Profile: The secrets of Nick Train’s investment discipline
The VIX: Are markets in a bubble of faith?
Sector Focus: IA Europe ex UK
Have we learned nothing from the financial crisis?
Learning the lessons of the past decade
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Welcome to the latest issue of FE Professional – we hope you all had a great summer and are gearing up for the final quarter of the year. A financial magazine coming out this time 10 years ago might have covered the growing problems in the US subprime mortgage market – especially after a “complete evaporation of liquidity” forced BNP Paribas to close some of its funds. These fund closures, which took place on 9 August 2007, are widely considered to be the start of the financial crisis. A decade later and we are still living with the consequences of the game-changing events that followed. The cover story in this month’s issue asks what lessons should have been learned from the crisis – and if investors have indeed taken them to heart. There’s some sobering points made by the investors we spoke with. While some improvements in the regulatory system have been made over the past 10 years, there is growing concern that the response of governments and central banks to the crisis – essentially flooding markets with extra liquidity – could be creating the very conditions of the next crash. It would have been nice to write a feature on the 10th anniversary of the crisis that concluded everything is fine and all the danger is firmly in the past, but that sadly doesn’t seem to be the case. It’s not all doom and gloom though. Elsewhere in this issue of FE Professional, we speak with FE Alpha Manager Nick Train to find out the secrets behind his ultra long-term investment approach while Standard Life Wealth highlights some of the key positions in its portfolios. We also have an FE Analytics Masterclass on price types and charges as well as an explanation of the latest changes to the FE Investment Approved List, which saw CF Woodford Equity Income dropped in favour of CF Woodford Income Focus. All the best,
Nick Train began his career as an investment manager at GT Management in 1981, having graduated from Queen’s College, Oxford with a degree in Modern History. He left GT in June 1998 after 17 years, upon its acquisition by INVESCO. At his resignation, he was a director of GT Management (London), investment director of GT Unit Managers and chief investment officer for pan-Europe. Train joined M&G in September 1998, as a director of M&G Investment Management. In June 1999 he was appointed as head of global equities at M&G. He left M&G in April 2000 to co-found Lindsell Train Limited, where he runs the CF Lindsell Train UK Equity fund and was appointed investment manager of the Finsbury Growth & Income Trust in December 2000. He is investment adviser to the Worshipful Company of Saddlers.
10.3% 10.1% 9.4% 8.6% 6.8% 6.7% 6.5% 6.4% 5.4% 5.4%
Senior reporter at FE Trustnet
“It’s a bit strange that we don’t buy and sell more”
“Everybody says, with some justification, that knowing when to sell is the most difficult aspect of asset management,” the FE Alpha Manager explained. “Our response to that is therefore to do as little of it as possible. “I don’t want to make any claims in terms of what our track record means or whether it’s sustainable – I haven’t the faintest idea – but I think it is true that the most notable thing is how little activity there’s been. “We’ve always said it is more important to run your winners than it is to trade in and out of stocks and that’s all it is, really.” The manager pointed out that not only has he run his winners but he has continued to run his losers, which have then become winners once more over time.
“Even I think it’s a bit strange that we don’t buy and sell more than we have done”
Source: FE Analytics, bid to bid total return in sterling between 31 Jan 2000 and 31 Aug 2017
Finsbury Growth & Income Trust's 10 largest holdings
One challenge high-conviction managers perhaps face more than ever is the ability to keep a cool head, given today’s internet-driven world where news and market movements are updated and obtainable almost every second of the day. Train said there are a number of factors allowing him to block out any market noise when investing and remain true to his convictions. “Firstly, you need to go into business with Michael Lindsell because he is the thickest-skinned, most dogmatic, most unshakeable person you’re ever going to come across,” the manager said. “I am much more prone to wobbles and wibbles – Mike brings out the best in me with that. “Then the other factor I also think is a huge advantage that so-called ‘amateur investors’ also share with us, which gives them at least as good a chance as a professional investor.
But one investor who is well-known for his ability to block out any short-, medium- and even long-term noise is star manager Nick Train. The manager, who runs the £4.2bn CF Lindsell Train UK Equity fund and £1.2bn Finsbury Growth & Income Trust, builds concentrated portfolios of around 20 durable, cash-generative business franchises – which rarely changes over time. Train’s investment “epiphany” came after reading Robert Hagstrom’s ‘The Warren Buffett Way’. “Not that I didn’t know a bit about Buffett before then but I’d never read it drawn together so clearly as in that book," he said. “If anything, reading that book made me think ‘do you know what? I’m going to have a go at this’. Obviously it resonated so, if there was an epiphany, that was it.” Hagstrom’s classic book breaks down the successful investment strategies of the so-called Sage of Omaha.
The secrets of Nick Train’s investment discipline
This process has clearly worked for Train. Since the turn of the millennium, he has comfortably doubled the gains of his peer group composite with an average total return of 547.34 per cent to the end of August 2017. Given the portfolio has such a low turnover, the manager said most of his time is spent focusing on existing holdings as opposed to seeking new ideas. “What I’ve found quite frankly is that, even with a 20-stock portfolio, there’s always part of the portfolio that’s doing really well, a bit of the portfolio that’s sitting doing nothing and a bit that’s doing badly,” he explained.
“I don’t want to make any claims in terms of what our track record means or whether it’s sustainable – I haven’t the faintest idea”
Performance of Nick Train vs peer group composite since 2000
FE Alpha Manager Nick Train tells FE Professional how he ignores market noise and runs his winners over the very long term.
Buffett’s famous investment rules include ‘An investor should act as though he had a lifetime decision card with just 20 punches on it’ and ‘When we own portions of outstanding businesses with outstanding managements, our favourite holding period is forever’. Reflecting this, Train estimates that 60 per cent of Finsbury Growth & Income trust’s holdings have remained in the portfolio since took over it some 17 years ago. While there have of course been some changes over his tenure, the manager said it has been at a “glacially slow” pace.
Source: Frostrow Capital, as at 31 July 2017
“Ideally, what we want to be doing is adding to the areas that are doing badly or doing nothing. Because we like these companies, so we ought to be buying more. “Sometimes you need reassurance that’s you’re doing the right thing when you’re adding to something that’s not working, so a lot of research effort goes into it. “Even I think it’s a bit strange that we don’t buy and sell more than we have done, but I promise you it doesn’t feel as though there aren’t things to do all the time.”
“I am much more prone to wobbles and wibbles – Mike brings out the best in me with that”
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“What you do know for sure is that strategies with high levels of portfolio turnover raise the bar against themselves in terms of achieving success because the costs intrinsic to that are higher,” he reasoned.
“The advantage is that we work in an environment where the phone isn’t ringing the whole time and we also don’t have 20 colleagues around us with different emotional make-ups and different views of the way that investment works, panicking and shouting. That can be very distracting and can really throw you off track. “For an investor with an individual perspective, just being able to quietly get on with doing what you think is the right thing to do is important as well. The investing environment is important.”
hile everyone knows they should ‘invest for the long term’, it is a feat that very few people seem to manage amid market corrections, macroeconomic fears and the temptation to chase momentum.
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'We don’t think about it as earnings or pure valuations. Our analysts are looking at the business models to understand the opportunity,' says Spencer. Despite rich valuations, companies such as the FANG quartet (Facebook, Amazon, Netflix and Google) continue to drive their own growth amid a slow global recovery. By the end of May, for instance, just 10 companies, including the FANG stocks, accounted for half of the S&P 500’s yearly gains. Similarly, Asian giants like Alibaba Group Holding, Samsung Electronics, and Taiwan Semiconductor Manufacturing are responsible for generating much of the gains within their own country indices. ‘Alibaba, one of our top holdings, was a name that a lot of people had trouble getting comfortable with because it has more of an Ebay marketplace model,’ claims Spencer. ‘But we soon understood that they were on the way to monetising more like Google’s search monetisation. Since then it has really come to dominate the e-commerce and payment marketplaces in China.’ This trend also reflects the new “winner takes all” investment paradigm. Because GDP growth has been extremely sluggish and the business cycle is so late now, investors have allocated large premia to stocks capable of generating their own growth. The result has been the outperformance of high growth stocks at the expense of traditional value shares, which have underwhelmed. Unlike past years, buying solid companies at cheap valuations is no longer a sure-fire recipe for success. Instead, investing in high conviction growth companies, such as Salesforce.com, Alphabet, or Electronic Arts, has been one way investors have been able to achieve solid returns of late. That’s why Spencer manages a concentrated portfolio: He believes it’s important to invest behind the team’s highest-conviction ideas rather than placing smaller investments in companies that don’t hold the same level of growth potential, technological innovation, or managerial prowess. As at 30 June 2017, the portfolio’s top 10 holdings accounted for more than half of the fund. Moreover, the strategy’s “go-anywhere” approach allows him to hone in on the best technology ideas globally. ‘Our analysts are looking at business models around the world. We have holdings in the US, but also the UK, Japan, China, Taiwan, Singapore, Spain and Sweden. And we aren’t constrained by traditional metrics.’
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*As at 30 June 2017 Data shown for the I share class, net of fees in USD terms to 30 June 2017.
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Moreover, the strategy’s “go-anywhere” approach allows him to hone in on the best technology ideas globally. ‘Our analysts are looking at business models around the world. We have holdings in the US, but also the UK, Japan, China, Taiwan, Singapore, Spain and Sweden. And we aren’t constrained by traditional metrics.’ He added: ‘In many ways, Amazon was the poster child for disruption 20 years ago. If you took the time to really understand the company, you could see their business model taking shape. It’s unbelievable the amount of reinvestment they’ve put in, which was loathed by some at the beginning. So you need to understand if earnings are subdued by choice, and what the long-term potential is going forward, which can be tricky.’ And, concedes Spencer, investing in technology can be particularly fraught given how competitive the industry has become. ‘Even if you look at Google, it has a monopoly on search and that would be hard to disrupt of course. But it could be disrupted in a totally different way, through an app or particular service,’ he notes. ‘That’s the thing you have to be mindful of with technology: it’s hard to unseat the market leader, but it’s very easy to change an aspect of their business or force them to adapt, in the way that Snap moved into the messaging space with Snapchat.’ ‘These disrupters are hard to identify, and it usually happens very, very quickly,’ adds Spencer. ‘So thorough research is crucial. It also means an experienced active manager is better equipped to pinpoint a company’s potential– either as a disruptor, or a potential target to other disruptors.’ With years of experience and a strong global team behind him, Spencer has done extremely well in recent years. Although the OEIC fund only recently launched in March of this year, Spencer’s longer running T. Rowe Price Funds SICAV – Global Technology Equity Fund has returned 22.06% on an annualised basis since its launch in June 2015. By contrast, the MSCI ACWI Information Technology Index has returned 16.14% over the same period. Nonetheless, Spencer is confident he can continue to outperform. ‘This new business paradigm is not going away anytime soon, not least with such low global growth. It’s something investors have to embrace if they want to beat an index.'
Amazon.com, Alphabet, Netflix - these are just some of the technology giants that revolutionised the ways we communicate, conduct business and run our lives. As with most success stories, however, there are critics, and many are now questioning whether these companies justify the hype. Should we be looking at these companies in a different way? Josh Spencer, Citywire AA-rated manager (as at June 2017) of the T. Rowe Price Funds OEIC – Global Technology Equity Fund, says many analysts looking at successful technology names from a traditional standpoint will be frustrated. Instead, he advocates the need for a fresh perspective which places a greater focus on understanding a company’s long-term business model.
Global Value Equity Fund
Jeffrey Taylor’s £2.5bn Invesco Perpetual European Equity fund has made a 150.17 per cent return over the past five years, which has come with annualised volatility of 12.98 per cent. It focuses on superior quality European ex-UK companies that are trading at attractive valuations, with Taylor using the same process to run the fund for more than 10 years. The value approach used by the fund means that periods of underperformance can be expected; as such the fund is tipped for investors with a long investment horizon or looking to diversify a broader ‘core’ European equity fund.
The largest member of the IA Europe ex UK sector is the £4.3bn Jupiter European fund, which has FE Alpha Manager Alexander Darwall at its helm. Darwall builds a concentrated portfolio of around 40 names that he believes can grow over the long term regardless of the economic climate. Over the five years in question, it has made a top-quartile 129.81 per cent total return with annualised volatility of 11.21 per cent. The FE Invest team said: “Darwall has built up an impressive track record in European equity investing, and this strategy and style of buying high-quality global companies has now weathered a number of market environments.”
The £3.1bn Threadneedle European Select fund, which is headed up by FE Alpha Manager David Dudding and Mark Nichols, has made a 104.13 per cent total return in the past five years. This has come with annualised volatility of 11.3 per cent. The portfolio is built around quality businesses that have a competitive advantage and operate in sectors with high barriers to entry. Square Mile said: “Both Mr Nichols and Mr Dudding are patient investors believing that investing in higher quality companies will present investors with superior returns over the longer term. This philosophy has remained consistent throughout Mr Dudding's career.”
Risk/reward in IA Europe Excluding UK sector over 5yrs
Neptune - European Opportunities in GB
FE Alpha Manager Alister Hibbert’s £2.6bn BlackRock European Dynamic fund has a similar approach to the well-respected BlackRock Continental European fund, but it has a bigger risk/return budget that allows it to deviate more from the index and allocate more to smaller-sized companies. The process behind it marries fundamental company research, an awareness of macro themes and use of sophisticated risk management tools to exploit market inefficiencies. Over five years, it has made a 135.31 per cent total return with annualised volatility of 11.24 per cent.
Inside the IA Europe ex UK sector
Rory Powe’s £756.1m Man GLG Continental European Growth fund has made the IA Europe ex UK sector’s highest total return over the past five years, at 188.76 per cent. This has come with annualised volatility of 10.58 per cent. Powe took over the fund in October 2014 when he joined the firm; he has close to three decades of European equity experience, having run Invesco’s flagship continental European strategy for 10 years before founding Powe Capital Management in 2001.
Source: FE Analytics, bid to bid total return in sterling between 31 Aug 2012 and 31 Aug 2017
L&G - European Index Trust in GB
Henderson - European Selected Opportunities in GB
This £2.5bn fund made a 110.93 per cent total return over five years with 10.87 per cent annualised volatility. Lead manager John Bennett builds his portfolio around mean reversion, meaning that the fund often starts to invest in areas just as they are going through their worst period. Because of this, the fund has somewhat of a contrarian portfolio and can underperform at times – although it does have a strong long-term track record. Square Mile said: “Having faith in the team's ability to successfully examine both an industry's dynamics and a company on its own merits has, more often than not, reaped rewards for investors over the longer term.”
Man GLG - Continental European Growth in GB
Invesco Perpetual - European Equity in GB
BlackRock - European Dynamic in GB
FE Professional looks at the performance of the IA Europe Excluding UK sector over recent years, as well as revealing the most researched funds by professional investors.
The most volatile member of the peer group over five years has been the £442.2m Neptune European Opportunities fund, which is headed up by FE Alpha Manager Rob Burnett. Over this period, annualised volatility stands at 15.96 per cent with total returns being a second-quartile 105.75 per cent. Burnett believes that a relatively benign outlook for Europe means value sectors are “well positioned for a long-term renaissance” and is positioned accordingly, with big bets towards financials and materials stocks.
Click a hotspot on the scatter chart to view more about that fund
This £3bn index tracker is the largest passive vehicle in the sector to hold a place on the FE Invest Approved List. It has made a five-year total return of 102.55 per cent, which puts it in the third quartile; annualised volatility has been 11.45 per cent. The FE Invest team likes the fund because it “keeps things simple” by fully physically replicating the index, only undertaking stock lending under strict conditions and minimising the use of derivatives.
Threadneedle - European Select in GB
For much of the time since the global financial crisis, those investing in European equities have had to endure a challenging backdrop. Following the heavy sell-off of 2008, the region lurched into the eurozone sovereign debt crisis and was at the heart of investors’ concerns for several years. Growth across the continent was lacklustre, with several countries needing bailouts from bodies such as the International Monetary Fund and miles of column inches were dedicated to a potential breakup of the eurozone. Sentiment has returned to the area more recently, thanks to improving economic conditions and an ambitious monetary stimulus programme from the European Central Bank. Over the five years to the end of August 2017, the average IA Europe ex UK fund has made a 104.76 per cent total return – ranking it in ninth out of the 39 Investment Association sectors. What’s more, the peer group holds on to its ninth-place ranking over 10 years despite the global financial crash and the eurozone debt crisis, posting a 93.61 per cent total return. European equities are an area of the market often highlighted as being good conditions for active managers to outperform in and FE Analytics appears to back this up: three-quarters of the funds in the IA Europe ex UK sector have beaten the MSCI Europe ex UK index over the past decade. There are 15 funds headed by FE Alpha Managers in the peer group, including Alexander Darwall’s Jupiter European, David Dudding’s Threadneedle European Select and Rob Burnett’s Neptune European Opportunities funds. Some 21 funds also hold the top FE Crown rating of five.
Jupiter - European TR in GB
Becket shares many of these concerns. He added that if any lessons are to be taken from market conditions now, it’s that future investment returns are going to be lower from here on. “The current rates of return from fixed interest markets and valuation levels in equities will prevent the healthy returns of the last eight post-crisis years being repeated. Partly that is mathematical fact, in the case of bonds, but with equity valuations now extremely high, all of us involved in markets need to rest our expectations,” he concluded. “Like many difficult lessons, it might just be easier to ignore such thoughts and hope for the best, but we believe that would be a mistake. Investors will be able to make money in the next 10 years but it is going to be hard work and the need to be selective is pressing. My best guess is that there will be lots of lessons to learn from the coming 10 years and quite a few of them will be painful.”
While some investors are clearly mindful of the potential risks still floating around the system as a whole, it appears that the market as a whole is not concerned – if implied volatility is anything to go by. Despite a recent tick-up on back of the North Korea crisis, the VIX index – also known as Wall Street’s fear gauge – has been sitting at close to historical lows for some time, suggesting traders and investors are largely relaxed about the possibility of increased volatility. Figure 3 shows the VIX’s closing price since 2007 and how it has trended down over the past 10 years. Over this time, the average close has been 20.1 but in the three months to the end of August 2017 it fell to just 10.1.
“We have come a long way, but there is still further to go and bumps along the way should be expected”
Source: FE Analytics
Steve Eisman, senior portfolio manager at Neuberger Berman, said: “Pre-crisis, the position of regulators – which was the long-held view of former Federal Reserve chair Alan Greenspan – was basically: ‘We trust you know what you are doing, so carry on’. This is not the position now. It is more like: ‘We do not trust you know what you are doing and we are going to watch you like a hawk’. The system is now heavily regulated and closely watched, which I believe is right. “The reality is the system is much safer today and there are not any systemic concerns. For example, Citigroup’s leverage ratio has dropped to 10 to 1, far reduced from the 35 to 1 in the pre-crisis period. Even if were to see a problem with subprime auto loans, which some cite as a concern today, there is simply not enough leverage in the system to create a major systemic issue like a decade ago.
Eisman made his name at Morgan Stanley unit FrontPoint Partners, where shorted securitised subprime home mortgages. He was later profiled by Michael Lewis in his book The Big Short: Inside the Doomsday Machine and a character based on him was played by Steve Carell in the film adaptation.
Of course, this downbeat assessment comes after 10 years of some strong market returns. As the table shows, decent gains have made in most market areas apart from commodities, which have struggled against a deflationary backdrop and some lacklustre economic growth.
little over 10 years ago, the French bank BNP Paribas stopped investors from withdrawing money from three of its funds after admitting that a “complete evaporation of liquidity” in the US subprime mortgage market made it impossible to value their assets.
That date – 9 August 2007 – is widely seen as being the start of the global financial crisis. A decade later, there are still questions over whether investors have learnt any meaningful lessons from these events and fears are abound that the next crisis is already in the making. Although the initial problem was rooted in US subprime mortgages, it soon spread. The loans, which were issued to borrowers with poor credit histories, had been carved up and repackaged along with traditional mortgages then sold to investors with AAA ratings.
Fidelity International’s Tom Stevenson said: “Somewhat surprisingly, the cumulative returns of high yield bonds and emerging markets over the past decade have pipped US equities. Bonds have benefited from the collapse in interest rates in the wake of the financial crisis but without first suffering the savage bear market that equities experienced in 2008 and the start of 2009. “What jumps out even more for me, however, is the benefit of a balanced portfolio. While there have been some years when every single asset class has risen, and some when there was a mixture of risers and fallers, there hasn’t been a single year in which everything has fallen together.” However, these returns do necessarily mean everything is now good. Sanlam FOUR Multi-Strategy fund manager Mike Pinggera cautions investors against thinking that this market progress means the financial crisis is firmly in the past: it’s just because measures such as quantitative easing have pushed them towards record highs.
“Since the crisis, we have seen further examples of reality interrupting received wisdom. Before 2010, Italian, Spanish and Irish government bonds were seen to be as nearly safe as German bunds, until they were not. Last year, Brexit and the ascent of Donald Trump shattered the sheltered convictions of political analysts. “All of this is further hard evidence that to be successful in navigating financial markets, one has to be open-minded and look port as well as starboard when watching out for gathering storms. But this is not all: one must remember that asset class characteristics and asset class relationships may dislocate dramatically in a rapidly changing market environment.” As might be guessed from his previous comments, Becket does not believe that investors as a whole have learned to challenge the status quo. “All the concerns that grew during 2008 over excessive valuations, tight credit spreads and poor liquidity all seem to have been mostly forgotten. The reach for yield that we are currently witnessing, which again is in no small part down to the central bankers and interest rates that are too low, bears all the hallmarks of the last crisis and we have responded to this by systematically reducing credit risk across our portfolio,” he said. “What have we at Psigma learned from the last 10 years and how has it affected our investment process? The first thing is that investor sentiment and positioning have become even more important as inputs behind an investor’s decision making. Opportunities to go against the crowd, such as at the start of 2016, can be seen clearly in data and this is an increasingly useful tool. “That being said, we have also learned that Keynes was right when he remarked that the ‘market can stay irrational much longer than you can stay solvent’; the widely expected and never arriving rise in bond yields is clear evidence of that.”
As the number of borrowers defaulting started to rise and the housing market fell, securitised mortgage investments became toxic and no-one could figure out where exposure to bad debts lay. Banks stopped lending to each other, the credit crunch intensified, banks started to collapse or were bailed out and eventually the global economy stalled.
FE Professional looks back over the 10 years since the start of the financial crisis and asks what they have taught professional investors and their clients.
VIX closing level between 1 Jan 2007 and 31 Aug 2017
Is another crisis just around the corner?
The first signs of trouble in the US housing market as subprime specialist lender New Century Financial files for bankruptcy French bank BNP Paribas suspends three funds that invested in the US mortgage market. It blames a “complete evaporation of liquidity” In the UK, investors queue to take their money out of Northern Rock – the first run on a bank in the UK since 1866 JP Morgan agrees to buy Bear Stearns, which is on the brink of collapse due to its exposure to the failing subprime investments Authorities prop up America’s two largest lenders Fannie Mae and Freddie Mac, two government-sponsored enterprises that bought mortages from banks US bank Lehman Brothers collapses. Banks and corporations globally begin to fail. In the UK, HBOS is taken over by Lloyds US signs an act to effectively bailout its financial system. UK government steps in to save its banking system The International Monetary Fund begins approving loans to stabilise countries including Ukraine and Iceland Global economies begin to go into recession. Central banks cut rates in a co-ordinated effort to stem the crisis Global stockmarkets hit post crisis lows. Interest rates are reduced to record lows in US and UK. Both countries begin huge quantitative easing measures OECD says the world economy is near the bottom of its worst recession in post-war history
“The banking sector was at the heart of the crisis and this sector will need to be given the all clear if we are truly able to we have ‘arrived’ on the other side. With the Bloomberg European Banks and World Banks indices trading 60 per cent and 25 per cent below the 2007 highs respectively, there is still some way to go. It is worth remembering the technology-heavy Nasdaq index took 15 years to recover from the bursting of the tech bubble. “Investors must also remember that recovery is a process not an event. Part of the process will be the tapering or removal of stimulus. While this stage of the process may itself cause some market turbulence, it is an important step back to normalisation. So, ‘are we there yet?’ Not quite. We have come a long way, but there is still further to go and bumps along the way should be expected.”
There have been some major changes in the past decade, with one of the areas coming under the most scrutiny being regulation. With under-regulation being seen as one of the main causes of the crisis, government across the globe have moved to give their financial watchdogs greater powers.
“People always come up to me and ask what the next ‘Big Short’ will be,” Eisman said. “The truth is I simply do not have an answer, and do not want to have an answer to this question. I lived through this period and do not want to see anything like it again.”
But it all looks calm now…
Thomas Becket, chief investment officer at Psigma Investment Management, argued that not much has changed when it comes to the worlds of central banking, politics and financial markets over the past decade. “In a recent interview I was asked what the key lesson was that had been learned since the financial crisis. I struggled to think of any,” he said. “Indeed, my primary view is that in most cases the exact same mistakes made at the end of the bubble that brewed at the start of this century are being remade. Yes, some of the players, markets and instruments might have changed but many familiar strains can be seen. This doesn’t bode well, in my opinion.”
Editor of FE Professional & FE Trustnet
“I lived through this period and do not want to see anything like it again”
“I was asked what the key lesson was that had been learned since the financial crisis. I struggled to think of any”
Performance of UK equities between 1 Aug 2009 and the start of QE by the Bank of England
A brief history of the global financial crisis
The events are well known as is the response by the world’s governments and central banks – which involved slashing interest rates to record lows and embarking on unprecedented quantitative easing programmes. However, despite an almost continual focus on the financial crisis some investors warn that we simply haven’t learnt the lessons it should have taught us.
Has anything changed?
Senior portfolio manager at Neuberger Berman
Steve Kelso, chief executive of Ashburton Investments, puts this down to central banks’ intervention in markets. He does not see this as boding well for the future. “With volatility at the lowest levels in modern history, the frequency and amplitude of volatility spikes is likely to increase moving forward. We are now in an environment of interest rate hikes, for the first time since the end of the crisis, while the other monetary policy efforts are set to begin unwinding. We would argue it has been the abundance of liquidity, rather than any economic expansion, that has played the major part in the sharp rise for asset prices over the past decade,” he said. “The current combination of high leverage ratios and low volatility is a dangerous cocktail for investors in a backdrop of rising interest rates, particularly with volatility set to return. Leverage is a friend for investors as long as volatility stays low, but is dangerous if it reverses. Severe volatility on a leveraged portfolio has often led into the territory of stop losses and fire sales to meet margin calls. This is what occurred in 2008 and at the end of every other investment cycle.”
VIX closing level between 1 Jan 2007 and 31 Aug 2017
The post-crisis bull run
Hartwig Kos, co-head of multi-asset at SYZ Asset Management, is clear of the lesson that should have been taken from the financial crisis if we are to avoid a repeat: the status quo must always be challenged. “Before 2008, mortgage bonds were deemed to be boring and safe, until they were not. No one expected half of Wall Street’s banks would disappear, be absorbed by other banks, or be bailed out by the US Treasury, until it happened. No one imagined the Federal Reserve would become one of the biggest buyers of the US bond market, until it happened.
“There will be lots of lessons to learn from the coming 10 years and quite a few of them will be painful”
Apr-07 Aug-07 Sep-07 Mar-08 Jul-08 Sep-08 Oct-08 Nov-08 Dec 2008 Mar-09 Jun-09
“‘Are we there yet?’ While this is the question every parent fears, it can also be used to describe the thinking of many investors 10 years on from the financial crisis. Unfortunately, this question still remains unanswered,” he said.
Source: Schroder Investment Management
Have we learned nothing in the decade since the global financial crisis?
There were also fund-specific stories I would like to highlight.
Lazard European Smaller Companies Dodge & Cox Global Stock Goldman Sachs Global CORE Equity Portfolio Lazard Emerging Markets Henderson Emerging Markets Artemis US Select Baillie Gifford American Investec Enhanced Natural Resources Investec Global Gold Sarasin Food & Agriculture Opportunities Woodford Income Focus Allianz Strategic Bond Jupiter Absolute Return
US, commodities and Woodford changes in the FE Invest Approved List
Research manager at FE
The latest rebalancing (it’s a twice-yearly event) occurred on 13 September 2017 and the main turnover was within our range of active US equity funds. Most investors are now aware of the difficulties for an active manager to outperform a highly efficient market such as the US. This complexity is highlighted by the negative information ratio (-0.21 per cent annualised) of the IA North America sector relative to the S&P 500 index. In other words, it costs 21 basis points of relative performance for an average active equity manager to take 1 per cent of active risk (as measured by the tracking error). Our process leads us to pick active managers who consistently apply their process and are comfortable with its biases. This was done at the cost of active manager who are trying to outperform the S&P 500 but by rigorously avoiding any style or industry bias (risk management). We decided to recommend the Artemis US Select and Baillie Gifford American funds, but to remove Legg Mason Clearbridge US Large Cap and T. Rowe Price US equity funds. Cormac Weldon, manager of the Artemis US Select, is well-known to us as we used to recommend his Threadneedle US Select fund. We were disappointed to see him and most his team leaving Threadneedle to join Artemis, as it imposed us to remove the fund from the shortlist. Nevertheless, we monitored its settlement at Artemis and became relaxed that he has complete freedom to implement his investment philosophy. Concerning Baillie Gifford American, the fund has a strong track record in US growth investing with a benchmark-agnostic approach. The fund, however, exhibits a high-level of volatility due to the fund being heavily concentrated in high conviction positions. Therefore, the fund would be most suited in a portfolio with a long-term investment horizon as well as one that can tolerate the high volatility. There was also some turnover with our range of commodity funds. It was not very surprising given the volatility of the metals, agricultural and energy prices over the last 12 months. A high beta strategy would have fared well in the second half of 2016, but most of its gains would have been offset by losses made from March 2017. We decided to buy into the Investec process for commodities, designed by FE Alpha Manager George Cheveley. Investec takes a process heavy research approach with the team focusing on the medium-term direction of all commodity prices. In addition to being one of the cheapest of its peers, it also provides a cautious access to the commodities market not only through global resources equities but also through direct commodities. Investec Enhanced Natural Resources and Investec Global Gold are now included in our FE Invest Approved List.
EUROPE EX UK EUROPEAN SMALLER COMPANIES GLOBAL GLOBAL EMERGING MARKETS NORTH AMERICA SPECIALIST STERLING STRATEGIC BOND TARGETED ABSOLUTE RETURN UK EQUITY INCOME
changes in the FE Invest Approved List
Although it was launched, only recently we decided to express our preference for CF Woodford Income Focus over CF Woodford Equity Income. There is currently little difference between those two funds managed by Neil Woodford, except for the long tail of illiquid unquoted companies with the Equity Income fund. We believe equity income investors have little interest in those names, apart from the potential capital gain (which so far failed to be realised). We also added the Allianz Strategic Bond fund, managed by Mike Riddell. The fund uses a process that should produce a low correlation to equities, lower than most strategic bond funds. Finally, we supplemented our shortlist of IA Targeted Absolute Return funds with the Jupiter Absolute Return fund. We highly rate manager James Clunie for its knowledge in shorting stocks but we have been very impressed by his strong understanding of the limits to his process and philosophy, which should protect investors when the market environment is unfavourable to his style.
Charles Younes explains the changes to the FE Invest Approved List that took place after its latest rebalancing.
FP Argonaut European Alpha Newton Global Opportunities Legg Mason Clearbridge US Large Cap Growth T. Rowe Price US Equity BlackRock Natural Resources Growth & Income Aviva Strategic Bond Woodford Equity Income
hen recently rebalancing the FE Invest Approved List, it was our allocation to US equity funds that was the biggest area of change – although there are a number of individual stories to be told, including a switch between two Woodford funds.
The FE Invest Approved List is a shortlist of over 100 quality fund choices that cover all sectors and asset classes, providing a complete universe of active and passive funds. The list is constructed by combining FE’s four quantitative rating systems, which identify the best funds, the best managers, outstanding groups and the funds that the adviser industry has the most confidence in. The quantitative foundation of the shortlist allows us to create an independent recommended fund buy list that is free from the traditional biases of qualitative research. This quantitative basis for selection is validated by our analyst team, which independently researches each fund and interviews all of the key individuals. The qualitative foundation also aims for the shortlist to be diversified, in order to avoid any bias in every asset class.
The Baillie Gifford Pacific Fund is different from its peers. While most funds take a value-orientated approach, this £290 million fund is clearly positioned as a long-term Asian growth fund. Despite the managers being enthusiastic about the operational performance of their holdings, there has been a lag in performance while the market caught up with their enthusiasms. But the tide has turned. Growth is back in favour in Asia and we believe the success of these companies is being reflected in share price terms. The Baillie Gifford Pacific Fund has an active share of 73% and annual turnover of just 23%, reflecting its long-term approach. Asset allocation within the portfolio is not driven by requirements to invest in a particular economic sector or to be invested across all the areas in the region. The shape of the portfolio is dictated purely by where the individual opportunities lie. Currently, this shakes out as 33% of the fund invested in China, 24% in South Korea, 17% in India and 7% in the ‘new kid on the block’ Vietnam. The appeal of Chinese companies is the country’s well-documented move from an export orientation to a domestic focus. This translates into strong growth in retail sales, especially online. The economic reforms afoot in India have also caught the manager’s eye. Demonetisation and the Goods and Services Tax should make it easier to do business and will improve efficiency significantly in the years to come. Vietnam’s economy has been growing at 6% per annum over the past three years, benefitting from China’s move out of low-cost manufacturing. The portfolio has two large overweight positions – information technology and consumer discretionary stocks. A step change in computing power and a resulting global semiconductor super-cycle, means Asian companies are well placed to benefit. This leap forward in computing power should facilitate rapid growth in the broader technological market, leading to increased data generation and analysis, further cloud storage needs, greater online mobile usage and developments in Artificial Intelligence. Hence, the fund has its bigger holdings in the likes of Tencent, Samsung, Alibaba and TSMC, the chip maker. The rise of the Asian consumer class is also well represented by investments in JD.com, the online retailer, and Ctrip, the travel services company. Asia is on the march. Time to get in step.
Asian opportunities are calling. Find out more.
Learn more on the study and the strength of the T. Rowe Price Active Management Approach
Director, Marketing and Distribution
ASIA ON THE MARCH
All figures as at 30 June 2017.This information has been issued and approved by Baillie Gifford & Co Limited and does not in any way constitute investment advice. As with any investment, your clients’ capital is at risk. The Fund’s share price can be volatile due to movements in the prices of the underlying holdings and the basis on which the Fund is priced.
2. Total Return
Clearing the murky waters of charging was a big part of RDR and the upcoming MiFID II and PRIIPs legislation take this one step further. Therefore, knowing what charges may or may not be taken into account when using FE Analytics is key.
n a world where regulation increasingly focuses on the provider of research, advisers are having to take on more liability for the accuracy of any data provided to their clients. Therefore, having confidence in the accuracy of any data that you see as part of your own research becomes more important.
It is important to state that the charges included in the data are standard fund charges and you would have to factor this into your explanation to your client. For example, the client may well be benefitting from a platform specific charge that decreases the overall fund charges they pay in reality. The only charges that are not included in the data are any dilution levies that may be applied to the fund and the adviser specific charge. However, the adviser charge, be it initial or ongoing, can be added to a portfolio in FE Analytics in ‘Portfolio Settings’.
Price types and charges made clearer
your investment research
3. Gross Return
I’m referring to the different ‘Price Types’ used in all the information you are presented with. Depending on which Price Type is being used, the end result is likely to change. In FE Analytics for example you have four options: What is meant by these options and in what situations should they be used? The differences are easily explained below:
Alternatively, please contact the Training Team if you have any questions (firstname.lastname@example.org)
Understanding the assumptions that are at work in the background of any data you are presented with (or indeed research yourself) will allow you to identify how and when fund managers are presenting information through rose-tinted spectacles, as well as having the added benefit of eliminating the chance that you provide flawed reports to your own clients. In part one of this two-part series, we will tackle two of the most common causes of incorrect research and reporting when using FE Analytics:
Understanding what is meant by Price Type and how each selection changes the data Understanding what charges are included in the data already
In a two-part series, Tony Town rolls up his sleeves and lifts the lid on one of the most powerful research and reporting platforms in the industry, shedding light on some of the mechanisms in the background that you need to be aware of to get the best out of your research and governance engine.
That brings part one of this mini series to its conclusion. The primary aim of this first instalment was to break open a common industry term, explain the meaning behind the ‘Price Type’ as well as analyse the impact it has on the data that you are digesting from the industry (and subsequently reproducing for your own clients). A secondary aim was to fan the flames of curiosity and provoke readers of this article to question the basis of any data presented for your consideration. That way, you can ensure that no-one is trying to blind you with science and, more importantly, you aren’t doing the same to your own clients.
In FE Analytics, all fund performance is net of charges, meaning that all ongoing fund charges are included in the price data itself – the data that gets sent to us should have the charges deducted from source. Initial Charges are optional and can be shown by changing the ‘Pricing Spread’ of a chart or table, from Bid-Bid to Offer-Bid on the main Active List page.
Common areas of misunderstanding often arise when using a Price Type that unfairly penalises one instrument over another. For example, using ‘Price’ when plotting both Inc and Acc funds may unfairly represent the performance of the Inc fund. The chart would show the performance of the Acc fund including the dividends reinvested (due to the nature of the fund itself), whereas the Inc fund would not have the dividends contributing to its performance. Knowing the definition of each Price Type allows you to choose the fairest foundation for your research and reporting. Whilst a general rule of thumb is to stick to the same price type for each instrument you are reporting, as demonstrated above – sticking to the same Price Type religiously can unfairly penalise some instruments when compared to others.
This is one of the most commonly used Price Types and in FE Analytics assumes any dividends are reinvested, net of tax, charged at the basic rate.
Find more information about training and support that FE offer at http://www.fetrainingacademy.com
Under the bonnet:
To start off, let’s tackle something which you probably encounter daily in different guises, but the reality that lies in the detail often goes unnoticed.
FE Analytics Masterclass
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Senior relationship manager at FE
Net Asset Value represents the total asset position of a company, minus any liabilities and is typically divided by the number of shares currently in issue, to reach NAV per share for valuation purposes.
This is probably the easiest Price Type to understand – it is just the daily price of the fund, with no dividends reinvested and no tax applied.
This is most commonly used for pension funds and includes any dividends reinvested, but gross of tax.
Standard Life Wealth’s most aggressive positions in this uncertain environment
Standard Life Wealth’s Target Return Managed Portfolio Service has five products ranging from Strategy 1, which has a target of cash plus 1 per cent, to Strategy 5, which has a target of cash plus 5 per cent. Explaining current positioning in the range, Hair said: “It is probably the most boring house view that I have ever had in that there is so much uncertainty out there and it is very difficult to take any aggressive positions. “Our house view will range from very light all the way up to very heavy and if you look at the asset allocations across all of the asset classes it tends to be neutral. “I have been in situations in the past where the house view could be very light in certain areas and very heavy in others where it is clear there is a valuation opportunity in a particular asset class. It doesn’t really feel like that at the moment.” The only exception to this is in Europe, which Hair said he has been allocating to more over recent months. Over the past year, the portfolios have been shifting exposure from the likes of the US and Japan to Europe.
“The reason for that is the operational leverage which is in the European equity market,” the CIO explained. “There is an improving market and improving economics, which are filtering through into improved earnings. Due to this operational leverage you tend to get a bit more bang for your buck in Europe.” Within Europe, Hair is using Will James’ Standard Life Investments European Equity Income and Stephanie Butcher’s Invesco Perpetual European Equity Income funds. The other area that Hair said he remains overweight (or ‘heavy’) is in the US, despite the high valuations in the market. Hair noted that it is not just the US that is expensive, with most asset classes seemingly fully valued and therefore it is more of a case of being forced to put money to work somewhere. “Everything seems fully valued or neutral in value – there is no clear underweight value area where we think we really should be invested in today,” he said. “Obviously it doesn’t make any sense to invest in cash – especially where inflation is – so it really is a case of growth and valuation.” As such, the CIO is blending overweight positions in both US and European equities to capture both parts of this equation. Unlike in Europe, however, he is using a combination of index trackers in the form of Vanguard US Equity Index and Fidelity US Index for his exposure. This is partly thanks to their structural weighting to the so-called FANG stocks of Facebook, Amazon, Netflix, and Google, which he said are well-placed to take advantage of an important theme – technological advancement. “Whilst everyone will be focusing in the short-term on what president Trump is saying, really you should be focusing on the technology side,” he said. “[FANG stocks] are a good example of companies that are out there and aggressively growing their earnings, targeting growth and generating a lot of free cashflow. In a sense no matter what Trump says they are exposed to longer term drivers of growth.”
GAM’s niche fixed income ideas that are driving performance
Source: Standard Life Wealth
n overweight to US and European equities as well as infrastructure assets are among the key exposures of Standard Life Wealth chief investment officer John Hair, who says he has otherwise established a “boring” house view given the uncertain backdrop
Performance of Standard Life Wealth's Conventional MPS 3 since launch
Additionally, Hair noted that as well as this technological theme, he sees upside for the economy, with the US one of the few places in the world where interest rates are rising and are predicted to go up further. “I think [the overweight position to US equities] is really because of what we see happening in the US economy as well. Earnings are very good. What’s happening at a company level is that as the economy is doing quite well that is filtering through into the earnings that companies are generating,” he said. “One should always, to a certain degree, try and ignore short-term political noise because it doesn’t matter – it is what is happening in the underlying drivers of change in the wider economy that matter over the longer term.” The final area Hair is allocating some of his risk towards is infrastructure, which he is using in place of some fixed interest allocation – an area he is ‘light’ or underweight. “We have shifted a bit of our risk budget is in global infrastructure and that is an example of trying to diversify our returns away from markets,” he said. “Infrastructure projects tends to be long-term contracts and offer a sensible level of income in the region of 5 to 6 per cent with secure 30-year debt which is normally backed up by governments. “It is quite an attractive way to invest into government backing as opposed to directly investing into gilts.” However, he is wary of the ‘hot money’ that has come into the sector in recent months, with many investors looking further afield for their income opportunities. “Demand for these higher yielding vehicles is a function of what has happened to government bonds and the low yield you’re getting from 10-year bonds,” he noted. “When we first invested we were getting a yield of 7 to 8 per cent and now we are getting yields in the region of 5 to6 per cent. You’re also seeing a bit more gearing coming into the sector. So we are very selective in what we invest in but again this is a relative story.”
Reporter at FE Trustnet
FE Professional finds out where the Standard Life Wealth model portfolio service is taking its biggest bets despite heightened uncertainty
The VIX, below, is a widely used measure that is meant to be forward looking and gives an idea of market risk, often referred to as the ‘fear index’. A high index number indicates fear and a low number indicates relative calm. An index value of 18 on the right-hand axis is often referred to as the long-term average.
Sheridan Admans is an investment research manager at The Share Centre.
What is giving investors little reason for concern?
The stock market continues to rise too despite event risk and stock market valuations looking stretched in the US. Should investors worry or keep calm and carry on? This chart shows the fall and rise of the value of the companies listed in the S&P 500 index since the stock market crash of 2008.
What has fuelled the growth of the S&P 500?
olatility is subdued in the face of Hurricanes Harvey and Irma, the Mexican earthquake, political tensions over North Korea, terrorist attacks in Spain and the controversy that followed the events in Charlottesville in the US.
What is giving investors little reason for concern?
Central banks have pursued an aggressive programme referred to as quantitative easing since the stock market crash of 2008, which has significantly reduced the cost of borrowing. Companies have devoured this cheap credit, funding dividend and share buybacks. Buybacks give the appearance of companies’ improved operating performance; overtime this triggers additional demand from investors for the shares and inevitably eases concerns. More recently companies have ramped up merger and acquisition activity another reflection of cheap access to credit.
Investment research manager at The Share Centre
The Share Centre’s Sheridan Admans asks what investors should make of high equity markets coupled with a subdued VIX index.
Low volatility is normally associated with stable or predictable conditions and there are reasons why the VIX has been at record lows recently. Predictability of central bank’s monetary policy is the most obvious. Bankers have gone out of their way to manage expectations and monetary policy has supported asset prices, while prudent regulation of financial markets is also a factor. Financial reform and regulation in developing economies has also made them less susceptible to boom and bust scenarios. In addition to these three aspects and from a more technical perspective, some in the market are now starting to question the complexity of volatility trading strategies and whether the VIX remaining at its lowest levels is a case of the tail wagging the dog, only time will answer this one. Volatility traders buy and sell options in the pursuit of gains by betting on the direction of volatility. What keeps pushing up equities comes back to monetary policy and the job it has done to push up bond prices to still expensive levels. Investors are left with the alternative of buying shares with little understanding of what excessive risks they may be taking. As the VIX chart clearly shows investors are pricing in little or no perceived risk. The VIX illustrates investors are finding it hard to know what excessive risk taking looks like due to the distortions monetary policy involvement has had in markets on the usual methods of risk measurement.
As you will see, it is presently at historic lows indicating little or no perceived risk. The S&P 500 is at or near all-times highs and the VIX is at or near historic lows. Is this a bubble of faith or is it different this time?
Market corrections might be good for headlines and spreading fear but they are in fact a healthy part of any regional economic mechanism. However, timing a market correction or something more destructive is a near on impossible task. Anyone boasting that they managed to time the market are, according to Bernard Baruch, ‘only liars’ highlighting the near impossibility of ‘always be out during bad times and in during good times’. Investors can become victims of poor market timing, as history has shown on many occasions that some of the worst market fluctuations were followed by periods of significant market recovery. Markets regularly touch on moments of increased volatility when faced with an unknown outcome. However dark those clouds are, though, things settle down and calm gets restored: just cast your mind back to the stock market crash of 2008, the Dot Com crash of 1999 and the Asian crisis of 1997 to name only very few. Selling too early can lead to missed upside. Selling early can also mean that income distributions can be missed. A better strategy might be to review your asset allocation, make sure you are sufficiently diversified to cope with a market downturn, which should help strike the right balance between risk and return. Remember that pound cost averaging can be a real positive strategy during a downturn. If you have been extremely fortunate to time the market days before a correction are you as confident you can time getting back in? Probability is not on your side! Pound cost averaging allows you to benefit throughout the ups and downs of the market. If you are nervous about volatility spiking or a market correction you could take some profits from your existing holdings. If you are not confident the market has topped or volatility has bottomed you could reinvest the proceeds into alternative strategies that are invested in the market and may do well to protect you against so much loss should we be on the cusp of a correction or worse.
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