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Clive Hale on investment strategy - 2016

Brexit - July 2016
 
Clive Hale“We are continually faced by great opportunities brilliantly disguised as insoluble problems”. Lee Iacocca

 

 

Having been out in Spain for the last week I count myself lucky to be away from the gnashing and wailing; and let’s be clear that I am not talking about the footie, a competition that has always been a disappointment for the UK (but let’s hear it for Wales) and, for me, a metaphor for the EU and all its secretive machinations that drive a coach and horses through the democratic process; witness this week’s quote from Martin Schultz the president of the European parliament. “The British have violated the rules. It is not EU philosophy that the crowd can decide its fate.” It would appear that democracy is not allowed in the EU dictatorship.

At the end of the day the democratic decision of the British people is to leave the indubitably undemocratic EU; so how to grasp the great opportunity with which we have been presented? Trade agreements will of course be high on the agenda and the quicker this process starts the better. Comments from the more rabid EU bureaucrats, Juncker et al, suggest that some form of punishment is required “pour encourager les autres.” There is however something of a mellower tone from Germany where they understand that we consume a goodly percentage of their exports and imposing penal tariffs would be a shot in the foot; if not both feet. Europe is in fact declining in terms of trade volumes and it is more important that we look further afield, something, under the auspices of the EU, where trade agreements are negotiated en bloc, we have been unable to do on our own initiative for a very long time. After finalising a trade deal with China, Swiss exports quadrupled.

The weakness of sterling also gives us an advantage in our terms of trade and even a 4% EU tariff would be absorbed by the currency depreciation. After Norman Lamont’s unsuccessful battle with George Soros in 1992 the UK economy boomed as a result of sterling’s demise and there could be an equal opportunity here. The major winners may well be Britain’s young, who are not scarred by the experience of futile attempts to do business in places such as France. They haven’t been defeated by the pointless bureaucracy so endemic within the EU. They have a blank canvas. They carry no baggage and despite their protestations to the contrary I am reminded of Oscar Wilde’s observation that, “I am not young enough to know everything.”

Four key factors made Britain great. Democracy is clearly one; so the will of the people must prevail. If this result is “diluted” in any way, we really do have a more significant problem. Secondly and thirdly, rule of law and property rights are enshrined in our psyche, these are totally unaffected by this decision. Finally, as predominantly a trading nation we developed to what we are today and the referendum outcome enhances our ability to trade in the long run. Regardless of who leads this nation for the next few years, the entire population needs to throw off its depressive mind set. Change is upon us; let us again be a real example for what is good and democratic in this world.

Clive Hale – Director FundCalibre Ltd www.fundcalibre.com July 12th 2016


In between we had the signing of the controversial Maastricht Treaty. It paved the way for monetary union and included a chapter on social policy. The UK negotiated an opt out on both, as well as on the 1995 Schengen treaty on border controls, which was at the core of EU values in allowing freedom of movement across Europe; another example of generating significant unintended consequences as we are now witnessing.

In 1999 there was something of a crisis of confidence as Jacques Santer, the President, and all 20 commissioners resigned after revelations of fraud, nepotism and mismanagement. Romano Prodi became President promising radical change in the way the EU is run. It would be safe to say that he didn’t make much progress on that front as it is now over 20 years since any firm of accountants has been willing to sign off the Commission’s accounts. It was also in 1999 that the euro became the official currency, but it was not until 2002 that euro notes and coins were introduced. Since then the debate over closer fiscal and political union has raged and we have had some very close encounters with disaster although the Greeks and Cypriots will tell you that ‘disaster’ might have been preferable…

Now the debate focuses on the UK. Does the EU need us and do we need the EU? It would be a huge blow for the EU were we to leave, but they will no doubt continue on their cozy (crazy?) path to eventual currency oblivion and the UK will do very well thank you very much, watching from the other side of the Channel. Woodford Investment Management commissioned Capital Economics to produce a report detailing the pros and cons of in or out. Their conclusion, which you can read here, is that it makes little difference to the UK economy, but to my mind the choice matters a great deal. The following passage (my emphases) taken from a statement by Michael Gove, making his reasons for going against his cabinet colleagues and voting to leave the EU, is an excellent summation of the reasons for us to go our own way.

The EU is an institution rooted in the past and is proving incapable of reforming to meet the big technological, demographic and economic challenges of our time. It was developed in the 1950s and 1960s and like other institutions which seemed modern then, from tower blocks to telexes, it is now hopelessly out of date. The EU tries to standardise and regulate rather than encourage diversity and innovation. It is an analogue union in a digital age.

The EU is built to keep power and control with the elites rather than the people. Even though we are outside the euro we are still subject to an unelected EU commission which is generating new laws every day and an unaccountable European Court in Luxembourg which is extending its reach every week, increasingly using the Charter of Fundamental Rights which in many ways gives the EU more power and reach than ever before. This growing EU bureaucracy holds us back in every area. EU rules dictate everything from the maximum size of containers in which olive oil may be sold (five litres) to the distance houses have to be from heathland to prevent cats chasing birds (five kilometres).

Individually these rules may be comical. Collectively, and there are tens of thousands of them, they are inimical to creativity, growth and progress. As a minister I’ve seen hundreds of new EU rules cross my desk, none of which were requested by the UK Parliament, none of which I or any other British politician could alter in any way and none of which made us freer, better off or fairer.

It is hard to overstate the degree to which the EU is a constraint on ministers' ability to do the things they were elected to do. I have long had concerns about our membership of the EU, but the experience of Government has only deepened my conviction that we need change. Every single day, every single minister is told: 'Yes Minister, I understand, but I'm afraid that's against EU rules'. I know it. My colleagues in government know it. And the British people ought to know it too: your government is not, ultimately, in control in hundreds of areas that matter.

We are the world’s fifth largest economy; an economy that is more dynamic than the Eurozone, we have the most attractive capital city on the globe, the greatest “soft power” and global influence of any state and a leadership role in NATO and the UN. Are we really too small, too weak and too powerless to make a success of self-rule? On the contrary, the reason the EU’s bureaucrats oppose us leaving is they fear that our success outside will only underline the scale of their failure.

If Brexit becomes a reality, what are the investment implications? To plagiarise Chou en Lai, “It is far too early to tell”, but we have seen sterling weaken significantly and we should perhaps expect more of the same, in which case looking abroad for opportunities would make sense. Emerging and Asian Markets on a long term valuation basis are hardly expensive. Aberdeen Emerging Markets, Invesco Perpetual Hong Kong and China and Goldman Sachs India Equity are candidates for the former category and JOHCM Asia Pacific and Matthews Asia Pacific Tiger for the latter. All five are Elite rated by FundCalibre.

FundCalibre is a direct-to-consumer funds website and ratings business


 

How I learned to stop worrying and love the banks - February 2016

Clive Hale

Dr Strangelove would have felt quite at home in today’s markets or perhaps at the helm of a major central bank, suggests FundCalibre director Clive Hale

 

A recent headline enquired whether we should be worried about the banks. Well, there have been relatively few times when worrying about the banks has not been in vogue but now is not one of them. The cap on UK deposit protection was reduced last year to £75,000 per account, to reflect the strength of sterling as the EU-wide bank deposit protection scheme is set at €100,000. Given sterling’s current weakness, however, it may well have to go back up again …

"The Chinese are inclined to have a long term perspective – in direct opposition to the foreign exchange market, which likes to get where it wants to go with some alacrity."

On top of that we are now in a position where any future bank failures, across the EU, will be dealt with by way of a bail-in, not a bail-out. Under a bail-out the banks are given taxpayers’ money by the government. Under a bail-in the banks take money directly from taxpayers’ bank accounts – in other words, if you have more than the deposit guarantee amount you would kiss it goodbye if your bank failed.

The residents of Cyprus – including a not insignificant number of ex-pat Brits – found out the hard way how this worked in 2013. They received little sympathy from the mainstream media on the basis anyone holding more than €100,000 was likely Russian, an arms dealer or both.

Granted, there were a few of those, but most of the ‘serious’ money escaped as, on the weekend before the Monday the banks were closed, the London branches of said banks opened for transfers – a facility gratefully taken advantage of by those ‘in the know’. That did not include many ordinary Cypriots whose businesses have still not recovered and whose life savings have mostly vanished forever.

Still, it could not happen here … could it? Well that is one of those things that makes me go ‘hmmm’ – with a hat-tip to Grant Williams at www.ttmygh.com. Bank credit default swaps across Europe have been rising sharply, which does not necessarily spell imminent disaster – but do have a look at the charts of Deutsche Bank and Santander and see if that makes you feel any better.

And it is not just the commercial banks. The world’s central bankers seem to have lost control of their senses too. The European Central Bank and the Bank of Japan have both instigated ‘NIRP’ – that is, a negative interest rate policy – which directly translates into negative nominal government bond rates in almost all European countries.

In Switzerland it is all the way out to 10 years – and Japan has just got there too. The UK two-year rate is a heady 0.03% – so still positive by the skin of its teeth, albeit negative in real terms.

This just does not make any sense. What the central banks are, in effect, saying to the rest of the banking system is ‘You haven’t got the message yet. You haven’t made enough loans, so get out there and do it, otherwise we’ll keep cutting until you do because we have run out of fresh ideas and the only thing we can do with this piece of string is push on it.’
 
For its part, the bond market is saying zero or low real GDP growth plus zero or low inflation equals zero or low nominal GDP growth, which means debt/GDP ratios will keep increasing, which means governments are less able to repay debts … which means bond yields should be going up, not down! (Thanks to Kevin Doran at Brown Shipley for that observation) Things have truly gone mad and we are living in a Dr Strangelove world – and that did not end well.”

The Swiss and Danish central banks are using the same policy but, in this case, to stem the unwelcome attraction of foreign inflows. As we saw with the Swiss franc early in 2015, when the weight of money overwhelms the central bank the inevitable happens.

The People’s Bank of China believes it too can defy the markets. The Chinese have already thrown a lot of money at their equity market – to little effect – and have spent well over $1 trillion (£690bn) of their reserves supporting the yuan in the face of ‘imperialist running-dog speculators’. A recent People’s Daily op-ed was entitled “Declaring war on China’s currency? Ha ha!” – which must have left George Soros quaking in his boots …

China’s policymakers want to manage the yuan downwards at their own pace and not to be seen to have been forced into that position – loss of face is very important in this part of the world. The reality of the situation is that everyone else is busily devaluing and this is making Chinese goods less and less competitive. They need to devalue – and by a significant amount.

Back in 1994, they devalued by nearly 30% – all in one go – and the cheapness of the currency attracted huge foreign investment allowing the Chinese to emerge from ‘the dark ages’. Policymakers need to do the same again. If they try to defend the currency they will eventually run out of their foreign reserve buffer and still have an overvalued currency. They have been facilitating a very profitable carry trade by capping currency and credit risk for a long time so switching horses, as it were, to facilitating currency speculators should not be a problem for them.

The Chinese are inclined to have a long term perspective – in direct opposition to the foreign exchange market, which likes to get where it wants to go with some alacrity. There will be a war of words against the ‘running dogs’, who will ultimately receive the ‘blame’ for the inevitable devaluation – thus saving face and giving everyone involved what they want.

When the yuan devaluation happens, the Hong Kong dollar peg will almost certainly go with it too. At that point it will be time to start heading back into Chinese equity markets – so now is the time to be doing some preparation by looking at Elite-rated funds, such as Invesco Perpetual Hong Kong & China as well as First State Greater China and Threadneedle China Opportunities, which both score highly on Albemarle Street Partners’ AlphaQuest ratings.

FundCalibre is a direct-to-consumer funds website and ratings business


Clive Hale

Not another forecast – January 2016

Rather than looking forward to the year ahead, suggests Clive Hale, a partner at Albemarle Street Partners, our time might be better spent reflecting on the human follies perpetrated during 2015 – and on how we might recognise them again

At this time of year, tradition dictates we peer into the future and pretend we have the foggiest idea about what is coming down the track. Those who have the courage to look in the rear-view mirror may find they got a few of last year’s guesses right and those who do not … well, they just keep on guessing.

On the subject of guessing, sorry, forecasting, here is an interesting observation from the Macro Man blog: “I had to laugh when Yellen said that she "wasn't aware of a better model" for forecasting inflation … because I wasn't aware of a worse one! The Fed's inflation forecasting track record is, to put it bluntly, appalling. If you track the rolling 1 year forward projection for the core PCE deflator with the actual result, you find that they have a correlation of -0.68. Quite literally, they'd have a tough time being more wrong if they tried!”

"Those of you who recall Harry Truman’s observation that 'A lie will get round the world before the truth has its pants on' will enjoy what Collum has to say."
 
To read Clive Hale's 'Technical update after an "interesting week", please ​click here

Rather than looking forward then, our time might be far better spent reflecting on the human follies perpetrated during the last year – and on how we might recognise them again through the accompanying morass of misinformation. As it happens, David Collum – a Professor of Chemistry and Chemical Biology at Cornell University (although do not let that put you off) – has done just that. Here is the opening gambit to his 2015 year in review:

“I wade through the year’s most extreme lunacies as well as a few special topics while trying to find the overarching themes. I love conspiracy theories and detest detractors who belittle those trying to sort out fact from fiction in a propaganda-rich world. My sources are eclectic and if half of what they say is right, the world is a very weird place.”

Those of you who recall Harry Truman’s observation that “A lie will get round the world before the truth has its pants on" will enjoy what Collum has to say. His review’s subtitle, incidentally, is ‘Scenic views from Mount Stupid’ and he also has this to say in the introduction:

“Presenting such a review poses a multitude of challenges. There are important topics from past years that remain important but will not be repeated. How many times can one rail on underfunded pension plans, unfunded liabilities, or a quadrillion-dollar derivatives market? These matters are important, but the plot line doesn’t change much year to year. I’m skipping right over Japan; it’s a basket case, but not enough has changed to spill some ink.

“Despite reams of accrued notes and links, I am light on the Middle East because nobody understands it (or eats parsley). It’s that Mount Stupid descent again. I leave topics like global warming, mass shootings and Israel versus Palestine to those who like to shout a lot. Other ideas manage to stay at centre-stage year after year. Compartmentalizing the topics can seem artificial. How does one separate broken markets from the Federal Reserve? Sovereign debt levels from bond markets? Government from civil liberties?”

The whole piece is extremely readable, if long, and Collum does not pull his punches. In a moment, I will pick out a couple of his punchier observations but, first, here are a few memorable quotes he has gathered:
* On those “broken markets”: “These markets are all rigged, and I don’t say that critically. I just say that factually.” Ed Yardeni, president of Yardeni Research, Inc.
* On gold: “Buying gold is just buying a put against the idiocy of the political cycle. It’s that simple.” Kyle Bass, Hayman Capital Management.
* On energy: “We keep thinking that lower energy prices are somehow good for the economy. That can’t be, because energy prices or commodity prices in general don’t drive economic growth. Economic growth drives commodity prices.” Stephen Schork
* On bonds: “Bonds have never been more expensive in human history, and yet their supply has never been higher.” Tim Price, PFP Group

Collum on bonds

“In the past, I have called the bond market the “bond caldera” – a bubble so large you can only see it only from space. I believe that, someday, we will all be hosed when the liquidity leaves the system. This is not a unique view, but many bond speculators believe that (1) central banks would never let rates rise uncontrollably; (2) they are smart enough to get out first; and (3) their counterparties will actually pay them when the time comes. Apparently, there’s a lot of omnipotence to spread around. Until the burst, I simply marvel at the metastability with awe.”

 

Collum on inflation

“I was asked recently about why I hold gold while facing deflationary risk. That’s easy: people of prominence and authority are still saying incredibly stupid things and making asinine decisions. Let’s look at a few:

“I do not hesitate to say that although the prices of many products of the farm have gone up . . . I am not satisfied. It is definitely a part of our policy to increase the rise and to extend it to those products that have as yet felt no benefit. If we cannot do this one way, we will do it another. But do it we will.” Mario Draghi, European Minister of Inflation and Debasement

“Inflation is hopefully giving little signs of moving up in the right direction.” Christine Lagarde, director, IMF

"Even if we had some kind of shock that sent prices up for some reason, the Fed has the tools to stop inflation. That’s not very hard … There is a whole generation of people who don’t remember inflation. They don’t know what it is, and so I think inflation is a non-existent threat." Alice Rivlin, former Fed governor, making my brain hurt

“The award for the most moronic statement goes to … envelope please … Alice Rivlin! If we don’t know what inflation is, it can’t hurt us. Fabulous!”

 

There is more – much, much more – and, if your appetite has been whetted, you can read Collum’s review in full on Chris Martenson’s Peak Prosperity website, where you may find other items of interest. For those of you not so whetted, however, here is one final quote – this time from Elliott Management Corporation’s Paul Singer:

“The ‘risk’ case is only being made circumspectly by people who are being ridiculed as clueless Cassandras … Our belief is that the global economy and financial system are in a kind of artificial stupor in which nobody (including ourselves) has a good picture of what the next environment will look like. The difference between ‘them’ and ‘us’ is that they mostly think that policymakers will muddle through, but we assume that a very surprising and scary environment lies in wait.”

Albemarle Street Partners is a consultant to both financial advisers and the investment management industry and provides whole-of-market research on a monthly basis.

Clive Hale on investment strategy - 2015

Clive Hale

Watching and waiting – December 2015

FundCalibre director Clive Hale assesses the progress and effectiveness of the respective monetary easing programmes on either side of the Atlantic  

There may be the beginnings of a musical in the title of this month’s column but there is no doubt that watching and waiting upon the US Federal Reserve is a whole song and a dance routine in itself. After all, it is widely accepted that there is very little doubt that almost everybody knows that the world’s major central banks are not going to let anything untoward happen to the markets.

This ‘belief’ began with the Greenspan ‘put’, which morphed seamlessly into the Bernanke ‘put’ and, until recently, was the Yellen ‘put’. The present chairwoman has had her work cut out to maintain the Fed’s credibility as Master of the Universe, but it does seem that, at long last, she is about to lay an egg and accede to the clamour to raise rates. Buried in the latest Federal Open Market Committee minutes was – significantly – the observation that any further delay in raising rates would damage the Fed’s credibility.

"It would seem unwise to continue with more QE but central banker sagacity is a strange beast"

The recent data on employment – there are nearly 2,000 indices on the FRED (Federal Reserve Economic Data) website covering employment so there should be something there for all tastes – has been “strong” but, despite Rosy Scenario’s appearance, the most recent GDPNow number from the Atlanta Fed shows a decline in the growth rate for the fourth quarter of 2015.

First-quarter GDP in the US has been consistently low in recent years, as seasonal factors drag the number down, so we face the prospect of the Fed having to reduce rates again in the New Year. How embarrassing would that be? Still, at least US policymakers would have something to cut … Maybe that is the only reason to raise now but the belief in central bank omnipotence will be wearing pretty thin should that scenario come to pass.

Over in Europe, Dr Aghi is leaning in the opposite direction. His jawboning is legendary – in July 2012, he uttered the “whatever it takes” phrase, which galvanised the bond markets into believing he had their backs, and that belief is still in evidence. The Italian 10-year yield, which before that statement was standing at 6.5%, is now 1.4%. To put that into perspective US treasuries yield 2.2% and gilts 1.8%.

The ECB’s December meeting saw a further round of monetary easing. One might wonder why this is necessary having already put aside in excess of €1 trillion (£723bn) to buy up European debt. Quite simply, the answer is … QE does not work – or certainly not in the way intended, which was to get the money supply moving again by persuading the banks to lend to businesses and so kick-start the economic growth engine. There has been some tepid growth in issuance but demand has been lukewarm too – mainly as a result of euro austerity as preached by Germany and imposed on the unwilling by the ECB and the EU commission.

It would seem unwise to continue with more QE but central banker sagacity is a strange beast. Draghi has extended the initial QE period by a further six months and reduced interest rates on bank deposits at the ECB to minus 0.3%. Quite why an additional cut of 10 basis points should make the banks keener to lend we find hard to comprehend. What is really needed is an end to austerity. Lower tax rates could very conceivably bring about higher growth rates and, in turn, a higher overall tax take.

The European economy desperately needs a boost with employment across the euro area averaging 10.8% – although it is less than half that in Germany (4.5%) and nearly twice that in Spain (21.2%). In Germany, wage growth has continued unabated for the last 10 years whereas in Spain it has been flat. Any improvement in the Spanish economy has come as a result of ‘labour’ taking a hit.

European markets are not expensive, but we would prefer to see if the fiscal stimulus Draghi is hoping for actually arrives before adding to positions. Still, if you are of a mind to use any further weakness to add to European weightings then the following FundCalibre Elite-rated funds are worth considering – the BlackRock trio of Continental European, European Income and European Dynamic, the Henderson pair of European Focus and European Selected Opportunities, Jupiter European Special Situations and, finally, Threadneedle European Select.

FundCalibre is a direct-to-consumer funds website and ratings business


Clive Hale

Oh-oh seven – November 2015

Clive Hale, a partner at Albemarle Street Partners, finds not a quantum of solace in the spectre of what an error by central bankers could mean for market volatility

Bond has been on my mind a lot of late but, unlike many people, it is not the Daniel Craig film but the horror movie – or perhaps the comedy of errors – that is the fixed income sector I have been watching through my fingers. This world is not full of fast cars and vodka martinis – well, perhaps for a few of the fund managers it might be – but the rather more mundane considerations of duration, liquidity and the direction and timing of interest moves.

The numbers of actors who have played 007 on-screen may be growing but it has nothing on the fixed income cast-list. In the three most popular Investment Association bond sectors – Sterling Corporate Bond, Sterling Strategic Bond and Global Bonds – the listed funds align themselves to a total of 70 different indices and benchmarks, with more than a few declining to follow any benchmark at all.

"With global GDP still anaemic at best, how far can equity multiples be pushed until it is finally spotted the emperor is lacking in the clothing department?"

The huge range of strategies on offer even within those three fund groupings makes it very difficult to say who has done a decent job. Such is the variety of ways to make – and lose – money in bonds, many investors have settled on using ‘strategic’ funds on the heroic assumption their managers will know what is going on at the ECB, BoE, BoJ, SNB and others and position their portfolios accordingly.

And yes, I deliberately omitted the Fed from that list on the basis barely anyone – including most of the FOMC members – has a clue what is going on there. US policymakers seem to be saying rates should be going up and yet, at the ECB, Mario Draghi has threatened they might actually be about to go down …

But why in fact do we need to invest in bonds at all? A lot of them have negative real yields and the attraction of the high-yield sector is on the wane as defaults inevitably start to rise. Yields are also on the up there, of course, but that should be taken as a warning not a magnet.

Over the past 35 years or so, the bond bull market has been the only game in town and, looking at the chart to the right, it may still be. The asset class posted its most recent all-time high in September – so no sign of a bear market … or at least not yet. Over the same time period, portfolio construction has been in thrall to modern portfolio theory and mean variance optimisation. Bonds, based on their historical long-term track record, are deemed to be less volatile and hence less risky than equities so exponents of mean variance optimisation will tell you an allocation of 60% to bonds and 40% to equities will be a nice and cosy low-risk strategy.

Yet that assumes bond and equity returns will behave in the same way they have done for the last 35 years, which seems ever so slightly unlikely, does it not? The current seven-year forecasts for real returns from US large cap equity and US bonds suggested by GMO, for example, are minus 0.6% and minus 1.1%. Stick that in your mean variance optimiser and see what comes out of the sausage machine …

Now, GMO suffers from the same problem as the rest of us – we are all fallible when it comes to forecasting, but the point with modern portfolio theory is that a small change in your assumptions can make a disproportionate difference to the asset allocation you end up with. GMO’s three highest forecasts are for emerging market equity, emerging market debt and timber – an interesting sort of a portfolio that would cause a certain amount of indigestion for the ‘Modernistas’. The long-term historical US equity return may be 6.5% but, in our monetary policy-constrained, experimental world that seems a far-off realisation too.

Liquidity received a mention in the opening paragraph and there is no doubt it could be an almighty problem one fine day. If that comes to pass, it will not be just the bond giants and their investors who will suffer, it will be all the bond funds – large and small. How long would any dislocation last? If it is a ‘flash crash’, high-frequency trading-type event, maybe not very long. If it is based on the perception rates are going up for some time and to levels that only five years ago were deemed ‘normal’, then probably a lot longer than most investors can stay solvent.

Those who were early to eschew bond world used cash as their proxy but, in a negative real rate environment – and one that looks like getting worse before it gets better – we need to look elsewhere. In short, we need ‘alternatives’. Along with ‘hedge fund’ and ‘derivatives, that word does not always receive a good press – ‘Too difficult for the end-investor to understand’, as the refrain often runs. But they will understand all right on the day their 60% allocation to bonds is found wanting …

While we wait for the Fed to make up its mind on whether or not to raise interest rates in December, we also need to contemplate negative nominal rates in Europe, which is one way Draghi could force the banks to use their reserves more effectively. He would hope for them to make more loans to businesses but it is just as likely the money will move into the asset markets.

With global GDP still anaemic at best – the CEO of Danish shipping giant Maersk has said the IMF’s forecasts of growth are far too optimistic – how far can equity multiples be pushed until it is finally spotted the emperor is lacking in the clothing department? A mistake on interest rates either way could usher in the ‘Spectre’ of significant market volatility in both bonds and equities – the scenario that, in their infinite wisdom, the central banks are trying so desperately to avoid.


Clive Hale

The tune is familiar

Make a list of all the factors that preceded the last financial crisis and, says FundCalibre director Clive Hale, it is starting to feel like déjà vu all over again

It is not totally clear that Mark Twain ever penned the aphorism so often attributed to him – that history does not repeat itself, although it does rhyme – so let’s kick off with a different well-worn cliché that he definitely did not write. It is starting to feel like déjà vu all over again.

The financial crisis, from which – depending on the talking head who happens to be speaking – either we are recovering or we have recovered, was preceded by increasing levels of corporate malfeasance, an ever-burgeoning level of debt, a laissez-faire attitude to problems of global conflict, stockmarket exuberance, some serious financial complexity and supreme central bank indifference. Remember the then Fed chairman Ben Bernanke averring that “the subprime crisis has been contained” and “there is no bubble in the housing market”?

"The economic data is all over the place so the bulls and bears practise selective hearing. It was ever thus."

And so today, for example, we have Volkswagen owning up – though only after being prodded with a very sharp stick – to a quite staggering disregard for corporate governance. The company’s now ex-CEO “knew nothing” and, while the EC in Europe and DEFRA in the UK knew something, they did not tell and thus one of the most trusted and revered names in the auto industry is now dust – and dust that is a very long way from settling.

The potential fines, penalties and costs associated with recalling 11 million Passats, Jettas and the rest – let alone the class actions that will be legion – will pale into relative insignificance when set alongside the damage done to the German auto industry and the diesel brigade across the world (are VW really the only culprits?) and the knock-on effects to the economies at large. If US and Japanese manufacturers of – predominantly petrol-powered – cars had had anything to do with pointing the finger, they might now be pondering the wisdom of the admonition ‘Be careful what you wish for’.

If that were not enough, the mining conglomerate Glencore may also be teetering on the brink – if only to judge by the rise in its credit default swap price from €140 (£104) last October to above €700 now and the continuing destruction of its share price. Glencore, a company not wholly unaccustomed to controversy, acquired Xstrata in 2012, becoming one of the world’s largest mining and commodity broking organisations. It controls more than 50% of trading in the global copper market along with similarly strategic positions in many other commodities.

The company’s precarious financial position is of concern given the huge turnover in commodity futures where it performs the counterparty role for a significant proportion of trades. A failure here would have severe financial repercussions and has already been dubbed ‘Lehman 2’ in the making in some of the more excitable corners of the trading floors and the media.

If the financial crisis was caused by too much debt, then the fact there is a lot more debt in issuance globally than back in 2007 is not hugely comforting. The central banks’ penchant for QE has hoovered up a lot of this issuance but over-regulation – to prevent such a financial crisis ever happening again (the regulator’s perpetual refrain) – has reduced bond market liquidity to a fraction of its former self.

That is just fine when everyone wants to buy the latest high-yield tranche – if you remember, we used to call this ‘junk’ – but when it is time to pay the ferryman there will be precious little ‘coin’ to be had as today’s adequately-sized exit door will shrink to the size a cat-flap. With China now exporting deflation that may not happen for a while yet, but it is undoubtedly bubbling away – and not quietly.

And talking of liquidity, there is not much of it in the equity markets either. Since the financial crisis, the S&P index, for one, has risen inexorably on declining volumes – and a major percentage of that volume is in the hands of ‘high-frequency traders’. These are the clever electronic trading platforms that supply lots of additional liquidity to markets – equities as a well as bonds and derivatives – so they must be a jolly good thing, yes?

Well, they certainly think so but then they would, wouldn’t they? The whole high-frequency trading arena is shrouded in mystery as far as most people are concerned, including many investment managers whose attitude is: “If they are shaving the odd penny off price quotes, then that’s the cost of doing business isn’t it?”

But on 24 August, the Monday morning when the recent ‘correction’ began, many exchange-traded funds (ETFs) could not be priced. As stock prices traded outside normal limits, the gyrations caused by the consequent trading halts triggered for high-frequency traders meant that close to half the stocks on the New York Stock Exchange did not have an opening price. 

The high-frequency traders helpfully came up with a solution, simply suggesting ETFs should not price on a minute-by-minute basis – one of the major attractions over buying funds that only price daily. A better solution might be to ban high-frequency trading or at least put everyone back on a level playing field – but don’t hold your breath waiting for the regulators to wake up to what is going on. One high-frequency trader proudly announced 24 August was its most profitable trading day ever … now, remind me of the definition of ‘hubris’?

The central banks still believe in divine intervention and, given the number of occasions recently when markets have slumped at the opening only to claw their way back into the green by the close, the Federal Reserve ‘put’ is still very much in play. Much was made of the in/out ‘hokey cokey’ over raising US interest rates and Janet Yellen has not left the dancefloor with her reputation enhanced. To be fair, her job is not an easy one as there have been a number of conflicting comments on the direction of rates from her fellow FOMC members.

Meanwhile, back in the UK, Bank of England governor Mark Carney has appointed himself in charge of the global climate debate – perhaps to take our minds off the fact that he, like Yellen, has not overseen a rate rise since taking office. The economic data is all over the place – for every positive item, there is a negative number to choose from – so the bulls and bears practise selective hearing. It was ever thus.

As for global conflict, there is an abundance of trouble wherever you look. The only reason I am pleased to be back from gloriously warm Cyprus is that it lies a mere 60 miles off the coast of Syria. The building tensions there could beget some serious ‘fallout’. The oil market shenanigans, arguably caused by the Saudis’ desire to blunt the US frackers, have also inconvenienced the Russian bear and Putin is never one to take things lying down. Teaming up with the Iranians, however, was not part of the Washington script.

So what are we to make of the current market gyrations? There is much talk of value being spotted but, unlike previous ‘buy the dip’ episodes where the recovery to new highs was marked in days, we are now some six weeks into new territory. This is a new pattern that could still resolve higher but – to end with a less clichéd cliché than we began – as Chairman Mao’s foreign minister Chou En Lai observed when asked what effect the French revolution had on the development of socialism: “It is much too early to tell.”

FundCalibreis a direct-to-consumer funds website and ratings business


Bear in a China shop

FundCalibre director Clive Hale considers various explanations for the recent market volatility and, looking at where we go from here, suggests bonds may still have one final hurrah left in them 

The traditionally quiet month of August, when all good City folk should be sunning themselves on the Riviera, this year exploded into action. Now that we have high-frequency traders running the show, allegedly supplying liquidity – which must be one of the biggest jokes perpetrated on a largely unsuspecting investment community – volatility has been eye-watering.

From 24 to 28 August, for example, the Dow Jones Industrial Average moved up and down by a total of 5,612 points and it has been the same story in commodities – most notably oil, where Brent crude started that week around $46 a barrel, got down as low as $42 and then traded above $50. For their part, bond markets – usually seen as a safe haven when things go a bit ‘awry’ – have also been in the eye of the volatility storm. The 10-year US Treasury yield fell below 2% to 1.9% on the Monday morning, but by Friday it was as high as 2.2%.

What on earth is going on? The explanations are legion – Chinese devaluation, Chinese economy, Chinese stockmarket … though not according to China. Oh no – as far as policymakers there were concerned it was about interest rate speculation in the US and the inability of the Fed to articulate its intentions without the customary obfuscation. Quite so …

The commodity complex has been quietly imploding for some time. Punditry is of the opinion that lower commodity prices – particularly oil and the industrial metals – would be good for increased economic growth, which of course it would be if only there were any. Commodity prices rise as a result of growth, not the other way around – proven in reverse by the continuing decline of prices as news slowly leaks out of a slowing Chinese economy.

Yet all of this is relatively old news so why the mayhem in the equity markets? Well, as ever, it seems it is all down to the inability of homo sapiens to act rationally, which is a huge problem for economists as they assume rationality as a given – otherwise their models do not work. Once the creeping doubt, of which we have had much of late, translates into a ‘significant market move’, the herd mentality kicks in and up and down we go. The press then goes on the rampage searching for ‘the trigger’ when all the time it was ‘us’!

After a sharp fall – in four days the UK index dropped almost 12% from 6,526 to 5,768 – we could expect a rally. And indeed we have had one – a bounce of some 8% since the low. What happens next is crucial. Are there still doubters out there? Or will ‘rationality’ prevail? Is it rational, for example, to insist ‘nothing has changed’ so the bull market can continue?

The topping action of the major indices, in particular the S&P500, suggests otherwise. This distribution pattern when the market transfers stock from strong hands, who have ridden the bull for some time to the latecomers, who are now keen to get on board, is characterised by a rounded pattern that eventually gives way – which it has.

A second bearish signal is that the 50-day moving average has crossed below the 200-day moving average – both of which are now falling. One swallow does not make a summer (even if we could do with one before September is out) but, without some more significant central bank manipulation – capitulation on interest rate rises through to more QE, the efficacy of which is very much open to question – we can, at best, expect markets to go nowhere with regular bouts of volatility to maintain the apprehension. A move below the recent low at 5,768 would suggest a lot more downside – eventually testing 5,000.

Although there was some volatility in sovereign yields, the ‘risk-off’ bond sectors all did pretty well in August as did the Targeted Absolute Return brigade, where only one unfortunate manager in the Investment Association fund grouping performed worse than the UK equity index.

With the Chinese devaluation effectively exporting deflation to the West, bonds may still have one final hurrah. For consideration in this sector are AXA Sterling Credit Short Duration, Baillie Gifford Corporate Bond, Baillie Gifford High Yield Bond, Fidelity Strategic Bond, Jupiter Strategic Bond and Kames Investment Grade Bond, all of which are Elite-rated by FundCalibre.

FundCalibreis a direct-to-consumer funds website and ratings business


Clive Hale

Three fixes

It is summer and everyone seems to be out enjoying the sunshine – the trouble is, says FundCalibre director Clive Hale, Greece has not been fixed, the Fed is in a fix and gold is being ‘fixed’

It is August – the month when even the Eurocrats take a break. As such, the illusion that Greece is fixed is maintained but here are some assumptions, dangerous or otherwise, courtesy of Mish Shedlock’s Global Economic Trend Analysis site:
* The current total accumulated bail-out for Greece is €326bn (£233bn);
* Greek GDP will remain at €216bn;
* The interest rate on the bailout will be 0%;
* Greece can immediately achieve a surplus of 3% of GDP;
* Greece will hold that 3% surplus for as long as it takes to pay back €326bn; and 
* Every penny of Greek debt surplus will go to pay back creditors.

"For now, enjoy the sunshine and hope the ECB deploys its €1 trillion treasure chest to good use."

Now let’s allow Shedlock to do the maths: “Three per cent of €216bn is €6.48 bn. At €6.48bn per year, it would take Greece 50 years to pay back €326bn. But none of those assumptions is true. The interest rate will be small, but it likely won't be zero. Greece won't come close to a 3% surplus. 100% of the surplus won't go to the creditors. The only possible favourable condition in the mix is GDP. Greek GDP will eventually rise above €216bn, but that will take years. In the meantime, interest expense accrues, adding to the total amount that needs to be paid back. At 1% of GDP (€2.16 bn per year), it would take 150 years.”

It cannot work, can it? No. But, for now, enjoy the sunshine and hope that the ECB deploys its €1 trillion treasure chest to good use. The chart below shows just how effective goosing the US Federal Reserve’s balance sheet has been for the S&P 500. Could it be the same for euroland? Jupiter EuropeanBlackRock European Dynamic and T. Rowe Price European Smaller Companies have all benefited from taking that view and should be in the vanguard if European equities continue to be favoured.

Note how, as the Fed has tapered and then called a halt to QE, the S&P 500 has followed a similar trajectory. A reduction in the Fed balance sheet would not bode well would it? And if policymakers raise rates any time soon, then that is just another form of tightening with potentially the same result.

On a cyclically-adjusted price/earnings ratio of 26.3x, the US market is higher than it has ever been – other than in 1929 (27.3x) and early 2000 (43.0x). That is not to say it could not go on to emulate the dot com boom, which only got going in 1996 when the price/earnings ratio was the same as it is today – the dénouement, of course, coming four years later. So is there another four years left in this bull market? If you think so – and many do – then have a look at Brown Advisory US Flexible Equity and Legg Mason ClearBridge US Aggressive Growth.

Meanwhile, what is happening to gold? Nobody with any degree of price sensitivity – distressed seller or not – would look to put in an order to sell more than $1bn (£642bn) of gold in the overnight market, and yet that is exactly what happened on 20 July, for example, and there have been similar occurrences every month this year.

There is unprecedented demand for physical gold. The futures market is in ‘backwardation’ – that is, when the spot or cash price of a commodity is higher than the forward price – and yet the paper market keeps getting smashed while short positions are at a record high. The sums involved are breath-taking. Is gold the canary in the coal mine? Maybe the following passage will give pause for thought:

“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods.

“The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves. This is the shabby secret of the welfare statists' tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights. If one grasps this, one has no difficulty in understanding the statists' antagonism toward the gold standard.”

The author of this passage? Alan Greenspan in 1966. With China accumulating gold as fast as possible and with Shanghai fast becoming the global trading centre for the barbarous relic the “statists” option of making it illegal to hold gold is receding just as fast. As history has repeatedly shown, gold remains the only sensible currency.

FundCalibre is a direct-to-consumer funds website and ratings business


Wily minnows

Liquidity is not just an issue for bond managers, says FundCalibre director Clive Hale, but that does not mean advisers are short of potential fund options, particularly from some of the smaller investment houses

Now that markets around the world – both equity and bond – have had a fit of the vapours, liquidity has become a serious talking point rather than an academic issue. It has been compounded by the herd-like instinct of investors to troop into the largest and hitherto best-performing funds. It seems they do so without considering that, by inflating the golden goose, their chances of ‘super profits’ are greatly diminished – especially if they all head for the exit at the first cry of ‘Fire!’

One bond fund manager suggested to me recently that the liquidity analogy about getting out of a burning theatre through a small exit door has taken on a new twist. Should you even get as far as the door, it will not be enough just to walk through it – you still have to convince someone on the outside to swap places with you.

"If advisers are required to judge the suitability of their investment advice to their clients, is it not incumbent on the fund managers to provide guidance too?"

In that event, he said, he would not be surprised to see some funds ‘gated’ – that is, closed for dealing for a period of time until liquidity returns – as we have see happen with property funds in the past. Let’s not forget either the liquidity issues in that sector too – although at the moment the money is flowing in and the main issue for managers is finding sufficient investable properties to satisfy the demand. That will not always be the case …

If investors were rational – if only – they would let the fund manager make the decision about how to position the bond exposure, but even this gets trickier as the fund grows in size. The larger a bond fund becomes, the more holdings it has to have to maintain even a semblance of liquidity – and so it starts to resemble the market and performance drops off accordingly.

These funds can no longer have as many, if any, high-conviction bets – no matter that this was probably the reason people started investing in them in the first place. Still, there is no need to follow the herd if you are prepared to do your homework. Brown Shipley Corporate Bond, run by the inimitable Kevin Doran, and the relatively new, TwentyFour Corporate Bond, in the very capable hands of Chris Bowie, are well worth a look.

Both are of a size where liquidity is nothing like the issue it is for some of the megaliths in the sector – though that is not to suggest they do not spend a lot of time thinking about it as they construct their portfolios. Meanwhile Baillie Gifford Corporate Bond – Elite-rated by FundCalibre – is another candidate that is still relatively small and does a superb job in evaluating the credit risk of its holdings.

It is not just in bond world that liquidity is an issue – small-cap funds arguably have greater problems and many of the more popular ones are already closed to new business. Liontrust UK Smaller Companies is Elite-rated and has yet to reach a size where liquidity is a significant problem. In bond world, market-making capacity has shrunk dramatically since the change in rules and regulations after the financial crisis, bringing with them many unintended consequences, of which a lack of liquidity is one. With small-caps, the market-makers are still alive and kicking, there is just not enough stock to go around – we are talking small-cap equities after all …

In both sectors, an alternative strategy would be closed-ended funds – that is, investment trusts. From the fund managers’ perspective, they do not have to worry about liquidity in the fund as they will not have redemptions to deal with – meaning they can hold illiquid bond or small-cap positions and let them ride through market cycles. The issues of fund closure and gating go away too. For the buyer, however, liquidity still raises its head. In this case, the issue is being able to acquire sufficient stock in the first place, in the secondary market, without pushing the price to a premium to net asset value – or selling at a large discount, for that matter.

Another ‘thought du jour’ is whether fund managers should make comments about the suitability of their funds – for the retail investor in particular – when market conditions and/or liquidity make their particular style or size of fund ‘unsuitable’. Having been around the block more times than most investors, I am a great fan of ‘caveat emptor’ but, regrettably, that is no longer politically correct.

With my compliance hat on, therefore, I have to ask – if advisers are required to judge the suitability of their investment advice to their clients, is it not incumbent on the fund managers to provide guidance too? If not, why not, I wonder? We cannot depend on risk ratings or volatility numbers or performance, for goodness sake – though that is still the first port of call for many – as these are all backward-looking and will inevitably fail investors just at the time when they would be most needed.

Not surprisingly, some managers who are prepared to wear their hearts on their sleeves include a number of the minnows. Coram, where Martin Gray and James Sullivan have set up shop, is one such and has a range of funds positioned in line with their views that markets are generally very expensive but still offer some pockets of value. Nor are they averse to holding cash if even those attractive valuations go away.

Another newcomer is the VT Price Value Portfolio, run by Tim Price, who sleeps with a copy of Graham and Dodd under his pillow, along with Killian Connolly, who has Warren Buffett’s autobiography under his! They aim to invest 70% of the fund with value managers who meet their criteria of low price-to-book ratios, among other commendable value metrics, with the balance in investment holding companies – again with low price-to-book ratios and high potential earnings growth. That they are able to find such managers and stocks is very encouraging for investors with a timeframe to reap the benefits. After all, as GMO’s Jeremy Grantham is fond of saying: “Value managers are never wrong, just early.”

By no means a minnow any more, Schroder MM Diversity, which is Elite-rated by FundCalibre, is prepared to take defensive positions when the manager deems it appropriate – as is the case currently. And of course there is also the absolute return community, with the FundCalibre Elite-rated Church House Tenax, Premier Defensive and Old Mutual Global Equity Absolute Return funds, along with the newly launched Aviva AIMS Target Return and Income offerings, all playing their part and aiming to preserve investors capital as their main criteria.

FundCalibre is a direct-to-consumer funds website and ratings business


Mere speculation

With some bonds starting to look more like speculation than investment, says FundCalibre director Clive Hale, Target Absolute Return funds have an increasingly important part to play in portfolio construction

“We should get used to periods of higher volatility,” ECB boss Mario Draghi observed at a press briefing at the start of June. “At very low levels of interest rates, asset prices tend to show higher volatility.” And the bond market swooned. Well blow me down – I thought they taught this stuff at school. It just goes to show that when momentum is your friend and markets appear to be a one-way bet, all rational thought goes out of the window.

"It just goes to show that when momentum is your friend and markets appear to be a one-way bet, all rational thought goes out of the window."

Bond maths is baffling for most of us, but it is still fairly obvious that a 100 basis-point move from 1% to 2% is going to cost you a lot more than one from 9% to 10%. 10% bond yields? Oh, those were the days – along, of course, with double-digit inflation …

Draghi is merely pointing out the blindingly obvious and, while it is just as well that someone has, it is a touch ironic it was him. But then bond world hangs onto his every word – all very reminiscent of that past eminence grise Alan Greenspan – another of the central bank bubble blowers.

The move from a low of 0.05% in yield for the German 10-year bund to the current 0.88% represents an 8% loss for bond holders. Such a short-term move in equity prices often comes with the territory, but such is the asymmetric risk for bonds – with repayment at par, the upside recovery is constrained – that this is starting to grow very painful indeed. The longer the duration, the more painful it gets and, as the chart to the right shows, German 30-year losses are around 20%. Ouch!

So far, and especially in the eurozone, the fall-out has in the main been limited to sovereign debt and has not reached out into corporates and high yield – partly because the euphoria following the ECB’s QE announcement did not affect those sectors. However the volatility in bond world is such that the message is ‘Beware!’ – if sovereign yields continue to rise, there will most certainly be a knock-on effect further down the food chain that will be exacerbated by the shrinking of liquidity in these markets. 

Ben Graham had this to say about the definition of investment: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” He was in all probability referring to equities but it might give bond ‘investors’ pause for thought if they consider that, by Graham’s definition, what they are currently dealing in is pretty ‘speculative’.

So what is an investor (with no inverted commas) to do? Alternatives abound, but we are not talking about fine wine or works of art where prices are even more ludicrous. The IA Target Absolute Return sector is beginning to throw up some interesting candidates.

Many funds in this sector are targeting equity-like returns with much lower volatility. They do this in the main by employing a number of non-correlating strategies. This does not make them totally immune to sudden changes in market direction but it does help in that all their trades will not be facing the same way. Their losers will in the main be balanced out by their winners.

At the lower end of the volatility scale we have Premier Defensive Growth, managed by Paul Smith, and the Church House Investments Tenax offering managed by James Mahon and Jeremy Wharton. All three managers are acutely aware of the need for preservation of capital and follow a multi-asset approach.

Further up the risk spectrum come Old Mutual Global Equity Absolute Return, managed by Ian Heslop, Smith & Williamson Enterprise, run by Rupert Fleming, and Henderson UK Absolute Return, run by Luke Newman. As their names suggest, these are more equity-oriented funds although managed with an absolute return mind-set. They target higher returns than the multi-asset funds over the longer term and there will be periods of drawdown. All these funds are Elite-rated by FundCalibre.

As an alternative to those ‘speculative’ bonds, Target Absolute Return funds now have an important part to play in portfolio construction.

FundCalibre is a direct-to-consumer funds website and ratings business


Have we lost our way?

It is time to stop putting numbers on portfolios and return instead to understanding what the fund manager is about and explaining that to investors, argues Clive Hale, a director of FundCalibre

As an industry we seem to have forgotten our roots and have instead become obsessed with trying to manage risk by hijacking mathematical models that can never accurately map the emotional investment landscape. Risk is all about losing money and, whether we like it or not, the attributes attached to that outcome are almost entirely emotional.

Just ask investors in a ‘cautious’ fund, with a high weighting to supposedly ‘safe’ low volatility bond funds, populated with alleged triple AAA-rated paper, after the Lehman bust, how they felt. As a result, the regulator embarked on a series of heart-searching exercises that culminated in the Retail Distribution Review and so the quest for suitability and a formula for determining portfolio risk began.

"Measuring risk using historic volatility can only be used as the most basic of guidelines and should not be the main or only input into constructing a portfolio."

Modern portfolio theory (MPT), on which a great number of ‘risk’-based portfolios are managed, was the brainchild of Harry Markowitz and came into existence over 50 years ago – so perhaps it is not so modern after all Although human emotions have remained the same – and were way before Markowitz’s time – markets have moved on. We now have more asset classes than he could have ever dreamed of and, in theory, more asset classes mean more diversification and hence less risk. In theory …

One of the many spanners in the works of MPT is globalisation. Everything is connected with everything else instantaneously – and in a high-frequency trading world, possibly even quicker. The emotional journey, however, remains the same. A market is unloved and there are few buyers, apart from the canny (uncanny some would have you believe) value investor, who sees an opportunity and knows that – eventually – he will be right. As GMO’s Jeremy Grantham once said: “Value investors are rarely wrong, just early.”

Some of the early adopters will be shaken out in the inevitable corrections that accompany market bottoms, but slowly the pace of buying will increase and we have ourselves a trend. The momentum investors are now in play and the market marches serenely onward and upwards. Retail investors then smell the coffee and join in.

All the while, as the market rises steadily, volatility falls and your ‘suitable’ risk-defined portfolio needs to take on more risk to remain suitably suitable. The value investor at this stage is more than happy to sell to the unwitting band of risk ‘controllers’, who are buying near the top of a market, thus turning rational investment practise – that is, buying low and selling high – on its head.

In days of yore, and perhaps to this very day, this distribution phase in the market could take some time. Then there would be a trigger, which tipped the balance in favour of the sellers, and the market revalued in smart fashion, with many late buyers forlornly holding on for a return to the peak.

Plunging markets mean higher volatility so those risk ‘controllers’ sell near the bottom to ‘reduce risk’ to those canny value buyers and the cycle starts all over again … no doubt to be followed by another regulatory review to make sure that clients in suitably unsuitable portfolios don't suffer the same fate yet again.

Investing comes automatically with the risk of loss of capital. There will be occasions when you will lose money – no ifs or buts – and if you continue to buy high and sell low then disappointment is guaranteed. An application of common sense is required and that discipline is aided in a significant way by adding in a value component to any analysis of risk.

We really do not want to hear any more that, over 15 years, bond volatility is low and therefore a high weighting is the ‘optimum’ strategy for a ‘cautious’ investor. So far this year, the bond ‘rout’ has been confined to sovereign issues and, in the UK, an investor in a gilt tracker has now lost around 5% since the market peak in early February. Long-dated funds, which have done so well for so long, have lost around 10%, which, in both cases, has wiped out the paltry level of income on offer for some considerable time to come.

So far the rapid rise in yields has not been as evident in the corporate bond and high yield sectors – quite possibly because these are home to much retail money in search of an income and it takes them a lot longer to realise a sea-change might be afoot. There is also the ominous question of market liquidity and, should investors decide to sell, they may find that the rather large door marked ‘exit’ has turned into a cat-flap.

We cannot of course rule out an end to this ‘corrective’ phase but, to highlight what volatility in bond world could mean, here is an example of what we might expect if the setting of interest rates were to return to ‘normal. The UK 10-year gilt saw a low in terms of yield of 1.4% on 25 March. It currently stands at 2%.

Were it to rise to 3% where it stood on 30 December 2013, only 15 months ago, the loss of capital would be around 13%, from the low while, if 4% were reached – where it last stood four years ago – the loss could top 20%. If these rate changes were to be translated over into high yield, the losses would be even greater. The typical bond fund may currently have a duration of less than 10 years, but you get my drift.

Regardless of the market direction in the short term, all these sectors remain insanely overvalued and carry a very high risk of capital loss –  at best they can be described as speculative investments and not for the risk-intolerant.

Measuring risk using historic volatility can only be used as the most basic of guidelines and should not be the main or only input into constructing a portfolio. Applying a value-based orientation makes much more sense when combined with a reasoned approach to asset allocation, taking into account the current – and anticipated – twists and turns of the global economy. Value will out in the end in direct contrast to paying a high price for assets divined from an archaic mathematical formula.

Fund managers who employ this approach will have periods of underperformance but they also have preservation of capital in mind, which is the real trademark of the risk-aware and you just cannot put a number on it.

Funds that come into this category, having a forte for matching asset selection to the global economic picture, include the Schroder Diversity, Jupiter Merlin, M&G Episode and Coram Global ranges. The Aviva AIMS Target funds also deserve a mention in this regard. They do target a low overall volatility, but this tends to fall out of the investment process, rather than being their raison d’etre.

Fund volatility will naturally rise and fall but, so long as the investment philosophy is sound and well-articulated to the end-user, this phenomenon can be relegated to the status of background noise. Let’s stop putting numbers on portfolios and funds and get back to understanding what the fund manager is about and explaining that to the investor. Isn’t that what we used to do?

FundCalibre is a direct-to-consumer funds website and ratings business


Dust off the bargepole

Continuing on his quest for value in equity and bond markets, Clive Hale, a director of FundCalibre, highlights three areas with  potential for growth over the longer term – though of course many investors will currently be reluctant to touch them

Equity and bond markets across much of the world have enjoyed the benefits of central bank quantitative easing (QE) – first in the US and the UK and then, more recently, in Japan and Europe. QE is first directed at sovereign debt purchases from the banks and other institutions, which leaves them with cash to do with what they will.

With loan growth rising – though very slowly – much of this cash has ended up back in the markets. Bonds are not only being bought by central banks, but, knowing there is more buying to come, also by other investors – or should that perhaps be speculators? This has driven yields in parts of Europe below zero. Apart from the speculative component, this cannot be called value by any stretch of the imagination.

Equity markets in Europe – and in Germany and France in particular – have benefited hugely from bond-buying by the European Central Bank. Arguably they are playing catch-up, having missed the train the S&P 500 has been riding, because of concerns over the future of the eurozone.

As Europe’s largest exporter Germany should benefit from the weakness of the euro but, at the same time, businesses face headwinds in terms of slowing export markets, particularly in China. The French economy is suffering from socialist government meddling and, while much is made of improvements in the Club Med countries, it has been from a very low base and now euro weakness is adding to import costs. So European markets are rising on a significant flow of liquidity rather than the prospects of strong – as opposed to tepid –economic growth.

In the US all appears well on the surface with unemployment close to 5%, but the hourly earnings rate, set out in the chart on the right, tells a different story. It has barely moved for five years and what trend there is is down – much of the US is not that well-off. Earnings surprises have mostly been to the downside so far in 2015 and the equity markets can hardly be described as cheap.

So which markets have not benefited from the rise and rise of the S&P 500 and the mighty dollar? Where might we find some value? Well, of course, it is usually in all those areas that come into the ‘not to be touched with a bargepole’ category. Not everyone has been convinced by the Japanese three arrows strategy and so they have missed out on some interesting gains – albeit with the currency hedged back into sterling.

It might just be that dollar strength is over for the time being – the markets are saying there will not be a rate rise until December, having originally gone for June – so hedging probably is not necessary and, as you can see from the chart below, the Nikkei has a very long way to go catch up even a small part of its decades’ long underperformance of the world indices.

Since 2000, it has barely marked time and, while a return to the excesses of the late 1980s is highly unlikely, there is room for more pick-up against the more expensive equity markets. Funds worth considering here are Baillie Gifford Japan, GLG Japan Core Alpha and Neptune Japan Opportunities – the unhedged varieties in the case of the latter two.

Across the East China Sea, the Shanghai Composite index has had a remarkable run on hopes there will be further stimulus from the government. The concern here is that speculators will be in for a very bumpy ride if the authorities decide to restrict share-buying on margin so perhaps, in the short term, we may see some profit-taking.

The Asia Pacific region generally has underperformed the world index since 2010, however, and a lull in dollar strength and better news from China would reverse this sector’s fortunes. Funds here to look at include Schroder Asian Alpha Plus and Aberdeen Asia Pacific Equity.

And finally to the emerging markets, which have been hammered by dollar strength and commodity price weakness. With both these factors on the turn, there could be a pleasant surprise awaiting investors. In the debt markets, Standard Life Emerging Market Debt and Aberdeen Emerging Markets Bond are two FundCalibre Elite-rated funds while, for equities, we would highlight two relative newcomers – Charlemagne Magna Emerging Markets Dividend and Somerset Emerging Markets Dividend Growth – along with M&G Global Emerging Markets.

On a long-term view, these three markets offer the potential for growth – especially in Asia and the other emerging economies, where the rise of the consumer will be a powerful driver.

FundCalibre is a direct-to-consumer funds website and ratings business

 

More from Clive Hale on investment strategy

Perchance to dream – March 2015

Buying value on a long-term basis may be the only strategy worth pursuing over the longer run, says Clive Hale, a partner at Albemarle Street Partners, but that still leaves the awkward question of where to find it these days

Recent weeks have seen an acceleration in dollar strength – as well as its opposite, emerging currency weakness – along with a further rise in the yield of US treasuries. Meanwhile, the euro has taken the brunt of western economy currency weakness, in the process falling to a 12-year low, yet European stockmarkets are on a tear. At the same time, the uptrend in US equities is still very strong and US unemployment is approaching the so-called ‘natural rate’, which is in the low 5% range. Oh – and gold has been given another bath and has closed below $1,200 ($800).

These are just a few of the many variables we have to factor into our assessments of the global economy and financial markets and the question of where to invest our money. That there are many more opinions than there are inputs says much about the statistical probability of successful forecasting. We just do not know with any accuracy what is in store – other than that buying value on a long-term basis is the only strategy worth pursuing over the longer run.

"That there are many more opinions than there are inputs says much about the statistical probability of successful forecasting."

And where is the value today? If you turn over a few rocks in unlikely places, you might find a morsel or two – Japanese real estate investment trusts, perhaps, or some of the junior gold miners, but where is mainstream money going to find a home?

When you are unable to determine the risk-free rate of investing with any certainty – either because central banks have manipulated that rate via QE or because of the plain skulduggery in the LIBOR ‘fixings’ – then it becomes even more dangerous to make assumptions. The rate proxy used to be the yield on 10-year treasuries and, given the explosive rise in said yield of late, it may be making a comeback …

The spread between treasuries and German bunds is at a significant high and should be corrected, shouldn’t it? Well, maybe not for a while. The European Central Bank (ECB), in its infinite wisdom – although it is of course subject to the same statistical probabilities of success as we mere mortals – has decreed that buying sovereign bonds down to yields equal to the ECB facility rate of minus 0.20% is allowable. So, with 10-year bunds currently yielding a positive 0.40%, there is still a way to go …

At the same time, the ongoing decimation of the euro is driving up the cost of imports for those forced down the austerity road while giving a free ride to the major exporters – the leading light among whom just happens to be … wait for it … Germany.

Like so many things today, it just does not make any sense, does it? The rise and rise of the dollar (see chart) has been reinforced by comments from she who must be listened to at the Fed – in this instance, please re-read the earlier observation about statistical probability at least twice for emphasis – that their “patient” stance on the slow economic recovery may well transform into “OMG have you seen the unemployment numbers?” by the middle of the summer and we have the first rate rise.

This is causing havoc within both emerging economies and others closer to home, such as Austria, with huge dollar-loan obligations that are becoming harder and harder to service. Shades of 1994 perhaps? In the short term, there might be a pause for breath but longer-term history suggest that, when the dollar gets moving, it can travel a long way. But what might impede its progress?

It is hurting countries with a dollar peg and the significant other in that scenario is of course China. Might they let the peg go? Well, they will have to at some time and the “let’s abandon the dollar as the global reserve” rhetoric is gathering more adherents. A recent billboard in downtown Shanghai eulogised the yuan as the “next world currency”.

China has been adding gold to its reserves as fast as it can, the implication being that some sort of gold-backed currency would provide a very satisfactory alternative to the ‘worthless’ dollar – not to mention the quite ‘euseless’ euro. Since Nixon abandoned the gold standard in 1971, fiat currencies have been running on borrowed time.

Central bankers understand value it would seem – just only when it suits them. However this still does not answer the question of where to invest today. Value managers are finding it increasingly tough, if not impossible, to find what they are looking for and equity markets are generally looking stretched, albeit still in uptrends for the time being.

Bonds, which traditionally have been seen as a safe haven – or as ‘risk-off’ assets, in today’s parlance – are now taking on what looks like equity downside characteristics. Gold is being bludgeoned – though it may be worth picking up in ‘baby steps’ as it trends lower – while commercial property, albeit not as expensive as its residential neighbour, is hardly cheap either.

To misquote the bard: “Perchance to dream that there were a yield from cash; ay there’s the rub.”

Albemarle Street Partners is a consultant to both financial advisers and the investment management industry and provides whole-of-market research on a monthly basis.


Beware Greeks bearing spanners - February 2015

Clive Hale, a director of FundCalibre, provides his commentary on the ongoing match between Greece and Germany and considers how investors might want to play Europe with the result still undecided

"A clueless political personnel, in denial of the systemic nature of the crisis, is pursuing policies akin to carpet-bombing the economy of proud European nations in order to save them.” So said Yanis Varoufakis, the current Greek finance minister, with regard to the policies emanating from (take your pick) the European Central Bank (ECB)/the European Union (EU)/Germany/All of the above.

Varoufakis, and his boss Alexis Tsipras, are being portrayed in the mainstream press as Marxist tyrants who will lead the Greek economy into ruin. Their argument is that, courtesy of the ‘Troika’ of the ECB, the EU and the International Monetary Fund, Greece is already in that state but the root of the problem goes back much further. To get to join the euro club in the first place, ‘convergence’ had to take place.

By 2001, the year in which the first wave of Euroistas adopted the blighted currency as their own, even the Germans had worked out that interest rates across the member state would have to converge – to the rate enjoyed by Germany, of course. Greek 10-year bond yields went from well over double digits to around 5% by the time the euro became a reality and hit a low around 3% in 2005.

Not quite down to German levels then but borrowing costs had fallen dramatically to the point where every Greek shepherd boy was driving around in a Porsche Cayenne. German industry cannot be supported by its domestic economy, so it has to be a global exporter and, by having a hand in lowering interest rates across Europe, the great machine is thus fed.

We are now rapidly approaching the day of reckoning. Like the shepherd boy in his Porsche, the Greek government is not – and never was – in a position to repay the loans so expeditiously foisted upon it. The correct medicine would have resulted in some serious problems for the banking system – and not just in Greece. But instead of proffering the red pill, the good doctors prescribed the blue pill (piling on more debt) and everyone happily relaxed into a state of acquiescence and denial.

Varoufakis is now saying, none too subtly, that the German emperor has no clothes. The body language displayed at his meeting with his German counterpart was a picture – Wolfgang Schauble said the pair had “agreed to disagree”; Varoufakis that “they hadn’t even begun to agree to disagree”.

The latter has written two books on game theory and, while that does not make him an expert in that field – in much the same way a doctorate in economics does not give him all the economic answers – at least he understands the rules of a game the euronauts patently do not.

The Germans have said stick to the agreement or we will bankrupt you. The French on the other hand, realising breaking the rules is usually their prerogative, have at least acknowledged the Greeks might have a point. So the two major powers in Europe are starting to face in different directions. Then the Americans weigh in and line up with France. Not because they like the French – ‘French fries’ are still off the menu Stateside – but because Greece (and little Cyprus) have a ton of oil and gas reserves and have always been a buffer zone in the Balkans.

The ECB has already cast the first stone by preventing the use of Greek sovereign debt, which does not have investment grade status, as collateral in loan transactions. This means they will, for the time being, have to go down a more expensive route – an additional €60m (£44.3m) a month in interest payments – to borrow cash to prop up their banks. If there is no agreement by 25 February, then even this facility will be withdrawn and Greece could be unceremoniously booted out of the club.

In the past, any resolution of euro ‘conflicts’ has tended to have been achieved by a mixture of fudge, obfuscation and outright lying. This time around the Germans arguably have more to lose than the Greeks so get out your game theory textbooks and place your bets.

The question that remains is how to play Europe while this match remains undecided. We have seen some strength in German and French markets – mainly because the biggest tranche of quantitative easing buying will be in those two countries – and we suspect most of the proceeds will end up in the stockmarkets rather than being lent into the economy.

A more smallcap-focused fund that will shortly be joining Baring Europe Select as Elite-rated by FundCalibre is T. Rowe Price European Smaller Companies Equity. T. Rowe has a history of ‘growing’ its own fund managers with longevity in the job and consistency in their performance – and Justin Thomson, who runs this fund, is no exception.

Other more large company-oriented Elite-rated options include Blackrock Continental European and Blackrock European Dynamic, Jupiter European and Jupiter European Special Situations along with Threadneedle European Select and the two Henderson funds run by the admirable John Bennett – Henderson European Focus and Henderson European Select Opportunities.

FundCalibre is a direct-to-consumer funds website and ratings business.


A happy new year? – January 2015

The fact 2015 has started much as 2014 left off should come as no surprise to anyone, says Clive Hale, a director of FundCalibre – after all, markets care little for arbitrary changes in dates. As such, he offers no predictions – only observations

The falling price of oil is just one of many variables currently facing investors, which also include the fate of Greece, the strength of the dollar, the flight of Shinzo Abe's third arrow, relations with Russia and the greater Chinese slowdown. Then of course we have elections in the UK, which should be interesting in the debate if almost certainly inconclusive in the outcome. It has even been suggested a coalition government might be formed between Labour, the Scottish Nationals and UKIP – if so, I'll be catching the first flight to somewhere a long way off.

The world’s central banks still appear to be in control – or at least so they seem to think. Now he is no longer in that particular club, Alan Greenspan thinks things look a bit "risky". Well, risk is what investing is all about after all, but what is this elusive “particle” that is now supposed to be orbiting our portfolios?

"Of course markets have an enormous propensity to make us look like fools. This time last year, the predictors were saying to a man – including this one – that sovereign debt was hugely expensive."

Some would have you believe it is all about volatility. If it goes up and down a lot, the ride will be bumpy but you stand to make a lot more money than in something that gives you a smoother ride. Looking back over the last 30 years or so that smooth ride would have been government bonds and, for most of that period, returns would have been better than equities. So a low-risk portfolio should be stuffed full of them right? Absolutely – so long as your risk model looks purely at long-term historical data and ignores where we are in the journey.

Of course markets have an enormous propensity to make us look like fools. This time last year, the predictors were saying to a man – including this one – that sovereign debt was hugely expensive and due a very significant correction as rates were bound to rise, were they not? If there is one data series that is consistently called incorrectly this is it – perhaps a reason why the largest component of the derivatives mountain is in interest rate futures.

Thus, in 2014, a gilt tracker would have made you nearly 15% against a pretty much flat UK equity market and the 10-year gilt now offers a scanty yield of 1.6%. Across the Channel, the 10-year Bund is at 0.4% and everything under five years duration pays a negative yield. Yes – investors are willing to pay a premium just to get their money back …

As the chart of US 10 year Treasuries shows to the right, we have come a long way in the interest rate journey and, while further gains are possible, can yields go much lower? If we are going Japanese – and the Germans already appear to be – then of course they can. But while, 10 years ago, having 50% in investment grade bonds in a portfolio for a cautious investor would have been eminently sensible – especially with one’s attention in the rear-view mirror, can the same be said for today?

The major unintended consequence of government and central bank intervention since then Fed chairman Paul Volcker's stand against inflation in the late 1970s and early 1980s has been to generate its nemesis – deflation. With interest rates near zero in the major economies, there is nowhere for intervention to go to solve this latter problem.

Strangely the answer must be higher interest rates. We will then see some ‘creative destruction’, which is what the financial system needs to reset and start a proper economic cycle. However, with the investment banks who stand to lose the most controlling the strings – just who do you think got the US Budget bill changed to allow banks’ derivative positions to be included in subsidiaries covered by FDIC insurance (in other words, the taxpayer covers the losses)? – we need stronger hands at the tiller than a coalition of ‘politicians’.

So, as usual, what to do? Well, with the central banks behind you, what could possibly go wrong? Momentum in the US, and in sectors such as real estate investment trusts, is still strong while the Chinese ‘A’ share market has woken from a deep sleep. European equities may be the next play if the ECB can push Germany into a round of quantitative easing – and, of course, you might just want to hedge your bets with a Gilt index tracker.

Funds worthy of consideration could therefore include Artemis US Equity and Artemis US Extended Alpha, both of which are very similar to the successful vehicles Cormac Weldon and Stephen Moore ran at Threadneedle. The pan-European F&C Real Estate Securities fund is an interesting momentum play in this central bank-assisted market and for European equities look at Threadneedle European Select or JPM Europe Dynamic (which has Sterling-hedged share class). Lastly, for a Middle Kingdom play, consider Invesco Perpetual Hong Kong & China.

FundCalibre is a direct-to-consumer funds website and ratings business

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