behind the US with the ECB continuing to expand the purchasing program of investment grade bonds from European banks. It seems that the major beneficiaries of the ECB’s liquidity measures are the banks (and therefore the governments) of the weaker southern European states. The Banks within northern Europe, with the occasional hiccup, do not need this stimulus, nor indeed do the northern European governments.
Rock bottom interest rates have encouraged some investors to consider investing in houses, not for their own residential needs, but rather to rent out as an investment. This needs to be treated with caution. Even houses in reasonable condition outside the biggest cities cannot, with the best will in the world, make a comparable return even to the negative yields in the 10 year Government bond markets. One has to take into account the costs of purchase (some 10% of the purchase price) the fact that prices are unlikely to rise appreciably over 10 years, the fact that all buildings will need to be repaired at the owners’ cost and also that there will inevitably be times when a property is unlet. These factors will reduce the returns of rental property to a point where a well balanced fund portfolio will provide a much better return.
Gold has once again become a topic for serious discussion. The market collapse of the past few years has caused discipline to be re-imposed, with unprofitable mines and mining companies being shut and less ill-thought out investment in new mines taking place. A certain, but small amount of physical gold – in sellable form – might be worth considering as a defence against disaster as long as it is kept somewhere safe from theft , where investors can access to it in the event of a true crisis. Banks are not ideal depositories as they are likely to remain firmly closed when disaster strikes.
Investors should, above all, seek a broad diversification within their portfolio. There are many fund managers who skillfully find sound equity investments, but these investments should be balanced with well managed bond funds. Investors should also consider mixed strategy funds, covering the equity and the bond markets as well as absolute return funds, where performance is not necessarily correlated with movements in the markets.
Many new funds and new strategies have sprung up since the markets became volatile. Not all are managed with the skill that makes them worth considering and many will not survive. Therefore, when selecting funds for a well-diversified portfolio, only fund managers who can show at least a three year track record of managing risk, including in adverse markets, should be considered.
Much is made of the costs contained within a fund (the Total Expense Ratio or TER) and the fact that fund managers might have the gall to pay themselves too much, including sometimes with performance fees. This is nonsense. Funds should be selected purely on the basis of net returns to investors over a longer period when compared to their peer group and the ability of the manager to manage risk. A successful fund manager deserves to be well rewarded as long as the investor gains the benefit. Funds that in yield and risk terms fall below the top quintile of their peer-group should not be selected for investment anyway and if they are already in the portfolio should be considered for replacement.
John Townsend advises clients on their investment portfolios for Matz-Townsend Finanzplanung.
He is a Fellow of the Chartered Institute for Securities and Investment in London.