Economic Commentary

As we begin to look forward into 2015, I should start by wishing you and your families a Merry Christmas and a prosperous New Year.

2014 has been an interesting year for financial markets; despite continued growth in domestic equity markets and other developed economies across the globe, and many supposed ‘good news’ stories, national debt continues to grow and savers continue to suffer as a result. Our feeling is that precious few countries have really been prepared to tackle their debt problems in a serious manner, and the only thing that is certain as we look forward, is that nothing is indeed certain!

Debts: Our attitude towards debts remains unchanged. In our view, repayment of debts should be prioritised; even in a low interest rate environment. M4

Verdict: Repay debts! 

Cash: The heavily anticipated rise in interest rates has still not arrived despite numerous false alarms during 2014. When a rise in rates does eventually take place any increase will be small in our opinion; continued high levels of government debt being serviced cheaply by low rates means that any significant rise is highly unlikely for many years in our opinion. The general consensus within the marketplace, and we are inclined to agree, is that base rates could creep up to 2% within two years.

Verdict: Overweight. Whilst interest rates are

frustratingly low, cash is the only truly safe defensive

home for monies at this moment in time. Despite the

unexpected continued rally in bond and gilt markets,

they do represent a higher risk to capital at the moment

than is traditionally the case, and we therefore continue to support heavy cash holding.

Low Risk: The ‘low risk’ or fixed income space of the market is becoming increasingly difficult to call. For some time we have been concerned by the record low yields and high prices and have been concerned at the prospect of both capital losses and potential liquidity issues if the bond market is suddenly out of favour. We have therefore tended to favour strategic bonds due to their flexibility; many of their managers too have had difficulty calling the market in recent times, with some funds moving to very defensive, short-dated positions and even ‘shorting’ UK and US government bonds in some instances. We interpret this to mean that the market anticipates a rise in rates in the near future.

Whilst the impact of any rise in interest rates is open to debate and to some extent a nominal rise may already be priced into current valuations, the fact remains that these investments are marketed as ‘low risk’. At this time we stand by our view that they do not represent the traditional small risk to capital that they usually do.

Verdict: Remain underweight in other low risk investments, continuing to favour strategic bond funds due to their flexible mandates.

Property: Last time out we were bullish on the prospects for property and this has proven to be the case thus far; with returns from UK commercial property and infrastructure in particular being very favourable and in double-digit territory over 12 months.

Many income investors who previously held large cash portfolios to provide their income have been forced into alternative assets in order to maintain the same level of income. With property investments being backed by physical assets many view property as a safer home for their savings and with the high income yields on offer, property investments have prospered in recent years.

We still favour a diversified property portfolio, incorporating exposure to the UK and overseas commercial property, as well as exposure to infrastructure and property shares depending upon attitude to risk. As mentioned elsewhere in this newsletter, our preferred infrastructure trust is looking relatively expensive to buy at the moment and we have therefore also shortlisted a ‘listed’ infrastructure investment to occupy this space.

Verdict: Overweight. With interest rates predicted to stay low, we retain the belief that commercial property and physical infrastructure investments are likely to remain in favour for the foreseeable future.

Mixed Investments: Investments in this space are wide reaching indeed, and include a range of different investment strategies. With both the UK equity and bond market looking slightly stretched in our view, traditional investments in this space blended between fixed income and equity could be at risk of capital loss in the short term in our opinion. We are therefore favouring investments with a more flexible mandate at this time; particularly those able to employ ‘shorting’ strategies and/or the use of commodities and currency as diversifying qualities. We are looking for this aspect of the portfolio to generate some kind of return irrespective of the prevailing market conditions, and we believe this type of investment is best placed to achieve this.

Verdict: Underweight. Certainly of the asset classes which display defensive and growth characteristics, property would be our asset class of choice at this time, and by default therefore we believe an underweight position here is sensible in most cases.

UK Equity: At the time of writing, the UK market has suffered somewhat of a correction in recent weeks on the back of global oil concerns. Nonetheless, we feel that the UK could benefit from steady growth in the years ahead although there is a general election on the horizon which could have an impact upon growth.

Certainly the UK has emerged from the global economic crisis with more conviction than many other developed economies, and with anticipated continued low interest rates and low levels of inflation, we believe that real returns from UK equities could be attractive in the short to medium term.

We do feel that the mid-cap area of the market looks expensive in general, and we would therefore encourage active management for this element of the portfolio. The small-cap arena continues to look appealing to us, particularly if a ‘pro-corporate’ government remains in power. Some investment trusts continue to trade at attractive discounts and with private investment accounting for a larger proportion of small-cap investment off the back of less funding from banks, the number of investment opportunities in this space for private investors is higher than it has been historically.

Verdict: Reduced weighting. In spite of a relatively optimistic view on the UK, we feel that the emphasis of the equity element of portfolios should now shift to a more globally-focused mandate. We will therefore be amending our asset allocation from January 2015 onwards to incorporate a proportionately smaller UK holding in favour of overseas territories.

Overseas Equity: The overseas equity asset class covers a broad range of regions and sectors, all of which will not. The fact remains however that these markets continue to post higher GDP growth than developed markets, and are generally burdened by lower levels of debt. We therefore feel that they are undervalued and for an investor willing and able to take a long term view, investments here continue to offer great value. Of course, not all emerging economies are the same (the recent troubles experienced by Russia highlight this!) and our preference therefore is to hand over the selection of the individual economies to a proven fund manager. At this moment in time there are some investment trusts trading at attractive looking discounts due to the negative sentiment towards this area of the market.

We commented last time out that we felt the commodities market looked attractively valued for a long term investor. Regrettably the market has generally moved backwards since then, particularly in the energy sector where the sharp falls in value of crude oil have hit investors hard. A strong US market and, in particular, a strong dollar is invariably negative for commodity investors based outside the US. However, there are also other political factors which are discussed in articles elsewhere within this bulletin.

In spite of this setback, we are sticking to our guns. We still feel that the commodities market is a good growth play over the long term; an emergency OPEC meeting is scheduled for January which is likely to lead to an agreement over crude oil production levels if reports are to be believed. Whilst a strong dollar could see suppressed growth for a little while longer yet, the significant upside potential of these stocks mean that when political and economic conditions towards this area of the market change, any capital losses incurred can quickly be recovered if history is a sign to the future. In the coming months we are likely to begin introducing renewable energy alternatives onto our shortlist as sentiment towards these markets begins to gather momentum.

Verdict: Increased weighting. As mentioned above for the UK equity asset class, we feel that in a world where the UK is playing an increasingly small role, the equity content of a portfolio should carry more global diversification.

Overseas Equity: The overseas equity asset class covers a broad range of regions and sectors, all of which will not perform in perfect tandem with each other. We split this space into four categories; developed equities, emerging equities, commodities and specialist investments.

The developed equity space is invariably where the majority of overseas monies will be invested, and our view is that in this well-regulated space, keeping costs low is the key to achieving consistent returns. Interest rates and inflation in most developed markets are low, and therefore the smaller the cost, the higher the level of real return, particularly in markets where active management rarely adds considerable value such as the United States.

That said we do believe that active management in Europe and Japan could provide added value looking forward. Shinzo Abe has remained in power following the recent snap-election, and this means that his policy of devaluing currency in an attempt to stimulate economic growth will continue. With this being the case we feel that the Yen is likely to weaken against sterling, and we therefore favour actively managed funds (preferably hedged back to sterling) to provide exposure to the Japanese market.

Similarly in Europe, The ECB is determined to ‘do whatever it takes’ to avoid deflation and this could include quantitative easing on top of the asset-buying which has already been taking place. Many European investment funds have been in ultra-defensive mode in recent years, electing to take the safe route and be overweight in the large, safe sectors such as utilities and healthcare. This has led to very attractive valuations in some of the more cyclical sectors and if the experts are to be believed, some of the more cyclical-minded funds could stand to benefit from some very attractive long term valuations going forward, if a higher degree of volatility can be stomached in the short term.

We commented last time out that emerging markets looked to be attractively priced as a long term investment, and we still believe this to be the case. These markets have enjoyed their moments over the past twelve months, only to be set back by changes in the economic landscape.

The fact remains however that these markets continue to

post higher GDP growth than developed markets, and are

generally burdened by lower levels of debt. We therefore

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able to take a long term view, investments here continue to offer great value. Of course, not all emerging economies are the same (the recent troubles experienced by Russia highlight this!) and our preference therefore is to hand over the selection of the individual economies to a proven fund manager. At this moment in time there are some investment trusts trading at attractive looking discounts due to the negative sentiment towards this area of the market.

We commented last time out that we felt the commodities market looked attractively valued for a long term investor. Regrettably the market has generally moved backwards since then, particularly in the energy sector where the sharp falls in value of crude oil have hit investors hard. A strong US market and, in particular, a strong dollar is invariably negative for commodity investors based outside the US. However, there are also other political factors which are discussed in articles elsewhere within this bulletin.

In spite of this setback, we are sticking to our guns. We still feel that the commodities market is a good growth play over the long term; an emergency OPEC meeting is scheduled for January which is likely to lead to an agreement over crude oil production levels if reports are to be believed. Whilst a strong dollar could see suppressed growth for a little while longer yet, the significant upside potential of these stocks mean that when political and economic conditions towards this area of the market change, any capital losses incurred can quickly be recovered if history is a sign to the future. In the coming months we are likely to begin introducing renewable energy alternatives onto our shortlist as sentiment towards these markets begins to gather momentum.

Verdict: Increased weighting. As mentioned above for the UK equity asset class, we feel that in a world where the UK is playing an increasingly small role, the equity content of a portfolio should carry more global diversification.