Investment Newsletter - March 2013

Investment Newsletter March 2013

Spread Your Bets We are very pleased to see equity markets continue to rise, with the FTSE 100 closing above 6,500 on 11 March.

Clearly this has a very beneficial effect on portfolio values and the decision to be “overweight� equity for most clients made a real difference to performance.

We still believe there is value in equity markets and therefore have been generally recommending staying overweight for the time being. However, as markets continue to rise, this is making equities less attractive in general. Whilst we really like seeing higher values, the rapidly rising equity market is actually making our job more difficult!

Portfolio Construction When constructing a portfolio there is an in depth process we go through to select all the asset classes and funds we think are appropriate.

At all times we must remember that, no matter how confident we are in an asset class or fund manager, we could be completely wrong! As a result, our eggs are in several baskets, trays and other containers!

We might think that equities look utterly compelling value, as we did when markets were below 5,500 in 2011. We might even think there is little value is any of the other asset classes. However, we would never have put 100% of our client’s hard earned money into equities. If we had been wrong, then the results could have been disastrous.

Even a mistake in timing, where we make a correct call but are way too early, could have serious consequences in the short term. What if we bought at 5,500 and markets went to 4,000 before they recovered? What would be the effect on client confidence, or the income of those who require it?

Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | March 2013

This means we always have to diversify a portfolio, holding assets that either have low correlation with equities or no correlation at all. Sometimes we even want to hold assets that are negatively correlated, and would rise in value if equities fell!

Our aim with each holding outside of the equity part of portfolios is therefore twofold. Assets have to a) be likely to make money in our opinion and b) hedge our equity risk.

In the current climate, finding such assets is becoming more difficult. We are increasingly having to choose between assets we think will make money OR will hedge the portfolio. It is very difficult to find assets that will do both.

This is partly because government and corporate bonds which traditionally filled both of these roles have become expensive. Government bonds may hedge the portfolio but we think they will probably lose money over time.

Conversely, the higher risk end of the corporate bond market may still make some reasonable returns but these bonds have become more and more correlated with equities.

Innovative Solutions We have had to become more innovative, for example using the Defined Returns products which will provide a fixed return if the equity market doesn’t fall below a certain point. These have some of the characteristics of fixed interest and have produced some very good returns to date, but have more correlation to equities than we would like.

We don’t really want to create more of these products at current market levels, and with much lower rates on offer from the banks.

We also recently bought a global inflation linked bond fund for most clients. This we do not expect to make a great deal of money, but being very high quality bonds should provide some protection if equity markets sell off. It should also provide a hedge against inflation rising. In some ways we hope this fund does not do very well! However, we do expect it to beat cash returns, the other main requirement.

Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | March 2013

Other ways we have tried to diversify portfolios in a more innovative way include using so-called “absolute return” funds. We don’t like this term as it implies the fund cannot lose money. They can fall in value, but they have the ability to make money in a falling market as well as a rising market, provided the fund manager gets their calls correct. We prefer the term “alternative equity” for this type of fund.

Most portfolios hold more alternative equity than in normal conditions, as it gives us exposure to rising equity markets whilst being generally more defensive should the markets pull back.

We can also buy absolute return bond funds, where a fixed interest fund manager can make money (if they position their fund correctly!) from falling values as well as rising values. Perhaps we should call these “alternative fixed interest” funds! We do not hold such a fund at present but may do so in the future if we become more concerned about fixed interest.

Traditional Diversifier One of the traditional diversifiers that has historically provided a return with low correlations to equity has been commercial property. We have avoided this asset class for the past year or so, as property values have been falling.

Property performance is very much linked to economic performance and so whilst the economy has suffered, so too have property investors. In times of crisis property can become more correlated to equity as they are both linked to the economy, but in more normal markets they act very differently.

As the economy improves, we are likely to want to invest in property again, particularly as it also provides an effective inflation hedge. The majority of returns should come from rental income, but capital values need to stabilise before we will consider investing. There are signs that they are beginning to do so.

However, the opportunity for property investment is not yet compelling enough for us to take the risk. This leaves us in a quandary if we need to take some more profits and reduce equity risk, or if we feel that fixed interest could turn negative. In the short term, we may need to hold more cash within portfolios.

Should we decide to hold cash it would be a short term move. If equity markets pulled back, this could be an opportunity to put more back into shares, or create more Defined Returns.

Alternatively, we might hold it until an opportunity in property, or another asset class, arises.

After a good run of performance we are determined to protect your gains, whilst maximising the chance of more growth.

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 Services Authority. Equilibrium Asset Management is entered on the FSA register under reference 452261. The FSA 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 | March 2013

General Economic Overview The global economy has generally picked up, with emerging markets and the US growing relatively strongly. Challenges remain, particularly in Europe and the UK. Inflation remains high and we are concerned that it could move significantly higher. Interest rates are unlikely to rise for some time, and more quantitative easing is possible in the UK.

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

+5 -5

strongly positive strongly negative

Equity Markets We remain positive taking an 18 month view, based on company valuations. After a fantastic run, we have reduced our score to “neutral� and have typically banked some gains in portfolios. We are less positive towards the UK market than we have been.

Fixed Interest After a strong run in corporate bonds we believe returns will tail off. We are avoiding conventional Gilts whose values have been inflated. We are increasing exposure to inflation linked bonds.

Outlook

0 -3

Commercial Property Commercial property prices have been falling over the past 12 months or so but this appears to have slowed. The rental yield remains potentially attractive and as the economy picks up we will look to re-enter this asset class. We have upgraded our score from a -5 to a -3.

-3

Residential Property

-5

We believe prices are likely to remain largely flat over 18 months.

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, neutral fixed interest and hold no 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.

-5