Investment Newsletter - June 2013

Investment Newsletter June 2013

Hot Off The Press!

This weekend, we were delighted to be included in the FT Private Client Wealth Management survey. The 46 firms analysed manage a grand total of £150 billion of assets between them.

Despite the firms included being, on average, 10 times larger than ourselves we were satisfied to see that our Balanced Model Portfolio performed better than the average over the majority of timescales. The analysis of the current asset allocation would indicate that our outperformance has been achieved with less risk than most of the other portfolios which is the real acid test of a good manager.

Our client to adviser ratio is 25% lower than the industry average meaning that our advisers can dedicate more time to looking after their clients. In addition, our fee structure seems simpler, includes more services and initial indications show our costs appear lower than average.

So, in summary, better performance, genuinely personalised service and lower costs. Our investment and management team will now fully analyse all the data to identify not just what’s working well but also which areas we could improve upon and what other services that we could introduce.

Withdrawal Symptoms On 22 May the FTSE hit 6,840, its highest level since 1999.

Around this time I wrote an article for Citywire entitled “A Very Strange Bull Market.”

Here is a paragraph from the article: “This feels like the strangest bull market in memory. With stockmarkets around the world getting close to or surpassing their record highs, the over-riding feeling amongst many investors appears to be not excitement, but disbelief. Investors seem to be waiting for the next setback.”

Fast forward three weeks and we have definitely had that setback, with the FTSE closing at 6,336 on 6 June, more than 500 points lower.

As with the very rapid market climb, this fairly steep fall has had a very strange feel about it.

The trigger for what at this stage is still deemed a minor “correction” was remarks from the US Federal Reserve that they might start to reduce quantitative easing later this year should the economy continue to improve.

Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission

Investment Newsletter | June 2013

Some investors believe it is QE which has been driving the markets up, and are worried about what will happen when it is withdrawn. The Fed has always insisted QE would only continue until the US economy can stand on its own two feet and so QE was always going to be temporary.

Unfortunately, it seems some investors have become addicted to it!

These concerns have exacerbated a strange phenomenon we have noted of late: bad news is treated as good news and good news as bad news! Bad economic figures mean that stimulus should continue. Positive reports on the economy make withdrawal of QE more likely.

Over the past few weeks, this has seen both equities and government bonds fall at the same time. Usually, they are somewhat negatively correlated – if stocks fall, bonds tend to rise and vice versa. This shows the distortions in the market provided by QE.

How to react?

Essentially, government bond and equity markets have fallen because the global economy is gradually improving.

It may not feel like it in the UK, but even here we are seeing signs of life. However, in the US and in Japan, two of the three largest economies in the world, growth has improved markedly.

In the case of government bonds including UK gilts, the sell-off is entirely rational and what is supposed to happen in an economic recovery. Should the economy continue to improve, government bonds should drift slowly downwards until their yields, recently at record lows, get back towards normal.

This is because government bonds are “safe haven” assets; places to park your cash in times of crisis. It is natural that yields should rise (meaning capital values fall) as things get better.

However, for equities, if the economy is improving this should normally be seen as a positive. Short term volatility may stay high whilst the effects of QE withdrawal are pondered, but ultimately the better the economy the better the chance that company earnings can grow. We are mindful to always remember that it is the companies that are important in equity investments, everything else is just noise.

The recent sell off in equity markets therefore presents a buying opportunity in our opinion. To that end, we have purchased a FTSE Allshare Tracker fund for most clients, topping up equity by typically 3% of portfolios from tactical cash. We may sell this again if markets get back to where they were three weeks ago.

In our model portfolios, we have typically purchased this fund at a FTSE 100 level of around 6,240.

However, for government bonds we think this may be the start of a slow but prolonged sell off.

Although we don’t hold gilts, we do have corporate bonds in our portfolios, and these could be dragged down by gilts.

Whilst we have changed our portfolio to protect ourselves against this scenario and against rising inflation, we believe now is the time to reduce fixed interest. We have typically reduced by up to 5% of portfolios, instead buying additional commercial property.

Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission

Investment Newsletter | June 2013

Property Improvement We have typically been avoiding property in portfolios for some time until only recently purchasing between 3% and 5% of portfolios.

Whilst commercial property in general has continued to generate an attractive rental yield, capital values have been falling and have all but wiped out the income benefit.

The chart below shows the monthly reports of the IPD UK All Property index over the past few years. The green bars show the income return, which has remained pretty steady over this period.

However, the red bars, which are the capital gains or losses, have varied and since late 2011 they have consistently been below zero. Commercial property has lost capital value each month since then. The blue bars are the total return each month (capital and income).

The trend appears to be changing. In the last month for which we have data, April 2013, the capital loss was just 0.01%. We have also plotted some trend lines on the chart which show the pickup in returns:

Capital values appear to have stabilised. We do not need to see capital growth to see positive returns, only stability. If this remains the case, we expect perhaps 4% to 5% returns from property over the next 12 months.

Property is also highly correlated to the economy. If this continues to improve, we could perhaps see some capital growth further down the line, boosting returns.

Property also has the added benefit of having very low correlation to either equities or bonds. We hope that the addition of property back into the portfolio will both enhance returns and reduce the risk from QE related volatility.

Mike Deverell

Investment Manager

Equilibrium Asset Management LLP Brooke Court Lower Meadow Road Handforth Dean Wilmslow Cheshire SK9 3ND United Kingdom Visit us at www.eqasset.co.uk t : +44 (0)161 486 2250 f : +44 (0)161 488 4598 e : askus@eqasset.co.uk Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission

Market Views | June 2013

General Economic Overview The global economy has generally picked up with the exception of Europe. However, this has caused concern that central banks will withdraw stimulus earlier than expected.

Inflation has subsided generally although it is still above the Bank of England’s 2% target in the UK. Inflation is likely to increase again later in the year.

Asset class key + positive - negative = neutral (normal behaviour)

+5 -5

strongly positive strongly negative

Outlook Equity Markets After the recent setback we have upgraded our outlook, as we believe the prospects for many companies is improving. However, we expect some short term volatility with concerns about QE.

+2

Fixed Interest It is possible that the 30 year rally in government bonds has now come to an end. This could drag down corporate bonds in turn, although certain pockets of fixed interest could still do well. We have reduced our exposure to fixed interest.

-3

Commercial Property Capital values appear to have stabilised after 18 months of falls. If capital remains stable then the asset class could produce reasonable returns from the rental yield. Some small capital growth is possible as the year progresses.

Cash With interest rates remaining at record lows, returns on cash could remain below average for some time.

Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and alternative equity, underweight fixed interest and hold up to 10% in property.

A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.

These represent Equilibrium’s collective views. There are no guarantees. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.

-2

-5