Education

Vanguard Lifestrategy – not much social distancing

22nd October 2020 by Mark Potter Leave a Comment

Introduction

I thought it was time I posted something for my subscribers who are invested in passive multi-asset funds, most likely via the very successful Vanguard Lifestrategy range.

Readers may know that if one picks these funds, one is accepting the well established (but arguable – See Multi Asset Academy) idea that equities add volatility to a portfolio and fixed income investments add a stabiliser. With a well thought out asset allocation to various parts of these high level asset classes, one can build funds with more or less equities and therefore more of less volatility. Volatility is one way of looking at the risk of capital loss.

So Vanguard market funds with anything from 20% to 100% invested in equity index trackers. The non equity element is invested in a range of fixed income trackers. One would expect the funds to all perform about the same in terms of market direction (because although the asset allocations are different, they invest in the same indices), but not degree. Over the long term, the 100% equity fund ought to make you more money, but the ride will have been a lot bumpier.

However, the relative directional movements of equity and fixed income markets may not be what the textbook would have you believe in the short term.

The fact that Vanguard, for sensible marketing reasons, offer funds differentiated by 20% changes in equity content can result in the sort of strange results that any fixed algorithm will output when several variable inputs change at the same time.

A coming together of returns over 3 years

Here is what I am working up to:

If you look at current data from Morningstar for 3 year annualised returns from the Vanguard Lifestrategy 20%, 40%, 60% and 80% equity funds, the results for all 4 are within a few basis points of 4.7%.

More recent returns favour the funds with more fixed income (because of the Covid pandemic) and the 3 year average volatility is reported as increasing with the equity exposure.

The interesting point, applicable now and maybe rarely in the future, is that one cannot buy investments and expect that a given asset mix will always deliver a predictable return and perhaps more relevant for portfolio builders, at times the inverse relationship between equites and fixed income assets breaks down.

Over the last 3 years, a wholly unpredictable event has meant that cautious investors have made as much money as adventurous investors.

Knowing what we do about recent events, we might think that is intuitively what should have happened. But it is not what mechanistic risk modelling software tools would have predicted.

Implications

Does that probably rare coming together of fund returns mean we ought to change our portfolio design methodology.? I think not – for me it just confirms that in building portfolios we should be allowing for as many unforeseen possibilities as possible and undertake reviews based on what we actually know at the moment.

So, taking that to its logical conclusion, fixed income investments have recently performed as well as equities for less volatility. That implies central banks are predicting a recession. At current ultra low interest rate levels, it also makes fixed income assets look super expensive.

Bearing in mind that we have drawn this data from passive asset allocated funds with no bias to US tech (where there have been big jumps in equity valuations) , it also suggests that ordinary global equities in general are cheap. That brings us back to my suggestion that looking for value might be a rewarding use of research time.

Researching UK funds – an example

21st October 2020 by Mark Potter Leave a Comment

I recently published a new permanent page on the site about the process of being contrarian in selecting funds and used an example of researching UK funds (which I think are cheap at the moment) to explain the process.

I have continued that research process and one curiosity popped up that I thought might be educational.

If you list UK funds in your preferred research tool, you will find the Blackrock UK Equity fund showing a year to date return of around 3% which is pretty good relative to the average large cap fund or even the benchmark index, say the FT All Share. This is a 5 star fund in Morningstar’s ratings.

It so happens that listed right next to it in the ranking order I selected was the Royal London UK Equity Class M fund which year to date has lost about 19%. Note that this is different to the Royal London UK Growth fund which did a little better and is classified as a mid-cap blend fund.

Now that is a whopping 22% gap from Blackrock. How come?

You have to put in time doing your research if you want to find real bargains in the funds market

This is a blog post, so I will keep the answers short, but I am happy to discuss the research in more detail with subscribers.

It is not that Royal London are just useless – the team they acquired when they merged with the Co-op has a good reputation and has delivered excellent results with other funds, notably sustainability focused ones.
The fund manager at Royal London is relatively new (started 2016) – that might be a factor? The smaller companies fund which he runs is a poor performer.
The performance of the 2 funds was similar until 2020, so something very different happened recently. In fact the Royal London fund has a Morningstar 4 star rating.
A really big clue comes from the Morningstar 9 box equity style grid. The BlackRock fund is large cap growth and the Royal London one large cap value on Morningstar’s overall assessment.
The top 10 holdings have considerable overlap, so the variation must be further down the holdings list, which we can’t immediately see.
Although these are UK funds, the BlackRock fund has 25% of its stocks listed in the US, Royal London only 5%. An overseas listing is acceptable for a UK fund if the firm’s main business activity is in UK, or it is in truth UK based. Both funds own Experian plc, which is US listed, for example.
Blackrock’s fund has a significant weight to technology and sensitive stocks, Royal London does not.

More research (like looking at half yearly reports) may reveal some more about the strategy of each manager, but on recent evidence, BlackRock made the right calls for a limited recovery in the UK stock market, biasing the fund away from some parts of the market. Royal London would look to be a good contrarian pick for the brave, although there may be better alternatives. I have not completed my work on this subject yet!

If you are going to invest against the trend (the momentum factor), you need to be thorough with your research and to supress your psychological biases. I will try to keep posting examples to help out!

Monday mashup – what are CBDCs?

19th October 2020 by Mark Potter 2 Comments

As I got not a single question from subscribers, I will consider the Q&A idea to be a non-runner!

I will turn the tables.

My question: who knows what the above initials stand for?

I suspect no-one, yet the introduction of CBDCs has the potential to undermine the operations of every private sector bank in the world and change the whole balance of power in both democratic and autocratic countries.

I think it is possible that the wholesale introduction of CBDCs could be the best opportunity in around 150 years for governments to wrest back the power they have steadily lost to corporations since the late 19th century.

The acronym stands for Central Bank Digitised Currency.

Digital currencies are an interesting and current topic, but like most new ‘products’ have all sorts of hidden risks at the early development stage. Maybe that is why the UK Regulator the FCA is banning the sale and promotion of digital currency derivatives (the most risky way of ‘playing’ with an investment or commodity) to retail investors from next year.

Serious Bitcoin fans who want to take out hedges and so on will get around this by dealing on overseas exchanges, I guess.

And you may know that Facebook thought having a digital currency – Libra – was a good idea and that the G7 nations were seriously opposed to that, rather supporting my proposition that controlling currency will be the new battleground between states and mega corporations.

The news is that China is encouraging Hong Kong residents to get their hands on a chunk of Chinese government digital money by giving away lottery tickets and Shenzhen residents are already able to open digital Renminbi accounts with e-wallets. China is where about a quarter of all the people in the world live, so what happens there is significant.

Would you want to put your money with a government bank?

Any of you that have National Savings Certificates or Premium Bonds have already taken that decision and many did so because they thought it was the most secure option.

That makes me think that a government sponsored e-wallet account would quickly take market share from commercial banks.

The institution that has all your money and also controls the legislative process may be one to worry about. What do you think?

Morningstar gets commercial

7th October 2020 by Mark Potter 2 Comments

I have noticed today that the free access to Morningstar’s 2 page X-Ray is now no longer available and even users of the service via the II platform are only getting the one page report. I have asked II if this as a permanent change, as only recently they were promoting use of the service and to cut it back without an announcement seems churlish to me.

This is not a surprise because what was on offer for nought was enough of the very expensive professional offering for most private investors. I expected Morningstar to ‘monetise’ this in due course.

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Monday mashup – stupidity or dishonesty?

5th October 2020 by Mark Potter Leave a Comment

No, this is not about the US President’s recent remake of Driving Miss Daisy because if it was the word ‘or’ would be inappropriate.

I am referring to the way in which many governments of the developed world are dealing with the pandemic. Any one who has spoken with me over the last few months will know that I believe the phrase “second wave’ is unhelpful and probably a mispreprestation of the facts.

Ignoring the obvious facts that happen to be inconvenient is a speciality of the human race.

It implies, I think, that the course of the pandemic is predictable based on what has been observed in the past with other viruses. That is possible, maybe even a reasonable way of preparing, but should not be an excuse for failing to observe what is actually happening and acting decisively.

Some facts

Here are what I think are the facts as we know them now and which are not being bluntly (honestly?) put in front of the public of many of he world’s most developed nations. Especially those where politicians raise a lot of money from vested interest groups on all sides of the political spectrum.

The virus spreads virulently between people in enclosed spaces who are not widely separated. Like workplaces, nursing homes, police stations, party function rooms, packed baseball stadiums and I guess hermetically sealed presidential cars.

Full lockdowns slow the virus spread to a very low level. These are psychologically difficult for many people and severely restrict normal life for part of the population.

When the virus is spreading at a low level, contact tracing is easier and helps keep the lid on things.

A relaxed attitude to containment is possible in rich countries with well resourced health services and an educated, socially responsible population, but at a cost of more deaths, especially of older people.

At this stage the long term impact on those who have recovered from the virus is not well understood, nor is the transmission rate amongst children.

Economic consequences

Those are some of the established facts about the virus. Other facts that are pretty obvious relate to the economic consequences:

Complete lockdowns will quite quickly (in a matter of months) wipe out whole sectors of the business community. A few businesses will benefit.

Government money pumped out to keep businesses solvent is putting future generations into ‘hock’ by gigantic amounts.

Government bail out money is going to sometimes be fraudulently used, will in many cases be only a sticking plaster and will eventually drain into the ‘pots’ of investment speculators.

What is an honest assessment?

A sensible person would conclude:

Governments must admit that there is no feasible balancing act in which the maximum number of lives are preserved and an economic shock is avoided.

There are really 2 options only:

No lockdowns (the Sweden option and apparently what is happening in some US states and maybe the default in large less developed countries in Asia). That will result in more deaths, especially of the elderly, but limited economic damage locally. In many countries, this may see extreme stress applied to health services and that may have unpredictable consequences in itself.
Full lockdowns and tight control of the population (the New Zealand and China examples are obvious ones). This will have economic effects that will be painful in the short term, but which richer countries may be able to tolerate in the hope of a much faster return to normal.

Any other approach is a fudge, a pretence that some sort of half baked lockdown, switched on and off, revised, dropped, localised and so on after a crisis has arisen will save the most lives and keep businesses open. Anything that is not option 2 is option 1 with a misguided attempt to fit some airbags and crash impact zones.

Those countries that opted for option 2 for just long enough to see their numbers improve and then relaxed have really just wasted all the advantages they built up and reverted to option 1 without telling anyone. During that time, the populations of those countries have become disillusioned and are less likely to do what they are asked.

OK, it’s only my point of view….

Maybe you disagree, or maybe you would say you know all that already.

My point would remain that the politicians in the Western world that I hear from via the (now broadcast and electronic) news media are not displaying leadership, are pretending that all will soon go away magically (especially Trump but also many others) and in the meantime policy making is shambolic, confused and ineffective, frequently reacting to events.

That is like crashing a car in the rain because all four tyres were bald and just replacing the airbags and driving off again.

This matters firstly because more people will get ill and die without any obvious gain. It is tough to suggest that there is any gain in more people dying, but wars have taught us that the process of human existence means that at times some people die because humanity is fighting for a civilised future. What adds to the pain is if they die because of totally incompetent leadership, rather than in the pursuit of the general good by the most effective means.

For us as investors, this matters a great deal as well.

The feeble, half-witted, misdirected and plain dishonest management of the pandemic response in countries accountable for a very large proportion of global economic activity will in due course feed through to a recession that will compare with the one between the Wars.

I started by saying this was not about the US President, but he features!

As then, the very rich will come through in pretty good shape, but I doubt if the rest of us will avoid some severe pain if we are not prepared.

Rant over!

Monday mashup – crystal ball gazing? Or forecasting?

28th September 2020 by Mark Potter Leave a Comment

It is easy enough to work out what investors have to worry about at the moment and to give those risks a rating on probability of causing problems – even to guess when the problems will emerge. For example:

The US elections – happening very soon and a risk if there is not a clear win for Trump or Biden and Trump refuses to depart even though the polls say he has lost. I don’t think which candidate wins will make much difference on its own to US stock markets, but a constitutional crisis would.
Covid 19 – a risk that stock markets are in effect ignoring because many players like the consequent pouring out of nearly free money that is either in effect being invented, or which will be a burden on future tax-payers (which won’t include them, of course!). This Nelson like way of viewing global economics will maybe win a battle, but like Nelson, the corporate warriors won’t be able to avoid a bullet for ever. When it will come is unclear, but I suggest this is a medium term risk.
Related to the above is over valuation of shares – the detachment of many companies’ valuations from a logical base and therefore the undermining of many established rules for making sound investments. This looks to me like a repeat of various past periods in recent history. Such bubbles of investment naivety usually burst without much warning. That could be any time soon.
And finally for Brits only (and maybe with lesser consequences for Europe) – Brexit. This one has a very easy to observe time scale. We will probably know in less than a month whether or not a deal is really going to happen and even if that is strung out as some suspect. we are going to know by Christmas. The emails I have been getting from the Foreign Office as an EU resident Brit suggest that a least that bit of government is certainly expecting no deal.

None of the above will be new to readers, I am sure, but I find it helps to keep the simple facts in mind when fighting one’s sub-coscious biases, like the Fear of Missing Out (FOMO).

When it stops raining, the sun will come out!

Of course, there are always risks, including ‘Black Swan’ events that might dent our invested wealth and blow our plans off course.

What perhaps is unusual at this time is that it is so easy to see so many risks and know that the market is not properly ‘discounting” them (ie allowing for them in valuations), except perhaps the last one, Brexit.

With the exception of some international mega cap businesses and selected mid and small cap firms, the UK stock market has performed very poorly for some time now. The relative performance of the main UK indices has been awful.

Because the Brexit risk is rapidly coming to a head, one might take the view that whatever happens, the removal of uncertainty and the ‘happening’ of the consequences of Brexit in full in 2021 will make investing in the UK a much more attractive proposition, because whenever there is major change, there are winners as well as losers. We can look for fund managers that we think know how to pick winners in a recovery situation.

I have thought for maybe 2 years that I wanted to participate in this opportunity. I bought UK value (ie out of fashion) and smaller company funds in late 2018 and 2019, thinking that the new Government was going to ‘get Brexit done’. In essence, although I did not wholly trust Boris Johnson, I though his election would unlock the Brexit process. For a while this seemed to have been a good call, but things went pear-shaped.

Even allowing for Covid 19 being a major spanner in the works this year, I was in any case misguided. I have only made money on the smaller companies fund, and given up and sold out of the value funds, because I expected to lose even more money in the near term. I would rather reserve the money in a defensive fund and buy at even cheaper prices. That sort of timing call has risks, of course, which is why I have titled this post as I have done!

I do not think any differently about the consequences of Brexit , only that my timing in buying into the most sensibly valued major stock market in the world was wrong (that happens to all investors sometimes, even the greatest). So I am once again looking for opportunities to buy UK shares at really cheap prices in the near future. I will publish some of my research soon!