Over the long run, the market has provided substantial returns regardless of who lives at Number 10.

Next month’s snap election is the first national vote in the UK since the EU referendum. While the election’s outcome and overall impact are unknown, there is no shortage of speculation about how the election will impact the stock market. Below, we explain why investors would be well-served avoiding the temptation to make significant changes to a long-term investment plan based upon these sorts of predictions.

Exhibit 1: Growth of a Pound Invested in the Dimensional UK Market Index
January 1956–December 2016

For illustrative purposes only. Past performance is not a guarantee of future results. Index is not available for direct investment, therefore, their performance does not reflect the expenses associated with the management of an actual fund. Dimensional indices use CRSP and Compustat data.

Trying to outguess the market is often a losing game. Current market prices offer an up-to-the-minute snapshot of the aggregate expectations of market participants— including expectations about the outcome and impact of elections. While unanticipated future events (genuine surprises) may trigger price changes in the future, the nature of these events cannot be known by investors today. As a result, it is difficult, if not impossible, to systematically benefit from trying to identify mispriced securities. So it is unlikely that investors can gain an edge by attempting to predict what will happen to the stock market after a general election.

The focus of this election is Britain’s exit from the EU. But, as is often the case, predictions about the outcome and its effect on the stock market focus on which party will be “better for the market” over the long run. Exhibit 1 shows the growth of £ 1 invested in the UK market over more than 60 years and 12 prime ministers (from Anthony Eden to Theresa May).

This exhibit does not suggest an obvious pattern of long-term stock market performance based upon which party has the majority in the Commons. What it shows is that in the long run, the market has provided substantial returns regardless of who lives at Number 10.

Equity markets can help investors grow their assets, but investing is a long-term endeavour. Trying to make investment decisions based upon the outcome of elections is unlikely to result in reliable excess returns for investors. At best, any positive outcome based on such a strategy will likely result from random luck. At worst, such a strategy can lead to costly mistakes. Accordingly, there is a strong case for investors to rely on patience and portfolio structure, rather than trying to outguess the market, in order to pursue investment returns.

Risk Warning
This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.

Max Tennant - May 2017

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Ever ridden in a car with worn-out shock absorbers? Every bump is jarring, every corner stomach-churning and every red light an excuse to assume the brace position. Owning an undiversified portfolio can trigger similar reactions.

In a motor vehicle, the suspension system keeps the tires in contact with the road and provides a smooth ride for passengers by offsetting the forces of gravity, propulsion, and inertia.

You can drive a car with a broken suspension system, but it will be an extremely uncomfortable ride and the vehicle will be much harder to control, particularly in difficult conditions. Throw in the risk of a breakdown or running off the road altogether and there’s a real chance you may not reach your destination.

In the world of investment, a similarly bumpy and unpredictable ride can await those with concentrated and undiversified portfolios or those who constantly tinker with their allocation based on a short-term rough patch in the markets.

Of course, everyone feels in control when the surface is straight and smooth, but it’s harder to stay on the road during sudden turns and ups and downs in the market. And keep in mind the fix for your portfolio breaking down is unlikely to be as simple as calling a tow truck.

For that reason, the smart thing to do is to diversify, spreading your portfolio across different securities, sectors, and countries. That also means identifying the right mix of investments (e.g., stocks, bonds, property) that aligns with your risk tolerance, which helps keep you on track toward your goals.

Using this approach, your returns from year to year may not match the top-performing portfolio, but neither are they likely to match the worst. More importantly, this is a ride you are likelier to stick with.

Just as drivers of suspension fewer cars change their route to avoid potholes, people with concentrated portfolios may resort to market timing and constant trading as they try to anticipate the top-performing countries, asset classes, and securities.

Here’s an example to show how tough this is. Among developed markets, Denmark was number one in Sterling terms in 2015 with a return of 30.6%. But a big bet on that country the following year would have backfired, as Denmark slid to the bottom of the table with a return of just 0.5% in 2016.

The US has had a stellar run, ranked in the top three of the world’s best performing developed share market three times in the past six years (2011, 2013 and 2014). But between 2002 and 2006 it was a laggard, appearing in the bottom five in each of these years (see Exhibit 1).

Predicting which part of a market will do best over a given period is also tough. For example, while there is ample evidence to support why we should expect positive premiums from small-cap, low relative price, and high profitability stocks, these premiums are not laid out evenly or predictably across the map. US small-cap stocks were among the top performers in 2016 with a return of more than 21%. A year before, their results looked relatively disappointing with a loss of more than 4%. International small-cap stocks had their turn in the sun in 2015, topping the performance tables with a return of just below 6%. But the year before that, they were the second-worst with a loss of 5%.

If you’ve ever taken a long road trip, you’ll know that conditions can change quickly and unpredictably, which is why you need a vehicle that’s ready for the worst roads as well as the best. While diversification can never completely eliminate the impact of bumps along your particular investment road, it does help reduce the potential outsized impact that any individual investment can have on your journey.

With sufficient diversification, the jarring effects of performance extremes level out. That, in turn, helps you stay in your chosen lane and on the road to your investment destination.

Happy motoring and happy investing.

Risk Warning
This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.

Max Tennant - May 2017

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From 6 April 2017, a new allowance may reduce the amount of tax due when leaving your estate, including your family home, to your descendants.

The allowance starts at £100,000 for 2017/18 and will increase during the subsequent three tax years by £25,000 per year until it reaches £175,000 in the 2020/21 tax year. When added to the current nil rate tax band of £325,000 per individual, this means an allowance per individual of £500,000 and £1 million for married couples and civil partners for their descendants before any inheritance tax is payable. Both these tax allowances can be passed onto the surviving spouse or civil partner.

This new allowance supports a Government aim to make it easier to pass the family home onto children, grandchildren, adoptive and step-children and may have a significant impact on inheritance tax planning strategies.

However, in order for your descendants to benefit, there are some important points to be considered:

• The qualifying property needs to have been your main residence at some point during your lifetime. You do not have to be living in the property when you die.

• If you own more than one qualifying property, your personal representatives can nominate which one should be used.

• You must leave the property to a lineal descendant. In addition to children and grandchildren and their spouses, this includes step-children, adopted and fostered children.

• It does not include your spouse, you can only transfer the allowance to them.

• The Main Residence Nil Rate Tax Band can be transferred to a surviving spouse or civil partner even if the first to die did not own a property.

• The total value of your estate should not exceed £2 million. In this case, the allowance is tapered down. It is reduced for every £2 which exceeds this limit.

• If you die in the 2017/18 tax year with an estate of more than £2.2 million then your residence allowance will be reduced to £0.

Use of Trusts
Care should be taken if your residence is to be placed in trust after your death. The legislation permits gifts into certain types of trust. This includes life interest trusts and those which benefit from preferential inheritance tax treatment. It does not include discretionary trusts even where the only people who can benefit fall within the definition of ‘lineal descendant’.

Downsizing
Your descendants can still qualify for the new main residence allowance if you downsize or sell up to move into care, provided you did so after 8 July 2015. It may be possible to use the main residence allowance to reduce inheritance tax on assets of any kind.

Limitations
Strict requirements may mean the main residence allowance is of limited use, especially if your estate is worth more than £2 million or you don’t want to leave your main residence to a lineal descendant. Each individual case will be different. We are very happy to answer any queries you may have and if this applies to you, we will discuss this at your next review meeting.

Risk Warning
This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.
 

Max Tennant - March 2017

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How women view money and investing differently

A little encouragement goes a long way

We tend to regard wealth as financial assets, large houses, and nice cars accumulated through a life of hard work.  Yet that is to view wealth in narrow terms; on the very day we are born we are wealthy in terms of our human capital, or in other words, the present value of all the future earnings that we will generate over our working lives.  This needs to be reflected in how we invest during the accumulation phase of investing.

As younger people have a long time to go before they will need the money, the advice they receive is often that excess earnings should be invested predominantly in equities.  A subtler approach takes into account the attributes of each person’s human capital, which ranges from bond-like to equity-like in nature.  Take for example a university professor and a fin-tech entrepreneur; the former has a stable income, linked to inflation and job security; the latter has little income stability and, most likely, a high correlation to the equity markets. The professor’s human capital acts like a bond, the entrepreneur’s as equity.

So, if they are both 40 years old and have the same level of financial capital, should they invest in the same way? Intuitively, the answer is no. 

Human capital should be treated like any other asset class; it has its own risk and return properties and its own correlation with other financial asset classes.

Ibbotson, Milevsky, Chen and Zhu (2007)[1] 

Those with more bond-like human capital could well take on more risk and those with more equity-like human capital should, perhaps, take on less risk with their financial capital.  Ironically, it is also possible that those who choose steady, stable jobs may have a lower tolerance to losses than the entrepreneur, and vice versa.  One can see the risk of this scenario.  Additionally, two partners may also have different levels of risk in their human capital. Imagine a professor married to an entrepreneur; together they form a balanced portfolio between bonds and equities and their investable portfolio of financial capital should reflect this. 

Figure 1: How human capital attributes influence asset allocation

Source: Albion Strategic Consulting

Cash-flow modelling can help those in the accumulation phase of investing to understand the financial impact of changes to their human capital.  Owning sufficient life cover to protect the outstanding human capital should be an important part of the discussion.  It is difficult to see how a stockbroker or investment manager can structure a portfolio sensibly, particularly where the investor still has substantial human capital, without the insight into, and modelling of, the client’s total asset picture.  No financial portfolio is an island.

[1] Ibbotson, Milevsky, Chen and Zhu (2007), Lifetime Financial Advice: Human Capital, Asset Allocation and Insurance, Research Foundation of CFA Institute publication.

Risk Warning

This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.

Max Tennant - February 2017

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Pay less attention to weather forecasts

How women view money and investing differently

A little encouragement goes a long way

On the winter solstice, Ifamax went to work on making life just a little bit better at the Dogs’ Friends Rescue, which is based near Cheddar. We went with no specific plan, other than for them to use us as they wished.

Ashton and Jamie were initially tasked with cleaning out some stables and then adding waste to their composting heap. I’m afraid I had to intervene momentarily to give a fork using demo. Having come from a farming background myself, watching those two boys in action with long fork handles was painful on the eyes.

Naomi and I were tasked with filling a skip. Dogs’ Friends are halfway through redevelopment of one side of their yard. Some old sheds were being removed and there was quite a bit of rubbish and rubble to clear away.

The biggest challenge in working in the main yard was being around six very large, but friendly Golden or Chocolate Labradors. These Labs took great interest in every item that was being removed and simply walked in your way when you least expected it. Naomi made the massive mistake of actually showing them some attention, which for her, resulted in trying to push off about one ton of dog for the rest of the afternoon, as they all competed for her affection.

Our last job was then for all of us to clear down the main yard. The surface is rather broken and is full of potholes. I think it’s an area that really needs funding as it can’t be easy to work with, especially during very wet or cold periods.

Ashton, Jamie, Naomi and I, all had a great day of hard work. It was pleasing to step back and see the change we had made and we would happily do it again.

If you would like to donate please to Dogs’ Friends, please click on the link.     

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We are somewhat loathe to put out yet another piece about what might happen in the markets as it risks focusing long-term, sensible investors’ minds on short-term events.  The referendum on Scottish independence, Grexit, China’s slowdown and most recently Brexit, have come and gone, in market terms, with most investors sitting on healthy increases in their portfolios since 2014, despite uncertainty at the time.  However, it is not a bad thing to revisit the robust rationale for the structure of our client portfolios, particularly at such a time.

With less than a week to go before US citizens exercise their democratic rights and responsibilities, the race between the two Presidential candidates – love them or loathe them – looks too close to call.  This campaign has, perhaps, brought out the worst of the US electioneering process between two polarising candidates, with much talk of the least-worst outcome.  At times it has been unedifying, to say the least.  Yet by this time next week, the world will have a new US President.  No-one ever said that democracy was easy.  As Churchill once said:

‘Democracy is the worst form of government, except for all the others.’

From a market perspective, share and bond prices, along with exchange rates, reflect all publicly available information, which includes the aggregate market view on both candidates, their economic and foreign policies and the various scenarios of who wins the House of Representatives and who wins the Senate.  It is therefore next to impossible to second-guess, at this point, what might happen to markets in terms of directional movements.  What we do know is that, like Brexit, there is likely to be a lot of uncertainty, which will be reflected in market volatility, as events unfold, and market participants try to make sense of the outcome delivered by the US people.

It is also worth remembering that it does not really matter which party is in power, from an equity market perspective. The relentless growth of the US (and global) economy, driven by the desire of the private sector for profit, is ultimately reflected in dividends paid to investors and the real growth in corporate earnings that leads to stock price rises over the longer-term.  Time is your friend.

Figure 1: Cumulative, nominal return – US equity market 1970-2016 in GBP and USD.

Data source: MSCI US Index TR from Morningstar Direct

Risks and mitigants

Shorter-term risks to investors’ portfolios include equity market volatility (nothing new there!); rises in bond yields; and weakening of the US dollar.  It is perhaps worth revisiting why our clients’ portfolios are structured as they are:

• Your equity holdings are highly diversified: holdings are diversified across global economies (emerging and developed), across sectors and by individual companies.  Although the US represents around 50% of the global equity markets, it is worth noting that around 45% of the sales of goods and services of S&P 500 companies are made outside of the US (1).

• Your bond allocations are defensive in nature: in the event that bond yields rise, again it is worth noting that US bonds form only part of the bond allocations held in portfolios and, where they are held, they tend to be short-dated bonds which are less sensitive to rises in yields (price fall) than longer-dated bonds.  The majority of bonds held in portfolios are of very high credit quality, which tends to do better at times of market uncertainty, compared to lower quality bonds.

• Your bond exposure is fully hedged, whilst equity exposure is unhedged: if the US dollar depreciates, then for investors with non-dollar portfolios, this could have a negative effect on performance.  Any clients with a US dollar portfolio will conversely benefit.  However, as indicated above, 50% or more of the equity assets are in non-dollar assets and 45% of overseas sales made by US companies will now be worth more in US dollar terms, supporting the US market.  A similar phenomenon has been seen in the UK, post-Brexit.  The bond allocation in portfolios will be largely unaffected by currency movements.

As ever, our advice is to stay put with your strategy and weather any storms that may come your way. Your portfolio is a sturdy vessel in choppy waters. Patience, discipline, and fortitude will see you through.  It is worth reflecting on the sage words of a former President:

Let us never forget that government is ourselves and not an alien power over us. The ultimate rulers of our democracy are not a President and senators and congressmen and government officials, but the voters of this country.

Franklin D. Roosevelt

Be it Clinton or Trump, they are only the vassals of the people.

[1]     S&P Dow Jones Indices (July 2016), S&P Foreign Sales at 44.3%, Lowest Level since 2006.

Risk Warning

This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.

Max Tennant - November 2016

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Pay less attention to weather forecasts

How women view money and investing differently

A little encouragement goes a long way

When news breaks and markets move, content-starved media often invite talking heads to muse on the repercussions. Knowing the difference between this speculative opinion and actual facts can help investors keep their nerve. 

At the end of June, the referendum for the nation to withdraw from the European Union. The result, which defied the expectations of many, led to market volatility as participants weighed up possible consequences.

Reporting on the result, The Washington Post said the vote had "escalated the risk of global recession, plunged financial markets into freefall and tested the strength of safeguards since the last downturn seven years ago".

The Financial Times said 'Brexit' had the makings of a global crisis. "(This) represents a wider threat to the global economy and the broader international political system," the paper said. "The consequences will be felt across the world."

Now it is true there have been political repercussions from the Brexit vote. Teresa May replaced David Cameron as Britain's prime minister and overhauled the cabinet. There are debates in Europe about how the withdrawal will be managed and the possible consequences for other EU members.

But markets have functioned normally. Indeed, within a few weeks of the UK vote the FTSE 100 hit 11-month highs. By mid-July, the US S&P 500 and Dow Jones industrial average had risen to record highs. Shares in Europe and Asia also strengthened after dipping initially on the vote.

On currency markets, the pound sterling fell to a 35-year low against the US dollar in early July. The Bank of England later surprised forecasters by leaving official interest rates on hold.

Yes, the Brexit vote did lead to initial volatility in markets, but this has not been exceptional or out of the ordinary. One widely viewed barometer is the Chicago Board Options Exchange's volatility index or 'VIX'3. Using S&P 500 stock index options, this index measures market expectations of near-term volatility.

You can see by the chart above that while there was a slight rise in volatility around the Brexit result, it was insignificant relative to other major events of recent years, including the collapse of Lehman Brothers, the Euro Zone crisis of 2011 and the severe volatility in the Chinese domestic equity market in 2015.

None of this is intended to downplay the political and economic difficulties of Britain leaving the European Union, but it does illustrate the dangers of trying to second guess markets and base a long-term investment strategy on speculation.

Now the focus of speculation has turned to how markets might respond to the US presidential election. CNBC recently reported that surveys from Wall Street investment firms showed "growing concern" over how the race might play out.

Given the examples above, would you be wagering your portfolio on this sort of speculation, particularly when it comes from the same people who pronounced on Brexit? And remember, not only must you correctly forecast the outcome of the vote you have to correctly guess how the market will react.

And think about this. Even if you do get it right, what's to say some other event might steal the markets' attention in the meantime? The world is complex and unpredictable. No-one really can be certain about anything.

What we do know is that markets incorporate news instantaneously and that your best protection against volatility is to diversify both across and within asset classes, while remaining focused on how you are tracking relative to your own goals.

The danger of investing based on what just happened is that the situation can change by the time you act, a "crisis" can morph into something far less dramatic and you end up responding to news that is already in the price.

Journalism is often described as writing history on the run. Don't get caught investing the same way.

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Pay less attention to weather forecasts

How women view money and investing differently

A little encouragement goes a long way

The UK has woken up this morning to a vote to leave the EU, the Prime Minister is set to leave office in October and the markets are suffering a bout of jitters.  We all knew that these were possibilities.  To some this is a good day, to others, it is not.  But we are where we are and we need to look forward to where we go from here.

We should not, however, lose sight of the fact that what we have witnessed is a long-standing, robust and stable democracy at work with both sides attempting to sway voters with the power of argument, passion, and belief.  Although we have seen some dubious use of facts and figures, some scaremongering on both sides and some less than savoury comments at the fringes, this process has been free of violence, open to all and with everyone’s vote holding the same sway; that we should be both proud of and reassured by.

We are also seeing the markets at work, trying to make sense of what this all means and reflecting the aggregate view in market prices.  We are likely to see market gyrations over the coming weeks and months, but we should all remember to view it as short-term noise.   There are many ‘known unknowns’ as Donald Rumsfeld would say: we face an uncertain and likely tough negotiation to exit the EU, with unknown outcomes; an increased likelihood of another Scottish referendum and threat to the Union; and the knowledge that broad change is upon us.

As individuals, we need to try not to worry about things that we can’t control, such as what will happen to the UK economy over the next five years, or where the markets go in the next few days, weeks and months.  We should focus on things that we can control such as the structure of our investment portfolios.  As we have explained before, your portfolio is well-positioned to weather this storm, both in its structure and the high-quality funds that we recommended to execute your portfolio strategy.  To reiterate:

Your portfolio is globally diversified in terms of its equity exposure

It is worth remembering that the UK economy represents less than 5% of global GDP, and its equity market is around 6% of global market capitalisation.  The stock market is also not a direct proxy for the UK economy as many of its constituents have considerable overseas operations, such as HSBC and Shell.  In fact, around 70% of earnings from FTSE 100 companies come from overseas.

Your portfolio has well-diversified exposure to other developed equity markets and emerging markets economies and companies, which will help to mitigate any UK-specific market fall.  Equity markets as a whole might be volatile, but that is the nature of equity investing, and being diversified will help. 

A fall in Sterling is actually beneficial to portfolio performance

This morning has seen a big fall in Sterling against the US dollar and the Euro.  Ironically, this fall is beneficial to your portfolio as the non-sterling denominated overseas assets that you own are now worth more in Sterling terms.  That is an example of a good diversification in action.

Owning short-dated, high-quality global bonds delivers strong defensive qualities

The primary defensive assets in your portfolio are short-dated, high-quality bonds, diversified on a global basis.   At times of market uncertainty, money tends to flood from more risky assets (equities and low-quality bonds) into high-quality bonds, driving yields down and prices up.  We have already seen early signs of this happening in the major bond markets this morning.

Have faith in your portfolios and resist the urge to look at its value too often. You don’t need this money today or tomorrow, so try not to worry about any short-term falls; that is the nature of investing.  This is a long-term strategy to meet your long-term goals.

As the dust settles on what is a momentous day for the UK and the EU, perhaps we should remember that almost an equal number of people voted to remain as to leave.  We now all need to find ways in which we can help to rebuild bridges with the other side in whatever small way that we can.  The UK has as a proud past, a strong present, and an exciting – if different – future to that envisaged by many when they went to bed yesterday.  Remember, we are the World’s fifth-largest economy with more people in employment than ever before, one of the longest and most stable democracies, and we are an educated, tolerant and open society capable of making the UK a huge success.  The vote is what it is and we all need to think about how we can contribute to making this happen.   

Risk Warning

This newsletter does not constitute financial advice. Remember that your circumstances could change and you may have to cash in your investment when the value is low. The value of your investment and any income from it can go down as well as up and you may not get back the original amount invested. Past performance is not necessarily a guide to the future. If you are in any doubt you should seek financial advice.

Check out more of the latest news from IFAMax:

Pay less attention to weather forecasts

How women view money and investing differently

A little encouragement goes a long way