Investment Strategy /Asset Allocation-First Quarter 2020
Any reference to benchmark should be tailored to individual client preference. These could, for instance, be
1) Absolute return based.
2) Cash/ LIBOR/SONIA, or equivalent, based (0.70%).
3) Inflation based. (UK CPI 1.5% November).
4) Index based (FTSE 100, FTSE All-Share, MSCI, S&P etc.).
5) Peer group based (Private client index, Morningstar, IMA category etc.).
6)Theme based e.g. ESG.
7)Bespoke list…e.g. list of other funds held/monitored/local competitors.
The above list is not exhaustive.
Furthermore, it may be appropriate to apply differing benchmarks to differing risk categories, and or adopt internal and external benchmarks.
Further macro details and individual investment ideas, model portfolios for varying benchmarks and risk profiles are available on request. These can be in direct, OEIC, investment trust or ETF form or a combination. As ever, portfolio construction should take full account of risk, return and degree of asset correlation appropriate to the individual client. Other client assets/liabilities should also be considered.
Cash –Neutral, Higher than normal.
Where appropriate, diversify some sterling cash into major overseas currencies, especially after considering the ongoing BREXIT process. The US dollar should certainly feature amongst the alternative currencies.
UK Equities-Neutral/small overweight
After reporting 1.4% GDP growth for 2017, and a similar figure for 2018, growth in 2019 is also expected to be anaemic, with risks to the downside, at the time of writing. Most recent data showed third quarter GDP, showing a mere 0.3% expansion (1.0% annualised), the lowest annual rate of growth since 2010.More recent October and November PMI and retail sales data showed weaker than expected fourth quarter development, and BRC figures, released on 8th January 2009,show the value of retail sales falling 0.1% in 2019,the worst annual figure since 1995.. Well publicised reasons include a more uncertain domestic consumer environment, weaker business investment, slowing global trends and political uncertainty, all interrelated. There is no doubt that the “BREXIT” has and will continue to affect many areas of the economy in different ways. One relatively brighter area has been the relatively low unemployment situation (3.8% unemployment rate announced December 17th), although poor productivity remains a problem and the “quality” of the employment is open to debate.
The residential housing market is continuing to show slower year on year growth, especially in London and the South East, where many properties are now showing negative year on year price comparisons. The lower volume of activity and increased time to completion have been all too evident in the recent sector profit warnings and cautious guidance from estate agents, house builders, domestic construction companies. Commercial property has also been very sluggish, especially in the area of retail (see more detail below).
Forecasts for 2019 GDP growth span a range of 0.5% to 2.0% with an average of 1.4% (30 forecasts), with most forecaster agreeing that in the unlikely event of UK crashing out of the EU in 2020 (no or very hard deal), the country could experience a sizeable recession. It is highly likely that quarterly GDP figures will be heavily distorted by Brexit related factors.
At the mid-March “mini-budget” speech Chancellor Hammond also guided GDP forecasts towards about 1.5% and re-iterated caution over relaxing the fiscal stance despite the budget improvement referred to above. Hammond’s successor Sajid Javid, in the autumn Budget speech, laid out a more expansionary stance, no doubt strongly politically influenced! Recent poor monthly budget figures, to an extent Brexit related, surprised a few economists. A new Budget is expected on 11th March,2020
Inflation, currently 1.5% (November 2019), by the widely used CPI measure, appears to have stabilised and forecasts of around 2.4% over the next three years were made by the Bank of England, assuming an orderly Brexit departure.RPI,currently still used for a number of indexation purposes is currently running at 2.2% year on year.
The Monetary Policy Committee is currently leaning towards a more dovish mode, though wage growth and sterling could apply upward pressure to the inflation rate even though other Brexit related issues and the global interest rate trend point towards stable or lower rates.
The Conservatives decisively won the December 12th election, and it seems highly like that the Withdrawal Bill will pass, and that the country will leave Europe on January 31st, 2020.The long process of re-negotiating a trade deal, product by product, along with other issues such as financial services, fisheries etc will then begin.
On a valuation basis, the UK equity market remains at a relatively “cheap level”, compared to its history and significant underperformance, versus world equities, since the Brexit vote in June 2016 continued right until the last quarter of2019. Corporate profits however, especially amongst the more international companies have continued to grow, as have dividends. The prospective PE multiple for 2020 is about 12.6 falling to an estimated 11.9 in 2021, with a dividend yield of 4.81%. (Source Morgan Stanley, December 2019). However, two notes of caution. The “E” of the PE ratio, at the time of writing, is subject to more than usual variation as company earnings are likely to be adjusted, both ways, following the BREXIT effect and related uncertainties. Income seekers should also pay extra attention to sustainability/growth potential rather than just absolute levels of dividends. Profit warnings are running at a much higher level (see recent EY note) and dividend reductions/cancellations are increasing.
|On a technical market note it should be re-emphasised that the FTSE 100 has a relatively large oil/mining weighting and that approx 2/3 of the FTSE earnings derive from overseas. The table below summarises the main differences between the three main UK indices. FTSE 100||FTSE 250||FT All-Share|
|Consumer(goods and services)||22.4||18.1||25.9|
|Telco and Tech||5.3||8.7||3.8|
|Utilities and Property||4.5||13||2.8|
Source: i-share,Lyxor.January 7th,2020.Leading sectors only
In a Morgan Stanley research note, it was estimated that 41%, 26% and 18% of FTSE 100 company sales were derived in Developed Europe, Asia-Pacific and North America respectively. The corresponding figures for the FTSE 250 were 67%, 10% and 14
At the time of writing I would recommend overweighting banks/insurance and rebuilding positions in utilities, telecoms, infrastructure etc following the decisive election result. Selectively some retail and property names may start to outperform. I would slowly rebalance towards more selective mid cap /small cap exposure after the recent outperformance of the larger more international FTSE 100 names.
These factors emphasise the need to be flexible and frequently check positioning on a see-through basis. This will be especially important as the BREXIT discussion moves from Withdrawal Bill to step-by-step trade renegotiation.
Expect increased currency volatility to continue during 2020
Europe ex UK- small overweight
The global recovery is set to continue into 2020, although growth estimates have been reduced in recent quarters. As recently as October 3rd, PMI data for consumption and services for UK, USA and Germany all underperformed economist estimates with the latter two falling into contraction territory.
In July the IMF predicted the world economy would grow by 3.2% this year, significantly slower than its estimates at the start of 2019.While the Fund currently sees a rebound to 3.5% in 2020,it has warned that such a recovery was “precarious” since it was premised on stabilisation in emerging markets and progress on resolving trade disputes. More recently, on September 19th the OECD produced revised figures projecting world GDP growth of 2.9%, the weakest performance since the 2008-09 financial crisis.Finally,in January 2020,the World Bank produced a more gloomy forecast of just 2.4% global growth for 2019 followed by 2.5% in 2020,stressing that any easing of US-China trade tensions is unlikely to lead to a rapid recovery. The Bank did however foresee above average growth in some of the larger emerging nations, such as Turkey, Brazil,Mexico and Russia, which had already experienced sharp slowdowns.
As well as the fading effect of US fiscal incentives, weaker indications from several European, emerging, and Asian countries, including China, point to more sluggish economic development.
Core inflation is also developing at a slower than expected pace with most leading nations experiencing price increases well below Central Bank targets.
The two factors above, in combination with certain geo-political concerns, are behind the more dovish monetary statements/actions currently being adopted. There are also wider calls for more expansionary fiscal measures e.g. infrastructure spending.
Cross border mergers and acquisitions plummeted, on average, to their lowest level since 2013, though this disguised a 6% increase by US targets and falls of 25% and 16% respectively for Europe and Asia.
Major risks could include inappropriate Fed/Trump action e.g. further protectionism, Chinese growth/deflation/management, further commodity/forex price volatility, and reaction to many political developments ( Iran,Hong Kong, Venezuela, Libya, Ukraine, Russia, Turkey, Korea being current examples).
On a global level it is also becoming increasingly important to factor climate/change/environment into investment decisions
The IMF reiterated that rising protectionism and debt levels remained the biggest global risks.
After 1.6% GDP progression in 2016 US economic growth recovered to 2.3% in 2017 with 2.9% for 2018 and a figure of 2.3% provisionally pencilled in for 2019.The Federal reserve itself expects growth of about 2.3% for full year 2019, highlighting strong job gains and buoyant consumer spending and corporate investment. Better than expected first quarter 2019 growth of 3.2% included a large element of inventory build, with more recent third quarter GDP figures showing growth of 1.9% annualised. The employment situation seems to be reasonably healthy, following some strike distortions, with a November unemployment rate of 3.5%, and hourly earnings growing at 3.1%.Figures just released from Mastercard showed retail sales during the critical November 1st to Christmas Eve period jumped 3.4% compared with the same period of 2018 (on-line 18.8%,physical stores 1.25). However, business investment, trade and certain manufacturing sectors are showing negligible progress.
Most recent inflation figures (core personal consumption expenditures) show November 2019 prices rising at 1.6%, still shy of the Fed’s 2% target.
The Federal Reserve raised short term interest rates in March ,June ,September and most recently on December 19st ,taking the target rate for the Federal Funds rate to 2.25%-2.5%.However recent shorter term economic data coupled with certain current geo-political uncertainties e.g. US/China,Brexit,Europe,South America have introduced a much more dovish tone to Fed thinking. At the August Fed meeting interest rates were cut by 25 basis points, and a further cut of 25bp was made on 18th September, taking the federal funds rate to a range of 1.75% to 2%.Slowing business fixed investment and exports were cited as the main areas of economic weakness, while consumer sentiment remained relatively strong, so far.A further cut of 0.25% was made in November, while the accompanying statement suggested a “pause” in interest rate movements, a sentiment re-iterated at the December 12th meeting .
European economic growth forecasts have shown a marked decline since mid-2018 levels and most forecasts for 2019 now fall in the 1.0% to 1.5% range, with the ECB itself looking for 1.2% (December 2019). During the last quarter of 2018, Italy contracted while Germany showed negligible progress and the situation seems to have deteriorated further during 2019, the IFO recently cutting GDP growth forecasts to 0.5% and 1.2% for 2019 and 2020 respectively. Going forward, global developments in the area of trade will be particularly important for the likes of Germany while a precarious political climate (Italy, Spain,Holland,Belgium) could be another source of investor uncertainty for the region. The pan-European composite PMI for December remained at 50.6, a level consistent with negligible growth. The breakdown showed a relatively strong services component but a slide within the manufacturing sector. For 2020 the ECB expects the eurozone economy to grow by 1.1%, more optimistic than a poll of 34 economists who forecast a range of zero to 1.5%, with an average below 1%.
The ECB lowered its inflation forecast to 1.2% for this year and 1% for next year at the September 2019 meeting, while the tentative 2022 forecast for 1.6% is still below the ECB target. December inflation figures, just released, show consumer prices rising at about 1.3%, higher than forecast.
Recent MEP election have continued to show an erosion of support for the traditional central parties, and while some of the more extreme political groups fared worse than expected, the Greens and Liberal Parties showed good gains. Volatile political developments continue to plague Germany, Italy and Spain amongst the larger countries.
Incoming ECB President Christine Lagarde will face early calls for measures to revive flagging economic growth, on top of the ECB monetary injection in September 2019 and further bond-buying. The subject of fiscal expansion, particularly by Germany is being widely discussed.
Japanese growth stalled in the first quarter of 2018 after eight consecutive quarters of improvement and then rebounded during summer months, before further softness due to natural disasters and a deteriorating trade situation. Current calendar 2019 economic forecasts are for about 1% annualised GDP growth, after a surprisingly strong first quarter and recently reported third quarter, but expectations of a somewhat weaker fourth quarter following the VAT rise. The Tankan Index for large manufacturer was also weaker than expected in December 2019, although the service component remained relatively strong.
The Yen 13.2 trillion package announced in early December 2019 to repair typhoon damage, upgrade infrastructure and invest in new technologies was one of the largest since the financial crisis of 2008-2009.
At recent meetings the BOJ pledged to maintain the current negative interest rates, yield curve management and asset purchase programmes, tweaking its forward guidance as recently as early November 2019.
Politics tilted in a pro-reform direction, after the October 2017 election landslide, which should help various economic and political initiatives. The political situation was strengthened further by the leadership victory late September 2018, which would make Shinzo Abe one of the longest serving Japanese PM’s since the job was created in 1885. The initiatives will include more focus on the quantitative actions, including higher care wages, pension reform, targeted infrastructure and some moves to tweaking the pacifist constitution. The re-appointment of Central Bank Governor Kuroda was helpful to the continuation of accommodative fiscal and monetary policy, a stance reinforced in the spring.
Inflation is still well below the official target (0.5% in November 2019) although oil price strength and early signs of wage and recent price growth are expected to accelerate the upward trend. Japan’s September jobless rate at 2.4%, is the lowest since 1994, and there are labour shortages in a growing list of sectors, including construction and elderly care. The parliament recently voted to allow more than 250000 foreign workers into the country on five-year visas, and with the improved electoral mandate, it is widely expected that the subjects of female participation and pension age changes will also be studied.
Monetary policy will remain dependant on inflation developments, and currently no major changes are expected to short or long-term interest rates until at least end-2019.At the recent BOJ meetings, the Board have voted to keep the benchmark short term interest rate at -0.1% although Kuroda hinted at further easing on September19th. In early October 2019, the long-awaited rise in VAT from 8% to 10% took place, although the impact was softened somewhat by cashback reward measures.
Asia excl- Japan
Efforts to boost domestic demand, either through monetary policy, banking reform and structural issues are bearing fruit in some areas, but are also currently hindered by currency volatility, high debt ratios, disinflation, politics etc. The spectre of a tariff “war” between USA and China, could of course, impinge adversely on some of the more open economies in the area and specialist zones e.g. Taiwanese semi-conductors. Other opportunities may also arise e.g. Vietnam.
Overall estimates for growth in the region have slipped over recent months, but the aggregate figure masks large individual country differences. For example, Vietnam is currently experiencing economic upgrades, partly as a result of the US/China tariff “war”.
At the National People’s Congress held in early March 2018, Chinese Premier Li Keqiang outlined an economic growth target of 6.5%, with a minimum target of 6.3% p.a over the 2018-2020 period, in additional to a lower fiscal deficit goal. At the conference there was more emphasis on quality of growth, pollution control and risk control, property stabilisation, liberalization of the financial system than numerical targets. Recent indicators however point to slower growth, with some estimates as low as 5%. At the time of writing Chinese moves to stabilise growth through a mixture of tax cuts, infrastructure spending and bank lending support, appear to be working, although the ongoing tariff discussions impose an air of huge uncertainty.
In India, much is still riding on the “Mondi” reform programme where long-standing concerns in the areas of infrastructure, bureaucracy and fiscal inconsistency need resolution.However,the recent election (May 2019), won by Narendra Modi with a landslide victory, gives the leader power to forge on with building a “New India”, and the surprise corporation tax cuts announced on September 20th give some reasons for optimism, although the religious “priorities” have to be monitored closely. Recent economic statistics point to a slowdown nearer 5% GDP growth than the 6% /7% of recent years.
Regional Equity Recommendations
Japan remains a favoured equity market, despite the global sterling adjusted outperformance in 2017 and 2018, though underperforming in 2019. Regarding the investment arithmetic, the prospective PE (13.9 falling to 12.89 in 2021 as at December 01,2019) is still lower than the world average and the price book ratio is near the lowest of all the major regions, at a level of 1.20. Corporate results for recent periods have been much as expected and further growth is expected over the 2020/2021 period. Analysts point to further scope for Return on Equity, currently just over 8.0%, to converge on the average for developed markets over coming years. On a technical note, Japanese institutions are undergoing a longer term bond/equity switch and the market tends to be under owned by overseas institutions. Regarding domestic demand, the BOJ and other buybacks amount represent a growing percentage of market cap on an annual basis while public and private pension funds are steadily increasing their equity weightings. Regarding the former, buybacks between January and November of 2019 are up 112% compared with the previous year, currently running at over $6 billion per month. Individual households hold approximately 50% of their financial assets in cash, extremely high by international standards, another source of equity demand. Finally, corporate governance (independent directors etc), buy backs, dividend hikes and current valuations on upgraded earnings are helping sentiment. About dividends, current low pay-out ratios (around 35%), give scope for above average income gains going forward. Currency strength/weakness is of course a double-edged sword regarding Japanese portfolio strategy. I recommend that some Japanese equity exposure, currently, be hedged back to sterling and or US dollar.
Europe (ex-UK) warrants a continued small overweight in my view.
With the current accommodative monetary policy, stable consumer sentiment and a more stable Euro, the market continues to deserve longer term attention. At corporate level, earnings are being helped by nominal sales growth, margin expansion, and lower tax and interest charges. There are many situations in exporters, capital goods, financials where equities appear good value on PE and Price/ Book considerations and offer reasonable dividend yields. However, at time of writing an escalation in the tariff “war” could have adverse effects on the margins and sales volumes of certain products e.g. German cars, luxury goods, and more than usual investor due diligence will be required. On the sectoral point for example it should also be remembered that the EuroStoxx 50 weighting in oil and mining is approximately half of that in the FTSE 100. On a cyclically adjusted price to earnings ratio (CAPE) often used by longer term investors the Eurozone trades at a considerable discount to the US market. The shorter-term PE ratio currently stands at about 14.3 for2020, dropping to 13.3 in 2021, with a prospective dividend yield of 3.7%. By historic comparison the market is fairly valued on a price earnings and price cash flow basis and good value on price/book and dividend yield considerations.
Asia (ex Japan) is currently dominated by China and related China plays such as Hong Kong and Taiwan in MSCI index terms. Over the longer term, the Chinese weighting could increase significantly, when more local shares may be included in the major index benchmarks.JP Morgan estimate that the Chinese A-share weighting could move from just under 1% in May 2018 to nearly 14% by 2025.This is in addition to the approx. 25% to 30% of the index already represented by mainstream Chinese stocks. As discussed elsewhere, the consensus is for a Chinese economic slowdown to around 5%-6% per year, but possible risks could emerge from several directions including excessive credit expansion, shadow banking, currency volatility, tariff escalation and geo-political tensions aggravated by President Trump. Equity investing as an overseas investor also faces hurdles in the shape of government control (including the stock market itself), currency policy, corporate governance issues and sometimes less than ideal accounting. A well-diversified portfolio could however include some longer-term exposure to the China region, directly or indirectly (Hong Kong, overseas plays, ETF, investment trusts etc.), but shorter-term volatility is expected. Amongst other countries, India remains an investor favourite, even though valuations are becoming quite full, and, like China, economic growth appears to be slowing faster than expected. Korea looks reasonable value, but the competitive situation should be monitored, and Australia, whose economy and currency are closely tied to the fortunes of the commodity sector, offers some interesting yield situations. Finally, Vietnam warrants attention as a high growth economy and possible beneficiary of any US/China tariff war. In aggregate the region has a prospective PE of just over 14.4 with a dividend yield of 3.0%
On equity valuation, US shares look slightly overbought on current metrics including shorter term price earnings ratio (18.3 times forward earnings-2020), price book ratio and yield, and longer-term Schiller PE look a little more stretched. Corporate share buybacks, one of the significant market support factors, over the 2010/2016 period, are slowing and household ownership of equities is high relative to Europe and Japan, for instance. However, equities are not priced in the bubble territory which occurred in 2000, multiples have retreated since early 2018 and sentiment indicators remain in neutral territory. Corporate earnings growth was upgraded following certain aspects of proposed Trump policy especially in corporate taxation, but dollar volatility, weak corporate investment, and overseas supply chain disruption should also be considered. If current tariff proposals come to fruition (a big IF), several US companies expect to be affected by disruptive volume and input pricing effects late. Apart from the trade figures it is important to understand the longer term impacts of intellectual property discussions, international on-line tax debate and specific company issues e.g Huawei.
There continue to be wide divergence between the economies of the emerging universe with, for example, Russia, Brazil and South Africa experiencing much slower growth, the latter also recently experiencing a credit downgrade and new political era, and many countries suffering from disproportionate commodity exposure (Russia), unstable/changing political situations (Venezuela, Turkey, Mexico, Brazil) and or/ high dollar debt levels. The changing US political regime clearly adds more uncertainties deriving from a volatile dollar, and selective protectionist policies. India is currently one of the rare outliers with minimal commodity or deflation worries but other issues that need addressing and hopes that the recently appointed Finance Minister continues to adopt the discipline imposed by her predecessor. However, on balance, developing economies which had been detracting from global growth for several quarters are now starting to stabilise.
Investors could consider some selective exposure to the region, which currently trades on a prospective 12.0 multiple on 2020 earnings, a considerable discount to other zones. Foreign Exchange could be an important issue from both currencies of investment and individual corporate effects. However, investors should also be aware the considerable risks that are plaguing the asset class, whether commodity pricing, debt, political change etc. In terms of industry sector, earnings are expected to be strongest in consumer discretionary, healthcare and information technology, although several analysts detect more “value” in the oversold financial sector. According to recent Morgan Stanley research, aggregate 2020/2021 emerging market earnings growth currently stands at a level of around 13% p.a. It should be noted that many emerging market companies are also rapidly increasing dividends, from a low level and there are some interesting pooled vehicles to exploit this. Morgan Stanley estimate dividend growth of 8.9% and 8.1% for the region over 2019and 2020 respectively. By contrast, developed markets are estimated to have dividend growth of approx. 6% p.a over the same periods. Despite the current volatility, Russia remains worthy of speculative attention on the basis of low valuation, stable government finances, well above average dividend yield, better commodity price trends, but clearly a higher risk/return play, while Vietnam is likely to remain an Asian favourite despite the rating and recent performance, and emerging Europe may receive more attention going forward. Weightings in China and India still seem appropriate and South Korea has also moved back to the attractive zone. South American politics are playing an increasing role in investor sentiment, e.g. Venezuela, Mexico and most recently, Brazil.
Government Conventional Fixed interest-The medium-term fundamental prospects for core government bond yields (UK, USA, Japan, and Germany) continue to depend primarily on inflation and Central bank policy outlooks. External “shocks” also introduce spikes in volatility from time to time and related hunt for perceived safe havens. Over the late summer period of 2019 worries over global growth and trade tensions pushed nearly $17 trillion of government debt into negative yields. However, since then, yields have risen sharply (price falls) taking approx. $6 trillion of the above into positive territory. The Japanese bond, for example rose above zero for the first time since March.
|On the first point, current inflation, as measured by the year on year rates in USA, Continental Europe, Japan and several emerging markets has remained low and below several Central bank “targets”. Region||Updated||10-year Govt yield||Spread versus T-Bond|
Other Fixed interest
It is forecast that the total returns from certain fixed interest outside the conventional core government bond space could yield relative outperformance, but allowance should be made for higher volatility liquidity, credit quality, dealing spreads etc. Some yield spreads still provide enough “cushion” versus conventional government bonds and may additionally have part equity drivers e.g. Preference shares, convertibles or be sector specific e.g. energy related.
The search for above average regular income continues, with several participants forced to move up the risk curve. A recent example was the large oversubscription for an Angolan bond issue
In general, a word of caution that using the ETF route for obtaining fixed interest exposure currently requires an extra level of due diligence regarding liquidity, spreads, degree of physical cover, tracking experience and of course full understanding of the underlying index.
Corporate Debt- Although many investment grade issues appear fully priced there may be opportunities in other grades if the risk/return/maturity/liquidity criteria suit. These may also be available in pooled form through ETF or OEIC or investment trusts. Selected US high yield (5.42% on 31/12/2019) may offer FX as well as bond spread and income gains, and it must not be forgotten that with corporate dynamics improving and a more favourable supply demand balance there is good scope for outperformance over the government sector.
|ETF||Yield p.a||OCF||Dividend payments||Physical cover|
|US High yield||5.42%||0.5%||Six monthly||Yes|
|Emerging local||5.24%||0.5%||Six monthly||Yes|
Emerging market Debt-higher risk but also potentially higher return but remember to analyse currency as well as income and capital. Also, available in ETF form, I-share SEML, holds over 200 securities with near 10% weightings in South African, Mexican,Thai, Brazilian, and Indonesian debt. Currently over 90% of the fund’s assets are rated A, BBB or BB and the fund yields 5.24%.Recent oversubscription for an Angolan government issue show continued “search for yield”
Preference Shares-Above average yields are still available, despite the large total return outperformance over the gilt sector over recent periods and remember the more favourable tax treatment for basic rate payers. Some of the UK bank issues look particularly interesting in this sector after recent/ongoing capital strengthening exercises and the results of the “stress tests”. Depending on risk appetite, annual yields around 5.5% to 6.1% are currently available on selected financial issues suitable for balanced accounts while, like corporate bonds, some higher yields can be found in more speculative issues.
Floating rate-provide an element of hedging against rate increases. Available in direct or investment trust structures and currently offering between 4.5% and 5.5% annual yield and priced at discount to assets. These instruments outperformed conventional government stocks during 2018 as short-term rates were increased, particularly in the USA, but have performed more in line with government stocks this year in total return terms.
Index Linked– These instruments continue to attract interest from both longer-term institutions with asset/liability issues and, more recently, from some shorter-term tactical funds. Linkers do offer some investment advantages such as low volatility(usually) and low correlation with several other asset classes and they are in relatively short supply.US investors are currently rebuilding holdings in the sector as the Fed weighs lifting the inflation target However, UK issues currently do not look particularly good value either domestically or by international comparison on most reasonable inflation assumptions or by comparison with other alternatives. The asset class suffered a shock recently following proposals to phase out/change RPI. In my view, there are other instruments that offer some degree of inflation protection/diversification at more reasonable price levels. The real yield on the UK FTSE All Index Linked Gilts is currently –1.83%
Zero-Coupons-Capital only, yields of over 3.9% p.a (annual equivalent) to November 2022, or 4.2% p.a. to November 2024 or 5.0% to November 2026 on recommended issues at time of writing. May suit event planning/higher income tax situations.
Convertibles-UK market relatively small and my favoured pooled vehicle has just been redeemed at near asset value. The sector is however worth monitoring, for the combination of a floor yield (in an era of very low competitive yielding products), with possible equity upside as well.
Corporate Bonds, UK order book-Selected issues may warrant attention. In the expanding London retail bond market, running yields between 4.0% and 5.0% on LSE quoted companies with between 4 and 7-year maturities are available on more stable underlying businesses, while much higher flat(e.g. 7%) and redemption yields apply to certain more speculative issues, especially in the energy area. A growing number of ultra-long issues are becoming available.
Following the historic decision on June 23,2016 to leave the EU, property markets, especially in London felt the aftershocks. Volume of activity and pricing were immediately affected and within days, property funds holding £15 billion of assets had closed the gate to redemptions. Over three years later, the markets have not settled, although some of the more drastic revisions and rumours have been softened. Amongst the main sectors, shopping centres are struggling with stalling consumer confidence and on-line competitors while the office sector, especially in London, is experiencing varying trends. The mergers recently announced between Hammerson and Intu,and Unibail/Westfield and recent Land Securities/British Land figures highlight the need to reduce costs in a troubled shopping centre sector. Interestingly, figures and statements from quoted company Segro PLC, by direct contrast, show the growth in logistics centres, warehousing as online shopping accelerates.
Over 2018, the MSCI IPD UK Index showed a total return of 7.5%, although this growth slowed to just 1% in the last quarter. Of the 7.5%,5.2% was attributable to income and included rental growth of 2.7%. By sub sector industrial values rose faster than retail values every single month. Over the first ten months of 2019 the Index has continued to show even slower total return. Income continues to be the positive factor as capital values decline across several categories, and Retail is still very poor, especially in London and the South-East
In the post BREXIT environment, investors in commercial property funds should be increasingly aware of “value adjustments” suddenly imposed on their unit holdings, large unproductive cash holdings, as well as perhaps a tightening of redemption procedures (see recent FCA papers), which is improving the relative attractiveness of closed end funds and direct equities. As ever however, watch location, management and balance sheets carefully! In major commercial property sectors,” tech” friendly features are increasingly demanded, while retailors juggle with the physical/online balance. In the specialist areas of student, logistics, medical, retirement accommodation and self-storage there is still good demand and in the medium term these sub-sectors are expected to become more “mainstream”. Many international investors have switched their attention away from UK towards Continental Europe, where rental levels, capital values and prospects are deemed more attractive. Remember also that property corporate bonds/preference shares may suit some client objectives.
Alternative Income / Other- Overweight
This “catch all” sector is taking on increasing significance during this current phase of volatile bond and equity performance and an expectation of lower returns, looking forward. It is noticeable that during the weaker equity periods, many renewable/private equity/infrastructure plays held their ground, and in some cases showed absolute returns. Funds which may fit the characteristic of better capital protection and above average yields and low correlation with other asset classes include
- • Infrastructure, including recent issues in the renewable sector, offering income yields around 5%- 6% p.a. Corporate activity e.g. John Laing, is an additional positive factor.There appears to be a global move towards various infrastructure related projects and this topic will be revisited during the Uk Budget statement in a couple of months.
- • By way of comparison, certain listed vehicles in the areas of private equity and specialised lending currently offer yields of 6%-8%, but careful due diligence and extra considerations of transparency, holding period and liquidity in differing market conditions should be considered.
- • Certain liquid transparent structured products, although special client permission may be required, and full understanding of the maths and counterparty risk are essential. These can be useful for hedging e.g. infinite turbo puts/covered warrants against a fully invested equity portfolio.The currently relatively low VIX level makes put option buying an interesting strategy
GOOD LUCK IN 2020
Disclaimer All recommendations and comments are the opinion of writer. Investors should be cautious about all stock recommendations and should consider the source of any advice on stock selection. Various factors, including personal ownership, may influence or factor into a stock analysis or opinion. All investors are advised to conduct their own independent research into individual stocks and markets before making a purchase decision. In addition, investors are advised that past stock performance is not indicative of future price action. You should be aware of the risks involved in stock investing, and you use the material contained herein at your own risk The author may have historic or prospective positions in any securities mentioned in the report. The material is provided for information purpose only