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MITON’S DAVID JANE: ARE FIXED INCOME INVESTORS TOO FIXATED ON BENCHMARKS?

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MITON’S DAVID JANE: ARE FIXED INCOME INVESTORS TOO FIXATED ON BENCHMARKS?
  • Fixed income benchmarks come with significant risk of negative returns
  • Prevalence of very poor quality credits coming to the markets
  • Investors need to be a genuinely active at times of heightened risk 

David Jane, manager of Miton’s multi-asset fund range, comments:

“It’s a simple but depressing fact that the vast majority of investors, or at least investment managers, are to some extent trying to beat an index. This isn’t necessarily a problem, until there’s too much money chasing too few good investments.

“This can be compounded in fixed income because the biggest components of the indices are those companies with the most debt. So supply creates its own demand. The same goes for equity, to a lesser degree, as the most expensive companies tend to have higher weights in the index.

“In favour of the index-plus approach is the argument that by selecting specialists for each asset class, and then charging them with beating that asset class, investors will get a superior return. This is a reasonable case, however, it of course ignores the most important decision of all – should you invest in the asset class in the first place?

“The index-plus investor never need make that decision, they must simply plough on investing the money as their clients have asked them to, into the asset class, irrespective of whether they think it offers the prospect of an attractive return.

“We raise this issue in the context of a very active fixed income issuance season. Very few investors in fixed income look upon the asset class as we do, i.e. from the context of being long only, unleveraged, and multi asset. Of those that do, few are outcome driven rather than benchmarked.

“For most investors, if they are worried about rising bond yields, they will have less duration than their benchmark. If they are worried about credit, they will carry less credit risk than their peers. This seems sensible until we consider what has happened to the benchmark, which has been consistently rising duration. So, a bond investor who runs a duration one year shorter than the benchmark duration today is taking more absolute duration risk than a neutral position only five years ago.

“The same goes for credit risk, although data is a little harder to come by as credit ratings are generally backward looking. New issuance defined as covenant light is now predominant in high yield, and the prevalence of very poor quality credits coming to the markets seems to move the risk all to the downside.

“When considering fixed income, we don’t consider any benchmark to be a proxy for our clients’ requirements and start from what might be termed first principles: what is the risk/reward of each investment we make and how does it fit within our overall portfolio.

“When looking at government bonds, conventional wisdom would say that long dated government bonds act as a good diversifier of equity risk in a mixed asset portfolio, as while they offer a lower total return they tend to rise when equities fall and vice versa. This would be a beautiful solution to the problem of running mixed asset portfolios, if only it were true.

“In fact, the correlation between gilts and equities is rather variable and while most often negative, not always so. Considering where we are today, one of the more probable causes of a setback for the economy, and hence equity markets, would be rapid rises in bond yields, then clearly gilts are not going to be a good diversifier. This, combined with the fact they are not offering an attractive income return, means they must be ruled out as the bedrock of a fixed income strategy. So we need to look elsewhere for diversification and return.

“A mainstream corporate bond strategy offers some of the same problems as gilts, yields are too low to offer an attractive risk/reward, particularly with credit spreads as low as they are, while interest rate risk is too high as the duration is too long. While the asset class offers slightly higher returns than gilts, overall downside appears to trump the upside.

“We need to look much deeper into the asset class to find the pockets of value which can offer a decent risk return profile. While the index for corporate bonds would suffer greatly from anything but the status quo, either growth is better, and hence yields rise, or growth deteriorates and spreads rise, leading to negative returns. Unless everything stays as is, we can find areas where the risk reward is more attractive, although to do so we must forego some potential upside.

“When we consider very short dated corporate bonds, particularly those issued many years ago when rates were higher we can find an attractive risk/reward profile. This type of bond can offer a decent yield pick up over cash while its total return is fairly independent of interest rates as its maturity is close at hand.

“While we must accept some credit risk, companies do not often fail completely without warning, so by avoiding industries and companies that are problematic, we can minimise, but not totally eliminate, this risk.

“So, our base case is dull, but steady returns, our downside is a smattering of defaults, reducing but not eliminating our return. But what of the upside? While not spectacular, there’s some upside from refinancing, as companies have a huge incentive to refinance higher coupon debt in order to reduce the interest cost to their profits and to do so they must pay holders a premium. So while we see little upside in buying the newly issued bonds we can see a little upside from owning those which get refinanced.

“In conclusion, we expect dull returns from fixed income, with the benchmarks offering a significant risk of negative returns either as monetary policy returns to normal as the economy grows and/or inflation rises, or from a weakening economy and hence credit spreads rising. This is a very poor risk reward profile, and a significant problem for benchmark hugging investors. It doesn’t however mean we must avoid the asset class altogether as we can find places where risk is much lower that offers a high probability of a positive, if low, return. At times of heightened risk you need to be genuinely active.”

Investing

What should I invest and How do I invest

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What should I invest and How do I invest 1

By Imogen Clarke

With all the uncertainty that has arisen from 2020, with lockdown threatening businesses and the warning of a second wave, the topic of investments has taken on new meaning. Nowadays, more people are concerned with what makes for a good investment, or, if you’re a novice, how to best invest.

For instance, you might be unsure about the reliability of the company you’re looking to invest in, as well as the long-term prospects of your investment.

If you are unsure of your investments, then it is best to seek advice from financial experts like The Fry Group, who deal with tax, wealth and estate planning. They will see that you have a strong financial plan in place to help meet your objectives. They will develop a strategy that is built around your needs and asses any risks that could hinder your plans.

There are some things you’ll need to consider for your strategy; for instance, are you looking to make investments that are more of a risk and will take longer to come to fruition? Or, alternatively, are you wanting a faster approach that will result in a steady income? Whether or not you decide to play it safe all depends on your current financial situation and whether you have the means to take more of a risk. Do you have any other debts that take precedence over your future plans? Is your investment strategy realistic?

With the aid of a specialist – or investment manager – you can design an investment concept that works for you and your goals, and start to build a regular income from your investments. There are four main areas when it comes to assets (groups of investments) that you can consider:

  • Equities
  • Bonds
  • Alternatives
  • Cash

Your investment manager will test the risks associated with your investment, and if it proves to be a positive investment choice, then you will be able to invest more over time.

So, how do you decide where to invest?

According to The Fry Group, ESG investing (Environmental, Social and Governance) is a good option for investors looking to support businesses that meet their similar ethics.

The main areas of ESG investing include:

  • Environmental challenges (climate change, pollution, etc)
  • Social issues (human rights, labour standards, child labour, etc)
  • Governance considerations relating to company management

According to The Fry Group, “Many investors choose to consider ESG investing in order to ensure any investment decisions reflect personal beliefs and values. As a result, they choose to support companies who are making informed, responsible decisions which take into account their wider societal and global impact. In this way investors can achieve peace of mind that their investments are creating a positive effect.”

ESG investing is also more relevant now than ever, as more businesses are looking to present themselves as an environmentally conscious corporation that recognises the values of their consumers.

As The Fry Group puts it, “In the past, ESG investing has been seen as a niche investment approach, for a relatively small number of people with specific requirements. This has changed significantly in recent years, with a growing awareness of environmental issues such as climate change and an increasing understanding of social issues and human rights. As a result, many people are increasingly interested in reflecting their opinions and lifestyle choices through the way they invest.”

So, if you want your investments to pave the way for your personal values and reflect your own morals, then this is the route to go down. But how does it all work?

There are four areas of ESG investing:

  • Responsible ownership and engagement: when companies are encouraged to make necessary improvements.
  • Avoidance or negative screening: whereby businesses are ‘graded’ based on how ethical their business practices are and are avoided altogether if their methods are not approved.
  • Positive screening strategies:when companies meet the ESG goals and are approved for investments.
  • Impact investment strategies: the purpose of this is to use investment capital for positive social results such as renewable energy.

You will need to take into account your own personal objectives as well as the objectives that meet the ESG investment criteria. And, in terms of financial performance, ESG investing can be hugely beneficial. Those who opt for ESG investing perform a more in-depth analysis into long-term and future trends that affect industries, meaning that they are better prepared for changes in consumer values when they arise. And, with all the unpredictability that this year has offered us so far, isn’t it better to do the research and have all angles covered?

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Investing

Investment Roundtable: Live with Jim Bianco

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With Q4’s macro picture still looking grim amid the return of exponential coronavirus waves in Europe and the U.S. and Europe, we speak with veteran macroanalysis strategist Jim Bianco, CMT for a data-driven deep-dive into the global economy and financial markets on Sept. 7th at 12pm EDT.

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Key themes:

  • Learn from Jim’s unique combination of quantitative and qualitative analytics which provide an objective view on Rates, Currencies and Commodities to make smart investment decisions
  • Identify important intermarket relationships he is watching with respect to Global Equities
  • Roadmap a global outlook for 2021 in view of socio-political backdrop giving viewers key takeaways and intermarket perspectives on global investing.

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Jim’s robust technical analysis includes a broad look at trends and themes in the markets, market internals, positioning such as the Commitment of Traders (COT), sentiment, and fund flows. Don’t miss out on this exclusive session from one of the investment world’s most insightful thought leaders.

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Equity markets react to a rise in Covid-19 cases, uncertain Brexit talks and the upcoming US election

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Equity markets react to a rise in Covid-19 cases, uncertain Brexit talks and the upcoming US election 2

By Rupert Thompson, Chief Investment Officer at Kingswood

Equity markets had another choppy week, falling for most of it before recovering some of their losses on Friday and posting further gains this morning.

At their low point last week, global equities were down some 7% from their high in early September. US equities were down close to 10%, hurt by the large weighting to the tech giants which at least initially led the market decline.

The market correction is nothing out of the ordinary with 5-10% declines surprisingly common. Indeed, a set-back was arguably overdue given the size and speed of the market rebound from the low in March.  As to the cause for the latest weakness, it is all too obvious – namely the second wave of infections being seen across the UK and much of Europe and the local lockdowns being imposed as a result.

These will inevitably take their toll on the economic recovery which was always set to slow significantly following an initial strong bounce. Indeed, business confidence fell back in September both here and in Europe with the declines led by the consumer-facing service sector. A further drop looks inevitable in October – fuelled no doubt in the UK by the prospect that the latest restrictions could be in place for as long as six months.

The job support package announced by Rishi Sunak did little to boost confidence. Its aim is to limit the surge in unemployment triggered by the end of the furlough scheme in October. However, the scheme is much less generous than the one it replaces as the government doesn’t want to continue subsidising jobs which are no longer viable longer term.  A rise in the unemployment rate to 8% or so later this year still looks quite likely.

Aside from Covid, for the UK at least, there is of course another major source of uncertainty – namely Brexit. Another round of trade talks start this week and we are rapidly reaching crunch time with a deal needing to be largely finalised by the end of October.

Whether we end up with one or not is still far from clear. That said, the prospects for a deal maybe look rather better than they did a couple of weeks ago when the Government was busy tearing up parts of the Withdrawal Agreement. With significant Covid restrictions quite probably still in place in the new year and the Government already under attack for incompetence, it may not wish to take the flack for inflicting yet more chaos onto the economy.

Markets remain unimpressed. UK equities underperformed their global counterparts by a further 2.7% last week, bringing the cumulative underperformance to an impressive 24% so far this year. The UK weighting in the global equity index has now shrunk to all of 4.0%.

It is not only the UK which faces a few weeks of uncertainty. The US elections are on 3 November. We also have the first of three Presidential debates this Tuesday. Joe Biden’s lead looks far from unassailable, a close result could be contentious and control of Congress is also up for grabs.

All said and done, equity markets look set for a choppy few weeks. Further out, however, we remain more positive – not least because the focus should hopefully switch from the roll-out of new lockdowns to the roll-out of a vaccine.

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