Its Not Harry

Comment and opinion for retail investors in the UK

Education

Cash as an asset class

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Introduction

In various places on this web site, I suggest that holding cash as an integral component of your portfolio mix is a way of diversifying risk.  In the briefest terms possible, keeping cash on hand lowers volatility, saves you selling at the wrong time and gives you the opportunity to buy cheap assets without notice.  In essence I prefer what is called the ‘cash plus risk’ investment approach to the traditional portfolio construction based on the assumed non-correlation between equity shares and fixed income or loan stocks.

Where to keep it?

In practice there are 3 main ways you can hold cash as part of your investing strategy:  in your bank, building society or other deposit taking institution (or in your sock, if you really must!), as part of your platform or wrap assets, or in the control of the fund managers you select.

It is worth mentioning that the managers of funds that list as a primary objective investing in stock markets assets have inconsistent views on holding cash within their funds:  some say it is not their job to hold cash and they will always be fully invested, others say they must hold cash to manage liquidity (common for property funds) and a third group hold cash as a tactical asset (especially in absolute return funds).  If you get a ‘drill down’ analysis of your funds portfolio from your adviser or platform supplier, you may well find you are more into cash than you thought!

Holding cash in money market unitised funds that invest in deposit like instruments like floating rate notes or synthetic zero dividend preference shares (that can still fall in value but are low volatility) only works if the long term returns are better than bank interest rates after tax plus the fund fees.  That is sometimes the case, but the best funds will show losses for periods, albeit they recover over time.

Holding cash in private accounts is the favoured approach of most investors because they are in control, can keep an eye out for the best products from banks and building societies and have instant access.  Tax favoured offerings from National Savings are a good bet at times depending on Government policy to borrowing direct from the public which varies a fair bit.

Keeping cash in your platform or wrap account is ideal if you are going to use the money for dealing quite soon, but interest rates on such money may currently be negative after fees are taken into account, so I would suggest such holdings would usually be short term.  The better platforms do offer access to fixed term deposit accounts to squeeze a bit more interest out of the system, but of course that may constrain an opportunistic quick buy of an asset you just decided was priced where you liked it!

My view

I think only modest amounts, intended for dealing (possibly raised from recent asset sales) should be kept on platforms.  I think your cash ought to be in your control, but that you ought to know that “investment cash” is separate from your day to day funds and any emergency reserve for unexpected capital items that you like to keep.

It helps if you keep that portfolio strategy cash noted in your records with your other portfolio asset data if you want to measure your returns accurately.  In good times, the cash holding will be a brake on performance and there will be a psychological ‘itch’ to invest it but when markets fall, it will be something you can access while you wait for things to get better and the psychology will all be positive!

Actually, in my opinion, holding a good cash reserve is not really a brake on good performance long term, because you can make the assets you do invest in that bit more adventurous and over time that will generally pay you back with better returns.  Recent research supports this supposition over more time periods than not.

 

House prices on the UK – on the slide?

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Confession

This piece is one of my occasional rants.  My ambition is to show readers that what gets quoted in the media (print or electronic) as ‘expert’ opinion is often out of context or plain stupid!  My ex-colleagues told me I was prone to ranting – my response is a rant is a proportional non-violent reaction to utter tosh being promoted as rational expertise.  It happens a lot in finance and economics!

Background

You may have read that the Halifax House Price Index reported a sharp fall in prices this month.  I used to work with the economist who created the original index, but no doubt is has developed since the 1980s.  Some suggest this was a ‘freak’ data item but I doubt that.   The on-line article then quoted the chief economist of an economic research business as saying something to the effect that ‘as long as interest rates don’t rise sharply and people don’t need to sell their houses because they can’t afford their mortgages, prices are not likely to fall’.  My hands were then moving to my head looking for a few remaining hairs to pull out!

Analysis and a bit more realism

Of course, repossessed houses coming on to the market in quantity would probably cause prices to fall very sharply, as they did in past recessions.  That is because of an increase in supply combining with a decrease in demand for owner occupation (partly mitigated by an increase in the demand for houses to rent).  That is just basic beginner’s economics.

However, what our chief economist friend seemed not to want to say (I am sure he thought about this) is that a more general reduction in demand alone, which we are actually seeing in London already, will also cause a fall in prices and a sharp reduction in demand will in time cause a sharp fall in prices.

For example, there are Brexit effects that are not much discussed.  Significant blocks of housing in the East Midlands especially are owned by or occupied on multi-tenant lets by Eastern Europeans.  I know this first hand – I live in Eastern Europe and have friends who have been to the UK to work, some returning home, some not yet, and my parents and sister live in the East Midlands.   That source of demand is already reducing as is evidenced by the shortage of labourers in some industries.

As Britain now appears to outsiders to be a more hostile place for foreigners (it is  – I was recently personally racially abused on a bus in Yorkshire on the apparent assumption that I was an Albanian), people with lots of money (eg Russian, Chinese and  Indian nationals) will not buy in London, which will turn off the main source of liquidity that has been driving prices in the South East too .  If net immigration falls as well, it is certain that demand side of the UK housing market equation will ease off.  That combined effect and possibly rising interest rates as well could mean a long down slope for house prices in those areas that have seen the biggest gains.  Maybe not a bad thing in economic terms, being just the turn of the cycle but falling house prices and recessions often come along together.

 

May Watching Brief now published

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This is the regular market commentary that I have always intended to publish.  I have altered the format completely, so it now feels much like the presentation I would have made verbally to clients if I had been reviewing their portfolios as part of their service contract when I was their IFA.  That would have fed through to any necessary fund switches, sales or additions.

This change is the result of feedback received, so I hope it useful.  I have not restricted it to Member Only this month, so non-members can see if it might be helpful and justify signing up!  Here is a link.

Of course, this cannot be the same as a full review with an IFA, because that would conclude with personal recommendations, which I do not offer.  But if you have an IFA, this will give you something to take to the review meeting, or even to prompt an extra phone call.   If you are making all your own decisions and you are a subscriber, feel free to contact me if you want to disagree, or want to see any more evidence!

 

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.