Investment Outlook
House View from Informed Choice 4th Quarter 2010
Informed Choice
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About Informed Choice
Informed Choice is a leading firm of Chartered Financial Planners, working with individuals, trustees and business owners to help them to build, manage and protect their wealth.
We were named as IFA of the Year at the Money Marketing Financial Services Awards 2010 and we are three times winners of the Gold Standard for Independent Financial Advice. We were named Best Retirement Adviser at the Moneyfacts Good Advice Awards 2010.
We are a firm of Chartered Financial Planners. This means we have satisfied rigorous criteria relating to professional qualifications and ethical good practice. It means you can be confident that you are dealing with one of the UK’s leading firms that is wholly committed to providing you with the best possible advice, service and support.
Our Quarterly Investment Outlook Report sets out our views on the general investment climate and creates a robust framework for our investment advice decisions. It also enables us to make tactical alterations to our strategic asset allocation models.
To find out more about our investment advice process please visit www.icl-ifa.co.uk/investment.
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Introduction
Dermott Whelan CFP ASIP APFS FCCA Chartered Financial Planner Investment Director
Welcome to the Investment Outlook report for Q4 2010. We publish this document once a quarter to record the findings and thoughts of our Investment Committee.
Our report this quarter comes just ahead of the announcement of potentially massive public spending cuts in the UK. The economy continues to recover, although the risk of a ‘double-dip’ recession has not completely gone away.
Differing views on the outlook for inflation pose challenges for the investment asset classes available.
Within this report we make some bold tactical moves, particularly with Cash where we have gone tactically overweight to accommodate a more cautious position within our portfolios.
We have also decided to be underweight in both Gilts and UK Equities; a move that may appear at face value to be counterintuitive as the two asset classes tend to be negatively correlated over the longer term. Both performed positively in Q3 and it is our belief that cash offers better protection in an equity market adjustment than Gilts. We do not expect a double dip recession, but rather continued uncertainty.
In European Equities, we have made the biggest tactical move, from our previously overweight position to an underweight position. This reflects our view of the prospects for various European markets, with the European sovereign debt crisis continuing to bubble away under the surface. We retain an overweight position in Asia and currently have a weighting three times the strategic benchmark which will be reduced to two times this quarter on valuation grounds.
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All of our tactical decisions and views for each asset class are explained in greater detail on the following pages.
We hope that you find this report interesting and we would welcome your feedback. Please do email us at hello@icl-ifa.co.uk or call us on 01483 274566 with any questions you have.
Dermott 5th October 2010
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Q3 2010 Review and Performance
At the start of the third quarter, we decided to take a less cautious position across the various asset classes. Between 1st July and 30th September 2010, the FTSE rose from 4,916.90 to 5,548.60, a rise of 631.70 points or 12.85%, almost the mirror image of the Q2 fall.
There was a similar rise in the value of the Dow Jones, from 9,773.27 to 10,788.05, a rise of 1014.78 points or 10.38%.
Our moves at the start of the third quarter enabled us to capture a lot of the value increase in risk assets, and this is reflected in both the absolute and relative to benchmark performance of our various model portfolios.
At the same time, Gilt yields fell to historical lows with the IMA UK Gilt sector average returning 3.19% in the quarter ending 30th September 2010.
Investment grade corporate bonds, which are typically closely correlated to the performance of Gilts, returned an average of 4.85% in the three months to 30th September 2010, as measured the IMA Sterling Corporate Bond sector.
We are very pleased with the performance of our core model portfolios, as demonstrated by the figures on the following pages. As before, we benchmark the performance of these three portfolios against a tailored benchmark created based on the strategic positions. This enables us to see the value we are adding through tactical asset allocation decisions and fund selection.
Whilst individual clients will naturally experience individual performance within their own portfolios, we expect that the following is an accurate reflection of actual performance experienced by clients following our models, or variants of our models.
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Informed Choice Cautious Model Portfolio (3/10 risk profile) Informed Choice Cautious
Cautious Benchmark return
Model Portfolio return (period
(period ending 30th September
ending 30th September 2010)
2010)
One year
+9.29%
+8.69%
Six months
+3.26%
+3.12%
+4.72%
+3.77%
+19.19%
+15.60%
Three months Since launch
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Cautious Benchmark:
33% FTSE Global Equity Index 10% IPD UK Property Index 13% Cash 17% Sterling Corporate Bond Index 20% UK Gilt Index 7%
UK Index Linked Gilt Index
Informed Choice Moderate Model Portfolio (5/10 risk profile) Informed Choice Moderate
Moderate Benchmark return
Model Portfolio return (period
(period ending 30th September
ending 30th September 2010)
2010)
One year
+9.84%
+8.47%
Six months
+2.34%
+1.41%
Three months
+5.33%
+4.06%
Since launch2
+21.86%
+16.69%
Moderate Benchmark:
50% FTSE Global Equity Index 10% IPD UK Property Index 10% Cash 9% Sterling Corporate Bond Index 16% UK Gilt Index 5%
1 2
UK Index Linked Gilt Index
4th July 2009 4th July 2009
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Informed Choice Aggressive Model Portfolio (7/10 risk profile) Informed Choice Aggressive
Aggressive Benchmark return
Model Portfolio return (period
(period ending 30th September
ending 30th September 2010)
2010)
One year
+9.34%
+7.50%
Six months
+0.29%
-1.00%
+6.95%
+4.96%
+24.46%
+18.60%
Three months Since launch
3
Aggressive Benchmark:
70% FTSE Global Equity Index 5% IPD UK Property Index 5% Cash 6% Sterling Corporate Bond Index 11% UK Gilt Index 3%
UK Index Linked Gilt Index
Please note that past performance is not necessarily a guide to future investment returns. The value of your investments may go down as well as up.
Data provided by Financial Express. Care has been taken to ensure that the information is correct but it neither warrants, represents or guarantees the contents of the information, nor does it accept any responsibility for errors, inaccuracies, omissions or any inconsistencies herein.
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4th July 2009
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Cash
The Bank Rate remains at a historic low of 0.5%. Within the Monetary Policy Committee, it appears that the majority of members are comfortable with this level of interest, even against a backdrop of sustained higher inflation above the government target.
Andrew Sentence remains a lone voice within the MPC calling for a rate rise. He has been publicly defending his position during the past four MPC meetings by expressing his concerns about inflation, particularly with the VAT rise to 20% being introduced in January 2011. He argues that inflation above the target of 2% into 2011 will be more damaging to the economy in the long run than a pre-emptive interest rate rise. He does concede that price inflation is unlikely to spiral out of control and it is a difficult balancing act.
The British public expect to see a modest increase in inflation, accordingly to the latest Gfk NOP Inflation Attitudes Survey published by the Bank of England. This shows the British public expecting average inflation to be 3.4% over the coming year, compared with a rate of 3.3% predicted in the last survey in May.
The three-month Sterling LIBOR currently sits at 0.73%, pricing in expectations of slightly higher borrowing costs in the near future.
We continue to believe that interest rates will remain low, with only modest increases to the Bank Rate in 2011.
Central Banks remain under pressure from Governments to maintain loose monetary policy. Economic recovery in the UK and other developed nations remains fragile, so higher than targeted inflation could be tolerated for some time without interest rates being forced up which could risk economic recovery.
With the average return on instant access cash savings at 0.77%, and price inflation as measured by CPI at 3.1% for the year to August, savers are guaranteed to make a loss in the current environment in ‘real’ terms.
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Whilst any allocation to cash is likely to be unpalatable to investors in this context, we continue to believe it remains an important part of a well diversified investment portfolio, as well as enabling investors to make tactical decisions as opportunities arise in the other asset classes.
Our House View for cash is to move to overweight from our previous neutral position, to accommodate a tactically cautious position within our portfolios.
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Fixed Interest
UK Corporate Bonds With lending to businesses from the banks remaining limited, Standard and Poor’s have predicted that sales of UK corporate bonds will increase as companies seek alternative ways to raise funds. Since the collapse of Lehman Brothers in September 2008, the issuance of UK corporate bonds has risen by a net £22.1bn. During the same period of time, net lending to British companies has fallen by £59.1bn.
As over 40% of the UK Corporate Bond market is made up of financials, there is a danger that the recent proposals made by The Bank for International Settlements (BIS) in Basel could result in the price of corporate bonds issued by banks falling over the next couple of years due to extra supply. The proposals for higher capital adequacy should make the banking sector more financially stable over the longer term, but in the short term it could face some challenges to get their balance sheets structurally correct and efficient.
The current slow growth and relatively low inflation environment in the UK (even if it is above Government/BOE targets) should be generally good for corporate bonds. Corporate bond managers remain quite positive on this asset class as companies now believe in balance sheet discipline, and avoid leveraging up. Assuming interest rates do remain low for some time, this should benefit the corporate bond market.
It is important to remember that corporate bonds, particularly those of an investment-grade quality, tend to be quite closely correlated to Gilts. A further ‘flight to safety’ could force Gilt prices higher, benefiting existing investors in corporate bonds but making this asset class look less attractive for new investors seeking yield.
Our House View for UK Corporate Bonds is to remain neutral.
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UK Index Linked Whilst the outlook for inflation in the UK remains uncertain, there is now a stronger argument for inflation rather than deflation, at least over the next twelve months.
There are good reasons to fear both inflation and deflation as an investor. A period of deflation would make it difficult to service public and private debt, as it would reduce the amount of nominal income available to do this.
Factors making inflation more likely over the coming months include the VAT increase in January and the Bank of England keeping interest rates low. Factors that could suppress inflation, particularly in the medium term, include the extent of public spending cuts when these are quantified later this autumn.
Our House View for UK Index Linked is to remain overweight.
International Corporate Bonds Companies globally are taking advantage of low interest rates to borrow cheaply, as an alternative to raising equity in often challenging conditions. There is a big margin between the cost of borrowing for the most financially secure companies and those with worse credit ratings. This is also geographically sensitive.
Microsoft managed to sell $1 billion of three year notes with an interest rate of less than 1% in September. The demand from risk-averse investors has seen the yields on high grade sovereign debt being driven down, resulting in a move to investment-grade corporate bonds in the search for higher returns.
The release of banking sector stress test results in Europe this summer calmed investors nerves somewhat, although fears continue to remain in some European markets. The cost of sovereign debt in the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) continues to be high.
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There is a growing interest in the potential returns available from Emerging Markets Debt. We will be keeping a close eye on the new Threadneedle Absolute Emerging Market Macro fund, which has the flexibility for the fund manager to express his highest conviction macro views via sovereign credit, rates and foreign exchange, both on an absolute and relative basis.
We do not typically recommend new funds to our clients and will want to monitor the performance of this fund for at least a year before considering it to be ready to recommend. It is promising to see this fund being introduced with a mandate that could prompt us to consider the inclusion of international corporate bonds within our models again.
Our House View for International Corporate Bonds remains neutral and we continue to exclude this asset class from our tactical positions.
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UK Gilts Yields on Government bonds in the UK and abroad have been falling due to investor fears that there is likely to be minimal economic growth, very low inflation and possibly deflation. Should these fears be proved correct, then UK Gilts could continue to offer some reasonable value. We are more convinced by the story for sustained inflation above the Government target, which would make Gilt prices look quite expensive.
Veteran UK Equity Income fund manager Bill Mott has recently warned that, should deflation fail to materialise, then holders of 10 year UK Government Bonds on 3% nominal yields could experience significant capital losses. He points to government and central bank fear of deflation which will prompt them to take whatever measures are necessary to prevent this from occurring.
Our House View for UK Gilts is to stay underweight.
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Equities
UK Equities Business volumes in the UK financial services sector have grown by the fastest quarterly rate since June 2007, according to a survey from the CBI. However, there remain concerns that tighter regulation and weak levels of demand could restrict continued growth during the next year.
The fear of a double-dip recession has kept UK markets quite volatile so far this year, with the usual slow summer trading period coming to an end in September with a more active stockmarket.
A lot has already been done to get the UK economy back on track, and once the findings of the next scheduled Spending Review have been announced this quarter, the markets should be able to look forward with a greater degree of confidence. Stock markets like nothing more than ‘certainty’ and vice versa, but this often leads to over valuation. We believe UK equities offer fair value at P/E of 14x next years earnings and good value relative to bonds.
Our House View for UK Equities is to be underweight this quarter, from our previous neutral position.
European Equities The recent fall in Irish GDP is a timely reminder that the European sovereign debt crisis is not finished. Their GDP fell by -1.2% in Q2 2010, after the Irish recovery only recently came out of recession, with eight quarters of contraction. The estimated bail out cost of Anglo Irish bank is currently €30 billion, equal to a years tax take!
For the year to date, this means the Irish economy has shrunk by -1.8%. As a result, the market now feels the Ireland is more likely to default on its debts than Vietnam, with a record rise in Irish sovereign debt yields to 4.67% and Credit Default Swap rates over 5%. This is still markedly below the 14% we saw in Greece earlier this year.
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Despite assistance from various agencies, including the International Monetary Fund (IMF), the markets continue to view various countries in Europe as incredibly risky from a sovereign debt perspective, particularly Greece, Spain, Ireland and Portugal.
We continue to favour fund managers who are selective when it comes to this asset class, as the Country risk needs to be fully analysed and understood before a position is taken. This highlights the importance of an active fund management in this region, and explains why we do not adopt a passive approach in Europe.
Our House View for European Equities is to go underweight from our previous overweight position.
North American Equities The US economic recovery remains very weak. Whilst the latest data from the National Bureau of Economic Research (NBER) has confirmed that the United States officially left recession in June 2009, other data has shown slowing performance, notably in output and employment.
The Organisation for Economic Cooperation and Development (OECD) has forecast that US economic growth will remain low “for some time�. They note the damage inflicted on the economy by the financial crisis and the significant loss of household wealth between the middle of 2007 and early 2009. It could take another couple of years before domestic demand returns to pre-crisis levels, and this is likely to restrain growth.
Now that the homebuyer credit has been withdrawn, home sales in the US are suffering. The National Association of Realtors (NAR) recently reported a 19% year-on-year fall in American home sales for the year to August. This was contrasted by four-month high in housing starts, reported by the Commerce Department.
Our House View for North American Equities is to be remain neutral.
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Japan Equities The Japanese government is working hard to make their exports look more attractive, with a recent move to cheapen its currency. This move was criticised by finance ministers in the Eurozone, who do not feel that unilateral actions are an appropriate way to deal with global imbalances between exporting and importing nations.
The attempt by Japan to boost its export-led economy has involved selling yen and buying dollars. This move should devalue the yen sufficiently to make the price of good competitive for Japanese exporters. Exporters in Japan need help at the moment, with their exports slowing for a sixth consecutive month in August.
There are fears that the Japanese economic recovery could be running out of steam. Even with the measures to devalue their currency, the yen remains stubbornly at a 15-year high against the dollar.
Japan remains embroiled in a political dispute with China, mostly recently concerning China’s decision to end the export of rare earth materials to Japan. It is hard to see Japan emerging as a ‘winner’ from any political dispute with the economically more powerful China. As China is the top destination for Japanese exports, a worsening political situation could result in even slower export-led economic recovery.
Our House View for Japanese Equities is to go underweight from our previous neutral position.
Asia ex-Japan Equities Barclays Capital recently lifted their growth forecasts for the Asia excluding China region to 8% in 2010 and 6.2% in 2011.
It was interesting to see the move made by Alliance Trust recently, reducing their holdings in UK listed companies to less than a third and switching into Asia and Emerging Markets. This saw their exposure to Asia increase from 13% to 20%. They continue to have a positive view for the outlook of equity markets, seeing the better prospects for growth in Asia justifying the higher valuation.
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One concern for this asset class is the potential for slowdown in Chinese economic growth. The Chinese government is working hard to slow the pace of growth, to make it more sustainable over the longer term. This combined with an uncertain outlook in the US could hurt Asian companies who rely on these two major markets to but their exports. Domestic growth is the stated aim of most emerging economies, including China.
Our House View for Asia ex-Japan Equities is to remain overweight.
Emerging Market Equities There are plenty of reasons to be optimistic about the prospects for emerging markets. These include supportive demographics and improving standards of living giving a new dimension to growth in the form of domestic demand. Over the past couple of years a wider gap has appeared between the performance of developed and emerging market economies, leading many fund managers to conclude there has been a seismic shift in attitudes towards investing in these markets.
Piero Ghezzi, head of economics and emerging markets at Barclays Capital, believes there is room for further market outperformance by emerging markets, and this should reflect their continued economic outperformance. Barclays Capital has recently lifted its growth forecasts for the region. They see Latin America as a region with particular potential, lifting their growth forecasts by 0.7% to 6.2% in 2010 and by 0.3% to 4.3% in 2011.
The investment story from Brazil remains positive, with the largest company in Latin America (Petrobras) recently making history with a $70 billion capital raising exercise in a share sale. This was the largest share offer in Latin America to date and almost twice as big as all of the mergers and acquisitions made in Brazil last year.
The Brazilian securities exchange BM&F Bovespa became the second largest exchange in the world in September, in terms of market capitalisation. It now sits behind the Hong Kong Stock Exchange in terms of size.
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Whilst Brazil and other Latin American economies are largely reliant on China for their trade, we believe that there remain investment opportunities in these markets, particularly in comparison to many Western economies where growth prospects remain stilted.
Our House View for Emerging Markets Equities is to move from neutral to overweight.
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Property
The UK commercial property market has slowed down over the summer. Prospects of a £1 billion property sale by Kuwaiti sovereign wealth fund St. Martins Property Corp, in both London and Europe, should wake up the market here in the UK and get things moving again. St. Martins plans to start focusing on larger property assets in London and other major European cities.
The prospect for interest rates to remain at their historically low levels should see banks increasing their lending to property investors, which would also help the market. Until now, the banks have preferred to rebuild their balance sheets rather than lend out capital to businesses. Assuming interest rates can remain low into 2011, we would hope that net lending will improve at the end of this year.
The news that Fidelity Investment Managers has purchased several UK commercial properties, in an expansion of their portfolio to gain greater diversification, is a sign of their confidence in this asset class. They have purchased three industrial sites and three offices, as well as some other individual property assets, in a deal reported to total £85 million.
Whilst a ‘double-dip’ recession could hurt the UK commercial property sector, particularly if it results in more retailers going bust in the New Year, we feel that the chances of this have continued to decline and rental yields are relatively attractive again. Occupancy rates are a key investment metric and appear to be stabilising.
Our House View for Property is to remain overweight.
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Current House View
§
Cash – go overweight from neutral
§
UK Corporate Bonds – remain neutral
§
UK Index Linked – remain overweight
§
International Corporate Bonds – remain neutral
§
UK Gilts – remain underweight
§
UK Equities – go underweight from neutral
§
European Equities – go underweight from overweight
§
North American Equities – remain neutral
§
Japan Equities – go underweight from neutral
§
Asia ex-Japan Equities – remain overweight
§
Emerging Market Equities – go overweight from neutral
§
Property – remain overweight
The terms ‘overweight’, ‘neutral’ and ‘underweight’ represent our view of tactical asset allocation adjustments to a well diversified strategic portfolio.
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