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AJ Bell – High yielding trusts: are the rewards worth the risks?

Please see article below from AJ Bell received 17/09/2020.

High yielding trusts: are the rewards worth the risks?

Investors hungry for income could find some opportunities once they’ve fully understand the business models of alternative investment trusts

Thursday 17 Sep 2020 Author: Hannah Smith

 Investment Trusts

Many investment trusts offer high yields which might tempt some investors in the current environment. But are they more trouble than they’re worth?

Some may be worth pursuing, while others can have complex investment models and come with underappreciated risks.

HOW MUCH CAN YOU GET?

Data from the Association of Investment Companies implies there are numerous investment trusts offering yields of 8% to 12% or even more, but the areas in which they invest are quite esoteric.

Doric Nimrod Air Two (DNA2) and Doric Nimrod Air Three (DNA3), for example, are trusts which buy aircraft and then lease them to airlines, while Tufton Oceanic Assets (SHIP) leases ships.

While investing in the Doric funds is really a binary bet on the survival of its main customer, state-owned airline Emirates, the Tufton fund has a more diversified portfolio of ships, although it has been affected by changing supply and demand and disrupted global trade due to Covid-19.

Miton fund manager Nick Greenwood owns Tufton in his portfolios, benefiting from its 8.6% yield. He says the assets have ‘residual value’ as scrap steel even if their value depreciates.

SPECIALITY FINANCE

Many high-yielding trusts borrow money to increase the pool of cash available to invest (known as ‘gearing’) and then use that money to invest in other people’s or companies’ debt. This web of involvement in the debt space may not appeal to risk-averse investors.

Volta Finance (VTA) is involved in corporate credit, mortgages, and auto and student loans, while Honeycomb (HONY) focuses on asset-backed consumer, property and small business loans.

Blackstone/GSO Loan Financing (BGLP) and Volta are among those trusts investing in collateralised loan obligations (CLOs), a single security backed by a pool of debt. Investors get geared exposure to leveraged loans which amplifies the risks.

Packaged loans played a key role in the events that caused the global financial crisis, so they will sound unpalatably risky for a lot of investors. But Sachin Saggar, an analyst at Stifel, says CLOs held up quite well throughout past crises.

‘If you look at how CLOs behaved in 2008, they actually came through quite well. They ultimately recovered all their losses plus more. But what you get with them is more volatility and risk.’

Greenwood at Miton says he is ‘nervous’ about some alternative lenders which have relatively new and untested business models. ‘Some of them seem to have run into problems lending money to people that decided they didn’t want to pay it back in benign conditions, so I wonder what’s going to happen in tougher conditions,’ he comments.

FURTHER USES OF GEARING

More mainstream trusts that offer high yields are Aberdeen Standard Equity Income (ASEI)Merchants Trust (MRCH) and Chelverton UK Dividend (SDV), in the UK Equity Income sector; and Acorn Income (AIF), in the UK Equity & Bond Income sector.

These trusts can pay high yields because of their use of gearing. Greenwood comments: ‘If a trust draws draw down some debt, they can actually pay out a much higher yield using the investment trust capital structure, but obviously that speeds up the rise or fall in the net asset value. You should always look at the leverage.’

HIGH YIELDS FROM PROPERTY

There are also property funds in the list of high-yielding trusts, such as Regional REIT (RGL), which was, until recently, yielding more than 11% through investing in commercial property such as offices and industrial building outside the M25.

Unfortunately, last month it reduced its quarterly dividend by 21% after adopting a more conservative approach during the pandemic. That still leaves it on an 8.9% yield based on guidance for dividends for the rest of the year and the ones already declared.

Real Estate Credit Investments (RECI)Starwood European Real Estate Finance (SWEF), and ICG-Longbow Senior Secured UK Property Debt Investments (LBOW) also feature among the highest-yielding trusts. They provide loans to commercial and residential assets at low loan-to-values.

Saggar notes it is currently hard to value property assets, so these trusts have traded down, however, he thinks their yields ‘seem relatively robust at this point’.

‘NOT A FREE LUNCH’

So how reliable have these funds been in terms of the track record of their yields, and how sustainable are these sky-high payouts?

Some trusts suspended or reduced their dividend payments in Q1 but have since restarted them, explains Saggar.

In a recent note on CLO funds, Stifel said there were ‘good reasons’ for funds to amend their dividend policies, namely the impact of coronavirus, but that many were trying to sustain payouts. ‘We highlight Blackstone and Volta as being the most cognisant of shareholders’ desire to continue to receive an income,’ it said.

In July, Stifel said Doric Nimrod should be able to keep up 20%+ yields on its funds for longer than expected, despite an uncertain environment.

Payouts overall have been relatively stable across the sector, says Saggar, although discounts to net asset value have widened on some trusts.

‘There are some bargains to be had because people have got rather nervous about some of these very high-yielding trusts, so there are some discounts around,’ notes Greenwood. However, the reason for wider discounts is that investors perceive rising risk, and this is something to bear in mind when looking for high yields.

‘If something’s yielding 8%-plus, there’s a reason why and it’s not without risk. It’s not like it’s a free lunch,’ adds Saggar.

So does holding a high-yielding trust mean investors are signing up for a wild ride? Not necessarily.

‘There is an argument that the high yield will actually smooth the volatility in the share price,’ says Greenwood. ‘But when you get events like the global financial crisis and the Covid-19 crisis, you’re reminded that anything can happen in the short term.’

Please continue to check back for our latest updates and blog posts.

Charlotte Ennis

18/09/2020

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Brooks MacDonald MPS Monthly Market Commentary August 2020

Please see below for Brooks MacDonald’s MPS Monthly Market Commentary from August, received by us late yesterday 18/09/2020:

  • Global equities resumed their upwards trajectory during August, as signs of economic improvement and positive developments on a COVID-19 treatment boosted optimism about a worldwide recovery. Further strains in US-China relations unsettled markets, although there was an apparent ease in tensions late in the month.
  • UK stocks were up during the month, after it emerged that the economy expanded by a stronger-than-expected 8.7% in June from May1 . However, GDP shrank by a record 20.4% over the second quarter2 , which pulled the economy into a deep recession. A renewal of quarantine rules for people arriving in the UK from certain countries pressured stocks, particularly those in the travel sector. The composite purchasing managers’ index (PMI) rose to 60.3 in August from 57.0 in July3 , according to an early estimate.
  • US equities were higher over August. Hopes of further government stimulus – yet to be finalised by month end – optimism about a vaccine and a continued rally in technology stocks propelled the S&P 500 and the Nasdaq Composite indices to record highs. The contraction in second-quarter GDP was revised to 31.7%, on an annualised basis, from 32.9%, although it remained a record slump4 . The composite PMI rose to 54.7 in August from 50.3 in July5 , an initial estimate showed. In a significant change to monetary policy, the Federal Reserve said that it would adopt a more flexible inflation target regime aimed at supporting employment and the economy.
  • European markets moved upwards, helped by signs of economic improvement, particularly in Germany, and optimism about a COVID-19 treatment. However, the UK quarantine rules, which mostly affected European countries, unsettled investors. The composite PMI fell to 51.6 in August from 54.9 in July6 , an initial estimate showed.
  • Japanese equities increased over August, although Prime Minister Shinzo Abe’s resignation, due to poor health, rattled the market late in the month. Stocks made a strong start to August as they tracked gains in US shares and as a weakening of the yen against the dollar boosted exporters. The rises came despite bleak economic news: GDP shrank by a record 7.8% over the second quarter, which pushed the country deeper into recession7 . The composite PMI was unchanged at 44.4 in August8 – remaining in contractionary territory – an initial estimate showed.
  • Asia-Pacific stocks (excluding Japan) made gains over the month on continued signs of economic improvement, particularly in China. The US-China tensions restricted the increases. In China, a rise in exports and reduced factory price deflation in July boosted optimism about an economic recovery. The same optimism helped push South Korea’s Kospi Index to a two-year high during the month. Taiwan’s Taiex Index came under pressure after a sell-off in technology shares. Australia’s benchmark S&P/ASX 200 Index was little changed as optimism about a vaccine was largely balanced by continued worries about COVID-19 infections in the country.
  • Emerging markets edged up over August, on optimism about a vaccine and as US-China tensions appeared to ease. Indian shares rose steadily, with vaccine hopes helping the BSE Sensex 30 Index to reach a six-month high. Brazilian equities dropped on renewed political uncertainty as the resignation of a number of top economic officials imperilled planned reforms. Equities fell in Argentina as the country battled rising COVID-19 infections.
  • Benchmark yields on core developed market government bonds – including the US, UK, Japan and Germany – rose over the month. US benchmark 10-year Treasury yields hit a record low closing level of 0.52% on 4 August9 because of market concerns about an economic recovery, although they rose steadily over the rest of the month. In the corporate debt market, US investment-grade and high-yield spreads tightened further.

Brief and informative articles like these are an efficient way to take away key points regarding recent market developments globally.  

Please keep reading our blogs regularly to give yourself a holistic and up to date view of the markets.

Keep safe and well,

Paul Green

17/09/2020

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UK equities outperform as sterling drops sharply

Please see below up-to-date commentary from Brewin Dolphin, received late yesterday. The article provides insight into mixed market performance with Covid-19 and Brexit developments noted as current contributing factors. 

Equity markets were mixed last week as markets struggled to gain traction amid a flow of (mostly) worrying news. There was the worsening second wave of Covid-19 in Europe and the announcement of tighter restrictions on socialising in the UK. Then, a potential hitch with the AstraZeneca vaccine, added to increasing worries of a no-deal Brexit. On the financial front, perhaps the most remarkable development was the 3.5% fall in sterling which likely helped the FTSE100 outperform its international peers over the past week.

Last week’s markets performance*

• FTSE100: 4%

• S&P500: -2.5%

• Dow: -1.66%

• Nasdaq: -4%

• Dax: +2.8%

• Hang Seng: -0.77%

• Shanghai Composite: -2.83%

• Nikkei: +0.86%

*Data for the week to close of business, Friday 11 September.

A mixed start to the week

Equity markets in the UK and Europe turned in a mixed performance on Monday despite encouraging news about the resumption of the AstraZeneca/Oxford University vaccine trials in the UK.

The FTSE100 closed 0.1% down on Monday and the more domestically focused FTSE250 rose by 0.7%. Sterling rose 0.76% against the dollar to $1.289, and by 0.42% against the euro to €1.085.

In Europe, the pan-European Stoxx600 gained 0.15%, the German Dax fell by 0.07% while France’s CAC-40 closed up by 0.35%.

In the US, however, the positive vaccine news from the UK helped boost sentiment, as the Dow closed up by 1.2%, the S&P500 rose by 1.27% and the Nasdaq rebounded by 1.87% to 11,056.65.

Analysts said hopes about an early vaccine were tempered by concerns about rising Covid-19 cases in the UK and Europe leading to tighter suppression measures, with a consequent dampening of economic activity.

In early trading on Tuesday morning, UK shares were heading up.

Brexit is back

The developments over the last week have suggested an increased risk of a no-deal departure. And just as in previous bouts of Brexit-related stress, the worse things go, the greater the pressure is on the pound. The fortunate thing from an investment perspective is that this tends to be supportive of UK bonds (which perform inversely to the UK economy), and also UK equities, because of their inverse sensitivity to the level of the pound. In other words, when the pound falls, all other things being equal, most UK equities rise.

This might seem counterintuitive, but the reality is that the sensitivity of even UK equities to the UK economy is generally low and mostly limited to a small number of sectors, such as retail, real estate, home construction and banks. More broadly, the overall market tends to be more exposed to the overseas currencies in which its revenues are denominated. For example, around 75% of the earnings for companies in the FTSE100 come from overseas and so are denominated in foreign currencies. Therefore, when the pound falls, these earnings are worth more in sterling terms and this helps UK equities.

Overseas equities, unsurprisingly, are even more inversely sensitive to the level of the pound as they are both denominated in foreign currency and economically linked to revenues received in other currencies.

Below we show the % change in trade weighted currency, the top graph shows 2015 to present and the bottom chart shows the period from 15 May 2020 to present.

What this means

All of which means that, ultimately, we don’t see Brexit as a material investment risk. Paradoxically, the greater issue for us is how to protect wealth when Brexit risks subside because, under those circumstances, we would expect to see the pound rise and bonds (and possibly equities) fall – again, all other things being equal.

So how do we see Brexit developing? It seems likely that the current standoff is another episode of the brinksmanship that has been exhibited throughout the last four years. The intention of the government is to pressure the EU into making some concessions on fishing and, most notably, state aid. Most outstanding issues between the EU and the UK seem reconcilable, but the state aid point is one the UK government seems to want to push. Why? It seems like the government wants to ensure it can do everything it can to support strategically sensitive industries such as technology and renewables. This idea of a “Made in UK” strategy to match the “Made in China 2025” strategy is what the European’s are afraid of. It seems likely that, when push comes to shove, the UK will be forced to find a way of discreetly backing down – but we can’t be sure.

Covid-19 developments

This also comes with an adverse trend in relative Covid-19 performance as well. America’s renewed surge in cases which began in the Midwest has failed to gather pace while some large states are seeing further improvement. Progress is not universal, however, and as we can see from Europe, a true second wave is likely in the US at some point. But for now, the US case growth numbers are improving which is helpful for Donald Trump as we approach the election in November.

Case growth in the UK, on the other hand, has accelerated. This prompted the government to impose new restrictions that came into effect from Monday to great consternation from the back benches. Evidence continues to point to Covid-19 as a continuing threat with the low rate of hospitalisations during France’s second wave now beginning to pick up. The concern here is that young people are spreading the virus amongst themselves and then introducing it to older generations of their families.

Covid-19 and your investments

Regarding the investment risks of a second wave of Covid-19, we believe that investors already expect successive waves until such time as there is a widely available vaccine. The question from an investor’s perspective therefore is not so much whether further waves come, but what the impact is on perceived valuations.

Understanding how the market reacts to that is not trivial. However, we should distinguish between what we saw in the early part of 2020 which was a shock, from what we might see in future periods, which will be more of an evolution of a known risk.

When we had the shock in March it was largely because the structure of the policy environment and the market were both set up for late-stage economic expansion. That is quite typical for the entry into a recession and is the reason that equity markets react so poorly to the onset of recessions.

On a valuation basis, the loss of a year or two’s worth of earnings is bad news but would not justify the falls seen earlier in the year – hence markets were able to rebound substantially.

With Covid-19 much more of a known-unknown, and with market expectations of ebbing and flowing regional measures to try and slow those waves, we acknowledge that Covid-19 remains an important factor for the market, but it should form part of the ‘wall of worry’ that markets often find themselves climbing.

Wall of worry

The cliché about climbing the ‘wall of worry’ describes the way in which markets are often resilient in the face of known risks. It assumes investors gradually become resigned to the fact that these issues will be resolved in due course and reflects the way in which the overly cautious gradually get sucked into the improving narrative. It is helped by such circumstances also tending to coincide with periods when monetary policy is very supportive.

One more handhold on that wall came from the news that the testing of AstraZeneca’s vaccine has been paused. Although one of the front runners, this was not the only candidate. However, over the weekend it emerged that the trial would resume in the UK and India, but it remains paused in the US.

Also providing a great deal of angst is the planned end to the furlough scheme next month. Chancellor Rishi Sunak is under a great deal of pressure from lobbyists and trade unions to extend the scheme further to prevent a “tsunami” of job losses this autumn.

An extension would not be without international precedent. Germany has announced an extension to its Kurzarbeit scheme, which gives financial aid to employers while allowing them to reduce employees’ hours. It had been scheduled to finish in March 2021 but has been extended for another year. France has also extended its version of the furlough scheme but has tweaked the rules so that employers must reduce hours for workers rather than keep them off work altogether. If the British government is going to follow suit, it is leaving it late.

We strive to update our blog content regularly in order to provide the most relevant and accurate data so please check in again with us soon.

Stay safe.

Chloe Speed

16/09/2020

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Responsible Investing

Responsible investing, socially responsible investing, ESG, Ethical investing, these are all terms you will have seen us use this year in our blog content. You may have also seen these terms in the press lately, as the impact of the Covid-19 pandemic has really accelerated these issues and brought them to the forefront.

Research shows that demand for Environmental, Social and Governance (ESG) and sustainable investment focused portfolios has hit record levels.

As we have stated before, this is something that we believe this is going to become a long-term trend and our aim with our blog posts on this area is to help you understand what this is and keep you updated with movement in this area.

Ethical investing has been a traditionally niche market with limited options however with ESG (environmental, social and (corporate) governance) investment become ever more prevalent and the Covid-19 pandemic, there now seems to be turning point for accelerating client interest in this area.

Brooks Macdonald recently conducted a survey in which they asked 188 advisers whether they thought the current pandemic would speed up a transition to a greener, more equitable society.

The response was an overwhelming yes with 90% responding positively.

Global fund data provider FE fundinfo, also did some research and found that 55% of IFAs increased the amount of client money in ESG investments in 2019 and that more than four-fifths of advisers expected demand for ESG options to rise in the coming year.

Many ‘ethical’ or ‘ESG’ screened funds now outperform the more traditional (aka ‘non ethical’) funds and portfolios. Morningstar data examined almost 5,000 Europe-based funds and found that around 60% of sustainable funds have done better than their non-ESG peers over one, three, five and 10 years.

The focus on ‘greener’ investments may suggest that it’s just the ‘E’ in ESG that is currently in the spotlight however if you look at the impact of the Covid-19 pandemic and even the recent Black Lives Matter movement, these also put the spotlight on the ‘S’ and ‘G’, putting diversity and social equality (including employment conditions and healthcare) up at the forefront and may make people think about aligning their investment preferences (i.e. investing into companies which support diversity and equality) with their own personal views.

Brooks Macdonald also did some research last year in which 800 individuals were surveyed on their views on responsible investing. One of their findings was that interest was high across all age groups, however, it was the individuals under 40 that were the most engaged with this with 94% saying they already used a responsible investment solution or would be interested in doing so.

Responsible investing therefore gives us an opportunity to connect with the next generation of clients. As it’s the future generations who will feel the benefit of living on a ‘greener’ planet.

We have noted recently in our ESG blogs that we expect the regulators to hone in on ESG matters and that assessing client’ sustainability preferences be a key conversation topic when discussing investments.

The FCA has already indicated that sustainability risks should be appropriately considered in the advice process that investment objectives should include the understanding of clients’ responsible investing.

Hopefully, this is further ‘food for thought’ for you to start thinking about how can your personal views and beliefs align with your investment strategy?

We are already actively discussing ESG issues with clients on a regular basis and will continue to develop these conversations and use the feedback in our processes within the business.

Please keep an eye out for more posts on these themes in the future, this is something we are committed to as a business and to help our clients understand.

Andrew Lloyd

16/09/2020

Team No Comments

Brooks Macdonald – Weekly Market Commentary

Please see below this week’s market commentary update article from Brooks Macdonald, which was received late yesterday afternoon:

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Please keep safe and healthy.

Carl Mitchell – Dip PFS

IFA and Paraplanner

15/09/2020

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Legal & General Asset Allocation Team Key Beliefs Blog

Please see article below from Legal & General’s asset allocation team – received 14/09/2020.


Our Asset Allocation team’s key beliefs

Recurring patterns

The day after the UK voted to leave the EU – more than 1,500 days ago – we wrote in our Key Beliefs that “Brexit will now dominate markets for a while longer and be a market factor for years to come”. This week, we cover the latest developments in that ongoing saga and two other recurring issues for markets.

As with all Key Beliefs emails, this email represents solely the investment views of LGIM’s Asset Allocation team.

Rule Britannia, Britannia waives the rules

The result of last year’s election reduced the probability of a soft Brexit outcome, in our view. Since then there has been no real progress in discussions with the EU, so the chances of a comprehensive deal have dwindled further.

The new Internal Market Bill, and the news that the state-aid regime will not be ready until mid-2021, further lower the likelihood of securing a deal. This means that – barring a Parliamentary block, a policy U-turn, or a significant softening in approach from Brussels – we are probably now looking at a narrow range of outcomes between a hard exit and a slightly less hard exit. The difference in economic impact between the two is relatively small, and is likely to be swamped in the current environment by COVID-19 developments and fiscal and monetary policy.

This news is not particularly shocking, as negotiations with the EU have been going back and forth for a while, but investors have woken up to Brexit risks again in the past few weeks. With the market probability of a no-deal exit reaching approximately 80% in our estimates, sterling fell by around 4% against the euro and US dollar.

Looking forward, the narrowing Brexit outcomes should mean sterling’s range is more limited too, so we wouldn’t expect the wild swings in the currency of recent years. We believe the tail risks are also skewed to the upside from here: a no-deal scenario may see a touch more weakness, but a sniff of a deal could stoke a greater recovery.

Israel: the first domino?

The unsettling news for Israel is that COVID-19 dynamics in the country are deteriorating on all fronts, with the government announcing a second lockdown on Sunday. Many had supposed that the economic pain of shutdowns would deter politicians from re-imposing them, but Israel has demonstrated that we shouldn’t rely on that.

The question we need to ask ourselves is whether Israel is the first domino to fall and if Spain and France are the next ones to topple. There are some idiosyncratic differences between Israel and continental Europe, such as in party politics, demographics and behavioural tendencies, but equally it is possible to draw some parallels.

Spanish and French ICU capacity per person is greater than Israel’s but, at current rates of case-load expansion and growing ICU occupancy rates, Spain looks like it may become stretched by the end of September and France potentially a month or so later. That said, the head of the Spanish health-emergencies department believes Spain has already turned a corner for the better in its latest wave.

We believe further full-country lockdowns in Europe are not part of the consensus thinking in markets, so there is a downside risk, but more lockdowns could mean more stimulus too.

Fiscal fail

Hopes for any further fiscal stimulus in the US before the elections darkened last week as a deal proposed by the Republicans failed to pass a Senate vote. Negotiations have become increasingly difficult of late and a failure to pass a deal soon puts millions of Americans in jeopardy.

While there is a wide range of outcomes over the next few months, the risk of the economy stalling in the fourth quarter has risen. The consensus probability of a stimulus deal stood as high as 90% a month ago but, with those odds plummeting, economists will need to embark on a series of forecast downgrades if Congress fails to act. This was also a likely driver of weaker equity markets in the past week, hidden somewhat by the headline news of the technical squeeze in tech stocks.

Both sides still seem far apart on reaching agreement on another round of fiscal stimulus. Republicans do not wish to provide state and local government aid to ‘bail out’ Democrat states, while there is disagreement within the party on the type of stimulus and whether another round is even necessary. Democrats meanwhile voted against the proposals as they contained some ‘poison pills’, such as funds for the coal industry and a tax break for private school costs.

Additionally, the Federal Reserve is having problems with its Main Street Lending programme, designed to help small firms, with only $1 billion of loans out of a total capacity of $600 billion made so far. This means the central bank’s ability to offset an underwhelming fiscal stimulus could be reduced.

The drag on the economy is building, but not yet apparent in the data. The blockages in approving further stimulus should not be seen as a cliff, but an increasingly steep downhill ride the longer the standoff continues.

Another useful article from Legal & General covering the latest developments with regards to Brexit and other recurring issues for markets.

Please continue to check back for our latest updates and blog posts.

Charlotte Ennis

15/09/2020

Team No Comments

Blackfinch Group Monday Market Update

Issue 8, 14th September 2020

Please see below for the latest Blackfinch Group Monday Market Update:  

UK COMMENTARY

  • House prices rose 1.6% in August from July’s level according to the Halifax House Price Index. The annual increase in house price accelerated to 5.2% from July’s 3.8%, hitting its highest level since 2016.
  • Reports suggest that the UK is willing to walk away from Brexit negotiations in mid-October if a free trade agreement hasn’t been agreed upon.
  • A week of Brexit talks conclude with the EU telling Britain that it should urgently scrap a plan to break the divorce treaty, but Boris Johnson’s government have refused and continued with a draft law that could collapse four years of negotiations.
  • A rise in the number of COVID-19 cases in the UK brings fears of a second wave, forcing the government to reimpose some restrictions over social distancing. Daily cases have risen to close to 3,000, from c.1,000 at the end of August.
  • The British Retail Consortium’s figures report that year-on-year growth in retail sales rose 3.9% in August, but city centre shops continue to struggle.
  • UK gross domestic product (GDP) rose for the third month in a row in July, up 6.6%, although this is still 11.8% below January’s level.
  • A report from the National Institute of Economic and Social Research forecasts that the UK economy will emerge from recession at the end of the third quarter.

US COMMENTARY

  • Comments from Donald Trump that he may seek to ‘decouple the US economy from China’ suggest that the trade war between the two nations is far from over.
  • The US revokes visas for over 1,000 Chinese students on grounds of ‘national security’.
  • Initial jobless claims for the week are an exact repeat of the previous week’s number of 884,000. Continuing jobless claims rose to 13.39mln, above analyst expectations of 12.92mln.
  • Once again mutual agreement between the Democrats and the Republicans fails to be reached over details of a further COVID-19 support package.
  • US inflation rises by 0.4% in August, higher than forecast, but below the 0.6% rise seen in July.

EUROPE COMMENTARY

  • Insee, the national statistics institute of France, forecasts that the economy will contract by 9% this year, down from earlier predictions of an 11% drop.
  • EBC President Christine Lagarde announces that monetary policy remains unchanged, but that the bank has to carefully monitor the ‘negative pressure on prices’ that the Euro is exerting.

ASIA COMMENTARY

  • Revised GDP figures for Japan show that the economy shrunk by 28.1% in the second quarter of the year, worse than preliminary estimates released in mid-August.
  • China reports its largest jump in exports in 18 months, rising 9.5% in August compared to a year prior.

COVID-19 COMMENTARY

  • AstraZeneca confirmed that it had halted work on its COVID-19 vaccine, currently in development with Oxford University, after a ‘serious event’ during the trial process, reported to be a member of the clinical trial falling ill. However, trials officially restarted over the weekend.

These articles provide concise well-informed views that cover the whole of the market and are useful to maintain your up to date view of the markets globally.

Please keep reading our blogs regularly to give yourself a holistic and up to date view of the markets.

Keep safe and well,

Paul Green

14/09/2020

Team No Comments

What could make ‘value’ stocks finally outperform tech and ‘growth’ once more?

Please see the below article posted by AJ Bell last week:

Warren Buffett once noted that ‘A pack of lemmings looks like a bunch of rugged industrialists compared with Wall Street when it gets a concept in its teeth’ and those investors who piled in to tech stocks must now ask themselves why they were buying and what they should do after three days of sharp falls.

If they were just buying because they felt everyone else was and were simply looking to flip the paper on to someone else, they may feel pretty exposed and unsure of what to do. If they were buying out of conviction that companies such as FacebookAlphabetAmazonAppleNetflix and Microsoft – the FAAANM sextet which still represents a quarter of the S&P 500 index’s total valuation on its own – have such dominant market positions, shrewd management, strong finances and powerful future cash flow prospects that they deserve even higher valuations then they may be inclined to buy on the dips.

This temptation to run with the narratives that technology stocks are relatively immune to the pandemic and worth premium valuations because of the relative scarcity of consistent earnings growth right now is quite understandable.

But there remains the danger that neither narrative is particularly new and is therefore at least partly priced in to technology stocks’ valuations.

Just look at how ‘growth’ stocks in the USA have wiped the floor with ‘value’ stocks over the past decade and since 2017 in particular. This can be seen by analysing the performance of the Invesco QQQ Trust, an exchange-traded fund (ETF) designed to track and deliver the performance of the heavyweight NASDAQ 100 index (minus its running costs), relative to the iShares Russell 2000 Value ETF, which seeks to do the same for a basket of around 1,400 American small-cap ‘value’ stocks:

Source: Refinitiv data

Since January 2010, the iShares Russell 2000 Value ETF is up by 124% in capital terms, for a compound annual return of 7.8% – so it is hard to argue that ‘value’ has ‘failed’ as a strategy. What is clear is that ‘growth’ has simply done so much better, offering a 490% return, or a compound annual growth rate of 18%, as benchmarked by the Invesco QQQ Trust.

The performance gap between the two stands at a decade high.

But it may surprise less experienced investors to learn that the last decade’s stellar outperformance from ‘growth’ has only just begun to cancel out the prior decade’s grinding period of marked underperformance relative to ‘value’, taking 2000’s launch of the iShares Russell 2000 Value ETF as a starting point.

Source: Refinitiv data

That miserable ten-year showing followed the bursting of the tech, media and telecoms (TMT) bubble, so investors in tech and growth stocks now need to ask themselves whether they should fear a repeat.

Valuation alone is never a catalyst for out- or –underperformance, but it is the single biggest determinant of long-term investment returns (and a decade seems like a suitable definition of long-term). If tech earnings keep growing and surprising on the upside, if interest rates stay low, if inflation stays subdued and the FAAANM stocks use the combination of product innovation and acquisitions to maintain and even deepen their powerful competitive advantages, then many investors will be tempted to dismiss valuation as an irrelevance.

But the trouble could start if regulators begin to take a hand, earnings disappoint (as Big Tech does not prove to be immune to the pandemic after all or the law of large numbers means it simply becomes harder to generate strong percentage growth figures) or the wider economy starts to accelerate and inflation picks up.

None seem likely now but that it why ‘growth’ has done so well relative to ‘value’.

If a COVID-19 vaccine is quickly and successfully developed and distributed, then stocks which are seen as ‘immune’ from the pandemic may be less in demand and seen as less worthy of a premium valuation.

Equally, if growth and inflation pick up, then investors may not be so inclined to pay such premium multiples for ‘growth’ companies, if rapid earnings increases can be acquired much more cheaply along downtrodden value, cyclical plays like industrials, financials and consumer discretionary plays.

Moreover, an increase in inflation could force Government bond yields higher, even if central banks decline to raise interest rates and let inflation run hot, as per the US Federal Reserve’s new ‘average’ inflation target.

Prior periods of rising 10-year US Treasury yields have coincided with attempted rallies in ‘value’ names, so perhaps a return to economic growth and inflation could be the trigger for a sustained period of underperformance from ‘growth’ and ‘tech’ stocks relative to value ones.

Source: Refinitiv data

Please continue to check back for our regular blog updates.

Andrew Lloyd

14/09/2020

Team No Comments

Jupiter Asset Management – Active Minds Blog

Please see Active Minds article below from Jupiter Asset Management – received 10/09/2020

Active Minds – 10 September 2020

Ed Meier – Fund Manager, UK Alpha

Exciting opportunities in UK’s transition to clean energy

When it comes to the transition to clean energy, the UK is well placed with the North Sea, which provides ample capacity to store captured carbon, along with the country’s amazing wind energy potential, said Ed Meier, Fund Manager, UK Alpha and specialist in utility companies.

In fact, energy from wind assets in the UK has the potential to be comparable to Saudi Arabia’s energy production from oil. Saudi Aramco produces around 12.5 million barrels of oil a day while the UK wind, if fully developed, could potentially generate the equivalent of 20 million barrels of oil a day, Ed said. It’s a phenomenal potential asset that would be exportable, and the UK government is very much supportive, he said.

In utilities there is a shift in market appetite related to the move to net zero emissions, Ed says. It’s now a legal responsibility for many governments around the world. In the EU, final energy consumption has recently been 20% electricity and 80% fossil fuels. To get to net zero, those numbers must reverse. This means extraordinary potential growth for an industry that has been shrinking. This provides an interesting opportunity, though with limited areas to invest in the UK, which has sold off much of its utility assets, he says.

There is a one publicly-listed utility UK company that is producing 12% of the country’s renewable energy, and the market is underpricing the stock, in Ed’s view. The company is reducing its cost base as it aims to produce clean electricity without subsidy post 2027. In addition, the company is developing a technology called biomass energy, carbon capture and storage (BECCS). It’s a global pioneer in this area and potentially could be a negative carbon producer (i.e. removing carbon from the air) – a vital step in helping companies get to net zero. Thus, negative emission technology could provide a significant level of value for the company, he says.

We’re all over the opportunities from the energy transition in the UK and believe it’s quite exciting, Ed says.

Matthew Morgan – Product Specialist, Multi-Asset

Fed’s fatal attraction to loose policy

The significance of what Jerome Powell and the Federal Reserve are trying to do should not be underestimated, said Matthew Morgan, Product Specialist, Multi-Asset. The recent speech from Powell could mark a critical break from three decades of central bank behaviour. It doesn’t necessarily follow that we’re going to see inflation rise imminently. What matters for markets is less the specific outcome a few years hence, more the balance of probabilities now. What the Fed plans to do shifts that balance from deflation towards inflation.

Following the ‘stagflation’ of the 1970s, the US Congress gave the Fed three main objectives in the Federal Reserve Reform Act of 1977: maximum employment, stable prices and moderate long-term interest rates, in that order. Since then, the principal target of central banks has arguably been to control inflation.

It’s the first point (maximum employment) that falls under the spotlight now. The Fed’s recent announcement of Flexible Average Inflation Targeting (FAIT) acknowledged that the Fed will do whatever it takes to deliver full employment, even if it means inflation being above the 2% target for a period of time.

Powell’s speech makes it clear that the lessons learned from the past few years are that the economy can sustain a higher employment level than previously thought without risking inflation (effectively admitting that 2018’s rate hikes were a mistake), and that the benefits of higher employment were beginning to be shared more widely across society. In addition, higher inflation is the easiest way to bring debt levels down.

This is a significant change to the Fed’s interpretation of its mandate. While there are many that will look – with good reason – to the significant deflationary pressures out there, for the multi-asset team the key takeaway is that this announcement frees the Fed to keep its foot on the gas for much longer than it could previously.

Joe Lunn – Fund Manager, Gold & Silver

Hi Ho, Silver!

The current bull market in gold and silver is best explained in macroeconomic terms, says Joe Lunn, Fund Manager in the Gold & Silver team. Investors’ disenchantment with the US dollar, due to the US Federal Reserve’s determination to continue to print money, has led them to reassess the merits of monetary metals. Yields on government bonds have become so low that they are unlikely to outpace inflation which means that some government bondholders face losses in real terms. Gold and silver, by contrast, are stores of real value.

During bull markets for monetary metals, silver can often rise faster than gold, says Joe. During recent months, the gold/silver ratio (the gold price per ounce divided by the silver price per ounce) has contracted. Silver has risen more quickly than gold: their ratio has fallen from 124 on 18 March, to 72 on 8 September. Joe expects it go lower still.

Joe believes silver bulls should play the contraction of the gold/silver ratio by investing in shares of mining companies. This allows investors to take advantage of the operational gearing in businesses where costs are largely fixed. A rise in the gold and silver price of about 20% could translate into a rise in a mining company’s EBITDA (net earnings with interest, tax, depreciation and amortisation added back) of more than 30%, he says. He also likes miners that are unlikely to issue new shares (some North American silver miners are prone to such dilutive behaviour).

A government’s attitude to COVID-19 is also important, Joe says. Mexico, for example, has granted key industry status to mining: mines would stay open even if much of the economy goes into lockdown. Peru, by contrast, is allowing companies to make up their own minds: miners might shut production if the second wave of infections continues to worsen. 

While Joe has strong views on the relative merits of individual mining companies, many of whose mines he has visited, he believes they should be held within a diversified portfolio as individual companies are not without risk.

Liz GiffordFund Manager, Global Emerging Markets

It’s not all about technology in emerging markets

Liz Gifford, Fund Manager, Global Emerging Markets, spoke about the opportunities available to emerging market equity investors outside of the large cap tech names that have been in such favour, particularly since the start of the pandemic. Liz and the team have a preference for companies with three key features: a high return on capital, a competitive advantage (protective moat) to protect those returns and the ability to grow while maintaining the high returns.

There are several examples of large, high-profile technology companies in emerging markets that meet those criteria, yet last week’s sharp correction in the US tech names underlined the need for investors to be well diversified across sectors. Liz touched on some examples of areas where the team can find attractive opportunities outside of large cap technology stocks.

One example she highlighted was a car rental company in Brazil with a 35% market share. It is the largest player in its local market, has scale and buys twice as many cars as its nearest competitor. This gives the company significant bargaining power that can benefit customers through lower pricing, which further reinforces the company’s dominant position in the marketplace. Covid-19 has presented challenges for the company, of course, but in the end Liz believes it will strengthen this company’s competitive position as smaller players go under.

On a similar theme, Liz also highlighted Thailand’s leading decorative paints company. The company has arguably already achieved its maximum market share, but Liz and the team see the local market has being underpenetrated both in Thailand itself and in neighbouring countries. Here the competitive advantage is in the paint mixing machine at the point of sale, these are expensive to replace and retail outlets don’t typically have capacity for more than one – keeping competitors at bay. The company’s high return on capital and continued growth potential make it attractive to the team. These are just two examples of the kind of stock opportunities that are available outside of the large cap tech names that tend to dominate passive indices.

Articles like this are useful for getting an insight to the market from market experts.

Please continue to check back for our latest blog posts and updates.

Charlotte Ennis

11/09/2020

Team No Comments

Royal London Economic Viewpoint & Market View Update

Please see below an update received late yesterday afternoon from Royal London which details their current Market View and Economic Viewpoint:

Market view

“The remarkable run of the global equity market continued in August, reaching all-time highs led by the US. The rally has been supported by signs of recovery in underlying economic data and progress in the development of vaccines and treatments for Covid-19. While there was a significant market sell-off at the end of last week, led by technology stocks, US equity indices remain markedly higher than they were at the start of August.

Equity markets were relatively calm for most of August. The VIX index, a measure of expected volatility based on S&P 500 index options, spent most of August hovering around 22 (a six-month low). However, the market correction at the end of last week caused the index to surge to around 37.5 although this has declined towards 30 as I write. For many, US equity markets near all-time highs will seem bizarre, but as I noted in March, markets are forward-looking, and just as they fell sharply as the uncertainty of Covid-19 emerged, so in response to the record monetary and fiscal stimulus they are taking the view that ultimately, there will be a substantial economic rebound. What is interesting is the acceleration of certain trends – notably technology-related areas such as digitalisation. While stocks will see the normal ebb and flow in sentiment, there can be periods where markets over-extrapolate trends, and this can manifest itself in higher price multiples that investors are prepared to pay to own assets with exposure to that trend. While there has been some evidence of these trends starting to emerge in part of the technology complex, underlying earnings growth and cashflow generation have been strong this year, but when this comes with multiple expansion, we need to approach this appropriate caution.

The risk-on sentiment seen in equity markets was replicated in government bond markets, with yields surging globally. Within this, European government bond markets strongly outperformed, while the UK gilt market lagged on anticipation of a massive supply of long-dated gilts over the next few months. One of the key strategies for our government bond funds this year, given the many uncertainties for investors, has been to embrace tactical, rather than strategic, trading around supply events. The next few months should provide ample opportunities for that approach.

Within investment grade credit, spreads (the yield difference between corporate bonds and government bonds) are now only about 0.2% wider on the year, with the average spread 1.25% at the end of August, though there is a lot of sectoral variation within this. Financial bonds (banks and insurance) have been notably strong in recent weeks, which have benefitted our credit portfolios given that they are typically overweight in this area and in particular subordinated financials. The high yield credit market has performed particularly well since the market crash in March, with August being no exception. It looks likely to have been one of the most significant months of issuance ever, with companies keen to take advantage of the high level of demand in the market. Periods of significant corporate issuance are often supported by increased risk appetite for the asset class but can see investors being prepared to accept reduced covenant protections. As fundamental investors we need to be especially diligent when these trends start to emerge and position our high yield funds accordingly.

As we’ve said before, the coronavirus pandemic has changed things forever. Our autumn investment series webinars at the end of September have been put together to look at how these changes will play out in various asset classes. We’re also providing an update on how RLAM functions, not because this is intrinsically interesting, but to give you confidence in how we are operating and have adjusted to this new world. In addition, I’m delighted that we will have Andrew Neil doing a session for us. Andrew has a unique insight into the political process here in the UK. Ten years ago there was an argument that politics mattered less given the consensus that existed at the time. In an age of Brexit and Coronavirus, that is certainly not the case, and I’ll be listening to what Andrew has to say with great interest.”

RLAM Economic Viewpoint

The months of economic recovery post-lockdown, into the early part of the summer were strong, bolstered by the release of pent-up demand. The current phase of the recovery looks more challenging and the pace appears to be slowing in many places. In recent weeks, data has been more mixed. US and euro area business survey data for August indicated growth, but with some survey indicators rising and some falling – sending mixed signals on whether growth is slowing or speeding up. Higher frequency mobility indicators have flattened in several countries over July and August. ‘Hard’ data for July, such as retail sales and manufacturing production, suggest that the pace of growth slowed in the US and euro area, although the latter is not yet available in the euro area. China’s business surveys suggest that the recovery continues, but the pace of improvement in ‘hard’ data series like retail sales has slowed.

Several factors seem likely to help hold back the pace of recovery, especially until an effective vaccine is widely available:

  1. Mandated social distancing;
  2. Damage done/scarring – relating to permanent job losses, permanent business closures and household/business balance sheet damage; 
  3. Fear – of the virus itself, but also of shutdown risks and related risks to job security and around the outlook for the return on any planned investment.

The progress of the virus will affect these (new case numbers have fallen in the US, but are rising in Europe). Governments have a direct role to play in 1); have pumped in a huge amount of economic policy support to limit 2); and through ongoing public health measures and economic stimulus, can help dampen 3).

Over the last few weeks, the role of governments is one area where risks are building, particularly in the US. US monetary policy remains accommodative and the FOMC’s recent adoption of an average inflation targeting framework further underscores that they will be in no hurry to take back that stimulus. Fiscal policy, however, has disappointed. There was some expectation that US politicians would agree a fiscal package earlier in the summer to offer at least some continuity after the provisions of the CARES Act rolled off – in in particular, the boost to unemployment benefits. With election campaigning now in full swing, it is less clear that both sides will be able to come together and pass a package. Another government funding deadline approaches at the end of this month, bringing the prospect of shutdown risk too.

Here in the UK, there are reasons to worry as well. Some temporary government interventions have been a big boost/support to activity, but it is not clear how well the economy will do once they are unwound. Eat Out to Help Out has been a success in getting people eating out, although it is too early to judge whether the effects will last. The heavily used furlough scheme is discontinued entirely in October. So far, the UK unemployment rate has stayed at very low levels as take up of the scheme has been high. That will have helped to shield many households from the effects of the crisis. As that support is unwound, more job cuts are likely as firms reassess their finances. It was notable that in the – generally strong – August PMI business survey, that the employment component remained weak. In their press release, compilers IHS/Markit comment that “lower payroll numbers were primarily attributed to redundancy programmes in response to depleted volumes of work and the need to reduce overheads before the government’s job retention scheme winds down”.

As for inflation, the data has yet to give a clear steer on whether the worst of the deflationary effects of the crisis are behind us. Across many developed economies, July inflation data surprised on the upside. However, euro area inflation went on to surprise on the downside in August, recording a first negative year-on-year print since March 2016 and the next print of UK inflation will incorporate the effects of the VAT cut and Eat Out to Help Out. As for how deflationary/inflationary the crisis will ultimately prove to be, the odds on an inflationary outcome have arguably risen after the FOMC’s change in monetary policy framework. However, “likely” aiming for “inflation moderately above 2% for some time” after inflation has been persistently below 2% – as has been in the US – is not a green light for a high inflation environment. Several other factors, including a boost for online retailing from the pandemic, are likely to work in the opposite direction on inflation.

Please continue to check our Blog content for advice and planning issues and the latest investment, markets and economic updates from leading investment houses.

Please keep safe and healthy.

Carl Mitchell – Dip PFS

IFA and Paraplanner

10/09/2020