Its Not Harry

Comment and opinion for retail investors in the UK

Basics

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!

Profit taking (skimming/slicing) – is there a trick to it?

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One of my readers has suggested an article giving general advice on when to take profits and in what sort of proportion would be useful.

This is a subject with several aspects.  How do you know when you are near the top of a market?  Is that even possible?  What about tax?  If you sell out of a good fund, where would you re-invest?  Should you re-invest at all?  Is the old quotation “time in the markets is better than timing the markets” (Anthony Bolton, ex Fidelity) the simple answer?

I can seek to answer these questions or at least propose  a logical way of taking decisions but the topic justifies an article as opposed to just a blog post.  I will add one to the “How to” area as soon as I can.  It will be unrestricted.

Yes! It does work!

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NotHarry’s approach to portfolio design is backed up by observations in very elevated places!

Below is an extract from Morningstar’s website, published yesterday.  I have read and highly recommend Daniel Kahneman’s (and his colleague’s)  book ‘Thinking Fast and Slow’.  It will go down in history as a seminal publication and be used in all sorts of university courses in the future. 

I certainly bear in mind his analysis and research now.  But I am very pleased to say that my articles on this web site and my recommended use of multiple portfolios to meet client objectives long pre-date my reading of the Nobel Laureate’s work.  It confused compliance people no end as they like to think that a client with risk score ‘x’ gets portfolio ‘y’, not that people are complex psychological units who want multiple things, sometimes in conflict, and don’t like disappointment.  Here is the article:

‘Finding out how people tick is a vital part of the investment process, Daniel Kahneman, Nobel laureate and author of Thinking, Fast and Slow, told the 30th annual Morningstar Investment Conference in Chicago.

He had this advice for financial advisers hoping to steer clients towards reaching their investment goals: “You need to find out what the client’s dreams are, what their fears are. And when bad things happen, you need to be there to help people stay on course.”

Kahneman, speaking with Morningstar behavioural scientist Sarah Newcomb, said that in in investing, research on behavioural biases can be used for good or evil. In the worst case, these biases could be used to exploit clients. In the best case, they could help a client develop and implement their financial plan and potentially improve their outcome

The first step is to decide what’s in the client’s best interest, Kahneman said. Then the adviser needs to find some way to develop a “regret proof” policy – a policy someone can live with when things go badly. This reduces the chance that a client will capitulate at the wrong time and possibly move to another adviser.

Kahneman described a practice he had developed with colleagues to improve investor outcomes. First, the adviser would try to determine the client’s loss aversion to create a measure of projected regret.

“We try to have people imagine various scenarios. We ask them, at what point do you think you would want to bail out?” There are some differences, Kahneman says, but he has found that even extremely wealthy people are loss-averse.

Two-Part Portolios to Manage Risk

The next step was to run client portfolios in two parts. One portfolio holds the assets the client is willing to risk, and the other is a much more conservative portfolio comprising what the client wants to protect. The portfolios are managed separately and clients get the reports individually.

This is helpful for clients because no matter the market environment, one of the portfolios is likely doing well. Of course, financially, it’s one portfolio, but framing it as two separate accounts helps clients understand and tolerate the risks better, he explained.

Asset allocation, in many ways, is the easy part. Helping clients set reasonable goals and adhere to their plan is the difficult part; it requires having in-depth, sometimes personal conversations with client. One element of the process taking a comprehensive look at the client’s present and desired future outcome.

“Individuals tend to do very poorly guessing what stocks will do. Admitting you don’t know is a very healthy step, but this admission leaves you with a great deal to do,” he said.’

 

Mary, Mary quite contrary

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Readers may have heard the phrase ‘contrarian’  with reference to a certain fund manager or investment style.  Generally this implies taking decisions that are at odds with the perceived thinking of the majority.

NotHarry has a T shirt with a quote from Mark Twain that goes something like this: ‘if you find you are one of the majority, it is time to stop and think again’.  That would suggest merit in challenging the accepted wisdom.  On the other hand the gurus of behavioural psychology point out that the ‘non thinking’ or at least not conscious thinking part of the human brain drives far more of what we do than the analytical, logical part, which makes a case for investing on what is usually called a ‘momentum’ basis, or following the herd.

The question then arises: is it good to be a contrarian in the long run?  Absolutely! But….

The way a contrarian is able to increase the odds of success in investing is to keep the analytic part of their thinking process switched on at all times.  Investing with the momentum makes sense if you get in at or near the start, like a surfer spotting the next big roller some way off the beach.  But you need to know how long to stay on the peak and when to safely get off.  Better to exit gracefully than crash out and get caught in the undertow.

A good contrarian investor is not someone who just buys cheap out of fashion assets, although that can be part of the process.  The contrarian assumes the majority view is wrong until they have proved to themselves that it is not, or even that it is wrong but will push share prices up for a while!  Above all the contrarian (maybe without actually knowing as much) understands that behavioural biases influence investment markets and clichés and simplistic rules of thumb are not an intelligent way of building a portfolio.

I will finish with an example.  It is widely believed that electric vehicles are the future and indeed there is concrete evidence of reduced sales of diesel cars.  A simple view might be to invest in Tesla or another car manufacturer with a stated specific total commitment to electric cars,  and so sell or even ‘short’ holdings in businesses like Volkswagen, Nissan or BMW. A contrarian would perhaps argue that with the most advanced production facilities in the world, these latter companies could switch to making electric cars much faster and at lower unit cost than a new player who will have to purchase vast amounts of capital equipment and learn the process.  So the contrarian would take advantage of bad news about diesel car sales resulting in lower share prices for a well run ‘traditional’ car company to build a stock position, especially if they can see from thorough research that plans for a major switch of production are already well under way.

In my view being ‘contrarian’ is simply a matter of fighting the human tendency to be one of the pack and keep your intelligence turned on all the time.  If you can do that, you will have a lovely show of investment blue bells and cockle shells.

Research or a promotion?

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“3 top rated trusts trading on a double digit discount” is the lead headline on the Morningstar email page that was emailed to me (as a retail investor) yesterday.  The follow on teaser text suggests that this could be because UK funds are “oversold” and therefore cheap.

However, reading the actual content, which is confined to a rather shallow commentary on 3 Smaller Companies investment trusts, one reads that the double digit discounts are less than the 10 year averages, which themselves are drawn from a relatively benign long term “bull’ market.  So no extra value there!

Playing the discount to premium game (and of course vice versa!) is an aspect of owning investment trusts, but one that adds extra risk.

Morningstar is  a good business with highly qualified academics in its research units so it is a pity that it seems to be turning into a touting vehicle for the fund managers that pay to get listed with it – a sort of quid pro, I guess.

In my opinion, if  a research organisation lives on the fees it gets from the people it researches, you can’t expect it to give you independent advice.  In this case, you obviously can’t rely on it to apply logic either!