Client Bulletins

Mankind has stretched ingenuity and creative accounting to their limits in addressing the global debt crises to date, not least this week in “saving” Greece. Sweet sticky desserts are national dishes, and this was €130 billion of pure fudge.  

We remain wary about the European Central Bank printing and lending €1 trillion to stricken banks despite the fact it will keep many afloat and has reduced borrowing costs for peripheral states. This was a master stroke of crisis management, without which we would very likely be staring Armageddon in the face. But problems have merely been deferred, not resolved. But who cares about tomorrow? Err – we do. 

Call us old fashioned, but the ramifications of spiriting walls of money out of thin air and lending them to zombie banks concern us. If banks cannot repay in 2015 does the ECB simply print and lend more, compounding the problem? Is no one worried about the junk collateral on the ECB’s balance sheet? Take these alongside myriad other concerns and the Eurozone looks more and more like a nightmare in waiting. 

Another conundrum is that unless the Euro weakens heavily peripheral economies will never be competitive, and the whole rotten Eurozone edifice will crumble anyway. The ECB lending spree is about nothing more than weakening the Euro, but each time the ECB floods the market with more toilet paper the markets perceive the Euro is now healthier, so it strengthens. This is pure Catch-22 with knobs on. 

Similar questions apply to Quantitative Easing in the UK (and the US and Japan). To wind down QE the Bank of England, which now owns one third of all gilts, must sell them. Flooding the market would depress prices and force yields up, leaving the BoE with a huge hole in its balance sheet. The sole likely means of repairing it is to print more money – and so the debt merry-go-round spirals yet further out of control. 

The only plausible way for the developed world to reduce its debt is to inflate it away. Some time ago we warned you of impending inflation when the RPI was at 0% – and are doing so again. A few years of double digit inflation would be welcome, and an oil price shock (the price must rise over the long run anyway) such as closing the Straits of Hormuz would be a Chancellor’s dream. No conspiracy theory there, then. 

As we have been saying planning has never been more certain. Cling to odds-on winners. Identify problem areas and either exploit them, or steer clear. Then stick to your guns and ignore the crowd, knowing the odds are on your side. As we said last week the huge advantage you and we have over the big institutions is that nothing hangs on matching irrelevant short term benchmarks or chasing hot money.

Since we have designed our business to ensure that you and yours are the sum total of it we are constantly looking for ways to add value to what we do. Hopefully the following initiative will prove to be a case in point.  

As you know we closed our doors to the outside world some time ago to concentrate solely on you and your friends and family introduced to us. This (ostensibly potty) initiative has actually proved to be a boon, freeing us up to devote more time to research and the entrails of your Accounts. No longer do we waste hours on strangers we often do not want and who do not know who we are or what we can do. 

Sometimes, however, folk approach us with simple problems we can solve easily, but which do not warrant going through the bind of new Client procedures. We often entertain folk here for half an hour, put them straight, tell them what to do, and bid them farewell without charging them a penny. This costs us only a little time and generates goodwill, a warm glow, and a steady supply of thank-you bottles. Hic. 

You may have family members or friends who could use some “quick and dirty” help, or maybe just a “second opinion”. If you refer them to us we will gladly help them without charge as an extension of the service we provide to you. If they quote your name they will be welcomed rather than politely fobbed off, as are casual enquirers. We promise to toast your health with any thank you bottles that come our way. 

And now to the Eurozone, where a €130 billion loan (gift) to Greece has been trumped by its central bank “lending” over €1 trillion, created at the flick of a switch, to 800 banks for 3 years at 1% interest. Lloyds, Barclays and HSBC filled their boots (and why not!) while Santander (a bank and Spanish) did not comment. Whatever – many participating banks were on the verge of going bust. Greece already is. 

These desperate moves averted Armageddon (for now) so euphoria has kicked in, prompting a stampede into “undervalued” Eurozone risk assets. We are not tempted to join the party because (among myriad other concerns) the recent measures could very easily backfire, with unimaginable consequences. So we aren’t about to change our long term strategy; buy Eurozone equities or bonds, or entrust cash to banks. 

That is the beauty of the “quiet revolution” on which our Private Client Service was built. We have severed all chains shackling you and us to financial institutions and their vested interests, and ours are 100% yours. We (as in you and us) have nothing to sell, no artificial benchmarks to constrain us, no bosses to brown nose, no conflicts of interest and no popularity contests to win. Together we hold all the aces.

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.

For our (financial planning) moment of the week we cross not the channel, but the Atlantic. The US this week announced interest rates would be held at the current 0-0.25% until the end of 2014. No big deal, you might think – but the ramifications are profound. 

Since owning the US currency is now (ostensibly) less attractive it lost value against near all others. Stock markets soared. Treasuries (US gilts) and most other sovereign debt prices rose, as did those of gold and other commodities. Even the blighted Euro has gained 2% since the news broke. Good old Uncle Sam – your Accounts have bucked up over the past few days too, so everyone’s a winner, eh? 

On the face of it there were sound economic reasons for the US action; for example providing US companies and public with a more certain financial backdrop against which to plan, thereby stimulating the economy. The cynic, however, might not look so much at the actions as the consequences; a rising stock market, lower borrowing costs, and boost to the competitiveness of US exports – all in an election year. 

Most countries want a weaker currency, and this is just the latest move from the key player. We covered this paper currency “race to the bottom” in a bulletin long ago, and it has intensified since. The US and UK are printing more money to defray their debt problems, which in turn accelerates the devaluation process. The Eurozone has not done so openly, but has achieved similar effects under various guises. 

Global currency fluctuations matter deeply to all of us, as they affect us both directly and indirectly. So, to the extent you must be exposed to any foreign currency, which would you fancy? Anyone want to bet on a rising Euro? The Eurozone needed this week’s surge like a hole in the head, since if it does not weaken substantially against the Dollar it will look more imperilled than it already does. Devalue it must. 

The US Dollar, despite interest rates pegged at zero until 2014; massive US debt, and further money printing pending might perversely be a strong bet. Sterling has many of the same problems, compounded by others we mentioned last week. In a decade the Chinese Remnimbi may be a global reserve currency, but its ascendancy may be horribly erratic and there are few ways (or reasons) to gain exposure. 

Picking any paper currency over any other is to us akin to choosing the best looking horse in the glue factory. The sole currency that makes any sense to us is gold. It may not increase in value, but should hold it. So as major currencies lose value, that of gold should increase in relative terms. We have bored for Britain on this topic for years so leave you with two points – one technical, the other whimsical.  

Gold pays you nothing to own it, so loses appeal when interest rates are high. The price therefore shot up on the US interest rate announcement which was not, in fact, earth shattering news – it is hard to envisage interest rates rising in any developed economy for some time. Second, muse on what might happen if demand for gold ever exceeds available supply. Unlike paper money, you cannot print more. 

So ignore “bubble!” headlines. With luck the price will plummet soon (that is why we limit exposure) heralding the economic crises will be over. That is unlikely, leaving gold to our minds one of the strongest risk: reward propositions there is. We still balk at suggesting your current weightings be increased, but certainly urge you to hold on to every speck of your gold dust – because it could become just that in every sense. 

This time of year our minds turn to holidays. Despite reigning optimism the Eurozone crisis is far from over, so that is seventeen countries we at KB Towers have crossed off our list. Unless it declares independence from the UK and adopts the Euro the Isle of Wight looks good.

We are yet again ignoring economic developments in favour of taking another look under the bonnet of what drives your asset planning. The topic is dry, but lies at the very core of our collective material wellbeing. As usual we will first set the scene, and then focus on how it might affect us all. 

Gilts have been used by Government since 1693 to finance expenditure not covered by tax receipts. The UK debt mountain has soared with excessive public spending, and much of the receipts from sales of new gilts is needed to pay interest on the old. This, and the reckless antics of banks, encapsulates the current economic crises. Levels of Government and bank debt are overwhelming, and the fat lady is singing. 

When you owe huge (any!) sums the interest rate you pay is key. Unlike our Eurozone friends the UK controls its own governance and interest rates, and if we run out of money we can always print more via quantitative easing (under which the Bank of England creates new money to buy gilts – a legal form of Ponzi Scheme). The UK is consequently considered to be creditworthy, and a “safe haven”. 

Looking at benchmark 10 year bond yields the UK’s current cost of borrowing (what investors demand to invest in gilts) is sub 2%, as it is in the US and Japan (other “safe havens”). Recent EU averages are 3% in France, 5% in Spain and 7% in Italy with Greece a snip at 35%. Hence the sovereign debt crises – countries are forced to borrow at elevated interest rates to repay debts that were already out of control. 

To surface from beneath its vast excess debt the UK’s ability to borrow cheaply is vital, and the coalition’s austerity measures (and not being in the Euro) have helped. But the economy must now grow to generate the higher tax revenues required to enable debt to be paid down; a wicked case of Catch-22 since economic growth is rarely synonymous with recessions suffered both at home, and by trading partners. 

The UK enjoys an AAA credit rating; a major reason why our costs of borrowing are so low. But we chaps fail to see how we can retain this throughout 2012, as we borrow more and more in the teeth of recession and austerity. If we drop an “A” borrowing costs (as in gilt yields) should rise, and gilt prices fall. Europe is in the grip of a vicious debt spiral, and we are susceptible to theirs as well as our own. 

Gilts are like the final base camp on Mount Everest – you cannot go much higher, but there is a hell of a long way to fall. Sooner or later higher costs of borrowing and/or resolution of the debt crises will likely decimate gilt prices. As we have long been saying personal exposure should be avoided (it will be on our watch) albeit it will be impossible to avoid the indirect impacts (which we will cover another time). 

Our second “so what” is that annuity and pension drawdown rates are largely sourced from medium term gilt yields; hence why those currently starting to take income from pension funds (or undergoing a drawdown income review) are being badly squeezed. For these folk gilt yields rising will actually be a blessing – to the extent, of course, that their pension fund had not been invested in gilts. 

Our third “so what” is good news for pensioners. The coalition has announced that for the purposes of calculating pension drawdown rates the determining 15 year gilt yield will be “floored” at 2%. The 15 year yield is currently 2.51%, so income can reduce from here – but only so far. Having said which, were the 15 year yield to slip below 2% the pension “floor” may not compensate for dire consequences elsewhere…..

Rather than ponder unknowns this week we open the bonnet of the financial planning car and look at the chassis and engine. The investment assets you add are what will power your car, but no matter what grades of fuel you use your driving experience will ultimately be determined by the build quality of your vehicle. 

We are often asked why one Wrapper performs better than another, and hopefully a brief explanation will help. For the purposes of the exercise we shall concentrate on the three main wrapper types we deploy in well over 90% of your planning affairs; namely Pension, ISA and General Wrappers (Onshore and Offshore Bond, KB’s Income Control Account and other special Wrappers are different cases entirely).

Matching Wrapper selection to individual Client needs (insofar as pre-existing arrangements allow) is our starting point. The asset allocation process follows, selecting first asset sectors, then asset types, and lastly the individual assets that will best combine to do the job. Umpteen considerations feed in to the final mix, but one constant at every single stage of the process is a heavy focus on tax. 

The three taxes we are predominantly concerned with are income tax, capital gains tax (on Clients themselves; on the wrappers, and on the underlying assets) and inheritance tax. Corporation tax (insofar as it impacts on individual asset types and the wrappers in which they are held) and stamp duty are amongst many other taxes we factor in to deliberations, but we shall concentrate on the “big three”. 

Dividends are paid net of (non-reclaimable) tax at source, so for income tax purposes it makes no difference which wrapper you hold shares in unless you are (or might become) a higher rate taxpayer. In this case we focus equity holdings on Pension and ISA Wrappers to avoid an additional 22.5% or 32.5% marginal rate of tax on income (whether accumulated or not) to enhance bottom line net returns. 

Interest is tax-free in Pension and ISA Wrappers, holding cash in which will avoid 20% tax at source (and 20% or 30% extra to higher rate taxpayers). But income from bonds (sovereign, corporate and some others) rolls up gross in Pension and ISA Wrappers, so taxpayers will save 20%, 40% or 50%. On a Bond Fund yielding 7% pa this enhances returns by no less than 1.4%, 2.8% or 3.5% pa. 

Pensions and ISAs are exempt from capital gains tax. This does not necessarily militate against General Wrappers, since CGT is manageable within all but larger portfolios. Pensions are exempt from inheritance tax but suffer special tax charges of 0% or 55% (most folk) on death, so good planning can make a huge difference. ISAs allow no IHT protection, but General Wrappers can be shielded by KB Trusts. 

So there are no “good” or “bad” Wrappers; disparities are down to how assets are spread across them. Our portfolios are designed to be “self-adjusting” so downturns in some asset classes will be offset by strength in others to deliver long term growth with a “smoothing” effect. If (current) stronger assets are concentrated in any single Wrapper it will shine (for a while) but the aggregate planning effect will be the same. 

Finally, an example of what happens if you do not get basics right. Tesco shares dived this week, and now yield around 4.5% pa net. Despite hiccups we wonder if the shares are not better value on a risk-adjusted basis than bank deposits. We are not advocating buying them, but rather musing that shares being possibly the safest bet for income-starved grannies shows just how crazy the world has become. 

Staying with Tesco and financial planning, we query how they are helping us spend less every day when our food bills keep rising. However, another of their slogans lies at the heart of everything we do. Now, more than ever, every little helps.

Albert Einstein observed “compound interest is the eighth wonder of the world” and Herman Hupfeld wrote “the fundamental things apply as time goes by”. This week we discuss a financial planning basic that is a case in both points, and expand on the fruits of our quest to optimise it for your benefit.  

All received financial planning wisdoms should be continuously challenged, but some endure. Our job is to separate the valid from the outdated, and to keep you aligned with the former while avoiding the latter. If you get the basics right, the rest will follow. Your planning is built on solid foundations of basics, but after building work is complete skilled maintenance is essential. Yesterday’s wisdom can often be deadly. 

One such basic is the importance of income, a key yardstick against which values of most assets can be measured. For example higher yielding shares depend less on (ephemeral) capital growth for total returns. You can bank and roll up income without regard to fluctuating capital values. The great majority of returns from developed economy equities are derived from compounded reinvested dividends over time. 

In a low-everything world a high income is hard to come by; one that beats inflation is a mirage, and the higher the income, the greater the risk. These received wisdoms were learned at mother’s knee – but are now totally out of kilter with modern reality. High incomes with acceptable degrees of safety and reliability are within reach, and can be harnessed to the benefit of anyone prepared to re-test their wisdoms.  

The golden rule applies most of all to equities in low growth developed economies, and near all KB Client assets allocated to these is in high yield Funds. The rule extends to fixed interest and cash assets, but sovereign debt does not offer sufficient income to compensate for solvency and capital depreciation risks. When it comes to cash sub inflation returns from insolvent banks on life support does not add up. 

We do break the rule. Gold, oil and foodstuffs produce no income, but their values dance to different tunes whose additional diversification benefits lie behind why we recommend you own them. Index linked bonds produce little income, but all growth and income is (crucially) linked to inflation. Many other assets (and the wrappers we use to hold them) work well mainly because they can convert income to growth. 

The only other exception to our rule has been Emerging Markets and Asian equities, where high economic and profits growth compensated for lack of yield in the past. But as economies mature dividend cultures evolve, and our quest to secure high income streams from these regions in robust fashion is now complete. We finally have a range of assets in our armoury that can be adapted to any income scenario. 

In a low growth world it is important to match investment income to individual needs as closely as possible, ideally with the latter being entirely covered by the former. This effectively leaves capital growth (the vital engine of future income increases) to “look after itself”; at the same time reducing the risks of capital erosion arising where assets need to be sold to cover income shortfalls. 

To us the prospects of 4%+ pa income from portfolios of strong cash rich companies in high growth economies compares favourably with receiving 2% pa with no growth potential from insolvent banks, or similar yields from absurdly expensive sovereign debt with capital losses baked in. Equities are arguably the new safe and gilts and cash the new risky. The entire concept of risk has stood on its head, so we must too. 

Fully stocking our armoury will impact on three “categories” of our Clients. The first is those taking income from their portfolios and the second those who plan to do so within known timeframes. The third is those in the capital accumulation phase, where conversion of growth oriented holdings to high yielding alternatives will be a gradual process. The income factor will feature more heavily in all Reviews from now on.