Its Not Harry

Comment and opinion for retail investors in the UK

Portfolios

Cold Turkey?

by Leave a Comment

In today’s news about the financial pressure being exerted on Turkey by the Trump administration, two blog posts I have made recently are brought together.

Currency fluctuation is a risk that can impact all portfolios

This is as I explained:  because many emerging economies have large amounts of US dollar denominated debt, the cost of servicing that debt goes up if the dollar appreciates relative to the currency of the debtor nation.  That is one of those ‘rule of thumb’ justifications for selling emerging market and broadly Asian stocks (although not logical for Japan and China, at least).

Tariffs have unpredictable consequences

In this case, tariffs aimed at Turkey (because they are not being nice to Donald, it seems), may lead to default on debts owned mainly by international banks, thus awakening sleeping concerns about the liquidity of the financial system when central bank money printing ends.

Thoughts

Turkey is not a small country and of course was once a significant regional power, so is unlikely to allow itself to be pushed around.  It talks about new alliances with Russia, although allowing for not such ancient history, one would not see the two countries as likely best mates.  But ‘need is must’ sometimes as the saying goes and I am sure President Putin would like more influence South West of the Black Sea.

A worry is that US foreign policy is now so ignorant that Trump sees Turkey as just another Middle Eastern country (because it is Islamic) and therefore a natural enemy of the US.  As I write that is seems bizarre, but I do believe it is possible!

It would be odd if this particular non-sensical action by Trump caused the market sell off that is rather overdue, but it will be a nervous few days.  Investors should keep an eye on events and be prepared to take any buying opportunities.

As a final thought, the Euro has been quoted as depreciating in today’s news as a contagion effect from the  Turkish currency crisis.  But it has hardly moved against Sterling – an indication of how uncertain an option the UK appears to international traders as the Brexit dithering continues.  The Pound looks likely to continue to fall against the US dollar so portfolio exposure to global trading businesses will benefit.

Facebook (and others) – risks now apparent, but should you exit tech?

by Leave a Comment

Depending on which news media you read, you are pretty much bound to have heard about record falls in the price of Facebook shares, apparently due to a slowdown in the rate of advertising revenue.

Of course, Facebook and for that matter Google, are in trouble with politicians for behaving “without moral leadership” to quote.  This factor seems not to have much impact on the share prices.  If you have any detailed knowledge of the history of the oil industry (the book to read is “The Prize” by Daniel Yergin), it will all look pretty familiar.   I am surprised President Trump has not started tweeting about anti-trust legislation, something that was prompted by the utterly disreputable behaviour of Standard Oil (the largest remnant of which is now Exxon Mobil).  Later this legislation was used to attack IBM, which in my college days was seen to be so large as to be able to outdo many nation states.  I realise many young folk won’t even have heard of IBM!

As I mentioned in a another recent post about share price swings, these are most dramatic where the share price is justified on the basis of expected future  profits growth, with the psychological overlay of the “fear of missing out” (FOMO).  So if profits growth is at risk and investors are sitting on large paper profits, they will dump shares in an instant.  There is a very old cliché in the investment world that a profits warning is always the first of many.   That default idea also exacerbates sell offs.

So, should investors now pull out of tech funds?  I personally will not.  Some fund mangers will see a fall in prices as a buying opportunity because the cultural change (like the adoption of oil as a fuel for motor vehicles as opposed to use in smelly heaters and lights) is genuine, set in and will not be reversed.  There will be winners and losers, new legislation and even systemic shocks to all the share values in the market, but I have no doubt that IT and media linked together are driving forces in business and profit generation for many years to come.

Yes! It does work!

by Leave a Comment

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?

by Leave a Comment

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.