Its Not Harry

Comment and opinion for retail investors in the UK

Education

Midweek Musings – Getting Personal

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Introduction

People who work as professionals in investment management will be expected to have qualifications that allow them to apply accountancy based ‘rulers’ over prospective investments, understand at least some basic ideas of statistics and probability and even know the meanings of various Greek letters in the context of their work. In my (unscientific) opinion this seems to explain why fund managers with degrees in the arts or humanities are on average less succesful than those who trained as accountants or who better still have advanced science degrees. Past students of economics may claim to be scientists, but in my opinions they are usually far from that!

There is a similarity between predicting the future returns from investments and weather forecasting. A great deal of computing power can be applied to analysing the past and some human expertise can be added to interpret that data, but in reality, the best we can hope for in terms of reliability is an indication of the most likely outcome.

Tomorrow there is a 50% chance of rain and a 50% chance of no rain – NotHarry forecasters plc.

In the case of the weather it is the scale of the systems operating across the globe (the impact of nature, in short) that makes precise longer term predictions impossible. In the case of stock markets, it is another aspect of nature that can be fickle or not well undestood: human behaviour.

In this weeks post, I intend to explore some ways in which I think investors can apply some ‘art’ in selecting fund managers. You might find what I have observed to be obvious common sense, but I know that many people imagine the people who work in investmemt companies are some sort of elite with wondrous skills. In spite of the fact that many are paid very highly, they are often far from that.

I once wrote that an actuary is someone can reliably calculate the probability of a good salary. A fund manager is usually someone who likes testing out personal prejudices with other people’s money!

A fund manager’s career path

If you have researched funds in detail, you will have read many mini CVs of fund managers as published in fund fact sheets and maybe expanded on the fund group’s web site or in Morningstar analyst research. Of course, in real life, not everyone makes progress for simple reasons of merit or seniority!

Most of the people with responsibility for the final purchses of investments, maybe from lists provided by a process within their firm or maybe just anything they like, will have reached that pinnacle of authority after working as an analyst in the same firm or in a bank or stockbroker. A few might have worked in industry (say as a pension fund manager or accountant) or ocassionally come out of the military or agriculture. Once upon a time, there was a good chance they went to a public school, but the globalisation of UK fund managmenent groups has diluted that particular “chumocracy”.

Most will have added a formal investment qualification to a degree at Bachelors. Masters or even Doctorate level. I have noted a number of people who took physics doctorates as successful fund managers. Such extra qualifications will usually have been secured many years before a the person got to be ‘running money’, but such is the nature of education – our GPs may not have taken an exam for 20 or 30 years. There are of course compulsory Continued Professional Devolopment programs (usually lightweight in my experience).

So far I have outlined the sort of moulds from which our fund mangers are formed and in truth they are a reasonably homogeous bunch, but….

If I had not been a fund manager, I would have been lead guirarist with AC/DC – so some may well be dreaming!

The ‘star manager’ or entreprenuerial fund manager

In his book ‘The Magic Mountain’ Noble prize winning author Thomas Mann introduces late on a striking character that he portrays as a ‘personality’. This individual is able to secure the attention and approval of his associates and friends without saying anything useful, structured or intelligent. This is shocking because earlier in the book, two other characters have been developed as highly educated and intelligent debaters with opposing viewpoints – one a humanist, the other a Jesuit. They just disappear into the background, outshone by the high wattage competition.

The author has in this book shone a bright light on a very important aspect of human behaviour.

We have had the opportunity to observe first hand in politics right now how an individual can rise to the highest level of influence simply by the force of an unusual (perhaps abnormal?) personality. I refer to Donald Trump of course, but one can probably say the same about Boris Johnson, Vladimir Putin and in the past the likes of Stalin, Tito and without doubt Hitler. The list in politics will be a long one.

Now what happens in politics is a mirror of most other aspects of human behaviour, albeit maybe a magnifying mirror. Someone who has the personality to push themselves forward, perhaps because they have ideas they want to try out on their fellow humans, maybe because they want great fame,wealth and luxury or simply because their brains works that way (as withh the classic personality disorders).

My research has shown me that the more extreme personality types (the most ‘pushy’, one could say) tend to get to the top in politics, the entertainment business and in business….

….and in investment management.

Because investing other people’s money is a highly regulated process in the developed world, there are systems that bear down on these most self opinionated of individuals so that their superfluity of confidence, which may through luck or skill see them having runs of success, is at least on a leash.

Those who are not happy with the constraints of others whom they regard as lower mortals will wait until they have a good repuation, have earned enough to fund a new business and talked some colleagues into the joys of escaping the bureaucracy and announce their new business – usually with their name on it.

The implications

Some of what I next propose is based on real events, actual examples and some is based on my own thinking about human behaviour.

There is in my mind no doubt that an intelligent mind is likely to bring an individual into conflict with the objectives and day to day operations of a large international business. Businesses are in effect organisms and their operations are designed to protect the whole in as efficient a way as possible. There is usually no room for mavericks. Who would want to be Elon Musk or James Dyson’s line manager?

Is it best to just let the hotheads go out and make a mess of things?

The most skilled senior managers know how to manage the best and even the most indepenent thinking employees early in their careers but eventually the strong willed individual acquires enough status (the ‘star’ badge) such that they are almost unmanageable. I am not an innocent in all this – my accountant once said to me that he and I were alike in that we were unemployable, meaning we had got to the point in life where we wanted to test our ideas without a hint of supervision. Good fund managers reach that point sometimes.

Some will set up a business with insufficient parallel resources, such as in compliance or sales and marketing and will simply be unprofitable. This is very common and many managers move back into the fold of a fund group that is a little more respectful of them than their past employer and they then run funds in a semi authonomous way, but with appropraite controls. Jupiter, Liontrust. Premier Miton, MAN GLG and others all have managers working for them that have been through that loop and in my judgement that is a positive. They have pulled their horns in a bit but still have individual talent.

Others, and this is where we must take extreme care, in spite of having very few people working with them, see their businesses storm ahead and so they attract billions in funds. You will know some examples: the now disgraced Neil Woodford, the very rich Terry Smith (Fundsmith), Messrs Lindsell and Train, Alexander Darwall (Devon). Others may be less familar – Teviot, Crux and Chelverton, for example. It is perhaps significant that the last 3, although all founded by people ‘setting up on their own’, do not have the founder’s name out up front!

The wrap

In summary, it is no surprise that quite a few top fund managers have strong personalities. This may be what got them to the top, rather than any other special skill. If they find the restraints of corporate life frustrating, they sometimes go off and do their own thing, with or without associates strong enough to rein in their wilder ambitions, whims and personal biases.

Most will fail and return, chastened to the corporate fold. A very small few will succeed and get very rich, which probably means they cease to be actually running money anyway. A separate small number will take a wrong turn or two, refuse to reverse and end up losing an awful lot of other people’s money.

As investors, we need the art of assessing people in general and using that in a common sense way to assess the risks of trusting our money to ‘big personalities’. As a rule of thumb, I don’t trust the breakaway new funds!

Midweek Musings – Spring Sunshine?

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As I write this (April 6th), I see stock markets well up on the day across the globe and Sterling is down. Both these factors (if they prevail until markets close) will give our porfolios a little Springtime valuation lift. Of course, that is one day’s events and as such pretty useless information for someone pondering the future direction of markets. But maybe short term data is of some use? That is my theme this week.

YTD (year to date)

Is the sun coming out or going in?

3 months data (YTD for 2021) is arguably more useful, not in terms of predicting future valuations, but because we know the global macro economic context and we can see how invesors in different places and types of assets have reacted to the sort of changes I highlighted in my Watching Brief last week.

If I had to pick only 3 relevant contextual factors, they would be these:

  1. economic recovery driven by vaccination programmes (or low Covid 19 incidence as in China),
  2. US government spending plans and the impact of those on inflation and interest rates,
  3. finally, those who prefer real profits to speculative momentum gains raising their voices more audibly and maybe being listened to.

Here is some data (year to date, various sources and rounded slightly).

Note that data extracted over a short period is very sensitive to the start and end dates (in this case January 1st and April 5th), so the absolute numbers are of only curiosity value: it is the relative differences that are interesting!

Major Markets (in local currency terms)

S&P 500 +10.2%
FTSE 100+4%
FTSE 250+7%
NASDAQ+8%
EuroStoxx 50+11.8%
TOPIX (Japan)+8.8%
MSCI World Growth (USD)-0.6%
MSCI World Value (USD+4%
Sterling Index (relative to a basket of currencies)+2.2%

This suggests that we should all have made money so far this year but that some of our returns as UK investors in overseas assets will have been dented by the revaluation up of Sterling which makes investments in other currencies worth less.

Funds

I checked out a few funds that I own, know well or which are representative to see if the above index data was reflected in performance, due to asset class selection (or asset mix for multi asset funds) or manager stock selection. This data is for the cheapest retail share class and in Sterling terms, so allows for the currency headwind where applicable.

MAN GLG UK Undervalued Assets+7.4%
Artemis UK Smaller Companies+13.5%
Baillie Gifford Global Discovery-4.3%
Fundsmith Equity+1.2%
Blue Whale Growth-1.8%
Vanguard Lifestrategy 60+1.5%
Vanguard Lifestrategy 100+5.1%
Royal London Sustainable Managed-2.5%
Wisdom Tree Gold ETF-10%

What do you make of that?

I draw these conclusions:

  • The UK has been a good place to invest this year (and indeed at the end of last year), holding its own for the first time since the Brexit vote. There is no currency headwind as there is for most other assets listed, so the UK, especially away from big foreign currency earners in the FTSE100 is more or less top of the pile. Of course, this is not a comprehensive list, but one I arbitrarily decided was interesting, abusing my editorial authority!
  • There are hints that investors have fallen out of love with some of the leading growth stocks as owned by Baillie Gifford and to a lesser extent by Fundsmith and Blue Whale.
  • The fixed interest element in the Royal London Multi Asset Sustainable fund has seriously dented performance. Indeed, as I have been saying for a while, fixed income investments are more risky at the moment than their long term volatility averages would suggest. This can also be seen in the difference between the returns from the Vanguard Lifestratgy 60% equity and 100% equity funds.

Do I conclude that I should be piling loads more money into UK smaller company funds and dumping my global growth assets? Of course not in such a simplistic way – only a very naive investor chases recent past performance. In any case, this data tells us nothing about systemic risk and that is still at a high level.

When markets sell off in a crisis, virtually all stock market assets fall and those that went up the most recently will usually fall the most!

So, I am as careful now about the amount of equity risk I am carrying as I have been for the last 2 years or so. The data above does validate my decision to use cash as opposed to general fixed income assets as my insurance policy. My decision to also use gold to a degree is open to challenge on the basis of recent losses, but I am sticking with that as a long term defensive asset with inflation proofing thrown in.

Of course, one has to be invested in equities to make money long term and it is possible to diversify in lots of ways within any equity asset allocation. Working out where markets are going is therefore worth the effort and looking at data like that above is part of the process. Markets are traded and priced on the back of human behaviour in my strong opinion, so it can be instructive to see what our fellow investors are up to!

Past performance is not a guide to the future as the regulators expect us to be told but recent past performance does tell us what investors recently chose to buy in the market conditions that we know about and which may well still prevail.

The fact that a fast car was travelling at 150 mph on the autobahn 4 hours ago does not really help the driver if he is in a traffic jam in the city or broken down with an overheated engine! But the driver might have avoided either problem if he paid attention to current data: the traffic info on his Satnav or Google and his car’s temperature gauge or the electronic equivalent.

In a sense recent past performance is informative even if not predictive. Use such data carefully, applying it to what you already know about the context and you will become a better investor.

Hans Brinkler – are you there?

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The Dutch boy with his finger in the dike – Hans Brinkler

I wrote recently that the collapse from overvaluation of some parts of the global stock markets – with consequent short term risks for all market valuations – might come from a single relatively small incident, like a hole in a dike or dam.

Today’s news that at least 2 really large banks (Nomura and Credit Suisse) have taken significant losses after a US Hedge fund (Archegos) defaulted on margin calls is worrying.

If an investor has exposure to shares through derivatives (eg options to buy or sell), and the share price moves unexpectedly outside of its usual trading range, the investor has to put up more money to cover potential losses when the derivates settle (a margin call). If they have not got the cash to do that, quickly trading the underling securities (ie the one that are being betted on) is the best way that the counter-party can protect itself and once that process starts there can be a domino effect. If there are multiple counter parties (likely), the ones who act slowest lose most money and other investors in the stocks on question will see at least short term losses due to the unexpected volumes of shares coming to market.

This problem may just be of the ‘hole in the dike’ variety and the market may supply a Hans Brinker to plug the hole.

If not, expect unpleasant damage, possibly a coming in floods.

Midweek Musings – ‘The Times They are A-changing’

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As one Nobel Prize winning poet once wrote.

A quick look at the lyrics of the famous Bob Dylan song is interesting – they are highly relevant for investors. As a ‘writer… who prophesize with (my) pen‘, I agree that the ‘the loser now will be later to win‘ is a valid concept for investing – what I call being a contrarian.

You can sing along with this week’s post and play air guitar (or even get out your Taylor or Martin)

If I asked you to name an American electric car maker whose share price has risen 43% year to date, would you think immediately of Tesla.

In fact Tesla’s share price is down 9% or so year to date (in US dollars).

The car company whose share price is up that much (again in US dollars) is one increasing its electric car production and putting its prestigious Mustang brand behind the ‘halo’ model’, which looks to be an impressive car. It is, of course, the oldest mass producer of all: the Ford Motor Company.

I have also seen several notes from investment writers pointing out that Volkswagen is making good progress with electric vehicle sales and the shares in that business are held in some ‘opportunity’ type funds.

I am not saying anything about the merits of Tesla cars versus other electric cars: I have not owned any EV yet and know that this is a subject where views are often rather partisan and nothing much to do with investment valuations.

What I am saying is that there is now a wealth of evidence that the serious investors in global stock markets are looking forward past the end of the current boom in ‘new’ (now not so new) technology champions. Shares in businesses that actually make profits, have free cash flow and generate dividends are at last coming back into fashion.

As the nobel laureate puts it:

The slow one now will later be fast; the order is rapidly fadin’; and the first one now will later be last

That could be me ‘propehezising’!

Midweek Musings – Home Advantage?

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My theme this week is the impact of currency fluctuations on portfolio returns. I have been aware of this important factor since I first started learning about investments. I can’t predict currency movements in the short term (a whole industry thrives on playing that game), but I think anyone can assess relative currency risk.

Key principles

My bureau de change!

Let’s start with some basics. What makes a currency more or less valuable? Here are some of the main reasons:

  • Security – how capable is the country issuing the currency of sustaining its relative value? A world superpower in economic (not military) terms with open, efficient and highly liquid markets will get the most respect. The USA, UK, Eurozone or Japan offer what are called the ‘reserve’ currencies. China wants to join that list.
  • Politics – is the government behind the currency respected as prudent and unlikely to borrow beyond the country’s means. Such borrowing might come in the form of ‘printing’ money and if there is more of a currency around, its value may well fall. A reserve currency country has more scope to extend its currency base, but not indefinitely
  • Interest rates and their anticipated direction (highly significant) – there are always people and corporations and even governments with surplus cash to deposit for short periods, even just overnight. Naturally, that cash gets placed where interest rates are highest and to deposit the cash, you probably need to have it in the relevant currency. So there is demand for currencies issued by countries with higher interest rates on offer. By the way, this fact is the main driver in the price of Bitcoin, which is non-national commodity asset that can be substituted for currency.
  • Asset prices in the issuing country – if a country has been having a hard time and is thought to have turned a corner, then richer market players will look to pick up assets of all sorts – shares, whole businesses, properties and so on – at bargain prices. To buy those assets they need local currency, so demand will increase. The opposite applies when the perceived prospects for a country turn negative, or just become muddied, which is why Sterling fell sharply after the Brexit vote.

How does that impact on our investment decisions?

How do fluctuations in currency impact investors, in a direct sense?

Most of the time, we will invest in funds, ETFs or shares priced in the currency of the country in which they are issued. Some funds have “hedged’ share classes, but hedging costs money and it not 100% effective, so has not proved popular with retail investors. So if there is a change in the relative value of the currency in which our investment is issued, the value in our investment report, which is in Sterling, will change, irrespective of any other factor.

Imagine we bought GBP1000 of units in a fund that invested only in the USA. Overnight, the value of the fund’s investments goes up while the US stock market is working by 1%. So our investments should be worth GPB1010 next day. Actually, that will rarely be the case.

If the USD dollar went up 0.5% relative to Sterling, our gain would be 1.5% (GBP1015). If it fell 0.5%, our gain will reduce to 0.5% (GBP1005).

Currency values fluctuate by small amounts daily most of the time, but there are exceptions. Generally, there are trends in relative valuation and sometimes (maybe rarely), one can take a view that there is high probability of one currency going up or down relative to another because one is aware of the impact of the factors detailed above.

For example, it was highly likely that Sterling would depreciate between the date of the Brexit referendum vote and the outcome of negotiations and so there was little currency risk for UK investors buying overseas funds. In fact there was a good case for owning no UK investments at all during that period, because there was no direct currency upside in them.

Note the changes in a currency’s relative value will impact on trade and corporate profits, so there is more to understand on this matter, but that is not something we need to cover here.

Sterling as the Phoenix

Anyone who looks at their portfolio regularly will have noticed weaker performance in terms of valuation numbers from global equity funds over recent weeks. This is mainy because Sterling has been appreciating steadily. The UK Pound Sterling index is a measure against a weighted basket of other currencies and it is up from about 127 to 138 since 6 months ago, nearly 9%. That is quite a headwind for valuations of stocks listed in other currencies.

Why is Sterling going up so steadily? There are multiple reasons which fit in with my criteria above.

Should we be carrying the torch for British businesses?

The final ‘doing’ of Brexit has reduced political risk, even if there is no economic boom yet. The success of the vaccination programme in the UK has been taken as implying an early re-opening of the British economy.

Interest rates rising is not likely to be a baked in expectation yet, so that is one NOT yet applicable factor. But there may be a growing anticipation of higher inflation, which would be followed by higher interest rates – the data points that way.

I suggest that main reason is that UK assets have become outstandingly cheap and overseas investors, slighly jaded with the big US tech firms and worried about the huge cash flows into non-profitable new ventures listed on the NASDAQ, are thinking about buying some old fashioned ‘value’ businesses that sell stuff all over the world, make profits and pay dividends (and as an aside, may be ripe for takeover). So I guess that an inflow of foreign capital is one driver behind the appreciation of Sterling.

Now if a lot of other people want to buy UK company shares and our profits from overseas investments are being cut back by a possibly long running increase in the value of Sterling, maybe we should be looking close to home if we are keen on getting some assets at good prices with no currency risk?

That has already quite a reversal of tactics for me. But as J M Keynes suggested, when the facts change, you need to change your mind.

I think UK investments, carefully researched with some of the contrarian techniques I have explained before, would be a logical inclusion on any shopping list for those wanting to put money into the market or bank some profits from their momentum led tech funds. And there will be no direct currency risk!

Midweek Musings – Let’s get started!

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It seems to be ‘de rigeur’ to use the phrase ‘Let’s get started’ or similar at the start of a YouTube video and who am I to fight fashion?

This new format will on occasions cover a little more ground than its predecessor but it is still my ambition that you can take it in over a leisurely cup of coffee. More detailed analysis will appear in the subscriber only monthly WAtching Brief, and if requested, by the addition of longer reads to the main permanent site content. There will be plenty of fund specific content to give you ideas to follow up if they are of interest.

I had decided to omit my usual graphics too, to use the minimum of screen real estate because I expect some people will read this on their smartphone, but if that disappoints anyone, please comment as usual. Feedback is welcome and acted upon. The initial reaction I got was that the graphics helped with readability, so I added some in! I will adapt as appropraite if there is more feedback.

This weeks theme – diversifying your equity holdings. How about Fintech?

Inflation reborn?

As I have already explained in recent posts, the yield on US Treasuries has been slowly climbing, such that the long end of the yield curve is around 1.5%. This has been happening for about 6 months but a whole swathe of data on inflation has made market participants begin to accept that higher interest rates are coming in the medium term. Central bankers are doing their best to suggest that they are in no hurry to raise rates, but some of the inflation numbers are striking.

I saw a presentation earlier this week, a European focused one, where data was presented showing raw material prices increasing annually now at over 3.5% and for some minerals, much faster than that. Food prices are also moving up sharply and most readers will already know about the huge jump in the cost of renting shipping containers. Add to that a big jump in crude oil pices and a massive overhang of consumer savings on deposit at banks, likely waiting to be spent as soon as the world opens up to travel and shopping, and predictions of significant price inflation seem logical.

Asset class selection

As most of my readers will know, rising interest rates are bad news for fixed income investors, because the value of securities already issued moves in the opposite direction to interest rates. Precious metals, if not in demand in industry or for retail consumption, will also lose value because they have no yield. Deposits of cash will earn better returns but initially that is almost bound to be below the rate of inflation.

This classic model of a lower risk diversified portfolio from around 3 years back now looks seriously in need of revision, although many components will have done well enough

Of the major asset classes. one is left with equities and physical property. The latter is an asset that could do well if the actual properties are carefully selected but most mature funds will own too many retail shops and conventional office blocks and not enough logistics warehouses and server farms.

I am sure that everyone reading this owns a good range of equity based funds, probably with core holdings in the major markets of the world and some tactical sattelite picks. Looking to add further diversity to this asset block is worth your attention, given that the alternatives are not attractive and the track record of complex derivatives driven absolute return funds is in the main absolute in the sense of being absolutely awful!

Is now the time right for Fintech?

Funds investing in financial businesses have been around for years, mainly owning banking, insurance company and wealth management company shares. That makes sense because financial services is a huge part of some economies like the UK and those sort of busineses are subject to very high levels of regulation, so must surely be less risky (post 2008).

But the application of technology to financial services is making as much difference as the application of steam power did to agriculture a couple of centuries back or the invention of mass production did to the availability of motor cars. Can we invest in that process of change? Of course we can and the overall shorthand is Fintech.

There are not so many financial funds on offer to retail investors but I found a few (not all will be on your favoured trading platform – that is another thing to check).

Below is a downloadable link to a Trustnet fund comparion I prepared, using the well known Fundsmith global equity fund as the benchmark, which I think is realistic. The funds I chose are really quite different in character and the correlations not too strong, bearing in mind that these are all equity funds with a global stock universe.

Example-Financial-Funds-vs-Fundsmith-1Download

As always, I am not recommending any fund and I would suggest that you take a look at the top 10 holdings, recent volatility and the typical market capitalisation of the holdings (using the Morningstar Equity Style box) because they will demonstrate quite a difference between the funds.

Jupiter actually offer 2 funds with the same manager. One is a very old fund – Financial Opportunities, the other (Financial Innovations) much newer. The innovations funds fits my idea of Fintech, but is much more risky, with the usual potential extra return and risk of heavier losses.

Im addition to the 3 in the chart, I also found these funds:

  • Jupiter Financial Opportunities – widely available UK listed, diverse large cap growth fund
  • Fidelity Global Financial Services – Luxembourg listed, mega cap bank and insurance led value fund
  • Black Rock World Financials – Luxembourg listed, similar to Fidelity with more bias to insurance companies
  • ASI Financial Equity – small UK listed fund, looks quite diverse , no named manager

There are of course Fintech ETFs (there are ETF’s for just about anything imaginable as a legitimate investment!), but I could find none offered with a UK domicile and only one with an Irish domicile, trading in US dollars and tracking the KBW NASDAQ Financial Technology Index.

Many of the real Fintech businesses are not unlike other new generation technology companies in car sharing, food delivery, internet gaming and so on. In other words, they don’t yet make profits, may be run by very charismatic people who frequently come from countries well East of London and survive on endless funding rounds. So investing in the innovative end of the financial services sector would have to be classified as high risk. But some very mainstream funds from investment houses like Baillie Gifford have been backing businesses that look pretty similar, as have many individuals with their ‘free’ trading apps. The latter may be a permanent feature of stock market pricing, so some suggest and that will help support more adventurous businesses and their share prices.

Other companies, especially those in internet shopping and money transmission services are longer established and profitable.

I repeat that I am not recommending an investment in this area to anyone, that is not my function, but I am suggesting it is an interesting area for research.

I can say, only in the interest of transparency, that I have invested in the Jupiter Financial Innovations fund. It is not uncommon for me to dip my toe into the water after completing a research exercise. Some times I wish I had not!