Its Not Harry

Comment and opinion for retail investors in the UK

Mark Potter

Pump and Dump?

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If the title of this post is a mystery to you, let me explain:

A pump and dump operation is a fraudulent manipulation of asset prices, usually individual shares, to make a large profit from naïve investors.

Essentially, the fraudster will buy a large number of shares that are cheap because the investee business is practically worthless. They then use a variety of illegal or shady methods to increase the price. These will usually include a hard sell over the telephone to vulnerable investors with a fake story attached, placing sales with friends who will sell out later and inventing news. As demand for the shares increases and the price starts to move rapidly because the fraudster may own a large part of the total shares available for sale but only actually sells a moderate amount at this stage, more and more greedy participants can be persuaded to enter the market.

When the fraudster has unloaded enough shares to drive the price up to an implausible level, he or she and friends will rapidly sell off the large remaining stock they have. A drop in the share price initially as liquidity improves may even make unwise buyers think they are now getting a bargain!

All that glitters is not gold….

The fraudsters bank a large profit and the share price collapses very fast, leaving many inexperienced investors with shares that are almost impossible to trade and therefore worth very little.

I mention this now because it feels to me like global stock markets are operating such a wheeze right now, albeit collectively and without a fraudulent intent.

I suggest this because global equity markets, those investing in company shares, have risen to levels last seen in the mid Autumn and seem to be heading relentlessly up. But there is no change in the global economic climate to justify this. In fact most real news is negative and many of the underlying risks are actually greater.

Many commentators are struggling to explain what element of the combined human psyche is responsible. Some say that the US and China are bound to do a good trade deal. Others say that the likelihood of the UK crashing out of the EU is reduced (although for the life of me, I can’t follow their logic). Others say that although profits are beginning to shrink and dividends might slip back, this is only happening slowly and basically ‘everything is all right’. Some point to central banks being rather worried, so potentially slowing rate rises (that is good news?!)

My feeling is that we have a situation that might be equated to the mindset of a gambling football supporter betting on his or her usually top flight team winning a major competition when they have managed to make it through the early rounds, even though the manager has just been sacked, the best players sold off and until a recent cup run, this year’s league results have been pretty rubbish. Because such a person needs a boost to justify their support, they will bet on the win. The idea of a loss after several years of glory is just too depressing. I think many stock market participants are talking up the market because the alternative is just too gloomy to contemplate.

This is worrying, because if there is a correction back to a new harsher reality, the big players will take their money off the able in a flash, at their pumped up prices, and we small investors will be left holding a lot of assets that have just been dumped. Time to increase cash weightings further? Personally, I think that would be prudent for anyone who does not cope well with short term volatility – and that will be most people.

Real World Risk – supplementary evidence!

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Here is a question to test your investment knowledge:

Over 6 months when stock markets have been volatile investment fund A has lost 4.73%. Over the same period fund B lost 2.38% and Fund C made 5.96%. Of the 3 funds, one is Absolute Return (AR), one is Asia focused and one is an ethical global fund. Guess which is which. All data is from FT Analytics and the funds are all mainstream retail collective funds.

Normal investment convention says that the Asian or ethical funds ought to be most volatile and the absolute return fund will offer some protection is volatile times. Most advisers would tell you that adding an ethical filter increases risk.

So perhaps you would have guessed Fund A was Ethical, B was Asian and C was the AR fund.

You would score 1 out of 3. B was indeed Asian The best performer was the ethical fund and the disaster was an AR fund.

Over a more realistic assessment period of 5 years the Asian fund did best, the ethical global fund pretty well and the AR fund just about kept up with deposit returns, although it did well enough until about 3 years ago after which it fell apart.

What this shows is that using past performance data on volatility or performance as a sole or main tool (alone or in a combination) in assessing risk or choosing funds is plain stupid. It is useful data but it needs to be contextualised. Above all one needs to remember that the point we are at now is almost always going to be a different financial climate than 5 years ago and probably 3 years ago.

A fund that for a particular reason goes up steadily over several years will have low volatility and good performance but might be well into bubble territory, for example.

Many published fund pick lists and even model portfolios use “risk rated’ returns where the risk element is calculated with statistical volatility and past performance numbers as major factors. That is not a good idea in NotHarry’s opinion! See the article about risk here for a longer explanation

Multi asset funds are fashionable but are they any use?

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A former client of mine from my time working as an investment adviser recently asked me what I thought about multi asset funds. By multi asset she meant funds that hold a range of asset types (often as low cost ETFs which can be traded almost instantly at low cost) and mix them up according to a stated objective which is usually specified in terms of risk and expected return.

They had been presented to her as a better option than a selection of specific individual asset allocated funds in market sectors, on the basis that the manager of a multi asset fund can change the asset mix much faster than an IFA can because the IFA has to go through all the hoops of making recommendations and getting client approval. Even an investor who runs their own asset mix and looks at their portfolio every day can’t trade as fast as a city institution, and probably has less information. The advice this investor had received even suggested that IFA’s are not really capable of advising clients what to do when there are sudden changes in markets. That comment came from the client’s own IFA!

The investment industry primarily invents products to sell like all other businesses

It is undeniable that a multi asset fund manager could quickly take money out of a market really quickly and move to cash or another type of asset if the fund prospectus and objectives allow that: investors need to know exactly what multi asset means for the fund they have in mind as it is not a narrow term and is open to interpretation. But even assuming a fund is recommended with absolute flexibility and manager discretion, some questions arise about the alleged advantages.

The suggestion that trading in and out of the market on the basis of short term news flow or analyst predictions would make you more money is largely discredited. Even if it does work, how do you know that the manager of your multi asset fund is any good at it? The evidence of returns from multi asset funds that seek to lower risk (absolute return funds) is that the managers in the main are in fact not at all good at it – I have written about that previously.

Furthermore, a single multi asset fund will have an objective that is decided by the people who want to market it – not your needs as an investor. A portfolio you build yourself or which is set up by a competent investment adviser will be designed to meet your risk requirements, cash flow needs and interest in the subject and typically won’t need to be quickly re-organised because of ups and downs in the stock market cycle – the existence of the cycle will be assumed and built into the portfolio design.

It is often true that the fees for multi asset funds are higher than for sector specific funds. OK, you may say, because they are managing the assets actively. If that is true, why are you paying an adviser if they have “out sourced’ this task because they don’t have the relevant expertise? You are paying twice. Would you go to the hairdresser and pay once to be told what style you need and then pay again in full for the actual haircut? Maybe some people would but at least they would appreciate what they are doing.

There is arguably a role, in my opinion, for ‘funds of funds’ which are slightly different. Here a manager picks funds or shares/ETFs with a specific focus where perhaps you or an IFA can’t access the whole market because it is too specialist or esoteric . I have invested in ethical multi manager funds myself, accepting the slightly higher fees. To date, as I maybe should have expected, the multi holding selections of the specialist have not really done any better than my own narrower researched funds mix.

Ethical, green, sustainable, ESG or what?

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It has always been difficult to select investments that meet an investor’s desire to be ‘ethical’. This is often because ethics are essentially part of a belief system so highly personal. But it is also because investing in a company that does something you personally think is ‘good’ (for example making cosmetics that are not tested on animals and which uses ingredients sourced with due regard for the environment) does not mean that the company is not avoiding taxes using complex offshore trusts, paying fair wages and so on. A business has to be checked out in several ways before we can feel comfortable with it, if we want to invest in line with our conscience.

This issue has been on the agenda of fund managers and investment advisers for quite a while and various methods have been used to label and filter companies as suitable for investors who have reservations about investing on grounds of their religious or ethical beliefs. Much of the early work was driven by religious investors and indeed the now taken over and vanished Friends Provident business was set up by Quakers and ran one of the first ever set of ethically filtered investment funds under the Stewardship brand.

Over the years labels such as Green (in various shades), ethical, SRI (socially responsible investing) and more recently ESG (environment, social and governance) have been applied, A variation of ESG could also be Ethical Sustainable and Governance but the Americans have formalised the former usage. Governance refers to corporate governance meaning the way the board of directors decides to interact with stakeholders, like shareholders, employees, governments and even the environment.

The research organisation Morningstar added an ESG rating to its fund research process a couple of years ago and that has its own particular assessment criteria. It is useful for advisers and as a starting point for research but it will not tell you if the fund meets your personal requirements.

The only way you can build a portfolio that gets close to meeting your personal ethical or religious requirements is to work out exactly what you won’t like your money to be supporting (like cigarette manufacturing or armaments production, for example). If you have an adviser, you need to have a long discussion with them on the subject so they get to understand your views.

It is then possible to filter out most of the investment funds in the market, because most will invest in major dividend paying businesses like tobacco, gambling and the production of weapons that the majority of people with strict ethical concerns won’t like . Of those that are left, you need to get some understanding of what they do allow as holdings and how they carry out their research. Remember even august bodies like the Church of England got caught out investing in companies like Wonga.com!

The personal track record and attitude of the fund managers which will be known to a competent adviser will be highly relevant data as will the specific objectives set by the fund management group.

Flying with RyanAir?

A final word in this introduction to a complex issue is that investors must be realistic: investment in shares via collective funds means being a small scale capitalist so your objectives (making a return from the profits of the company whose shares you own) will be in tension with the interests of the employees and customers of that company who want to have better wages and lower prices for better quality products – which reduces profits. It amuses me to hear people I know roundly condemning RyanAir whilst enjoying the returns coming through to their European investment fund from RyanAir’s excellent profit generation!

Brexit – implications for investors now

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The stock market reaction to last night’s drama in the House of Commons is muted so far, both locally and globally (I write this at around midday on January 16th). Sterling has strengthened which has been explained by no less than Mark Carney as evidence that the markets believe that a Hard Brexit is less likely and a delayed Brexit is on the cards, allowing a more sensible deal to be done.

I was a Remainer and given that I have chosen to live in Europe as an EU citizen, I can only confess to blatant self interest. I also voted for the first time ever in 1975 to join the EEC and still believe in the post war idea of a stable Europe being more likely with formal economic and social unity. I know that is not an argument everyone likes but I see much good week in week out in the projects for young people that are made possible by the EU.

As a financial and investment expert (sorry Mr Gove), I did and still do genuinely believe that Brexit was always going to cause economic damage to the UK in the short term. If anyone ever wants to know why, I can explain in great detail! Over the longer term, I can see both sides of the argument. I would have preferred the threat of a Brexit referendum to have been used in collaboration with the other EU countries who don’t like the Brussels set up, to seek reforms. Also I would have preferred some honesty all round.

I do agree with something said by many – that the decision of the referendum ought to be carried through, unless there is a second referendum as a result of a genuine public desire for one. It is not for Parliament to simply stop the process because the Government has proved to be an utterly incompetent negotiator. I suggest it is better for Brexit to happen, the consequences be dealt with (and I think they will mostly not be happy) and perhaps a new relationship with the EU established after a period of reflection.

Here I point out roughly where I live and why I can see Europe and the UK a little differently.

I understand very well the arguments for and against EU immigration because my parents and sister live in Lincolnshire and I personally know people of all ages who have come to the UK from Eastern Europe (many have returned now but some hold very well paid jobs in major businesses and public bodies) and also seen first hand that working in the UK has been an economic choice for young people with English language skills. It is definitely not the first choice any more for the brighter kids and places like Germany, Norway and even the USA will be getting skilled young workers who would have come to the UK.

What can investors expect? The first point I need to repeat is that Mrs May’s deal and whatever replaces it, unless that is a Hard Brexit, represent the beginning of the exit process, not the process itself. There will be many hurdles to overcome, some bonuses and some unexpected complications. Change involves risk and cost – always! So I remain pessimistic about levels of volatility, especially as currency exchange rates are much more a part of the risk assessment that they used to be. I am not rushing to invest anywhere in the world.

On the plus side, Britain has a developed economy with strong control mechanisms and an enterprise culture so a sell off on grounds of uncertainty only will throw up bargains as excellent businesses will have their share prices marked down below the levels justified by their profit and dividend paying potential. That implies a case for investing in the UK in stock picking ‘special situations’ and smaller companies funds.

Personally, I have already dipped my toe in the water by buying a small weighting in a leading UK small companies fund and been rewarded by a sharp loss to date! That is often what happens when one tries to see through the fog and into the future. More often than not, an initial set back precedes several years of excellent returns!