Investment Newsletter - October 2013

Investment Newsletter October 2013

Bouncing off the debt ceiling

By Mike Deverell Investment Manager

Political risk was once something we considered mainly for emerging market investing.

If we want to invest in China or Russia, we have to pay close attention to political risk as the governments of those countries can influence markets in all sorts of ways.

However, politics is now possibly the most important risk factor in investing in any asset class.

Had the US politicians not come to an agreement on Wednesday (16 October), they would have hit their debt ceiling on Thursday, running out of money to pay bills and potentially defaulting on their debts.

The fact that the Republicans in particular were willing to push their country to the brink of default in order to get their own way on healthcare policies is simply incredible.

Whilst the last minute deal averted this nightmare scenario and the US government has reopened, the situation has not been resolved and the (as the saying goes) can has merely been kicked down the road. The compromise reopens the government until 15 January and moved the debt ceiling back to 7 February.

Whilst talks will be ongoing in the meantime, it would not be surprising to see the US government shut down again in the New Year. Even if the debt ceiling is moved again, this has big implications for the US and global economy.

According to Standard & Poor’s, the current shutdown has shaved around $24bn off the global economy, reducing US growth by an annualised 0.6% for the quarter. A repeat of this would be disastrous not only for the economy, but for investor confidence. Markets

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 October 2013

Bouncing off the debt ceiling cont’d

have fluctuated wildly over the past couple of weeks as this situation developed.

Interconnected

The investment world is increasingly interconnected and over the past few years has been driven more by macro events than ever before.

Investment returns are being increasingly influenced by state entities. As well as the situation in America, the Eurozone crisis has gone quiet but it bubbles away in the background. With Spanish unemployment amongst the under 25s being over 50%, and with the situation being little better in other peripheral nations, there will surely be further issues along the way. How the political leaders deal with such issues is crucial.

Investment returns are also being driven by Central Banks, especially the US Federal Reserve. This not only influences bond and equity markets in the West, but speculation about the reduction of its Quantitative Easing (QE) programme had a big effect on emerging markets. One of the main reasons why these markets have underperformed this year has been big outflows due to concerns about reduced liquidity in the States.

One of our objectives with portfolio construction is to reduce the correlation between the different holdings within the portfolio. To this end we have been buying funds over the past 6 months which are less sensitive to changes in QE or political issues.

For example, whilst most fixed interest funds fell dramatically in May and June, our portfolio held up well and more than recovered all losses. They have generally been little correlated to standard corporate bonds and gilts, which was a deliberate move.

We have also been topping up property holdings which, whilst sensitive to the UK economy, are not directly affected by events in the US or Europe. These funds have been totally unaffected by the debt ceiling or “tapering� issues to date and we believe that will continue. Only if these issues have a knock on effect to the UK economy would we be concerned.

Equinox

Within equities, we have increased exposure to smaller companies within the UK which again have little connection with politics in the US. In fact, political changes have actually boosted this sector with recent changes allowing AIM shares in ISAs boosting this part of the market.

We continue to manage portfolios carefully to reduce some of the risks but also to capture opportunities as they arise. We will need to be vigilant and ready to both react to events, but also to be proactive and adapt portfolios well in advance of potential issues.

As it is October you will shortly be receiving the latest edition of Equinox, our half yearly magazine.

This edition features articles on property investing, effective tax planning, and a feature on why the wealthy often receive bad advice.

We hope you enjoy it and welcome your feedback.

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 October 2013

General Economic Overview The UK economy has continued to improve and Chinese data appears to have stabilised after a recent slowdown.

The recent US shutdown will hit growth on the other side of the Atlantic, but the risk of a US default has been averted for now.

Interest rates are likely to remain low for perhaps the next two years, subject to unemployment figures and inflation. We expect inflation to remain above the Bank of England’s target for the foreseeable future.

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

+5 -5

strongly positive strongly negative

Asset Class

Score

Equity Markets We remain positive about equity markets as companies continue to do well. We particularly like emerging markets which have fallen behind developed markets recently and look cheaper based on earnings. We are less positive about US equities which have done extremely well.

+1

Fixed Interest Corporate and government bonds in general have fallen of late, although the funds we hold have held up well. We have increased our score from a -4 to a -2 after these falls. As interest rates are unlikely to go up for some time, this should help prop up fixed interest.

-2

Property Over the past quarter, property has returned the equivalent of around a 7% annualised return, equivalent to our normal expected return. We have been increasing property of late and may do so again in the near future.

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

= -5

Balanced Asset Allocation For a typical balanced portfolio we are overweight equity and alternative equity, underweight fixed interest and are increasing property exposure.

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.

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