Investment Report for February 2016

OVERVIEW

The financial markets

Here it is a mixed picture. While in January, the government suffered a rare near-miss in a debt auction, with the number of orders only just covering the debt it wished to sell, recent auctions have been more robust. The need to find safe positive yields are trumping political concerns for most gilt traders. On the day the referendum date was announced, a sale of inflation-linked gilts attracted bids of £10.5bn — four times the amount on offer.

The picture though is very different in sterling, which has fallen sharply since the autumn. A run of weaker economic data has had an impact, while the bet on interest rates rises is now off the table. But the overwhelming majority of currency strategists point the finger of blame firmly at Brexit risks.

When Boris Johnson, the London mayor, declared his support to leave at the end of February, the pound suffered its biggest one-day drop since October 2009. The costs of insuring against a plunge in value after the referendum vote have also soared.

In the equity market, a poor performance from nearly every sector meant the FTSE ended the first quarter of the year in the red. But amid a tumultuous first six weeks of the year — where most of the main global indices hit multiyear lows on jitters about the Chinese economy — it is hard to pin the blame just on Brexit worries. The index is also full of international companies, meaning domestic worries often do not have the same impact as on other markets.

Markets recovered a little in February before snapping back during the first few days in March. To add to the gloom about the Chinese economy and the plunging price of oil we had the start of concerns about a British exit from the EU (“Brexit”). This impacted more on the currency than it did on the stock market with Sterling falling sharply on the foreign exchanges. The announcement by Boris Johnson that he was campaigning for our departure caused Sterling to drop over 2.0% in one day.

We will discuss the implications for Brexit later in this newsletter.

Although they were volatile, most world markets were flat over the month.

Gilts and Corporate Bonds (fixed income securities) turned in mixed results with gilts making around 1.5% and corporate debt losing around 0.8%.

UK commercial property grew by a modest 0.3%, which implied no capital growth, but receipt of rental income only, although some funds did better than this and still made gains.

Here is the chart of the FTSE 100 index for the last six months:

…and the last five years, which puts this into perspective;

 

FUND PERFORMANCE

Short-term Performance

Long-term Performance

(Source; Parmenion Capital Partners LLP)

 

PORTFOLIO REVIEW

All Portfolios

All portfolios produced modest positive returns during February.

Income Portfolio

The Income Portfolio gained +0.5% in February under-performing the benchmark (the average mixed investment (20-60% shares) fund) which gained +0.9%.

There were no changes to the portfolio during the month.

Balanced Portfolio

The Balanced Portfolio gained +0.8% in February and under-performed its benchmark (the average mixed investment (40-85% shares) fund) which gained +1.6%.

There were no changes to the portfolio during the month.

Tactical Portfolio

The Tactical Portfolio gained +1.6%% in February in-line with benchmark (the average Flexible fund) which also gained +1.6%.

There were no changes to the portfolio during the month.

 

WHAT DOES BREXIT MEAN FOR THE INVESTMENT SCENE?

The EU summit cleared the way for the announcement of a Brexit referendum. Although the pollsters believe the UK will ultimately vote to remain in the EU a lot can change in four months.

Announcement of the referendum has introduced idiosyncratic behaviour and volatility to UK financial markets. But this would likely prove mild compared with the more fundamental rupture that a UK vote to leave the EU this summer would cause.

Brexit effects can already be observed in financial markets. So when UK bookies suggest a one-third chance of Brexit, this should lead to visible pricing effects.

Should the UK vote to leave the EU the main impact will be on the value of Sterling. In these circumstances the outcome of the vote would lead to a great deal of uncertainty regarding Briton’s economic future; what would the outcome of withdrawal negotiations look like? On what terms would we trade with Europe? Would our export businesses face tariff barriers to trade? Would inward investment into the UK dry up?

We could also face problems financing our current account deficit and possibly our budget deficit. These deficits are financed by foreign investors who in the face of uncertainty could withdraw capital or decline to offer new funds on an ongoing basis. The result is likely to be a sharp depreciation in the value of Sterling.

We have already had a taste of what this would be like. Sterling fell 2.5% on the day Boris Johnson announced his support for Brexit.

Is a weaker Pound bad news? It’s a mixed bag. Weaker Sterling would boost exports (as they would be cheaper) and make imports more expensive, which would be inflationary. Interest rates might have to rise to protect the value of our currency which would hit business investment. There might be a recession. This would be bad for the UK stock market.

Against this weaker Sterling could actually boost the UK stock market as 70% of our dividends are earned overseas and the value of these overseas earnings are boosted if Sterling weakens.

The impact of a Brexit on the British economy is very difficult to predict. Short term I think the impact would be negative due to cancelation of investment plans owing to the uncertainty a Brexit would create. Consumers would also be cautious and postpone spending plans. However, long-term who knows? There is an argument that if we turn our face towards the East and Africa this could be to our advantage – especially if we abandon a failed “European experiment”.

What of our investment portfolios? We generally run very global portfolios in that all but conservative investors typically have more invested in overseas equities than in our domestic market. This provides some insulation against a nasty outcome if Brexit occurs; as Sterling depreciates the value of these overseas investments will rise and this could help offset a fall in our own UK market, which would be likely.

Of course, our portfolios also include other asset classes, such as property and bonds. These are likely to provide some insulation and in the case of the bonds also include some overseas currency exposure as a hedge.

Finally, we have scheduled a rebalance of the portfolios the week before the referendum. This is to ensure that the portfolios are reasonably neutrally positioned prior to the vote so an unexpected outcome won’t impact too greatly on customer’s investments.

We fully appreciate that one’s reasons for favouring a Brexit or not probably has little to do with finance or economics and our aim is not to influence customer’s voting intentions – merely to inform. Most clients seem concerned with other issues such as immigration, the Euro budget or the woeful reputation of Brussels. The main point is that the referendum will create uncertainty and portfolios are well placed to deal with the issues this will raise.

Whatever happens it’s going to be an interesting debate.

 

UK COMMERCIAL PROPERTY

We have had a change of stance on the UK commercial property market. UK commercial property continued to gain ground in January (the latest data available), although the rate of growth was the lowest since mid-2013. Uncertainties surrounding the looming European Union referendum are making investors and occupiers nervous. Some are now adopting ‘wait and see’ policies before either committing to taking space or making acquisitions. High prices in key markets like central London is also adding to the cautious mood.

Meanwhile, the rental market continues to strengthen. According to Strutt & Parker, industrial rents in Greater London could exceed £20 per square foot over the next three years. This reflects a reduction in supply as industrial land gets lost to other uses. Research shows that industrial property has been outperforming other sectors, outside of key central areas, since 2,000.

Also, changes in the way the retail sector operates are having a positive effect on industrial properties, as the rise in online retailing boosts demand for industrial space. The discount retailers, who have been comfortably gaining market share in recent years, saw a new entrant into the market earlier this month. Sir Stelios Haji-Ioannou expanded his EasyGroup empire even further with the launch of EasyFood in Ealing. He is aiming his offering below current budget retailers, such as Aldi and Lidl, with the hope of attracting the unemployed or those on a low wage. Average in-store prices are expected to be just 50p.

We were about to reduce exposure to commercial property fearing that the market was too expensive, but what to buy as a replacement? We are up to our limit on equity exposure (even though great yields are available here) and this only leaves cash or bonds. Both of these asset classes now yield very little – bonds dangerously so, as the value of bonds falls when interest rates rise and the yield on some bonds is negative; one pays for the privilege of owning them.

The alternatives are too unpalatable to contemplate and as the outlook for commercial property is benign and there is a 3.0% yield to be had, We are sticking with it for the time being.

PS Don’t forget the usual risk warning for all long-term investments: “The value of units can fall as well as rise, and past performance is no guarantee of future performance. The value of income payments from investment funds is not guaranteed and can fall as well as rise”.