Its Not Harry

Comment and opinion for retail investors in the UK

Portfolios

Watching Brief – June 2021

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Pottering About

Decline and fall?

It is increasingly obvious that we are living at the end of a cycle when it comes to global political systems.  But not necrssarily ending in the way we might have expected a few years back.

A long term status quo was first disrupted by the tearing down of the Iron Curtain, fall of the Berlin Wall and apparently successful popular uprisings in Arab and middle European Countries.  Even the election of a black president in the USA seemed to offer hope that modern democracy was maturing in a way that would serve citizens rather than exploit them under dictatorships or plutocracies.

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Midweek Musings – What Use Are Alternatives Funds?

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Introduction

Portfolio theory from the late 20th century suggested that one could mitigate the volatility risk of owning equities by buying fixed income stocks (bonds). Some investors would add real estate, usually commercial property, as well. That basic model had long been modified in the institutional investment market by the use of hedging techniques and the investment firms that market products to retail investors have for some 30 years now been offering ‘tamer’ versions of hedge fund investing in the form of absolute return (AR) funds. That phrase is rather UK centric and in the USA a more common classification is ‘alternatives’. Morningstar has pigeon holed funds into a range of alternative categories.

Some changes in Morningstar categories for Alternatives

That firm recently reviewed the classification against a background of general consensus that many funds thus described were not really doing what they promised. I recently listened to a presentation that explained what they had discovered in Europe and the UK and what they were going to do about it.

Here are the main points as I noted them:

  • AR or alternative funds are complex and many have disappointed
  • New categories would better describe the way such funds are supposed to work
  • In the past there has been a very high attrition rate as funds have failed and closed (or rarely, used one technique so successfully that it could not be repeated!). More funds closed than opened in 2019 and 2020 and only one in 5 funds in all their current alternative categories is more than 10 years old.
  • Some funds (for example many listed as long/short) are not actually being run any differently to mainstream equity funds, so should be recategorised in the relevant equity category. This I had observed years ago with the Newton Real Return fund, which was presented as an absolute return fund but was really just a tactical international equity fund.
  • There has been inconsistency at Morningstar in the categorisation of such funds across global markets. I think that UK investors would have maybe been using the Investment Association category (Targeted Absolute Return) anyway, so would not have been overly concerned about Morningstar’s global policy. That IA category also includes a mixed bag and should be treated with caution, by the way.
  • They are taking action that puts funds of a similar style together and with simpler definitions, where possible.
  • Their overall definition of what makes a fund ‘alternative’ now takes on board the concept of expanding portfolio diversity or eliminating dominant risk factors in traditional markets, having low correlation but some flexibility. One might guess that is what the average retail investor understands hedging to mean, so great!
  • A new category addition will allow for some managers using currency as a specific risk mangement technique
Researching alternatives should be a more straighforward process from now on.

Inplications for us

I think this is good news. I have explained to investors how difficult it is to identify the different styles in funds that are marketed as useful for diversification and risk control.

I have had to tell people that some products in the markets are using techniques like selecting non correlated global macro themes that are not recognised as Absolute Return objectives and so those funds are hard to research. The JP Morgan Global Macro Opportunities fund which I have owned for many years is one such.

The new categories will bring together funds like that (Macro Strategy) and assist our research. Moving funds that were pretending to be clever at handling risk back into groups with general managed equity funds will get rid of some funds that were not doing what they said on the tin!

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.

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’!

Monday Mashup – gold: hold or fold?

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The price of gold bullion has declined steadily in US dollar terms for some months since its peak last Summer. A decline in the value of the dollar relative to Sterling will have added an extra loss for investors reading this post, and that includes me!

Readers who own gold bullion may therefore be asking the question in the title.

Why own gold and what about Bitcoin?

I own gold bullion because some 9 months or so back, I wanted to have an asset that was not correlated with global equities and would retain value if the pandemic got totally out of control. Fixed income and physical property investments did not look like offering much value then (and they still don’t) and there was obvious demand for gold.

Gold is a commodity and generally commodities (which include cryptocurrencies like Bitcoin) don’t pay an income and won’t be worth more because an enterprise does well. The price is directly and only determined by supply and demand.

Because high value minerals like gold and high complexity assets like Bitcoin are hard to mine and bring to the market (for completely different reasons of course), the supply side is known to be limited. So in making an investment bet on such assets, one is always taking a view on the demand side of the equation.

Money ‘rotates’ around asset classes over time

What’s changed?

This is the key to working out the completely opposite path of returns for gold and Bitcoin over the last few months. We have less demand for gold (more on that later) and more demand for Bitcoin.

The latter has a new champion with a big fan base in the form of Tesla’s Elon Musk, who has invested shareholders’ cash into Bitcoin in a big way.

The other reasons for Bitcoin demand rising I can only guess, but I would suggest it is possibly our old friend ‘herd mentality’, plus a bit more of a reported positive attitude from blue chip investment houses, although not reserve banks!

The reduction in demand for gold can be attributed to several factors. The main one is that the pandemic risk is thought to be much reduced, so avoiding national ‘fiat’ currencies is less important. Another is that interest rates on US treasuries are slowly rising, implying a market expectation of inflation and/or a slowing of US government money printing in the mid-term – surely inevitable.

Although gold is an excellent inflation proof asset in the long run, it has no income yield. When risk free (as is the convention) assets like US treasuries also have no yield and could lose capital value on a rate rise, gold looks attractive.

When interest yields pick up, the short term investor would rather have the income now than the inflation proofing later, so money rotates away from gold to lower risk (now improved) yield assets.

If such investors exected a sharp rise in interest rates, they would hesitate to buy the fixed income assets, because of the anticipated capital loss, so the markets are telling us that they only expect gentle rate rises over a long period. There is some debate about that, but the collective psychology of the market is always right for the time being!

So, what to do?

One could take the view that gold is a useful core portfolio asset, offering security and diversity and over the long term is both a volatility damper because of the low or even inverse correlation with global equities, and it will serve as an inflation hedge. In that case, it makes sense to keep a modest asset weighting.

Should you invest in crypto currencies instead?

I am not qualified to add to the view of regulators and cental bankers who suggest that although these new assets are very similar in character to precious metals, the way they are traded is probably not unlike the trading of the shiny stuff back in the 19th century at the ‘gold rush’ sites. Some people made fortunes, some went on to control large parts of the market and most people were financially wiped out. In other words, retail investors ought to stay away for now.

Another point of view would be that the vaccine programmes are going well, Covid-19 infections are coming down, there will be no real double dip recession and instead a consumer boom will drive up prices and in time interest rates. That proposition would imply that owning equities, even though they are currently expensive in many markets, or even well selected property assets, is a better tactical (ie short term) option and both fixed income and conventional commodities are not likely to make money.

If you are of the latter more optimistic frame of mind, you ought to think about controlling volatility in other ways within an equity portfolio. Investing in infrastructure is something that comes to mind, given that we expect high levels of government spending, or adding heavier weightings to healthcare funds, perhaps? I am not sure I know the full answer at the moment.

I did it my way?

As for me…..

You might expect me to tell you what I will be doing.

The answer is that I will not add to my physical gold holdings and as I have cash to put into the markets when I see opportunities, the relative weighting will go down.

Aside from that, I personally see no case for selling out, but my circumstances and portfolio will not be the same as yours, dear reader, so if you own gold, you need to make your own mind up!

I hope these comments help.