Market Update 4: Moving forwards..

As investment markets have staged a remarkable recovery since the March lows, we feel this is a good time to reflect on what has occurred over the past few months and where we see the outlook from here. In the third week of February, we were seeing the start of a dramatic period of volatility, with global markets tumbling in the wake of the COVID-19 pandemic. In the space of the following four weeks, markets fell nearly 30% on a cumulative basis. The velocity of this bear market was severe, and we recognise that this was an unnerving period for investors. However, this is the typical nature of volatility in the aftermath of major economic/macro events. Our focus at that time and today has remained the same, as we stress the importance of calm heads and patience required for long-term investment.

In April, we saw areas of the stock market which were hardest hit by the sell off in February/March stage a recovery and as we stand today, equity markets are not far off the February peak. This strong recovery was not one we could have predicted but it does show the danger of over trading and panic selling at times of market pessimism, as you do run the real risk of missing out on any subsequent bounce. A plausible explanation for this recent market behaviour is that they (markets) are now more optimistic of a broader economic recovery and therefore the possibility of avoiding a prolonged recession.

Over the past few months, we have continued to be in regular contact with the fund managers who manage the underlying investments in our clients’ portfolios. Far from sitting on their hands and observing the dramatic moves in asset prices, they are utilising this time wisely to revisit the investment case of each of their individual holdings. This is a time when the importance of actively managed investment funds should come to the fore, as managers are able to make decisions in consideration of stock fundamentals, industry and regulatory pressures, as well as a view to structural forces that present risks and opportunities for companies in a post COVID world. We believe that these are essential considerations as our societies see the acceleration of many existing trends such as digitisation and sustainability.

In contrast to an active fund approach an index tracking strategy cannot take such factors into account and therefore investors are at the mercy of momentum driven market movements. We think this is the wrong strategy at a time when the world is shifting quickly, and distinct winners and losers will emerge in the coming months and years ahead.

There is a general consensus amongst the managers that we have spoken to that a level of caution is required and there are many conversations had about how they are seeking to increase the quality and level of conviction in their portfolios at this time to weather the period ahead. They will also seek to utilise market falls to initiate positions in high quality companies that have hitherto been expensively valued. This work should all be adding value for investors in the long term.

We do not think the recent market recovery means that volatility will now dissipate or that upward trends in markets will continue unabated. On the contrary, we think the level of uncertainty present for corporates and global economies means that further periods of market fluctuation would seem likely. Our consistent message to investors is to remain calm and focus on achieving long term capital growth through a diversified portfolio of assets with strong underlying fundamentals which is managed within an agreed risk parameter. We believe that a patient and calm approach is rewarded. In the meantime, we continue to actively analyse, review, and challenge our investment recommendations to ensure that our clients are benefitting from well informed and objective investment advice which will achieve their medium and longer-term objectives.

In aggregate, and despite the ongoing uncertainty, we believe that there is cause for optimism. The bespoke investment and financial planning strategies that are in place for each client are navigating this period of uncertainty, whilst being well placed to benefit from the economic recovery which should follow in time.

In the meantime, if you do have any concerns, please do contact your adviser to discuss this further.

Dividend Outlook Post Covid-19

What has happened?

The impact of Covid-19 has been felt across most sectors and companies. With economic activity being severely impacted in the short term and uncertainty remaining on the exit strategies that will be adopted by different countries, we can anticipate dividend cuts across many sectors. Even well capitalised companies with strong balance sheets have come under pressure and the short-term impact will be pressure on dividends.

What are the implications for investment funds?

The impact will be felt most across funds that invest with an income philosophy, equity income funds. These funds are focused on generating income from stock dividends. Dividend paying funds have historically been favoured by more conservative investors who are attracted by the steady, long-term payments and defensive qualities offered by many traditional dividend paying blue chip companies. These are often characterised as stable, profitable and mature businesses. Many of these funds will invest on a total return basis, meaning that they focus on generating a long-term return for investors which consists of both capital growth and income generation. They are not just reliant on dividends.

What are our thoughts?

We have a cautious mindset on the dividend outlook for the near term but are certainly more positive on the longer-term picture. We don’t think the current situation will result in an end to dividend culture but there will be a focus on responsible and sustainable dividend policies, which is ultimately a positive development for longer term investors. Against this backdrop, we have conviction in the managers of our preferred equity income strategies and the ability of these actively managed funds to use fundamental stock analysis to navigate this type of environment far better than a simple index tracking strategy. That said, it is anticipated that income payments from our preferred funds will be lower for the next 6-12 months.

It is important to note that these dividend cuts will not necessarily indicate problems with companies but can also reflect prudent management with the aim of protecting the financial position of a company for the medium to long term. This could mean that many companies will be able to resume or start raising dividend payments relatively quickly. Certain businesses with more debt and higher ongoing costs will prove more vulnerable to declines in revenues and the flexibility of actively managed funds will prove very useful in this environment.

We are actively engaging with fund managers to understand how this evolving economic situation might impact their strategies in the short term and how they will position for dividend growth opportunities going forward. Early indications from favoured managers are positive in acknowledging that, whilst there will be lower dividends this year, they remain focused on balance sheet strength and liquidity which will be key factors in the ability of companies to return to dividend growth. Some have forecasted a strong bounce in dividend pay-outs in 2021.

For clients with an income objective, this may be a more challenging environment, but it is unlikely that your portfolio income is driven solely by equity dividends. In a well-diversified portfolio, there will be more than one strategy for delivering the income or cashflow that is required, and this is something we will address in future articles.

In conclusion, we believe dividends will be under pressure for the next 12 months, but we think this will be a temporary situation and we will then begin to see dividend growth once again. The yield from most, if not all, asset classes has been impacted by recent economic events. Delivering income/cash flow will be possible and Five Wealth will cover this with clients directly.

The current situation also presents opportunities for long term investors. We use equity income funds within a balanced and diversified investment portfolio, and we should remember that our funds are still investing in companies with attractive qualities which will drive the future returns from your investment strategy.

The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance

If you have any questions or concerns, please do contact your adviser.

Market Update 3: COVID-19

News of the spreading virus and the unprecedented response from governments around the world continues at a pace. What we are now witnessing is a simultaneous and voluntary shutdown of the global economy and this has unsurprisingly sent shockwaves through investment markets. There are two main aspects to the economic shock now unfolding. Firstly, there is the impact from labour shortages directly caused by sickness from the virus. The second factor relates to containment measures which effectively means social distancing and self-isolation which has a direct impact on supply and demand for individuals and corporates. There has also been a realisation that historic levels of stimulus will be required to support many sectors of the economy. The inability of economists/investment professionals to accurately predict the path of the crisis, means that it is very difficult for the market to find stability in asset prices. It is really the medical/scientific data which will guide the market direction from here and we would suggest that it will be the medical data which will ultimately lead the recovery in markets. On a positive note, it is worth noting the stabilizing picture emerging in China and South Korea in terms of virus containment. With this update I think it is worth breaking down some the factors that are in our minds as we navigate these uncertain times.

We have seen dramatic moves in markets in response to the situation. At the same time, a dispute between Russia and Saudi Arabia has led to a collapse in the oil price. Bonds and commodities have sold off providing less of an offset to equity allocations in recent days. This included gold where investors have moved from what is traditionally seen as a safe haven store of value to what is perceived as the ultimate form of liquidity, cash. Currency has also come into play. The US dollar has behaved in line with its safe-haven status with sterling falling to its lowest level against the dollar in decades. Some of these movements may be reflected in the underlying values of your portfolio, positive and negative, but our method of constructing portfolios puts heavy emphasis on diversification by asset class, geography (ultimately, this includes currency) and industry/sectors. This should help to insulate clients from some of the dramatic movements in individual assets, markets or currencies.

Our recent fund manager meetings indicate that they are not making rash decisions to overhaul portfolios with excessive trading and panic buying or selling. Whilst they expect the economic fallout from COVID 19 to be severe, they suggest that the broad market sell off has presented significant valuation movements in favoured areas of the market. Some are reducing their lower conviction holdings in order to raise cash and enable them to drip feed into new stock opportunities as they arise. We are given confidence by this cautious approach. Certain areas of the markets are undoubtably more directly impacted by the effects of the virus outbreak. For example, those companies with exposure to travel or hospitality. Active management should help to navigate this new investment landscape by focusing on company fundamentals, which may mean avoiding those companies with weaker financials and focusing on the more robust business models.

We give a lot of resource to our fund selection and the ongoing investment research process at Five Wealth. This is not only about the style of investment, philosophy and process. Whilst these factors are very important, we do also place weight on the fund manager, whether this is one or two individuals or a more collegiate approach and this is why we emphasise the vitalness of fund manager contact. In all cases, we have confidence in the expertise of these management teams, reflecting the depth of knowledge, skill and experience that has helped them navigate multiple economic and market shocks over the years.

I would reiterate that our central belief is that whilst it is difficult to see a swift resolution to this situation, we do believe that both markets and economies will ultimately recover. We will continue to review events as they unfold and will contact you if we believe any action is required in relation to your investment portfolio. In the meantime, if you have any concerns, please do contact your adviser to discuss this further.

Market Update 2 – COVID-19 & Oil Prices

Given that it is more than a week ago that we first communicated about the coronavirus COVID-19 outbreak, we felt that it would be helpful to update clients on the most pertinent events during this time and summarise our thoughts on the continuing situation. Amidst a broad-based sell off in global equity markets, as investors have fled to assets of perceived lower risk, the US Federal Reserve made an emergency rate cut to counter fears of a major economic shock.

The Fed’s intervention did prompt a short-lived relief rally, but markets returned to negative sentiment in the face of the growing numbers of people infected with the virus across the world. Since the middle of February, the CBOE Volatility Index (or VIX) has seen a dramatic spike (see http://www.cboe.com/vix). The VIX is an index representing the market’s expectations for volatility and is widely used to measure the level of risk, fear, or stress in the market. Whilst it will be very difficult to call the bottom of the market and there will likely be further drops, it is worth noting that the elevated VIX index is said by some to signal a buying opportunity.

The sectors hardest hit over the past couple of weeks included automobiles, oil services, industrials and mining, which would be directly impacted by disruption to trade supply and demand. The worst affected sector was travel and leisure, as a potential collapse in demand from consumers as well as the threat of imposed government restrictions on movement hang over these parts of the economy. Other areas of the market such as healthcare, utilities and pharmaceuticals have proved more resilient. The latest price shock has come from the oil sector, as the oil price plunged overnight on prospects of an aggressive price war. Alongside this, we have seen the FTSE 100 open significantly lower this morning, in the biggest intraday drop since the global financial crisis.

Conversely, government bonds have rallied over the same period, with yields hitting historic lows, as investors sought their relative safety. Likewise, gold continues to rally as investors rotate towards traditional safe haven assets.

All in all, what we are seeing is markets trying to “price in” the risk of a global recession, as leaders acknowledge that COVID-19 cannot now be contained and is likely to have a profound impact on global supply and demand for an undetermined period of time. The very nature of this crisis makes economic projections very difficult.

So, what does this mean for investors? Well, for clients of Five Wealth we would reiterate our previous message.

• Remain focused on the long-term investment strategy.
• Do not panic and be reassured by the level of diversification (by asset class and geography) and active management in your underlying investment portfolio.
• Remember that you do not own “the market” and therefore, the headline movements in equities do not directly translate to the same magnitude of losses in your personal investments.
• Remember that markets are a forward-looking mechanism and therefore, before the global economy recovers, the market will at some point begin to “price in” an economic recovery.

We can’t predict when the recovery will occur but are confident that it will happen. We do not try to time markets for our clients and would suggest that attempting to do so, has the potential to do more damage than good. We will continue to review events as they unfold and will contact you if we believe any action is required in relation to your investment portfolio. In the meantime, if you have any concerns, please do contact your adviser to discuss this further.

Market Update – Coronavirus

You will be aware that growing concerns about the impact of coronavirus (COVID-19) have recently spread to global markets, as investors scrabble to quantify the impact of the illness on the global economy. Our first thoughts are of course with the victims of this latest global virus, but we are also acutely aware of the immediate impact this has had on investment assets and how this may be a cause of worry for our clients. We are watching markets closely but would acknowledge that it is very difficult to see when the current level of market volatility will stabilise. That said, we would reiterate that volatility is a normal feature of markets. For markets more generally, it is worth putting the recent volatility in context. The most recent bout of volatility has undoubtably delivered some significant drawdowns in global equity markets, but this follows a strong year of performance in 2019 when the FTSE All Share delivered a total return of 19.2%. These types of event will always have an effect on markets and have been followed by a recovery, but only time will tell the duration and extent of the impact in this particular case. According to Citi research, epidemics in the past 20 years have caused falls of varying lengths between 6% to 13% on the S&P 500 (source: www.cnbc.com) There are lots of studies out there which show the futility of trying to time the markets to avoid short term losses or capture market recoveries. Indeed, trading in and out of the market around this volatility can actually have a detrimental effect on long term returns. Not to mention the negative impact of short term trading on the continuity of dividend payments, which are also an important component of total investment returns. We take a long-term view of investments and that sometimes means looking through short term market falls in anticipation of longer-term gains.

In view of this, I would also highlight that we seek to build diversified portfolios for our clients and dependent on a client’s attitude to risk and objectives, this will mean holding a range of asset classes, sectors and geographical exposures. Importantly, not all assets behave the same way in a “risk off” event. Where we invest in multi asset strategies, there will be underlying assets that have actually increased in value over the past week, as equity markets have fallen (see chart below).

Our panel of investment funds will include many equity focused funds that are deliberately more defensive in character and the benefits of this have been witnessed over the past week. Whilst these funds have fallen in absolute value along with broader markets, they have typically fallen less than the market, which is what we would expect of such strategies. As an example, our global equity income funds have delivered returns between -3.3% and -3.9% this week, whilst the FTSE World index fell 6.95%. Our core multi asset strategies, have fallen between 1.05% and 1.25%.

In summary, we believe that you should remain focused on the long-term investment strategy, as your investment portfolio has been constructed in line with your individual risk constraints and return objectives. We would emphasise the benefits of diversification, both within exposures to a single asset class and through exposure to a wider selection of assets (e.g. bonds and commodities). We will continue to monitor the performance of your underlying holdings to ensure that they behave as we would expect and continue to offer potential for good long-term returns. We remain vigilant to what is happening in wider markets and will contact you if we believe further action is required.

If you have any questions or concerns, please contact your adviser.

Worried about markets or all part of the plan?

As I write this the FTSE 100 is up 0.2% today. Yesterday it was down close to 1.0%. In the last week it’s down, over the last month it’s up, but over the last 3, 6 and 12 months it’s down. We are clearly in a period of volatility. After seemingly steady growth in markets for the last 10 years its to be expected but worries about Brexit, US/China and the gradual unwinding of QE aren’t helping. Investors should understand that past performance is no guide to the future and investments (and the income from them) can fall as a well as rise. Fluctuations in investment values are to be expected and are part of the investment cycle.

So as an investor are you glued to your screens, checking portfolios and markets daily? Or are you secure in the fact that your investments are one part of your long-term financial plan?

Investment advice and financial planning aren’t the same thing. Its true that they often go hand in hand, also that in most cases for a good financial plan to succeed you need some good investments within that plan. But the financial plan comes first and is the most important part.

When I meet a potential new client the majority of our first meeting (sometimes meetings) are spent with me mostly listening and asking questions. I spend a lot of time getting to know people, trying to find out what their goals and aspirations are. This can take time and can involve a lot of conversation but it’s the most worthwhile and important part of the process.

Everyone is different but with relative certainty I can say that the end goal is rarely “investment growth”, more often “I want to be able to retire early and travel/spend time with my grandchildren etc”. It can get much more complex of course with companies, larger sums and intergenerational planning but the point is the same – investment growth is not often the goal, but it can often help to achieve that goal.

After understanding their true goal we will talk about investments. Experience of investing, views on risk, ability to withstand losses etc. We will talk about how we approach investments, our philosophy, what to expect. This is a very important part of the process but always comes second.

After this it is my job to go away and construct a full financial plan. This can be simple or it can be more complex, it depends on the circumstances.

A true financial plan will be bespoke for that person/family. It will take into account their circumstances, their objectives and their views on risk. It will include expenditure analysis, cash flow modelling and in most cases there will be some investments within it. The plan should cover short-term needs and address medium term objectives. It will be hoping to address long-term objectives too but be flexible enough to change with the individual, life has a habit of making our plans change!

If a plan is put together well the investments within that plan should not need to be called on in the short term. The plan will make sure there is enough cash to call on in emergencies and sufficient income for their needs (or it will be working towards this as priority). It should protect against unforeseen circumstances such as illness and not being able to work. It should be fully discussed so the clients will be completely aware of the potential that the investments within have for falls in value, indeed they should expect falls in value as this is part of investing. They should be secure in the knowledge that they have a plan that is long term, that it has been stress tested and the investments within that plan and their movements up and down are all part of it – not the sole focus.

Hopefully this means they don’t have to be glued to the market app on their phones and can spend time enjoying their lives and continuing to build towards their long term goals, whatever they may be!

UK Home Bias

There is a tendency for investors to favour allocations to their home equity market and this can disproportionately skew investment risk within a portfolio. There are many reasons why investors adopt such an approach (some of which are compelling), but ultimately, we believe that it is important for portfolios to be globally diversified in exposures to all asset classes. The UK equity market represents only 5.6%[1] of the MSCI AC World Index by market capitalization and yet allocations within investment portfolios can often represent sizable multiples of this percentage weighting. What are the reasons for this and how can we ensure that behavioural biases do not detrimentally impact client outcomes?

Global diversification avoids the risk of portfolio returns being derailed by a country specific market/economic event (e.g. Brexit). Diversification is particularly relevant in a mature market like the UK, whereby relying on UK equities, means that you are not directly exposed to the fastest growing economies. Whilst globalisation has resulted in greater correlation within global markets, there are still opportunities to benefit from global markets that stand at differing stages of the economic/market cycle. As such, when the UK market is in a state of uncertainty around Brexit outcomes, there are other parts of the world with a more solid economic backdrop which can help to drive returns.

It could be argued that there is sufficient exposure to global economies through the FTSE 100, where more than two thirds of revenues in the underlying companies come from outside the UK. However, the make-up of the UK equity market reveals certain sector biases. By focusing on this market, portfolios end up with risk skewed towards certain industries and sectors of the economy. For example, the UK market has a heavy bias to energy and consumer staples companies. Conversely, the UK market offers less opportunity to tap into specific growth areas such as technology. The dominance of certain sectors within a portfolio can result in greater volatility.

One important consideration is currency risk. When investing in overseas equities, changes in the rates of exchange between currencies may cause investment/income values to fluctuate. It is sensible for a UK based investor (with future liabilities in sterling) to have a sizable allocation to home markets. However, for some investors with substantial UK assets (including property and UK businesses) there may be scope to tilt an investment portfolio a little further towards global markets/assets.

Whilst an allocation to global markets will improve diversification risk, one stills need to be mindful of additional risks in some regions. Of course, geopolitical risk can be a feature of all individual global markets at one time or another, but it has more frequently been a primary concern for emerging market investors and therefore we should ensure that exposure to these particular markets are sized according to the overall risk profile of the client.

So, what does this mean for Five Wealth client portfolios. We would not advocate taking a market cap approach to asset allocation. We do however believe that “home bias” should be one of the factors we consider within a holistic approach to portfolio construction and risk management. A useful reference point might be to consider how the MSCI WMA Private Investor Indices balance the allocation between UK and international equities. This provides a snapshot, reflective of the industry’s current asset allocation views across a range of multi asset portfolios.[2] Whilst our firm aims to take long term strategic asset allocation decisions, our investment committee will also form a tactical view of the prevailing risks/opportunities in various asset classes, sectors and geographies and these will feed through to the ongoing management of client portfolios.

The value of investments can fall as well as rise and you may not get back the full amount invested. Past performance is not a reliable indicator of future performance. Investing in shares should be regarded as a long term investment and should fit your overall attitude to risk and financial circumstances.

[1] msci.com/documents/1296102/1362201/MSCI-MIS-ACWI-May-2018.pdf

[2] msci.com/wma