New Site

The investment blog of Mike Grant, independent financial adviser and principal of Montgo Consulting Ltd has now been moved to the company’s website I hope you will continue to read, enjoy and benefit from my thoughts in your own investment journey.

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Markets in a Tailspin

You are no doubt aware that global stockmarkets have sold off sharply this week. Some markets and stocks are in “correction territory,” defined as being down 10% or more off their peaks, for example the FTSE 100 index whilst others are in a “bear market,” down more than 20%, for example the Shanghai Composite Index and interestingly the US tech giant Apple.

The principal cause of the rout has been a slowdown in the Chinese economy and devaluation of the Yuan. In many senses there is nothing fundamentally new here. The rate of expansion of China’s economy has been declining for several years and it is well-known that the government is seeking to shift the economy from export and infrastructure led to one of domestic consumption. The goal is to create a mature economy, one that is more prevalent in the US and the UK. This is invariably a difficult and long-term task. Even so governments and central banks around the world would bite your hands off for Chinese GDP growth even if this falls to 4-5% in 2015. That said there is a suggestion it could be as low as 2%. Unfortunately official Chinese statistics are somewhat inflated and unreliable.

Given that the fundamentals of the global economy were known before the crash, they do not suddenly change overnight, I am always left wondering if a sell-off like this is principally driven by sentiment. A piece of bad economic data comes out and investors get into a lemming like tizz and head for the exit. It then becomes a self-feeding vicious circle.

My take is the global economy is recovering slowly from the recent financial crisis but the overall trend is positive if patchy.  In this context my general advice would be to hold equity investments for the long term. Park them for at least three to five years you’ll ride some storms but returns should good in the medium to long term.

Is there anything else I would advise? Before the Greek debt crisis when markets peaked in April and May, in client reviews I advised and arranged selected profit-taking to cash or assets and markets with more attractive valuations. I am pleased it worked well. However I will generally put further profit-taking on hold as there is no point in crystallising losses or small profit figures. For the contrarian investor I am reminded of  Warren Buffet’s mantra of being “greedy when others are fearful.” I prefer the word “bold” to “greedy.” Now may be time to invest cash earning diddly squat to buy equities at more attractive prices. Of course markets could tumble further. Unfortunately there is no risk free investment. Finally I return like a stuck record to my well-worn gripe, investors should consider making regular savings to equity investments for risk reduction and the potential gains from volatility and periods of depressed prices.

This blog is intended as general commentary on global stockmarkets and reflects my own views. It is not an invitation to invest in equities or undertake regular investment as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions. 

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The Case for Smaller Companies

It is pretty well established that over the long term smaller companies outperform large and mega-cap stocks. They are typically started and managed by entrepreneurs who retain large shareholdings meaning manager and shareholders’ interests are significantly aligned. They are invariably dynamic niche businesses with strong growth potential.

Smaller companies require the right economic and business environment to flourish and naturally there are failures especially amongst start-ups and fledgling businesses. Even established smaller companies tend to underperform in recessions. During the credit crunch they were adversely affected as bank lending dried up. In contrast larger companies can borrow at cheaper rates because they are more credit worthy and they can more readily raise money from corporate bond issuance, by-passing the banks. Moreover large and mega-caps tend to be diverse businesses which insulates them during recessions; they are likely to have strong balance sheets and large piles of cash and they can offload unproductive businesses, staff and assets. Smaller companies are leaner with weaker balance sheets and they have less scope for downsizing. However they are more likely beneficiaries of mergers and acquisitions.

One of the strongest arguments in favour of smaller companies is that they are very under-researched by analysts and the market often fails to value stocks on their intrinsic worth. A good stock-picking manager can identify these pricing anomalies, buy and make money when the market finally gets it.

Smaller Companies, Currencies and Exchange Rates

Smaller companies are much more geared to the domestic economy compared to large and mega-caps. This is especially important during the recovery and growth stages of an economy, as in the US and the UK where consumer confidence and spending is on the rise. In contrast large companies have significant overseas earnings and are more aligned to the global economy.

In this context it is worth noting that there may be a currency exchange benefit for smaller companies. Take the US where the dollar is strong. Smaller companies which import goods and services into the US to sell to the US consumer (68.2% of the US GDP was from consumption in third quarter of 2014; source: JP Morgan) benefit from lower input costs. In contrast a strong dollar is a headwind for US exporters but more importantly multi-nationals with a large proportion of overseas earnings. When these are converted back into dollars they take a hit. That is why I currently favour smaller companies in US equity space.

In Japan smaller companies are also attractive but the attraction arises from a different route to that in the US. Money printing or QE has weakened the Yen making exports cheaper. This boosts company revenues in Japan. In addition multi-nationals with global earnings in stronger currencies like the US dollar have an incentive to repatriate those overseas earnings back to Japan into Yen as they get a big bang for their buck. Some of those earnings will be invested in Japan and trickle into the domestic economy favouring smaller companies. In summary both larger and smaller companies are beneficiaries of a weak Yen and this is a key reason why I favour Japanese equities across the capitalisation spectrum. A key difference between the Japan and the US is the US consumer is happy to splash the cash whilst the Japanese are notoriously cautious spenders. This is a headwind for smaller companies in Japan not evident across the Pond.

A similar outcome to Japan is expected in Europe where the ECB (European Central Bank) is similarly undertaking QE. General economic recovery, a stronger banking sector and improved lending should also be positive for smaller companies. F&C (now part of BMO Global Asset Management) consider valuations in Europe are attractive compared to other markets.

The key point on currencies is that even if smaller companies do not benefit from exchange rate movements they are less geared towards them compared to larger companies. Of course a weak currency makes imports more expensive and this affects consumer spending so there is still some risk. In contrast low prices have been a tailwind for economies that are net importers of oil.

Smaller Companies and Interest Rates

The developed world has enjoyed unprecedented low interest rates for six years. All the talk is about “normalising” rates and questioning when interest rates start to rise and by how much. The consensus is that rates are likely to rise in the US at the end of 2015 or beginning of 2016 and the UK will follow shortly afterwards. However central banks are wary of raising rates too far too quickly to avoid destabilising the fragile recovery and sending economies back into recession. This is especially true with slowing growth in China, which will impact the global economy. Ongoing weakness may cause the date for interest rate rises to be further pushed back.

So how does rising interest rates impact smaller companies? Of course servicing existing bank borrowing or raising new finance will become more expensive. However high yield corporate bonds, which smaller companies tend to issue are less interest rate sensitive than investment grade debt issued by large companies. This is because the high coupon provides a premium over cash but also default rates on the bonds are unlikely to rise in an environment of rising rates. This is because interest rate rises are a signal of a healthy and growing economy and in this environment the risk of smaller company failures is reduced.

Clearly in the later stages of an interest rate cycle small-caps are expected to be more adversely affected, especially companies with high levels of borrowing. Higher mortgage rates will also curb consumer spending. That said with markets believing interest rate rises will be modest and gentle the impact of this cycle could prove to be relatively benign.


I remain positive about smaller company investment in the US, UK, Europe and Japan. Each market has its own fundamentals as explained. For the UK, smaller companies are a proxy for the economy as a whole and the signs of recovery for example in wages are looking good.

This blog is intended as general commentary on investment  in smaller companies and reflects my own views. It is not an invitation to invest in smaller companies as these may not be suitable for you or your risk profile. You should seek individual advice before making investment decisions.



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Take Aim

Markets have been on the slide in the last couple of months from their recent highs. The Greek debt crisis, a crash in Chinese equities and uncertainty about interest rate rises in the US and UK have weighed on investors’ minds. It was therefore a surprise to have reviewed a client’s portfolio of AIM stocks yesterday. AIM stocks are smaller companies listed on a separate London Stock Exchange index, called the Alternative Investment Market. The LSE state:

AIM is the London Stock Exchange’s international market for smaller growing companies. A wide range of businesses including early stage, venture capital backed as well as more established companies join AIM seeking access to growth capital.

AIM is in effect a junior market to the main index at the LSE. It is important to note that not all AIM stocks are start-ups or micro-cap stocks. A number are well-known established businesses such as Majestic Wines and Young & Co. It might also be a surprise to learn that one company James Halstead, a flooring manufacturer was founded in 1915 and has delivered 40 years of consecutive dividend growth. More than 100 companies have successfully graduated to the main index, for example Domino’s Pizza went from AIM to a FTSE 250 company in 2010. An earlier blog post on 6/9/14  described the opportunities of investing in the AIM market.

Back to my client. On checking valuations of the AIM share portfolio, some rises in the last six months from the end of January were quite spectacular:

Company A (Veterinary Services) – £3,696 to £5,037 (up 36.3%)

Company B (Data Services) – £2,073 to £3,032 (up 46.3%)

Company C (Leisure & Logistics) – £2,594 to £4,014 (up 54.7%).

The portfolio as a whole rose from £40,627 to £48,032 in six months (up 18.2%).

These gains reflect the ongoing rally in UK smaller companies but are also evidence of good stockpicking by the plan manager, Hargreave Hale.

Smaller and fledgling companies can of course fall sharply in value and there are risks including the potential for insolvency. Investing in AIM shares should not be seen as a one way bet. Since 1995 over 3,600 companies have chosen to be listed on AIM but many are considered to be poor quality and largely un-investable businesses. Stock selection is absolutely essential when investing in this market to identify quality companies and avoid the “dogs.” Investing in the FTSE AIM All Share index itself (I don’t believe any index trackers or ETFs are available) would have been a disaster. According to Hargreave Hale their average weighted AIM portfolio returned 136.86%  in the five years to 5/7/15, in contrast the return from the FTSE AIM All Share Index was 17.53% – Source : Bloomberg/Financial Times (Thomson Reuters DataStream). This comparison is not  entirely on a like for like basis as dividends have been included in the Hargreave Hale returns (some portfolios however pay away dividends) but the drift is clear. In fact I have not seen a single managed AIM portfolio from any provider that has not trounced the index.

Aside from strong capital growth potential AIM stocks offer suitable investors excellent additional benefits. Stamp duty is no longer payable on purchases unlike stocks bought on the main index and AIM companies can now be held within a stocks and shares ISA. In addition certain AIM stocks qualify for Business Property Relief. This means investors in directly held qualifying shares are exempt from paying inheritance tax after they have been retained for two years. That aside the key message I want to get across in this blog post is that UK smaller companies including those listed on the main index offer excellent opportunities for capital growth. I will write again shortly to outline the investment case for smaller companies in general not only in the UK, but the US, Europe and Japan.

This blog is intended as general investment commentary on investment  in AIM and smaller companies and reflects my own views. It is not an invitation to invest in AIM stocks (or through Hargreave Hale) as these may not be suitable for you or your risk profile. Not all AIM stocks qualify for Business Property Relief. You should seek individual advice before making investment decisions. 

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The Thoughts of a Contrarian Investor

Contrarian investors challenge conventional wisdom; getting them to agree with the consensus is like trying to herd cats. They do not always get it right but mavericks are always worth listening to, if for no other reason than to question your understanding on a chosen investment strategy. Perhaps the most famous contrarian investor in the UK is Neil Woodford, subject of my last blog post, but in this article I want to share the thoughts of another, Alastair Mundy who manages the Investec Cautious Managed (ICM) fund amongst others. He is down to earth and his communications are interesting, clear and are not unnecessarily complicated by technical charts and analysis. I have recommended the ICM to many of my clients and whilst the long term returns have been excellent the fund has underperformed its peers in recent years.

One of the reasons the ICM has underperformed its competitors in the Investment Association Mixed Investment 20-60% shares sector is Mundy is bearish on the global economy and has taken a defensive position in his portfolio. So whilst the fund can invest a maximum of 60% in equities in recent years the ICM has had a significantly lower allocation compared to its peers and has consequently underperformed. Mundy also has a short position in US equities on the basis they are expensive. It means if the market tanks the fund will gain. To date however the short on the S&P 500 has detracted from performance.

Another reason why the ICM has underperformed is its allocation to complementary assets. These include Norwegian government bonds denominated in Kronor, gold and silver and index linked bonds. You generally will not find these in other portfolios. The former are safe haven assets, whilst precious metals and index linked bonds are traditional hedges against inflation. With “risk on” sentiment favouring equities, event risk subsiding, the dollar strengthening and inflation muted these complementary assets have underperformed. However Mundy’s argument for his asset allocation is compelling. Firstly he questions whether funds labelled as cautious really are cautious with their high weightings to equities which look expensive by conventional measures.

Further in a recent webcast Mundy presented some interesting data to support his cautious outlook. From the fourth quarter of 2007 to the second quarter of 2014 global debt has risen from $144 trillion to $199 trillion. This includes government debt up from $33 trillion to $58 trillion (Source: McKinsey & Company, February 2015). Debt is still clearly a big problem for the global economy. Mundy also argued that there are plenty of other things to worry about, a Greek exit from the Euro, interest rate rises in the US and UK and a slowdown in China, yet he considers equity valuations seem to be saying there is nothing to worry about at all! The one equity market where he sees value is in Japan and this is reflected in a 12.6% weighting in the portfolio at 30/6/15, quite a big bet for a cautious multi-asset fund.

Finally Mundy suggested that the markets are underestimating the potential for inflation. Data from 1915 & 1917; 1945 & 1947 and 1972 & 1974 showed how price inflation rocketed from nowhere over two years. For example from 1972 to 1974 it went from 2.9% to 12.3%. (Source: Incrementum AG). He questioned if  investors actually saw the catalysts for these inflationary surges? Finally Mundy suggested central bank policy could be used to keep interest rates below inflation in order to shrink debt, a process called “Financial Repression.” If inflation surprises on the upside index linked bonds at least should rally.

The inclusion and retention of a fund like the Investec Cautious Managed in client portfolios despite a period of underperformance serves several purposes. Firstly it has an easily understood target return of CPI + 4% p.a. meaning its goal is to beat inflation. For me the use of the Consumer Prices Index is preferable to the less understandable LIBOR (London Inter Bank Offers Rate) which other targeted return funds use.

The ICM is a genuine cautious managed fund and as such it is not recommended for “shoot the lights out” performance. It complements pure equity and indeed other multi-asset portfolios with its unique asset allocation. Low or negative correlations mean risk reduction. Given these points comparisons with the ICM’s so called peers in its IA sector should not be given too much significance.

Finally I like fund managers who are willing to back their convictions. As noted Mundy has a big position in Japanese equities. It is at first sight a puzzling contrarian allocation for a cautious risk fund. However when valuations and other factors are taken into consideration it makes perfect sense. The latter include money printing, a weaker Yen, more investment into equities from the government and other public pension schemes and increased dividends and share buy-backs.

This blog is intended as general investment commentary and reflects my own views. It is not an invitation to invest in the assets and  fund highlighted as these may not be suitable for you. You should seek individual advice before making investment decisions. 

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Woodford Beaten by a Machine

A few weeks ago I came across an article in the finance section of the Daily Telegraph online. It read “Man v Machine – How Neil Woodford was beaten by a computer.” Naturally as a supporter of Woodford, one of the very best UK equity managers the headline piqued my interest. As you may be aware Woodford managed highly successful UK equity income funds at Invesco Perpetual, including the flagship High Income before setting up his own investment company, just over a year ago. He is an extraordinarily successful contrarian and value investor, and over the years he has called the market correctly, famously avoiding tech stocks at the end of the 1990s.

The logical conclusion from the headline is this is more evidence that passive index tracking outperforms active stock picking fund management. If Woodford can’t beat the market then what hope is there for the rest of the fund management industry, who by comparison with Woodford are mere mortals?

The article can be viewed via the link at the bottom of the page. It explained that an index tracking fund, the Vanguard FTSE Equity Income Index beat the St James’ Place High Income fund over a six year period since the former was launched on 23/6/09. The St James’s Place High Income was used for comparison rather than the Invesco Perpetual High Income fund as Woodford has run the former continuously over the period in question unlike the latter. With dividends re-invested, data from FE Trustnet showed the Vanguard tracker returned 133% against Woodford’s 107%.

So what should you conclude? Active fund management is now officially dead (RIP) and you should switch to investing in lower cost index trackers? Well that would be a perfectly understandable reaction and many investors and their IFAs have adopted passive investment strategies. However the industry has been divided about the merits of active versus passive strategies over many years and it was a subject I covered in an investment blog dated 10/6/14 (see link at the bottom).

It is an indisputable fact that Woodford was beaten by a tracker, the data does not lie, but it can hide some of the truth. So let’s look a bit deeper as the issue is more nuanced and complex. Whenever an analysis of returns is undertaken you have to consider the prevailing stockmarket conditions that applied over the relevant period in order to understand the context and significance of the data. The Vanguard fund was launched in June 2009 a few months after the nadir of equity markets following the financial crisis in 2008. This six year period to June 2015 has been marked by a period of unprecedented loose monetary policy from central banks, including ultra-low interest rates and money printing (QE). This has provided huge amounts of liquidity for markets and raised asset prices across the board, leading to a six year bull market for equities. “A rising tide float all boats,” is the oft use phrase to describe this phenomenon. One of the consequences of this rally has been the very high correlation of stock returns, good and bad companies have all benefited. In such markets it has been difficult for fund managers to outperform the index although a number of funds did so as the article explains.

The problem with index trackers is that equities do not always rise steadily nor do they always enjoy a bull market rally. In periods of high volatility, when markets move sideways or in recessions, disparity in stock returns increases significantly and stock picking comes to the fore. Index tracking tends not to do well in these market conditions and active fund management is likely to outperform. For example over the last year the new Woodford Equity Income returned 18.3% and the Vanguard tracker just 6.4%. The following chart of the FTSE 100 over the last year shows the market was volatile and has broadly moved sideways, precisely the conditions in which active fund management is expected to outperform.

Another issue that came to mind was whether charges been taken in account fairly in the comparison? I don’ think so when the costs are analysed. The Vanguard tracker is quoted as having an ongoing charge figure (OCF) of 0.22% p.a. It is dead cheap and this is one of the principal attractions of index trackers compared to actively managed funds where costs are higher and there is no guarantee of outperformance. The OCF for Woodford’s St James’ Place High Income is quoted in the article at 1.88% p.a. The higher costs are clearly a drag on returns and means active funds start with a handicap compared to index trackers. That said the Invesco Perpetual High Income fund, which my clients are invested in has a lower OCF of 1.67% p.a. although it is still much higher than the 0.22% payable to Vanguard.

However this is a simplistic charge comparison as it is does not take into account two cash benefits to clients from bundled share classes of actively managed funds such as the Invesco Perpetual High Income with an OCF of 1.67% p.a. This charge includes a payment of trail commission of 0.5% p.a. which I use to offset client fees for investment advice and typically a 0.25% p.a. rebate to the platform the investment is held on, to cover their administration costs. This means a comparison of charges of 0.22% v 1.88% (or 1.67% p.a.) is flawed. To have bought the Vanguard tracker with advice at the same rate and held it on a platform such as Fidelity FundsNetwork would have meant annual costs of 0.22+0.75% = 0.99% p.a. This extra 0.75% p.a. has not been priced into the returns data and exaggerates the differential performance over the six year period. In fact had the 0.75% been factored in the Vanguard fund’s I calculate the returns would have reduced from 133% to 124%, still enough though to beat Woodford’s fund.

So what do I conclude? Yes you can always find examples of where passive trackers outperform. However these normally occur in unique market conditions when equities are rising across the board. This has generally not been the case in the last 15 years. It is clear the timescales and hence market conditions over which investment performance of active and passive funds is compared has a strong bearing on the outcomes and caution is required in drawing conclusions on the best investment strategy.

This blog is intended as general investment commentary and principally reflects my own views. It is not an invitation to invest in the strategies or funds highlighted as these may not be suitable for you. You should seek individual advice before making investment decisions. 

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Volatility & Interest Rate Sensitivity

A recent feature of global markets has been increased volatility in both equities and bonds. Clearly the Greek debt crisis has weighed on equity markets especially in Europe. Incidentally UK banks have very little exposure to Greek debt although the knock on effect of a default could be significant given the EU is our biggest trading partner and the potential for contagion. The negotiations in the next few days, the proposed Greek referendum and the markets’ response once the 30 June deadline is reached will prove interesting.

Elsewhere China’s Shanghai Composite Index fell 8% on Friday. The index is now a whopping 20% below its peak, reached just a few weeks ago. Fears about monetary policy easing were a factor but Chinese equities have risen strongly in the last year and I suspect that investors have been taking profits.

In the bond market there has been a huge spike in volatility. You may recall in my last blog at the end of June I reported a sell-off in government bonds. According to Bloomberg yield volatility on 10 year German government bunds has risen to nine times the 15 year average.

So what do I conclude? This increase in volatility could be the early signs of trouble ahead. Markets are clearly uncertain and nervous and could be tipped into a full blown crash. That trigger could be the start of rising interest rates, expected in the US later this year and to be followed shortly afterwards by the Bank of England. As you may be aware the prices of fixed interest securities which include government and corporate bonds tend to fall when interest rates rise because the relative value of future coupons is eroded. Long dated investment grade bonds are particularly sensitive to changing interest rates whilst short dated issues and high yield bonds are less affected. This nicely brings us on to an interesting feature of the bond market called “duration.” Duration is a measure of the interest rate sensitivity of  bonds. Bond fund managers can actively manage duration to reduce risk for investors. This will be a subject for a future post.

To wrap up I want to briefly cover action investors can take to mitigate risk in their portfolios. There is a case for doing nothing other than parking the portfolio. This is the classic buy and hold strategy appropriate for long term investors especially those who are not overly risk averse. The thinking is that markets may well crash but they will recover and such investors are happy to ride the short term volatility. Whilst I advocate long term investing I prefer employing active tactical overlays to complement this strategy. So in recent months I have been advising clients during annual investment reviews to undertake selected profit-taking, either to cash or to undervalued markets or sectors. I have also advised switching from bond funds with high durations, for example gilt funds to those with lower interest rate sensitivity.

Interesting times are ahead. It is never dull being an investment adviser.

This blog is intended as general investment commentary and principally reflects my own views.  You should seek individual advice before making investment decisions. 

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Bond Sell Off, Investor Fears and Strategies

May has seen a sell-off in government bonds, in the UK, US and Germany. Yields had reached ultra-low figures and a correction was not unexpected. However investors are asking if this signifies the end of the bull market in bonds which has run for about 25 years. It commenced around 1990 when a secular long term trend of falling global inflation and interest rates started. Some of you will recall the double digit mortgage rates you were paying 25 years ago.

The sell-off in bonds does not appear to have been triggered by anything specific but investors are naturally concerned about the prospect that interest rate rises in the US will start shortly. The Bank of England is likely to follow suit shortly afterwards. Government bonds and investment grade corporates are especially interest rate sensitive as the value of the coupon, the rate of interest a bond pays is fixed, and its value therefore declines relative to cash when interest rates rise. A similar fall in bond prices is expected from rising inflation.

Clearly interest rate rises from historically low levels in the last six years is another step in the ending of “easy money.” The argument goes that bonds and other assets have risen indiscriminately on the back of loose central bank monetary policy including QE and low cost central bank finance, for example the UK’s Funding for Lending Scheme. Bonds have got drunk on liquidity and low interest rates but like all good parties it is coming to an end and a bar tab has to paid. Whilst the US is leading the way in normalising monetary policy, the “taper tantrum” in May 2014 caused by the Federal Reserve  giving notice that QE was ending was the first ruction, there is clear divergence globally. In many economies interest rates have been heading south whilst money printing continues in Japan and Europe. This reflects the fact that in many parts of the world economic growth is anaemic.

Most fund managers would argue that equities have better investment potential than bonds but investors are still nervous with stockmarket indices reaching new peaks, valuations in some markets and sectors looking expensive, company earnings growth not keeping pace with stock prices and fears of  a super taper tantrum and a Greek exit from the Euro. Whilst this in part a “wall of worry” syndrome, fundamentals do give cause for concern; there are systemic risks from a Grexit and potential for a major crash in the bond market. So how are investors positioning their portfolios in current market conditions? Here are a few perspectives from what I have been reading:

1. High Yield Corporate Bonds  

This type of fixed interest is less interest rate sensitive than government gilts and investment grade corporate bonds. This is due to their high coupons which provide a cushion against rising interest rates and falling prices. In addition high yield bonds have shorter maturities or durations than gilts. Duration or interest rate sensitivity is a function of maturity date of a bond. Long dated bonds such as gilts have high durations and hence are more vulnerable.

For investors credit quality is the key issue with high yield bonds. In the US they are somewhat disingenuously referred to as junk bonds. Currently default rates are low and are expected to remain so in the early stages of global economic recovery. Smaller companies which are often issuers of high yield bonds historically underperform larger companies only in the late stages of the interest rate cycle as an economic slowdown approaches. We are at the beginning of the cycle so the outlook for high yield bonds is OK in my opinion. That said stock selection is key and I would not advocate the use of index trackers or ETFs.

2. Cash Weightings Rise

Fund managers fearing a crash have been increasing the cash weightings in their portfolios. Aside from this being a defensive measure, cash provides liquidity if investors sell up in their droves and gives scope for managers to add to their best investment ideas on the dips.

3. Targeted Absolute Return Funds

According to the Investment Association who monitor inflows and outflows of investor money in different sectors large allocations were made in April to cautious risk targeted absolute return and money market funds. This is a clear sign of investor sentiment being cautious.

4. Diversified Bond Portfolios

In a recent blog, M&G a leading bond fund manager argued (as others do) that flexible diversified bond portfolios are favoured for fixed interest exposure. This is because different types of fixed interest have different characteristics as noted above. They warned that interest rate rises or inflation could trigger further sharp falls in government bonds and the risks of this are high. Moreover the very low yields will not adequately compensate investors for capital losses. However M&G observed following negative returns from global government bonds the 12 months were great times to own them. There was a big bond sell off in 1994 but in the following year returns were 16.9%. I have always felt bonds have an inherent self-correcting mechanism. If prices fall, yields rise and this attracts buyers.

In another article I read, M&G suggested that UK inflation although muted now could rise in the medium term and the markets are underestimating the risks here with a pre-occupation on the short term. The bond markets are consequently pricing CPI inflation at an average of just 1.6% p.a. over the next five years. Inflation could surprise on the upside from UK wage growth, a falling pound and a recovery in oil prices. Index linked bonds offer attractive opportunities as an inflation hedge whilst a portfolio shorter dated inflation linked corporate bonds with low or negative duration provides protection against rising interest rates.

5. Investing in Earnings Growth

There has been a clear move in equity investment away from US equities. A six year bull run, a dip in economic growth in the first quarter, concerns about earnings growth, a strong dollar and high equity valuations have shifted sentiment from Uncle Sam. Of course the rest of the global equity market is not especially cheap, so where do you invest? Robin Geffen, a leading fund manager and CEO of Neptune Investment Management acknowledges this but observes equities are not worryingly expensive in the markets they specifically like. These are where company earnings have broadly kept pace with prices. For example in Japan the price to earnings ratio (P/E) ratio of the TOPIX* Index is a very reasonable 13.3. However the earnings per share (EPS) growth for the 2014/15 year has been a very strong 16.7%.

Geffen also observed that in a bull market it is not uncommon for the S&P 500 index to hit 50 new highs in a year and to sell on the back of a high being reached is not a great idea.

*TOPIX is the Tokyo Stock Price Index a broad based Japanese stockmarket index. I understand it has around 1,600 listed stocks.

This blog is intended as general investment commentary and principally reflects my own views. It is not an invitation to invest in the areas highlighted as these may not be suitable for you. You should seek individual advice before making investment decisions. 

Posted in Fixed Interest, Gilts, Investment Strategies, Stockmarkets | Comments Off

Post General Election Surge & Market Outlook

Whatever your political persuasion UK stockmarkets have given a resounding thumbs up to the Conservative victory today. As I write the FTSE 100 index is up 2.08% p.a. whilst the more domestically focused FTSE 250 index has surged by 2.68% p.a. Favoured sectors include house builders, utility companies, banks, financials and outsourcers such as Capita. This has been a relief rally that Labour’s statist policies such as the mansion tax and cap on energy prices have not come to fruition. Sterling has also has risen, a sign that the foreign currency markets think the result is good for the UK economy. Uncertainty had been a headwind for the pound with a predicted hung parliament.

Considering the wider global economy M&G’s multi-asset team predicted that the divergence between loose central bank monetary policy and strong global growth rates would lead foreign exchange rate volatility. The dollar has surged in 2015 and the Euro has depreciated. With loose monetary policy in Europe and interest rates heading down in China, India and South Korea, dollar strength should continue. Rising rates in the UK and the USA will however make cash more attractive and fixed interest vulnerable to a sell-off especially with ultra-low yields and a rising oil price.

M&G are overweight equities, a position I broadly concur with. I currently favour Japan, Europe and US medium and small companies. Unlike global mega-caps with overseas earnings smaller US firms are oriented to the domestic economy and are less impacted by dollar strength. In fact US companies importing materials from overseas and then selling to US consumers gain from lower import costs.

Finally given the result of the General Election I would now include UK equities in my list of preferred markets, principally again small and mid-caps. These sold off last year but with mega-cap dividend payers looking vulnerable, a lack of analyst coverage of smaller companies and a domestic focus they look attractive.

This blog is intended as general investment commentary and principally reflects my own views. It is not an invitation to invest in the areas highlighted as these may not be suitable for you. You should seek individual advice before making investment decisions. 

Posted in Currencies, Equities, Fixed Interest, Interest Rates | Comments Off

Super Taper Tantrum?

You may recall back in May 2013 there was a sharp sell-off in equities and fixed interest when Ben Bernanke, the chairman of the Federal Reserve, the US central bank announced that tapering of QE was ready to start. The market ignored the good news that the patient, the US economy could come off its money printing life support and viewed the announcement as bad news. The sell-off was humorously called a “taper tantrum.” In the end the markets saw sense, investors focused on fundamentals, realised the US economy was in good shape and equities and bond prices rallied.

However the International Monetary Fund (IMF) has recently warned that global markets could suffer from a worse turmoil than in May 2013, when the US raises interest rates. This is expected later this year. According to the IMF it could increase 10 year US Treasury yields by as much as 100 basis points or 1%. To remind you with fixed interest which includes UK gilts and corporate bonds, prices and yields have an inverse relationship – when prices fall, yields rise and vice versa. Rising interest rates results in falling bond prices because the relative income from fixed interest is less attractive compared to cash. If US Treasuries prices fall the ructions will filter into other fixed interest markets and herein lies a related problem; liquidity in the corporate bond market has been a concern for a while. Selling in a falling market to meet redemptions will become difficult for fund managers and prices may plummet in the absence of a functioning market.

Whilst there are no liquidity issues in major equity markets there is still likely to be a broad based sell-off with capital exiting from emerging markets. Risk-off assets will benefit with a flight to quality, including safe haven currencies such as the US dollar, the Swiss franc and Japanese Yen, cash and potentially gold. Defensive blue chip equities are likely to ride the storm better than smaller and medium sized companies.

Essentially these events are consequences of the normalisation of monetary policy in the US. Unprecedented ultra-low interest rates and money printing have been a feature of the global economy since the financial crisis more than six years ago. Economies and markets will have to adapt to the return of more normal interest rates.

So what are the consequences for investors? In my view volatility will increase later in the year and a sell-off is not unlikely. Moreover it could be sharp. However many investors can afford to adopt a long term buy and hold investment strategy riding the volatility. Equities will fall but they should recover given the general trend of global economic recovery. Some investors however may wish to review their portfolios and take profits whilst markets are riding high. Switches can be to cash or cautious risk investments with a focus on, though not a guarantee of, capital preservation.

Whilst it is clear the IMF have identified a serious systemic risk in the global financial system I do not sense we are heading for a catastrophe and this is a sell all and head for the hills moment. Time will tell.

This blog is intended as general investment commentary and principally reflects my own views. It is not an invitation to invest in the areas highlighted as these may not be suitable for you. You should seek individual advice before making investment decisions. 


Posted in Fixed Interest, Liquidity, Market Commentary, Risk & Volatility, US | Comments Off