investment newsletter - december 2013

Investment Newsletter December 2013

By Mike DeverellInvestment Manager

Equilibrium Asset Management LLP (a limited liability partnership) is authorised and regulated by the Financial Conduct Authority. Equilibrium Asset Management is entered on the Financial Services Register under reference 452261. The FCA regulates advice which we provide on investment and insurance business; however it does not regulate advice which we provide purely in respect of taxation matters. Copyright Equilibrium Asset Management LLP. Not to be reproduced without permission

Jingle all the WayAs Christmas approaches it’s traditional to look back on the year that’s gone, and look forward to the year ahead.

2013 has been a great year for stock-markets. The FTSE 100 closed 2012 at 5,897, before climbing as high as 6,840 on 22 May 2013.

Whilst the index subsequently slipped back and now stands at around 6,540 as I write (11 December AM), this is not really representative of equities as a whole.

For example, the S&P 500 in the US has continued to reach new record highs and stood at 1,802 at close on 10 December, having ended last year at 1,426. Japanese equities continue to shine and, in the UK, smaller companies shares have continued to grow even as the blue chip FTSE stumbles.

We took a decision to tactically reduce large cap UK stocks in favour of smaller cap stocks earlier in the year,

and this has paid off well. The chart on the following page shows our two UK active portfolios against the FTSE All Share over the 12 months to 11 December:


Our UK equity portfolios have returned 24.78% (UK Dynamic) and 25.18% (UK Large Companies) respectively whilst the FTSE Allshare is up 16.72% on a total return basis. This is very pleasing but what is heartening is how our funds have continued to rise even as the FTSE has fallen, especially apparent over the last 6 weeks.

In other asset classes, it has not been a great year for fixed interest with the UT Corporate Bond sector returning only 0.82%, whilst the FTSE Gilt Index lost 3.14%. However, selecting the right funds made a huge difference, our portfolio returning 5.87% over the year. Again, what is pleasing is that our funds have continued to gain whilst the wider asset class falls, particularly since the beginning of November:

Jingle all the Way cont’d


A - Equilibrium UK Large Companies (25.18%)

B - Equilibrium UK Dynamic Portfolio (24.78%)

C - FTSE All Share (16.72%)

A - Equilibrium Fixed Interest (5.27%)

B - UT Sterling Corporate Bond (0.82%)

C - FTSE British Government All Stocks (-3.14%)


It has been a pleasing year in terms of returns, but what of the year ahead?

We believe returns will be harder to come by in 2014 than they were in 2013. We don’t expect to achieve 12% plus returns for a balanced portfolio in 2014, much as we would like to!

We do believe a return of around 7% to 8% is achievable for a balanced portfolio though, in line with its long term target. We just may need to be more creative to get there.

Equity no longer looks nearly as attractive, with US and European equities in particular looking expensive relative to earnings. We still think the UK can do ok, whilst Japan and emerging markets (China in particular) have the potential to do very well.

The Year Ahead

Jingle all the Way cont’d


This year has also seen the resurgence of commercial property as an asset class, which we generally bought back into in April. Over 6 months to 11 December our property portfolio is up 5.26%, an annualised return of well over 10.5%.

All these factors have led to some pleasing returns in our models, with the Balanced portfolio returning 12.28%

for the 12 month period to 10 December (after adjusting for fees) whilst a typical managed fund (UT Mixed Investment 20% - 60% shares) returned 8.28%. Again, we can see this gap widening over the past couple of months as our flexibility and ability to move away from a fixed benchmark paid off:

A - Equilibrium Balanced Model (1.5%) (12.28%)

B - UT Mixed Investment 20%-60% Shares (8.28%)

Many managed funds either couldn’t or wouldn’t invest much in smaller cap equities, the flexible fixed interest funds we are able to use, or property. They are too much

constrained by a benchmark, whereas we try and focus on providing the returns our clients need and expect, at the lowest possible risk.


The Year Ahead cont’d

Merry Christmas from


However, we have reduced equity exposure as we not only think returns will be lower but risks will be higher.

We think we can achieve the target return in a lower risk way. If equities perform very strongly this may mean we underperform in relative terms, but we will achieve our target growth whilst keeping risk down.

For most portfolios we are therefore slightly “underweight” traditional equity, however we are slightly “overweight” alternative equity. In aggregate, we are therefore “neutral” equity as a whole, but with a higher proportion of a more defensive type of fund. Alternative equity tends to benefit from rising markets but should do better in a falling market than direct equity exposure.

We have also recently bought a new defined return structured product from Barclays. This will potentially provide an 8% return provided the FTSE 100 is above 6,694 on 25 November 2014. It will make a good return in a sideways or marginally positive market. It doesn’t need markets to move up strongly to make a return so we believe this is a good option in the current environment.

We may institute a similar product with another provider in the New Year, depending on market levels. Please ask your usual Equilibrium contact if you would like further details of how defined returns work and the risks involved.

Given our recent reductions in equity, for many clients we are holding a substantial amount of tactical cash. This will most likely be used for the new defined return product, or could be used for “volatility trading” should the market drop significantly.

We are also moving back to a “neutral” holding in commercial property as we believe returns from this asset class could continue. Our best guess at returns from property is around 8% pa for the next 18 months.

We think next year for fixed interest could be similar to 2013, with small losses in gilts and small gains in corporate bonds. We believe our funds can continue to outperform and do not plan to make further fixed interest reductions unless this changes.

From an economic perspective, we expect most major economies to continue to grow and perhaps even get back to more normal levels of growth.

This will support equity markets longer term, but in the short term could actually cause more volatility as a stronger economy means central banks are likely to reduce stimulus. The US Fed has announced a reduction in the level of QE and they will probably carry on “tapering” their stimulus as the year progresses.

However, reducing QE does not mean interest rate rises are imminent. This depends partly on the unemployment rate reducing, as well as on inflation remaining under control. We doubt the Bank of England will raise rates until at least 2015, possibly later.

The crystal ball is cloudy as always, much as we would like it to be crystal clear!

The future is impossible to predict, but what we can do is make educated judgements and weigh up the risks and returns of the various asset classes. The key is to be vigilant as always and ready to adapt portfolios to a changing environment. We are never too proud to change our minds if the facts change!

We wish all our clients a very happy Christmas and look forward to seeing you in the New Year!

General Economic OverviewThe UK economy has continued to improve and inflation has fallen back. The US remains strong and Japan has improved dramatically this year, but the Eurozone economy remains weak.

The withdrawal of quantitative easing (“tapering”) in the US will dominate markets over the next few months.

Interest rates are likely to remain low for perhaps the next two years, even though unemployment has fallen quicker than expected. The Bank of England has committed to not increasing rates until unemployment falls below 7%.

Equity Markets

We believe returns will slow in equities after a very good 2013. A -1 score means we expect around 9% pa rather than our long term 10% pa assumption. We favour emerging markets and smaller companies over large ones.

Fixed Interest

Corporate and government bonds have proved very sensitive to concerns about the Federal Reserve tapering quantitative easing. However, our funds have great flexibility and have done reasonably well in this period. We expect returns to stay relatively steady.

Property

Over the past 6 months property has returned almost 5.5% (over 11% annualized). There is momentum building and rental yields remain attractive. We therefore believe property should provide in excess of our long term 7% pa assumption over the next 18 months or so.

Cash

With interest rates remaining at record lows, returns on cash could remain below average for some time.

Balanced Asset Allocation

For a typical balanced portfolio we are neutral equity, overweight alternative equity, underweight fixed interest and are increasing property exposure.

A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5 means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.

These represent Equilibrium’s collective views. There are no guarantees. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser.

-1

-2

+3

-5

Asset class key+ positive - negative = neutral (normal behaviour)

+5 strongly positive-5 strongly negative

Score


Asset Class

Market Views December 2013

investment newsletter - december 2013

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