Archive for February, 2012

As we said a few weeks ago the more uncertain the global economic environment is becoming, the easier it is to plan with certainty. If, that is, you have the fortitude to stick resolutely to long term plans and hold your nose through the bad smells that will assail our nostrils for years to come. A clhilling example follows.  

Any hopes we might forget about Greece for a while were dashed last Monday. The farcical shambles to which the Eurozone project has descended was exemplified by the fact its champions threw €130 billion down a bottomless drain rather than risk the alternative. Not so much a loan, as a ransom. Nothing was solved, so the Greek odyssey will inevitably keep coming back to haunt us like – yes – a bad smell. 

Our featured whiff of the week is currency depreciation. The UK, US and Japan have flooded their financial systems with printed money. The Eurozone is achieving the same via unlimited loans to Eurozone banks at 1% interest. The Chinese are joining in by reducing bank reserve requirements. This is a currency devaluation race to the bottom pure and simple. A race which, remember, all the major players want to lose. 

Government is stealing the future value of your savings to “fix” past profligacy. If you do not fight back, you will lose. This involves choosing carefully where to store wealth – and where not to. It is a process of elimination every bit as much as one of selection. To achieve it we need to identify and acknowledge the bad smells; analyse their short, medium and long term effects, and determine how to eradicate them. 

Much of the fresh-printed money finds its way into equities, forcing prices up (as at present). Shares will enjoy liquidity fuelled booms and gravity induced busts in turn. In treacherous markets we want to benefit from fair weather booms while anticipating the busts. We should hold some carefully selected equities, but in the absence of a talent for timing both booms and busts exposure should be kept under strict rein.            

Gilts (and also US, German and Japanese sovereign debt) are hopelessly expensive and will corrode wealth over time. In the short term they may retain their status as sanctuaries for the fearful, but must collapse sooner or later. Timing the turning point is for the birds, so wearing our long term gas masks they are simply best avoided. 

As paper currencies race each other downhill toward oblivion gold, silver, oil and food offer vital protection. Even if real assets did not themselves appreciate in value their owners will be relatively better off than the disciples of depreciating paper promises. And if the floods of monopoly money spark entrenched long term inflation, as every grain of logic tells you they will, we also want to hold index linked gilts. 

If we owned nothing else it would be shares whose booms should outweigh their busts and gold, oil, foodstuffs and index linked gilts to protect against the twin evils of currency destruction and inflation. Add a few “satellite assets” to diversify risk and deliver non correlated returns; reject the babble from “experts” and the futility of short term performance comparisons, and you have a durable plan to beat the odds.

Sadly Tweedledee and Tweedledum passed on buying Greece for 1p last week because we concluded no one would really be stupid enough to give us €130 billion. So we tell our Clients to expect the unthinkable – and then ignored our own advice. For heaven’s sake please don’t tell them.

As the slow motion Eurozone train wreck chugs inexorably toward the buffers of oblivion the third class carriage that is Greece is first in the line of impact. One way or another, sooner or later, the carriage will have to be de-coupled. 

The current EUphoria in financial markets appears to tell us we shouldn’t care – but we do. Current reasons for wild global optimism include (apparently) improving prospects for the US economy and the taming of global inflation. Yet, unnoticed in the background, and without fresh impetus from Iran, the oil price snuck past $120 this week. Good news for your oil holdings – but we’ll keep the champagne on ice. 

It is the time of year when we turn our minds to the nuts and bolts housekeeping that is end of year tax planning, and to stealing a march on tax planning opportunities as early as possible in the new tax year. Without regard to individual situations (which we are currently reviewing case-by-case) the following applies in general. Yes, this week we focus on ISA and pension allowances, the twin mainstream tax shelters. 

Back to basics. ISAs are regarded with general ambivalence, but the word “pension” has become tainted. But neither view is vaguely relevant. As far as you and we are concerned ISA and pension wrappers are simply empty boxes into which you can place just about any listed asset you wish without cost or operational differentials. The sole difference is that each is governed by distinct tax and legal frameworks. 

In general all those with unused ISA allowances for this year should try to use them (especially if they have funds elsewhere in taxable and/or ineffectual investments) and also plan to take advantage of the increased £11,280 allowance available during tax year 2012/13. The benefits are emphatic for higher rate taxpayers, and worthwhile to most others. Let us re-examine the three main benefits of ISAs. 

Bond and interest income is received gross, worth 20%, 40% and 50% pa to basic, higher and additional rate taxpayers. Dividends bear tax at source so there is no income benefit for basic rate payers, but big 22.5% or 32.5% pa savings for higher payers. Good asset selection can lead to the ISA income shelter being worth 1-3% pa across the tax bands, which can make a huge difference to long term returns.  

ISAs are exempt from capital gains tax, saving 18% of chargeable gains for basic rate taxpayers and 28% for higher rate payers. Those with small portfolios, however, should be able to avoid tax by using the annual exemption (£10,600 of realised chargeable gains per person this year, and next). But small portfolios can grow over time (the general idea, after all) so it makes sense to use the ISA shelter as you go.  

The final advantage of the ISA is that there are no HMRC reporting requirements so all the income and gains generated by the assets you shelter in your ISA Wrapper will never suffer tax (other than inheritance tax) nor need to be entered on tax returns. So in summary near all basic rate taxpayers will benefit from ISAs (if appropriately invested) and higher payers should do all they can to fill their boots. 

Pensions are gold dust to some. While tax relief on the way in is offset by tax on the way out, the equation is swayed toward pensions by the ability to take 25% of funds tax-free. Income tax relief of 20%, 40% or 50% gives effective grossed up returns of 25%, 66.67% or 100% and hefty boosts to tax exempt pension funds. The coalition is muttering about abolishing higher rate relief so “I’ll do it later” may backfire badly. 

Comparison with ISAs is further skewed by the fact that prior to benefits being taken pension funds pass to beneficiaries exempt from both inheritance tax and probate. In allocating resources between the two alignment to personal planning circumstances and requirements is essential. But judgments of Solomon aside, ISAs and pensions remain the predominant mainstream means of painlessly extracting tax advantages. 

Of course we will be reviewing your personal situations and will be in touch where we feel there is leeway for you to benefit from the dynamic duo based on information we have to hand – a timely juncture to remind you to keep us continuously up to date with any changes in your personal circumstances. But the main message of the day is that tax giveaways will become rarer, so don’t look a gift horse in the mouth. 

Which mythical gem takes us full circle back to Greece, which KB has bid to buy for 1p. Yummy – moussaka on demand and a bunch of idiots lend us €130 billion without a hope in hell of us paying them back. Ever heard anything so daft?

A riddle for you this week. When can increased uncertainty beget greater certainty? 

As we repeat ad nauseam no one can predict the future, and with the global economy poised on many knife edges the consensus is that it is now harder than ever. But if you peer through the storm clouds it has in many respects at least seldom been easier to identify what to avoid, which makes the selection of what to own (itself less taxing than we can remember) that much easier. 

Extreme uncertainty can throw up greater certainty – as the riskometer swings into the red future directions of travel can become more one-dimensional. Take interest rates here and the US. They can hover around zero for a long time, but must eventually rise. At that point you do not want to be holding fixed interest assets such as UK Gilts, US Treasuries and German Bunds, the current safe havens du jour. 

The next certainty is there is no certainty, and that there is no such thing as a “safe haven”. Recent experience shows under extreme conditions “risk” becomes near impossible to assess. The key risk metrics are overwhelmingly wipeout and volatility risk; themselves hard to quantify. So after identifying asset types best equipped to profit from the greatest certainties you should diversify widely between them. 

Global growth trends are lower than in the past, so your equity exposure will best be concentrated on securing high and sustainable income yields rather than relying purely on growth. High yields (over 4% is perfectly achievable – double that from gilts or cash) will at least compensate you for diminished growth prospects and the inherent increased volatility risk. Cash in the bank beats the hell out of hope. 

It is hard to envisage food and energy prices coming down over the long run, so own the “hard stuff”. Investing in companies operating in the two sectors might appear a good bet, but suffer from business risk. In the final analysis equities will behave like equities – not like the underlying in which they trade. For example, BP was affected badly by the recent oil spill but the oil price was unaffected. Oil cannot go bust. 

Major currencies will de facto depreciate due to Quantitative Easing (the Bank of England announced a further £50 billion print-fest this week) and other forms of “competitive devaluation”. As more and more monopoly money is pumped into the system existing cash will be worth less. Gold does not increase in value but is one of few assets likely to hold it relative to paper money, so owning some is sensible. 

Inflation may fall this year, and next. But future resurgence appears certain, not least due to the effects of QE. So we hold on to our Index-Linked Gilts regardless. Another reason to own oil and food is that they are major root causes of inflation, and another to own gold is that it usually protects against it. And global Index-Linked Bonds are worth tucking away, since inflation and bogus money are not solely UK diseases. 

Investors running scared of “all-time uncertainty” and/or who frantically shift from one “safe haven” to the next will invariably be getting their asset allocation horribly wrong. Short termism has seldom paid, and is now more dangerous than ever – very much the opposite of the desired effect. A considered patient long term approach to asset planning has always been the most sensible – and is currently also the easiest. 

Piece of cake, eh?

Financial markets were (unaccountably?) chipper in January, turning portfolios that struggled to make headway over the year to end December positive one month later. This underlines the futility of assessing performance over given periods. There is no certainty current euphoria will endure, but neither is there any reason to believe it will not. Asset prices can rise in the bad times, and fall in the good. 

While our investment approach has stood up extremely well we are (naturally) asked from time to time how performance might be improved. The single simple answer to that question is to take more risk – the inescapable consequence of which is that the likelihood of volatility increases in direct proportion. This brings us back to consider the real meaning of risk, which many folk associate solely with volatility. 

Volatility can work for you if properly controlled. If you believe an asset will rise in value over time price volatility might not faze you provided you do not need to cash it in during a downturn. The danger of not having access to the fruits of your planning when needed is more of a risk than volatility itself. Most dangerous is wipeout risk – the prospect of not getting a return of your money – rather than on your money. 

Judiciously blending assets of multiple select types, all of which might be expected to deliver positive returns over the long term, is the most sensible means of controlling most key risks. If we are asked to adjust portfolio risk profiles the best means of achieving this is usually to vary percentage allocations to each asset. A more aggressive approach is to reduce the number of assets. But which would you omit? 

On January 1^st last year there was no way we could have predicted that Index Linked Gilts would be the best performing asset sector of 2011. But we recommend Clients always own some because they complement all our other selected portfolio assets both on technical, and stand-alone, merits. Did we know gold would shine last year? No – we just knew that owning some in the prevailing environment is sensible. 

Neither did we know perfect harvests around the world would hit agricultural commodity prices, or that crude oil prices would rise in the teeth of recession – but we continued to see the wisdom of owning both.  There were few events last year we knew would happen (let alone what their impacts would be) so stuck to methodical knitting rather than rely on our opinions or predictive genius – or anyone else’s. 

Some of you combine our diversified balanced approach with an overlay of personal favourites and opinions (tempered by ours – with risk warnings!) and performance consequently diverges from our stock approach – in either direction. We enjoy these “conviction based” scenarios, since the buzz of “calling it right” beats the heck out of method. This collaborative approach can be very successful – but moderation is key. 

So, drunk on success, we’re off to start a Hedge Fund and get rich shorting the hell out of Euroland and the Euro on the premise that their problems are insoluble, and that sovereign states can print themselves out of oblivion whereas Euroland cannot. But wait – bearing in mind the current outbreak of loathing against fat cats perhaps we had best shelve the idea. Damn. Penury and the day job it is, then.