Its Not Harry

Comment and opinion for retail investors in the UK

Education

Christmas is coming soon – in my opinion

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What!  I hear that reaction as the UK weather simmers away at heat wave levels.

I am referring to the comment I posted on social media in the very early hours of the day when the Brexit referendum vote result was known – “The turkeys have voted for Christmas”.

In religious calendar terms, we are now in Advent and the first window on your calendar reveals the resignation of the entire Brexit department ministry.

What I meant by my comment was that the people who had the strongest grievance with the EU (for example, over open borders and immigration or the Common Agricultural Policy or social rights legislation), are not in fact the editor or owner of the Daily Mail nor Tory MPs who went to Eton, but actually ordinary working people who can’t get to see the doctor in East Anglia, or farmers in Wales or Dorset who don’t understand why the EU “dictates’ how they ought to farm, or Labour party members seeing wages suppressed by the employment of Eastern European workers.   These people would be worse off because of the certain economic consequences of breaking up the Single Market and also in my judgement at risk of being worse off because of the substitution of US style capitalism for the more socially balanced European version.

I think the fact that the ‘turkey farmers’, the big international employers,  are now telling bluntly how difficult it will be to operate out of the UK without a customs union is some evidence that my assessment was correct.  There are other proofs that are beyond the scope of this post.

As I have written before, the long term interests of the UK (or at least England) might just be best served by Brexit (although I would not bet on it).  As J M Keynes said – in the long run we are all dead.

To be clear (I could not resist using Mrs May’s word whisker), I do NOT believe that the EU does not need substantial reform, as do most of the members of the European parliament (except curiously the right wing parties who one assumes are all expecting it to disintegrate completely!).  The Commission is far too powerful, agricultural policy is at times bonkers and the bureaucracy needs trimming.  Unlimited immigration has undesirable social consequences: that is self evident (ask any Italian if you want another viewpoint). But equally the idea of the EU has huge merit in economic, social and peace keeping terms.  So I would personally have preferred a more Maggie Thatcher approach – use British clout to get genuine reform from within.

Since I posted my highly pessimistic reaction to the vote, things have got worse.  Many billions have been withdrawn from UK investment funds.  The Conservative party looks to be heading towards the disintegration that John Major staved off with difficulty (ultimately assisted by one A Blair!) and which David Cameron naively tried to fix with the referendum proposal.  Instead of UKIP, we now have the UKIP wing of the Tory party.

This represents political risk at the highest level for investors because this time the consequences of the politics are hard wired to the economics and the business effects.  Boris may want to abuse business, but big business runs the capitalist world – not him.   His ignoring business suggests to me he may be descended from King Knut.

I am not entirely pessimistic for investments in the UK in that what I am expecting is disruption, some specific negative consequences but then a rebalancing of the flows of business capital.  Jobs will leave the UK for Eastern Europe (I can already see that from where I sit now) and that will reduce immigration from the more developed places like Poland, Czech Republic, Hungary and the Baltic States as the better educated citizens of those countries get jobs at home.  Possibly some deals will be done with the US that might not have been done before, but I would expect that to be a matter of the UK buying more stuff from the US, not better jobs for UK workers – anyone who has worked on employee benefits for US owned businesses knows well that they screw every ounce of value from their employees.

Very close attention needs to be paid to portfolio composition and stock selection.  Places like Japan and India that have large internal markets and are not hugely impacted by UK and US politics might be safer investment havens than would commonly be the case!

I will no doubt return to this subject over the coming weeks.

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.’

 

Going to extremes or sensible hedging?

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Introduction

I am working on constructing a low volatility example portfolio for the members’ part of the web site and this is taking a long time.  The reason is that it is currently very hard to find assets that are cheap and likely to be steady low volatility earners.  Updating my knowledge of what the big fund management groups are doing to get returns on their fixed income (bond) and absolute returns fund confirms that more and more ‘innovative’ methods are being used – not  a good sign!

A gloat

Over a period starting about 18 months and lasting 6 months until mid 2017 I was fighting a lone corner as the senior member of my then employer’s investment committee, resisting inclusion of the M&G Global Macro Bond fund as a heavy weighting in the firm’s lower risk portfolio models.  The advice to include it was coming from the form’s external investment advisers and was based on the recent strong performance and the undoubted reputation of the lead manager.  They produced vast amounts of backward looking data showing how it would have  done better than what I proposed, had what I proposed now been included 3 years ago (not very logical, you will realise).

My objections were several but basically that the fund was a straight bet on the ongoing appreciation of the US dollar versus Sterling.  The big negative impact that strong US growth and possibly inflation would represent made the fund high risk in my view.

I was persistent and ultimately no doubt rather unpopular but in fairness to the committee and its chairperson, they declined to used the fund.

In 2017 the fund lost over 4%, fell from 10th to 85th percentile in the sector (Source: Morningstar) and the current top 10 holdings are now rather different.

What’s to learn and where are the dangers?

I am not suggesting of course that I am any cleverer than the highly regarded manager of the above mentioned fund or that he did something ill advised.  That is not the point.  He may well have never expected any advisers to use his fund as a diversifier in a lower risk growth portfolio.  He only works to his published objectives.  My point is that the people who recommended it did not understand how the recent past performance arose and what the implications of that would be based on what economic and financial conditions were at the time we were reviewing the fund as a possible recommendation.

This is the point missed so often by portfolio designers.  I think it was J M Keynes who said that ‘when the facts change, I change my mind’. If an event that was great for your investment holdings has ended (eg a sharp change in relative currency values), it is naïve to assume that the same performance can be repeated – in fact there is more likely to be some claw back.

The dangers I am currently identifying is that even experienced fund managers with excellent past performance records are struggling to find assets that can make money after the overly long period of value increases in fixed income assets.  I read today that prior to the change of government in Italy, Italian government debt was paying a net negative real yield.  It has now turned positive.  The facts changed – Italy has an anti-euro government.  Some famous fund managers lost very large sums in their bond funds the week of that election result.

It is almost as if, if you invest in bonds, you are being asked to be a bank – lend your money at risk – but unlike a bank, you also pay the borrower a fee for making use of your money!  Bizarre and surely a danger signal?

It seems that fund mangers are, perhaps out of desperation,  investing heavily in derivatives of various sorts.  I looked at a newish Absolute Return Bond fund and the top holdings were ALL CDSs (Credit Default Swaps).  These featured heavily in the 2008 financial crisis, being a major contributor to the insolvency of the huge American insurer AIG.  They are a legitimate insurance element in diversified  portfolios and maybe some people actually want to buy a managed portfolio of CDSs.  But a fund branded as an Absolute Return bond fund will sound to most people like it is very cautious.  I think they would be disturbed to find out how it is constructed.

Not what is says on the label

One of my friend recently posted on Facebook that he had bothered to read the ingredients list in an Activa sugar free yoghurt and found a huge number of ‘unexpected’ additives.  Yet this product is advertised as being for a healthy life style.  What you are led to expect by marketing psychology may be very different to reality.  The Food Standards Agency has just made this point in a report.

The same applies to investments these days.  You often don’t get what you might expect.  If you don’t pay attention, your financial health is at risk!  Read the label, or in this case the fact sheets.

I would suggest people who are not comfortable with investment risk might actually do better not investing at all at the moment, or only a modest proportion of their available assets, but I will keep working on some other options.