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Midweek Musings – Is Bigger Better?

21st April 2021 by Mark Potter Leave a Comment

I was asked recently if one could speed up investment fund or ETF selection by picking a reliable fund group and then just getting one’s asset allocation by picking the right variants from their range. Some fund groups are so large, offering hundreds of funds, that this would certainly be feasible.

A quick observation

In truth the size of a financial services business offering investment products will impact on the style of the investment manager given the job of running the fund. With passive ETFs, there is no manager, so one is looking for reliable systems, good index selection and low fees. In this latter case, bigger will usually be better.

A fund manager in a huge organisation (often a bank) with multiple service offerings, like J P Morgan, BlackRock or HSBC, will be just a small cog amongst larger cogs in a huge machine and may have to work with a lot of policy and complaince constraints, which in some ways is a good thing. At the other end of the scale, the ‘one man and a dog’ fund managers with an external ACD (like FP,LF,TM, VT and so on – the people who provide the regulatory services) have immense discretion but not much supervision, which adds risk, as was seen recenty with the Woodford fiasco.

In between those extremes are a variety of firm sizes with narrower and broader fund offerings and with managers having more or less discretion. Knowing something about the culture of the firm within which a fund manger works is useful and in fact one of Morningstar’s ‘pillars’ in assessing funds focuses on this issue.

A bit of fun

I tend to like analogies using motor cars, so I am tempted to match some well known fund managers with car makers, just to give you an approximation of scale and style (if you know anything about cars – most of my readers do!). The names are a sample of firms offering funds to UK investors that are mainly widely owned with a sprinkling of interesting niche players.

The car maker’s national origins are only partially relevant – I am thinking about the range and sort of cars (including general reliability) that they sell and how they make them and finally I estimated the share of the market that they take!

Please take with a pinch of salt! If anyone is curious about how I picked the car makers, feel free to get in touch.

Fund Group	Car maker that comes to mind
Black Rock, JP Morgan, Barclays, HSBC, Morgan Stanley	General Motors
Fidelity, Janus Henderson, Invesco, Schroder	Fiat Chrysler
Aberdeen Standard, Legal & General	Toyota, Honda
Jupiter, Artemis, Liontrust, Premier Miton	Jaguar Land Rover, Mazda, Volvo
Baillie Gifford, Ruffer	Tesla
BNY Mellon, BMO, M&G	Ford Motor Company
Guinness AM, Polar Capital, Montanaro	Lotus
Ninety One, Columbia Threadneedle, First Sentier, Aviva	Nissan, Subaru
Royal London, WHEB	Skoda
MAN GLG, AXA Framlington, Aegon	Peugeot, Citroen, Renault, KIA
Crux, Teviot, Somerset	Audi, Porsche, Mercedes
Fundsmith, Blue Whale, Slater	McLaren, Lamborgini, Ferrari
Vanguard	Volkswagen
Woodford	TVR!
St James Place	Rolls Royce :-))
Virgin Money	Lada

Midweek Musings – Getting Personal

14th April 2021 by Mark Potter Leave a Comment

Introduction

People who work as professionals in investment management will be expected to have qualifications that allow them to apply accountancy based ‘rulers’ over prospective investments, understand at least some basic ideas of statistics and probability and even know the meanings of various Greek letters in the context of their work. In my (unscientific) opinion this seems to explain why fund managers with degrees in the arts or humanities are on average less succesful than those who trained as accountants or who better still have advanced science degrees. Past students of economics may claim to be scientists, but in my opinions they are usually far from that!

There is a similarity between predicting the future returns from investments and weather forecasting. A great deal of computing power can be applied to analysing the past and some human expertise can be added to interpret that data, but in reality, the best we can hope for in terms of reliability is an indication of the most likely outcome.

Tomorrow there is a 50% chance of rain and a 50% chance of no rain – NotHarry forecasters plc.

In the case of the weather it is the scale of the systems operating across the globe (the impact of nature, in short) that makes precise longer term predictions impossible. In the case of stock markets, it is another aspect of nature that can be fickle or not well undestood: human behaviour.

In this weeks post, I intend to explore some ways in which I think investors can apply some ‘art’ in selecting fund managers. You might find what I have observed to be obvious common sense, but I know that many people imagine the people who work in investmemt companies are some sort of elite with wondrous skills. In spite of the fact that many are paid very highly, they are often far from that.

I once wrote that an actuary is someone can reliably calculate the probability of a good salary. A fund manager is usually someone who likes testing out personal prejudices with other people’s money!

A fund manager’s career path

If you have researched funds in detail, you will have read many mini CVs of fund managers as published in fund fact sheets and maybe expanded on the fund group’s web site or in Morningstar analyst research. Of course, in real life, not everyone makes progress for simple reasons of merit or seniority!

Most of the people with responsibility for the final purchses of investments, maybe from lists provided by a process within their firm or maybe just anything they like, will have reached that pinnacle of authority after working as an analyst in the same firm or in a bank or stockbroker. A few might have worked in industry (say as a pension fund manager or accountant) or ocassionally come out of the military or agriculture. Once upon a time, there was a good chance they went to a public school, but the globalisation of UK fund managmenent groups has diluted that particular “chumocracy”.

Most will have added a formal investment qualification to a degree at Bachelors. Masters or even Doctorate level. I have noted a number of people who took physics doctorates as successful fund managers. Such extra qualifications will usually have been secured many years before a the person got to be ‘running money’, but such is the nature of education – our GPs may not have taken an exam for 20 or 30 years. There are of course compulsory Continued Professional Devolopment programs (usually lightweight in my experience).

So far I have outlined the sort of moulds from which our fund mangers are formed and in truth they are a reasonably homogeous bunch, but….

If I had not been a fund manager, I would have been lead guirarist with AC/DC – so some may well be dreaming!

The ‘star manager’ or entreprenuerial fund manager

In his book ‘The Magic Mountain’ Noble prize winning author Thomas Mann introduces late on a striking character that he portrays as a ‘personality’. This individual is able to secure the attention and approval of his associates and friends without saying anything useful, structured or intelligent. This is shocking because earlier in the book, two other characters have been developed as highly educated and intelligent debaters with opposing viewpoints – one a humanist, the other a Jesuit. They just disappear into the background, outshone by the high wattage competition.

The author has in this book shone a bright light on a very important aspect of human behaviour.

We have had the opportunity to observe first hand in politics right now how an individual can rise to the highest level of influence simply by the force of an unusual (perhaps abnormal?) personality. I refer to Donald Trump of course, but one can probably say the same about Boris Johnson, Vladimir Putin and in the past the likes of Stalin, Tito and without doubt Hitler. The list in politics will be a long one.

Now what happens in politics is a mirror of most other aspects of human behaviour, albeit maybe a magnifying mirror. Someone who has the personality to push themselves forward, perhaps because they have ideas they want to try out on their fellow humans, maybe because they want great fame,wealth and luxury or simply because their brains works that way (as withh the classic personality disorders).

My research has shown me that the more extreme personality types (the most ‘pushy’, one could say) tend to get to the top in politics, the entertainment business and in business….

….and in investment management.

Because investing other people’s money is a highly regulated process in the developed world, there are systems that bear down on these most self opinionated of individuals so that their superfluity of confidence, which may through luck or skill see them having runs of success, is at least on a leash.

Those who are not happy with the constraints of others whom they regard as lower mortals will wait until they have a good repuation, have earned enough to fund a new business and talked some colleagues into the joys of escaping the bureaucracy and announce their new business – usually with their name on it.

The implications

Some of what I next propose is based on real events, actual examples and some is based on my own thinking about human behaviour.

There is in my mind no doubt that an intelligent mind is likely to bring an individual into conflict with the objectives and day to day operations of a large international business. Businesses are in effect organisms and their operations are designed to protect the whole in as efficient a way as possible. There is usually no room for mavericks. Who would want to be Elon Musk or James Dyson’s line manager?

Is it best to just let the hotheads go out and make a mess of things?

The most skilled senior managers know how to manage the best and even the most indepenent thinking employees early in their careers but eventually the strong willed individual acquires enough status (the ‘star’ badge) such that they are almost unmanageable. I am not an innocent in all this – my accountant once said to me that he and I were alike in that we were unemployable, meaning we had got to the point in life where we wanted to test our ideas without a hint of supervision. Good fund managers reach that point sometimes.

Some will set up a business with insufficient parallel resources, such as in compliance or sales and marketing and will simply be unprofitable. This is very common and many managers move back into the fold of a fund group that is a little more respectful of them than their past employer and they then run funds in a semi authonomous way, but with appropraite controls. Jupiter, Liontrust. Premier Miton, MAN GLG and others all have managers working for them that have been through that loop and in my judgement that is a positive. They have pulled their horns in a bit but still have individual talent.

Others, and this is where we must take extreme care, in spite of having very few people working with them, see their businesses storm ahead and so they attract billions in funds. You will know some examples: the now disgraced Neil Woodford, the very rich Terry Smith (Fundsmith), Messrs Lindsell and Train, Alexander Darwall (Devon). Others may be less familar – Teviot, Crux and Chelverton, for example. It is perhaps significant that the last 3, although all founded by people ‘setting up on their own’, do not have the founder’s name out up front!

The wrap

In summary, it is no surprise that quite a few top fund managers have strong personalities. This may be what got them to the top, rather than any other special skill. If they find the restraints of corporate life frustrating, they sometimes go off and do their own thing, with or without associates strong enough to rein in their wilder ambitions, whims and personal biases.

Most will fail and return, chastened to the corporate fold. A very small few will succeed and get very rich, which probably means they cease to be actually running money anyway. A separate small number will take a wrong turn or two, refuse to reverse and end up losing an awful lot of other people’s money.

As investors, we need the art of assessing people in general and using that in a common sense way to assess the risks of trusting our money to ‘big personalities’. As a rule of thumb, I don’t trust the breakaway new funds!

Midweek Musings – Spring Sunshine?

6th April 2021 by Mark Potter Leave a Comment

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)

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:

economic recovery driven by vaccination programmes (or low Covid 19 incidence as in China),
US government spending plans and the impact of those on inflation and interest rates,
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.

Watching Brief – April 2021

1st April 2021 by Mark Potter Leave a Comment

Pottering About

As we come to the end of the first 3 months of the year, it makes sense to take time to pick out what has turned out to be different or at least moved on, much as the weather does. There have certainly been some notable changes in the investment market background, perhaps not surprising after a change of government (and huge sigh of relief) in the USA, the real Brexit event and a varied start to the Covid-19 vaccination programmes globally.

This month, I offer for your contemplation a selection of topics where I think recent developments are worth noting and perhaps reacting to in your portfolio construction and review.

What’s new?

These are facts that I would propose are relevant to investors and should be allowed for in portfolio reviews and shorter-term tactical purchase and sales of funds or ETFs:

Sterling on the up

Sterling has appreciated significantly against all other major currencies. I have already commented on possible reasons for that in my weekly posts. This will have cut back returns on overseas investments and gold and on its own generated short term portfolio value reductions.

The tough questions is whether or not this is a permanent reset – my opinion is that for the time being it is and what is more, there is likely more Sterling appreciation to come. A response to that would be to increase ‘home’ weightings in portfolios.

Value makes a comeback

An inflection in the relative performance of value shares has, as I predicted, already happened. The MSCI World Value Index underperformed the main MSCI World index by 17% in 2020, but was up about 4% in the first 2 months of 2021 when the main index was up less than 2% (source: MSCI). Value funds with a bias to small and mid-cap companies have produced outstanding returns over the last 6 months with some UK funds showing returns in excess of 40%.

I don’t believe that is the end of the potential comeback as many assets in this segment are still trading at below long-term trend prices whereas the assets driven by momentum over so many years are still looking very pricey.

SPACS will buy any old company and are coming to the UK – maybe!

It is reported in US news media that regulators are becoming seriously concerned about unsophisticated investors putting their trust in SPACs that they don’t understand just because they are launched with a stuck-on celebrity name label.

As has been the case so often in my lifetime, just when an idea is about to be found out as a hopeless failure in the US, public service bureaucrats and politicians in the UK are promising to introduce it to the British public.

SPACs, another great wheeze to follow on from mortgage backed securities, ‘no win, no fee’, SATs for 7 olds and all other great American ideas that are UK must haves.

I read that there are anecdotal stories of new business owners being practically begged by SPAC fund promoters to ‘allow’ themselves to be bought and “IPO’d”. The flop of the Deliveroo market listing in the UK, because UK investment institutions make annoyingly sensible judgements has resulted in observations about the Americans being happy to take more risk (for that, I would translate ‘are more gullible’).

Balancing this up is the recent evidence that of late even in the USA IPO share prices are no longer going to immediate premiums but in the main falling back into losses very quickly. So maybe credibility is wearing thin even Stateside?

Basically, far too much cash is being pumped around to enrich a small unscrupulous segment of humanity. This is not just in SPAC fund raising, but everywhere in the market where someone else’s money can be used to turn a quick buck or million. That can only end in extra regulations or a crash, or both.

China is a hot topic and risk has become more apparent for investors

It is almost impossible to read serious content from a news or other media source at the moment without finding opinion, research or polemic about China. This commentary comes from many angles, mainly geopolitical: the seriously concerning reports of concentration camps and maybe even genocide of Uighurs, the crushing of any semblance of democracy in Hong Kong, threats to Taiwan, the creeping influence from the “belt and road” initiative, the activities of Chinese military hacker units and so on.

The above all concern me, but from a purely investment point of view, one has to expect China to become ever more important as a place of massive economic activity, with the tricky combination of gigantic consumer markets, huge enterprises, but the ever-present threat of state control.

It seems to me that the investments we probably all have in businesses like Alibaba and Tencent are riskier than we may have thought and we probably did not get them by electing to invest in China, but by picking Asia Pacific, Technology, Emerging Markets and other ‘global’ badged funds.

One way of controlling that risk might be to invest in funds that focus on businesses selling to the ever-growing Chinese consumer base, but which are not Chinese companies – see my comments right at the end.

A tangential point is that US policy has been hostile to Chinese investors for some time now, forcing Chinese owners to disinvest from American businesses. I wonder where they might be re-investing?

Somewhere where the politics tends to be more waffle and the regulator is known to be permanently looking the wrong way? Answers on a (small) postcard, anyone?

How much debt is funding equity markets?

The collapse of a US based hedge fund that had borrowed vast sums from an assortment of banks that appear not to have known that they were not a sole lender has caused a flutter in markets because the shares being used as collateral for the ‘punts’ of the particular, apparently not very respectable, hedge fund operator were dumped in the market as the banks tried to be first to get what money back that they might.

This might be a ‘one off’ but it could be a signal of underlying issues of some magnitude. If that were to be true, a 2007/8 like chain of events might be about to come to our screens as a sequel – sort of “Bear Stearns 2 – the bankers never learn”. Almost poetic.

Digging Deeper

Emerging Markets – not so emerging?

Emerging markets investment has been something that I introduced my clients to when I was working as an IFA, now maybe some 30 years ago, even before anyone talked about “BRICS” or thought it would be possible to invest in China. One of the first funds I ever recommended was the JP Morgan Emerging Markets fund and that is still going strong. The Templeton Emerging Markets Investment Trust was launched in 1989 and was run for some years by the legendary Dr. Mark Mobius, who was bold enough to venture into Russian oil company shares and act as main board director of a leading Russian oil company after the end of the Soviet Union, amongst many other forward looking decisions.

Since then some of the countries that one might have automatically assessed as eligible for an emerging markets fund have very large economies and are the bases of some truly global size businesses – South Korea being an obvious example. China will also be the home market of many companies in emerging market funds, even if the shares are listed on Western stock exchanges, with businesses like Alibaba, Tencent and AIA insurance (Hong Kong based) appearing in funds top 10 holdings almost by default.

Investment in India can also be in businesses that we know are operating extensively in the UK like Tata (owners of Jaguar Land Rover), or ICICI Bank.

Investing in emerging markets is clearly not now what it was in the 1990s. How can we analyse and break down the potential investment universe?

What do you get in an established emerging markets fund?

Taking the ‘granddaddy’ JPM fund mentioned above as a starting point, Morningstar tells us that the fund’s largest holdings are in Taiwan Semiconductor (8%), Samsung (6%) and Tencent (5%). So that’s nearly 20% of the fund in 3 large Asia Pacific region companies that might well be top 10 holdings in any Asia Pacific or Technology segment funds.

Trustnet tells us that the fund is 46% Chinese Equities, 15% Indian, 12% Taiwanese and 8% South Korean. All the other equities, which include a very small Indonesian element come to less than 20% of the fund. So is Emerging Markets even the right name for this fund? Surely that is more like Asia Pacific? It depends on what you think is the definition of ’emerging’.

Where is the world are stock markets really ’emerging’? I am pointing at Russia – that still qualifies!

Using Trustnet’s fund comparator, I checked this fund’s 3 years historic correlation with one other large Asia Pacific fund and with another Emerging Markets fund that is known for having a slightly different asset mix, both from Fidelity. Unsurprisingly the correlation between the JPM and Fidelity Emerging Markets funds was 0.95, very high. But the correlation between the JPM Emerging Markets fund and the Fidelity Asia fund was almost as close at 0.93. The Fidelity Emerging Markets fund, which has less exposure to China and a notable South African content was 0.94 correlated to the same investment house’s Asian fund!

I added the Aberdeen Standard (ASI) Emerging Markets Equity Income fund to the mix and find that it is less correlated with the Fidelity Asian fund at 0.88. Selecting funds with an income objective tends to get you less growth stocks and more value shares. However, it also has around 70% of is assets invested in the Asia Pacific region. The notable difference at present is the ASI fund’s large cash holding.

I conclude that in selecting a mainstream fund labelled as ’emerging markets’ we may actually just end up buying another slug of the same companies we own in our Asia Pacific funds and duplicate several holdings in our technology and global growth ‘stock picker’ or ESG funds.

Are there new truly emerging markets?

It would seem logical to assume that if a country like South Korea has matured in economic terms such that it no longer seems appropriate to consider it as ‘emerging’ in the sense of being much more exciting and adventurous than say the UK, Western Europe or the USA, there must be other less developed economies where we could take the risk and hope for the rewards of being in at the start of a long term growth cycle. Putting it another way, how do we find the next South Korea?

There are indeed such countries and economies. I live in one! Places like the ex-Soviet republics and vassal states are generally classified as Eastern European Emerging Markets. You can think of countries like Poland, the Czech republic, Hungary, Georgia or Kazakstan or even Lithuania, Latvia and Estonia, which have a combined Baltics mini-NASDAQ index..

There are long standing funds focusing on Latin America, although they generally invested almost wholly in Mexico and Brazil initially because of those countries having large oil and gas reserves.

There are ‘frontier market’ funds with scope to invest in Africa (although this is a segment better served with investment trusts) and there are countries on the Pacific rim that are ‘up and coming’ like Vietnam or Cambodia and also India’s neighbours in Pakistan and Bangladesh. There are several states in the Middle East with recognised regulated stock exchanges, including the wealthy Emirates.

There are at least 2 ETFs tracking indices or baskets of shares from these regions. The iShares MSCI Frontier 100 ETF is one such with holdings in 13 countries, the top weighting being to Kuwait.

But they will be more risky, surely?

Indeed, and in several ways.

Firstly, there will be additional higher volatility currency risks (although not in all cases – the Baltic States use the Euro, for example).
There will be liquidity risks: many of these markets have few shares listed and not many market makers. Some will not even have a conventional stock exchange. In theory those risks are reduced if you own an ETF as opposed to funds, because the ETF should be liquid at all times, but that is very much ‘in theory’!
There are risks in assessing value. Accounting data may be poor or suspect. Corruption is a problem in every market of the world, but undoubtedly more of an issue in poorer economies.
There could be extended political risk. Investing in China will often make one a co-investor with the government and as Mr. Jack Ma found out recently, the Chinese state only allows capitalism to run as far as suits its purpose. In other countries, the state may just nationalize an asset without compensation. Having said that the Russian Federation once nationalized an oil company (indirectly) to protect Western investors from a predatory and supposedly criminal oligarch’s banditry!

What should you be worried about if investing in new places?

These are just some of the obvious additional risks. The fund information documents give potential investors more expanded risk warnings.

However, if we are looking for something that will be a small satellite holding and where we want to be in ‘at the start’, we might find those risks to be acceptable, given a good fund manager to at least keep an eye on them.

It is also worth pointing out that some markets are in reality less risky than people anticipate. Only when they visit the countries of former Yugoslavia, the Baltic states or the countries of middle Europe do people fully realise that these are countries that have very long ‘first world’ fully European histories that were simply put on hold for a century by the Communist experiment. Many are very rapidly accelerating their financial and technological development ahead of Western European ‘fat cat’ counties.

In the same way that China became a manufacturing base for Japan, Eastern Europe is becoming a major factory outsource for Germany and a huge retail market for Italy, for example. There are even some home industries that have become highly successful with or without Western European investment – Škoda cars for example (a divison of VW) or EXSPLA lasers in Lithuania – a supplier to 76 of the world’s top 100 universities.

Some examples of alternative (less Asia Pacific biased) emerging market funds

Readers know very well that I don’t make recommendations and most of you have had some guidance from me in doing your own research, so this little list should only be taken as an appetizer to tempt you into some research of your own. I would not even say that I personally would necessarily buy any of them, although I do already own an Emerging Europe fund (managed by my Swedish bank, so not available in the UK).

One difficulty in researching this sort of alternative merging markets fund is that post Brexit, many fund managers will have domiciled their funds in Europe to get a broader market exposure, UK based buyers of such specialty funds being not that numerous! For this reason, I am listing funds that are more likely to be on offer on UK dealing platforms (but you need to check that out!)

Barings Eastern Europe Fund

An old stager in this market, not the best performer relative to the MSCI Emerging Europe benchmark over the long run, but has had good spells. A diverse management team with some names in it that suggest local knowledge!

Jupiter Emerging European Opportunities

When this fund launched I was taken aback by the confidence and rigorous presentation from the then manager (long since moved on), who was Latvian. I never thought that I would one day treat a trip to Latvia much as I used to view a drive to Cornwall or the Yorkshire moors!

This is a value biased fund with maximum holdings in Lukoil (a very Western style Russian oil company) and Gazprom (a Russian government co-shareholding). The holding in Sberbank at number 3 is interesting as this is a company that might one day be in Russia what Alphabet or Facebook are in the USA. Recent performance is poor and you would have to be looking for an exposure to a rising oil price to invest here, or see contrarian merits in the shareholdings.

Templeton Frontier Markets

This fund has a miniscule GBP fund class, suggesting no recognition in the UK, although I can easily buy it in Lithuania. The base currency is US dollars. It is Luxemburg listed. The fund has run since 2008 and Templeton have a long, almost legendary history as pioneers in emerging market investments thanks to Mark Mobius. The fund has a large weighting in Vietnam and genuinely looks like emerging markets funds did 30 odd years back! If you want to be a ‘leading edge’ investor, this might appeal to you but it is right at the top of the funds’ risk scale.

Schroder Small Cap Discovery

This is not specifically an emerging markets fund, but its holdings result in it being classified as such by Morningstar. It has an Asian Pacific bias too but does not have the ‘usual suspects’ in its top 10 holdings. Recent performance is strong. On the negative side, correlation with mainstream emerging market funds looks to be quite high.

Morgan Stanley Global Brands

This is a ‘left field’ suggestion. If one thinks that capitalism has for most of the last century been sustained by rampant consumerism (I do), then one picks investments that will benefit from the direction of consumer spending. There is a well-rehearsed and evidence-based argument that the huge populations of China and India include a very large new middle class that like Western brands, or at least prestigious products (like the rest of us!).

I therefore suggest that one can invest in emerging markets not only as the economies that will produce low-cost goods for global markets, but as economies that will consume high value goods – in quantity, just because the populations are so large.

Sad to say, perhaps, but regulation is also usually weaker in such places and US companies in particular (not to say Brits or Europeans are paragons of virtue) are expert at the use and abuse of marketing to achieve profit maximization when there are no holds barred. I say this from direct experience because when I visited South Africa in 1996 just after the end of Apartheid I discovered that British American Tobacco trained and paid attractive young women to give away cigarettes to teenagers in shopping centres.

So, if your conscience allows it, you can secure your exposure to emerging markets as an investment theme, not by investing in semi-conductor production or T-shirt making, but in whisky, perfume and Mini Cooper sales.

Midweek Musings – Home Advantage?

17th March 2021 by Mark Potter Leave a Comment

My theme this week is the impact of currency fluctuations on portfolio returns. I have been aware of this important factor since I first started learning about investments. I can’t predict currency movements in the short term (a whole industry thrives on playing that game), but I think anyone can assess relative currency risk.

Key principles

Let’s start with some basics. What makes a currency more or less valuable? Here are some of the main reasons:

Security – how capable is the country issuing the currency of sustaining its relative value? A world superpower in economic (not military) terms with open, efficient and highly liquid markets will get the most respect. The USA, UK, Eurozone or Japan offer what are called the ‘reserve’ currencies. China wants to join that list.
Politics – is the government behind the currency respected as prudent and unlikely to borrow beyond the country’s means. Such borrowing might come in the form of ‘printing’ money and if there is more of a currency around, its value may well fall. A reserve currency country has more scope to extend its currency base, but not indefinitely
Interest rates and their anticipated direction (highly significant) – there are always people and corporations and even governments with surplus cash to deposit for short periods, even just overnight. Naturally, that cash gets placed where interest rates are highest and to deposit the cash, you probably need to have it in the relevant currency. So there is demand for currencies issued by countries with higher interest rates on offer. By the way, this fact is the main driver in the price of Bitcoin, which is non-national commodity asset that can be substituted for currency.
Asset prices in the issuing country – if a country has been having a hard time and is thought to have turned a corner, then richer market players will look to pick up assets of all sorts – shares, whole businesses, properties and so on – at bargain prices. To buy those assets they need local currency, so demand will increase. The opposite applies when the perceived prospects for a country turn negative, or just become muddied, which is why Sterling fell sharply after the Brexit vote.

How does that impact on our investment decisions?

How do fluctuations in currency impact investors, in a direct sense?

Most of the time, we will invest in funds, ETFs or shares priced in the currency of the country in which they are issued. Some funds have “hedged’ share classes, but hedging costs money and it not 100% effective, so has not proved popular with retail investors. So if there is a change in the relative value of the currency in which our investment is issued, the value in our investment report, which is in Sterling, will change, irrespective of any other factor.

Imagine we bought GBP1000 of units in a fund that invested only in the USA. Overnight, the value of the fund’s investments goes up while the US stock market is working by 1%. So our investments should be worth GPB1010 next day. Actually, that will rarely be the case.

If the USD dollar went up 0.5% relative to Sterling, our gain would be 1.5% (GBP1015). If it fell 0.5%, our gain will reduce to 0.5% (GBP1005).

Currency values fluctuate by small amounts daily most of the time, but there are exceptions. Generally, there are trends in relative valuation and sometimes (maybe rarely), one can take a view that there is high probability of one currency going up or down relative to another because one is aware of the impact of the factors detailed above.

For example, it was highly likely that Sterling would depreciate between the date of the Brexit referendum vote and the outcome of negotiations and so there was little currency risk for UK investors buying overseas funds. In fact there was a good case for owning no UK investments at all during that period, because there was no direct currency upside in them.

Note the changes in a currency’s relative value will impact on trade and corporate profits, so there is more to understand on this matter, but that is not something we need to cover here.

Sterling as the Phoenix

Anyone who looks at their portfolio regularly will have noticed weaker performance in terms of valuation numbers from global equity funds over recent weeks. This is mainy because Sterling has been appreciating steadily. The UK Pound Sterling index is a measure against a weighted basket of other currencies and it is up from about 127 to 138 since 6 months ago, nearly 9%. That is quite a headwind for valuations of stocks listed in other currencies.

Why is Sterling going up so steadily? There are multiple reasons which fit in with my criteria above.

Should we be carrying the torch for British businesses?

The final ‘doing’ of Brexit has reduced political risk, even if there is no economic boom yet. The success of the vaccination programme in the UK has been taken as implying an early re-opening of the British economy.

Interest rates rising is not likely to be a baked in expectation yet, so that is one NOT yet applicable factor. But there may be a growing anticipation of higher inflation, which would be followed by higher interest rates – the data points that way.

I suggest that main reason is that UK assets have become outstandingly cheap and overseas investors, slighly jaded with the big US tech firms and worried about the huge cash flows into non-profitable new ventures listed on the NASDAQ, are thinking about buying some old fashioned ‘value’ businesses that sell stuff all over the world, make profits and pay dividends (and as an aside, may be ripe for takeover). So I guess that an inflow of foreign capital is one driver behind the appreciation of Sterling.

Now if a lot of other people want to buy UK company shares and our profits from overseas investments are being cut back by a possibly long running increase in the value of Sterling, maybe we should be looking close to home if we are keen on getting some assets at good prices with no currency risk?

That has already quite a reversal of tactics for me. But as J M Keynes suggested, when the facts change, you need to change your mind.

I think UK investments, carefully researched with some of the contrarian techniques I have explained before, would be a logical inclusion on any shopping list for those wanting to put money into the market or bank some profits from their momentum led tech funds. And there will be no direct currency risk!

Midweek Musings – Let’s get started!

10th March 2021 by Mark Potter 2 Comments

It seems to be ‘de rigeur’ to use the phrase ‘Let’s get started’ or similar at the start of a YouTube video and who am I to fight fashion?

This new format will on occasions cover a little more ground than its predecessor but it is still my ambition that you can take it in over a leisurely cup of coffee. More detailed analysis will appear in the subscriber only monthly WAtching Brief, and if requested, by the addition of longer reads to the main permanent site content. There will be plenty of fund specific content to give you ideas to follow up if they are of interest.

I had decided to omit my usual graphics too, to use the minimum of screen real estate because I expect some people will read this on their smartphone, but if that disappoints anyone, please comment as usual. Feedback is welcome and acted upon. The initial reaction I got was that the graphics helped with readability, so I added some in! I will adapt as appropraite if there is more feedback.

This weeks theme – diversifying your equity holdings. How about Fintech?

Inflation reborn?

As I have already explained in recent posts, the yield on US Treasuries has been slowly climbing, such that the long end of the yield curve is around 1.5%. This has been happening for about 6 months but a whole swathe of data on inflation has made market participants begin to accept that higher interest rates are coming in the medium term. Central bankers are doing their best to suggest that they are in no hurry to raise rates, but some of the inflation numbers are striking.

I saw a presentation earlier this week, a European focused one, where data was presented showing raw material prices increasing annually now at over 3.5% and for some minerals, much faster than that. Food prices are also moving up sharply and most readers will already know about the huge jump in the cost of renting shipping containers. Add to that a big jump in crude oil pices and a massive overhang of consumer savings on deposit at banks, likely waiting to be spent as soon as the world opens up to travel and shopping, and predictions of significant price inflation seem logical.

Asset class selection

As most of my readers will know, rising interest rates are bad news for fixed income investors, because the value of securities already issued moves in the opposite direction to interest rates. Precious metals, if not in demand in industry or for retail consumption, will also lose value because they have no yield. Deposits of cash will earn better returns but initially that is almost bound to be below the rate of inflation.

This classic model of a lower risk diversified portfolio from around 3 years back now looks seriously in need of revision, although many components will have done well enough

Of the major asset classes. one is left with equities and physical property. The latter is an asset that could do well if the actual properties are carefully selected but most mature funds will own too many retail shops and conventional office blocks and not enough logistics warehouses and server farms.

I am sure that everyone reading this owns a good range of equity based funds, probably with core holdings in the major markets of the world and some tactical sattelite picks. Looking to add further diversity to this asset block is worth your attention, given that the alternatives are not attractive and the track record of complex derivatives driven absolute return funds is in the main absolute in the sense of being absolutely awful!

Is now the time right for Fintech?

Funds investing in financial businesses have been around for years, mainly owning banking, insurance company and wealth management company shares. That makes sense because financial services is a huge part of some economies like the UK and those sort of busineses are subject to very high levels of regulation, so must surely be less risky (post 2008).

But the application of technology to financial services is making as much difference as the application of steam power did to agriculture a couple of centuries back or the invention of mass production did to the availability of motor cars. Can we invest in that process of change? Of course we can and the overall shorthand is Fintech.

There are not so many financial funds on offer to retail investors but I found a few (not all will be on your favoured trading platform – that is another thing to check).

Below is a downloadable link to a Trustnet fund comparion I prepared, using the well known Fundsmith global equity fund as the benchmark, which I think is realistic. The funds I chose are really quite different in character and the correlations not too strong, bearing in mind that these are all equity funds with a global stock universe.

Example-Financial-Funds-vs-Fundsmith-1 Download

As always, I am not recommending any fund and I would suggest that you take a look at the top 10 holdings, recent volatility and the typical market capitalisation of the holdings (using the Morningstar Equity Style box) because they will demonstrate quite a difference between the funds.

Jupiter actually offer 2 funds with the same manager. One is a very old fund – Financial Opportunities, the other (Financial Innovations) much newer. The innovations funds fits my idea of Fintech, but is much more risky, with the usual potential extra return and risk of heavier losses.

Im addition to the 3 in the chart, I also found these funds:

Jupiter Financial Opportunities – widely available UK listed, diverse large cap growth fund
Fidelity Global Financial Services – Luxembourg listed, mega cap bank and insurance led value fund
Black Rock World Financials – Luxembourg listed, similar to Fidelity with more bias to insurance companies
ASI Financial Equity – small UK listed fund, looks quite diverse , no named manager

There are of course Fintech ETFs (there are ETF’s for just about anything imaginable as a legitimate investment!), but I could find none offered with a UK domicile and only one with an Irish domicile, trading in US dollars and tracking the KBW NASDAQ Financial Technology Index.

Many of the real Fintech businesses are not unlike other new generation technology companies in car sharing, food delivery, internet gaming and so on. In other words, they don’t yet make profits, may be run by very charismatic people who frequently come from countries well East of London and survive on endless funding rounds. So investing in the innovative end of the financial services sector would have to be classified as high risk. But some very mainstream funds from investment houses like Baillie Gifford have been backing businesses that look pretty similar, as have many individuals with their ‘free’ trading apps. The latter may be a permanent feature of stock market pricing, so some suggest and that will help support more adventurous businesses and their share prices.

Other companies, especially those in internet shopping and money transmission services are longer established and profitable.

I repeat that I am not recommending an investment in this area to anyone, that is not my function, but I am suggesting it is an interesting area for research.

I can say, only in the interest of transparency, that I have invested in the Jupiter Financial Innovations fund. It is not uncommon for me to dip my toe into the water after completing a research exercise. Some times I wish I had not!