- US policy makers have little reason to become aggressive
- More and more bond issues with weak or no covenants to protect investors
- Equity markets are too willing to finance businesses on hope, not substance
David Jane, manager of Miton’s multi-asset fund range comments:
“The current bull market is often described as ‘the most hated bull market in history’, with many calling it artificial, or a bubble, right from the start. But what are the reasons for this negative sentiment and how should we react?
“The principal reason why the bears have been negative mostly stems from a disagreement with central banks’ quantitative easing (QE) and negative interest rate policy (NIRP) programmes. These have caused interest rates to become very low in both absolute and real terms, which in turn has led to the revaluation of all risk asset classes, to a lesser or greater degree. Whether you consider it the right policy or not seems irrelevant: it’s that the policy and the effect of the policy was predictable.
“Of course, were the policy to change and interest rates to become ‘normal’, valuations of equities and bonds would be very different in the future, but policy makers appear to be extremely wary of the destabilising effect this would have. At present, US policy makers, while further advanced in their tightening cycle, have little reason to become aggressive and rates remain accommodating. Therefore, it doesn’t appear that the interest rate cycle is about to end the bull market just yet.
“However, what does seem increasingly evident is that we’re in the latter stages of the cycle. It’s been a worry for a long time that central bank policy was primarily finding its way into financial markets, rather than stimulating the real economy, and that this would ultimately result in capital misallocation and capital destruction. This is a classic feature of markets, where in the highly optimistic later stages investors make decisions which they ultimately come to regret.
“There are numerous examples in the Euro denominated bond markets where negative government yields have led to high yield bonds with absurdly low yields. A recent example, which famous short investor Muddy Waters has been highlighting, is French supermarket chain Casino whose bonds maturing in 2019 yield 4.5 basis points. This is effectively a zero return to lend money to a company which, despite incredibly low financing costs, can only cover its interest two and a half times. It takes but a moment’s thought to realise that if interest rates rose materially this is not a company that will find life easy. Investors seem happy to accept a measly return right now in exchange for accepting the risk which in a bond is all to the downside.
“It isn’t just European high yield where investors are sowing the seeds of future disappointment. More and more bond issues are being launched with weak or no covenants to protect investors, and PIK (payment in kind) bonds have made a reappearance. These bonds typically pay interest with more bonds, as the company is too stretched to actually pay cash interest, despite incredibly low interest rates.
“A couple of recent bond issues caught our eyes, Tesla and Netflix. We have owned both these companies’ equity in the past as they’re excellent growth stories with huge potential, however, bond investors benefit from none of that, they simply get all the downside if the company fails to succeed. Both these companies have never generated a cent of cash flow to pay the interest on their bonds, it has to be paid from future bond and equity capital issuance. Let’s just hope conditions remain as favourable as they have been recently or they will have to make profits to pay their interest.
“It isn’t just bond markets where there are signs of excess. A number of recent new equity issues have shown that this market has also been a little too willing to finance businesses on hope rather than substance. Snapchat’s IPO is a good example, now trading at less than half the price it achieved in its first week on the market, as competing with the incumbent tech giants has proven harder than expected.
“Another example of excess could be Softbank’s huge fund raising to make technology investments. History will judge how successful a Japanese mobile phone company will be at running a US$93bn technology fund, but the fee structure alone should have waved a red flag for investors. Having made a fortune from its investment in Alibaba, investors must believe the company has the golden touch and are prepared to accept a very disadvantageous fee structure (in which outside investors provide the leverage which the manager benefits from).
“As multi asset investors, we seek to invest in ways that allow for a range of scenarios, and would avoid situations which look good now but, should conditions change, might go badly wrong. There are plenty of opportunities which are attractive, but might be resilient in a less favourable environment. A particular worry for us in this environment remains liquidity, as this is your ultimate fall-back position if conditions change. Illiquid situations with material downside risk are a particular source of concern, hence we are getting more conscious of our position sizes.
“We would not seek to call the top of the market as this phase can persist for several years, particularly as monetary policy, although tightening, remains highly accommodative. However, experience guides us to be alert to the potential errors that we might come to regret in the future and avoid situations, which when conditions do change, could go very wrong. It’s the decisions we make now which will determine not only how we do near term, but importantly how we fare when the market does ultimately turn.”
COVID-19 and PCL property – a market on the rise?
By Alpa Bhakta, CEO of Butterfield Mortgages Limited
Over the last five years, demand for prime central London (PCL) property has been fairly inconsistent. Sudden peaks in interest from buyers could be followed by periods of stagnate price growth. Nonetheless, the advantages of PCL property investment, particularly by international investors, has remained well known.
Well-funded development and neighbourhood re-generation schemes, alongside an influx of overseas investment, has resulted in a vibrant market with a diverse range of opportunities for prospective buyers.
Nonetheless, the PCL market has not been immune to the impact of the COVID-19 pandemic. During the first half of the year, the lockdown meant physical valuations and onsite inspections could not take place. People in the UK were also discouraged from moving properties unless they found themselves in extreme circumstances.
However, as we now enter the final weeks of 2020, I believe there’re plenty of reasons to be optimistic about the future prospects of the PCL property market. Buyer demand has resulted in a new wave of activity, and this is resulting in significant house price growth. Indeed, it was recently revealed by Halifax that the average rate of house price growth in November was at a four-year high.
Obviously, there are multiple factors that have helped sustain this strong level of house price growth. Most notably, the Stamp Duty Land Tax (SDLT) holiday has succeeded in coaxing buyers back to the property market––be they seasoned buy-to-let (BTL) investors or first-time buyers––by offering up to £15,000 in tax savings on any given property purchase.
However, it’s worth considering the other factors underway in London’s property market. With the UK in a second national lockdown, many investors will be keen on hedging against future COVID-imbued market uncertainty through acquiring safe-haven assets like British property. As you’ll read below, this is having a positive impact on the PCL market.
Investors are flocking to PCL opportunities
The PCL property market has managed to be one of the most active areas of the UK’s real estate market during the whole of 2020. When discussing why this is so, we must first begin by understanding the behaviours of overseas buyers.
Given that international investors represented over half (55%) of all the PCL property purchases recorded in the second half of 2019, anything to further incentivise or dissuade such foreign actors would hugely impact PCL property transaction figures.
Earlier in the year, alongside the announcement of the aforementioned SDLT holiday, UK Chancellor Rishi Sunak indeed announced that he would be implementing 2% SDLT surcharge for non-UK based buyers of British property from April 2021 onwards.
So, for those seeking properties worth over £5 million in the UK capital, a 2% additional cost may represent a substantial amount of wealth. To avoid this, many overseas buyers who may have been contemplating a PCL property acquisition have rushed to buy such properties before this surcharge is applicable. This trend will undoubtedly continue until 1 April, 2021.
Remote working and PCL
On the topic of the PCL market’s future, many property speculators were concerned earlier this year that London’s property market would potentially collapse entirely as a result of remote working. With homeworking set to remain the norm for the foreseeable future, commentators predicted that professionals would escape the capital en-masse in favour of roomier, cheaper properties farther from their London employer’s offices.
While there have been some signs of shifting demand from urban London neighbourhoods to suburban ones, according to Rightmove statistics, there has been no recordable effect on the UK’s property market as a result.
Conversely, property specialists Savills have actually discovered that over half of all transactions including properties worth more than £5 million in the UK this year were all located in just five central London postcodes.
A busy few months
Given the performance of the PCL property sector in 2020, I only foresee this market growing stronger and stronger in the years ahead. Recent developments in the production of COVID-19 vaccine have many hoping that we may return to normality by Spring 2021, which would represent fantastic news for those involved in bricks and mortar, should it transpire.
In the coming months, I anticipate a surge in activity across the PCL market as buyers look to take advantage of the tax breaks on offer. As such, it will be important that these buyers have access to the financing needed to complete these transactions quickly. If not, there is a risk any purchase they attempt might be concluded in April 2021 when the current tax breaks in place are removed.
Overall, I cannot help but be impressed by the performance of the property market more generally during the pandemic. Having experienced slow growth in the years following the EU referendum in June 2016, it is clear that buyers are eager to take advantage of the opportunities on offer. This is particularly true when it comes to PCL property.
An outlook on equities and bonds
By Rupert Thompson, Chief Investment Officer at Kingswood
The equity market rally paused last week with global equities little changed in local currency terms. Even so, this still leaves markets up a hefty 10% so far this month with UK equities gaining as much as 14%.
The November rally started with the US election results but gathered momentum with the recent very encouraging vaccine news. This continued today with the AstraZeneca/Oxford vaccine proving to be up to 90% effective in preventing Covid infections. This is slightly below the 95% efficacy of the Pfizer and Moderna vaccines already reported but this one has the advantage of not needing to be stored at ultra-cold temperatures. One or more of these vaccines now looks very likely to start being rolled out within a few weeks.
Of course, these vaccines will do little to halt the current surge in infections. Cases may now be starting to moderate in the UK and some countries in Europe but the trend remains sharply upwards in the US. The damage lockdowns are doing to the recovery was highlighted today with the news that business confidence in the UK and Europe fell back into recessionary territory in November.
Markets, however, are likely to continue to look through this weakness to the prospect of a strong global recovery next year. While equities may have little additional upside near term, they should see further significant gains next year. Their current high valuations should be supported by the very low level of interest rates, leaving a rebound in earnings to drive markets higher.
Prospective returns over the coming year look markedly higher for equities than for bonds, where return prospects are very limited. As for the downside risks for equities, they appear much reduced with the recent vaccine news and central banks making it clear they are still intent on doing all they can to support growth.
Both factors mean we have taken the decision to increase our equity exposure. While our portfolios already have significant allocations to equities and have benefited from the rally in recent months, we are now moving our allocations into line with the levels we would expect to hold over the long term.
Our new equity allocations will be focused on the ‘value’ areas of the market. The last few weeks have seen a significant rotation out of expensive high ‘growth’ sectors such as technology into cheaper and more cyclical areas such as financials, materials and industrials. Similarly, countries and regions, such as the UK which look particularly cheap, have fared well just recently.
We think this rotation has further to run and will be adding to our UK exposure. This does not mean we have suddenly become converts to Boris’s rose-tinted post-Brexit view of the UK’s economic prospects. Instead, this more favourable backdrop for cheap markets is likely to favour the UK.
We will also be adding to US equities. Again, this does not represent a change in our longstanding caution on the US market overall due to its high valuation. Rather, we will be investing in the cheaper areas of the US which have significant catch-up potential.
We are also making a change to our Asia ex Japan equity holdings. We will be focusing some of this exposure on China which we believe deserves a specific allocation due to the strong performance of late of that economy and the sheer size of the Chinese equity market.
On the fixed income side, we will be reducing our allocation to short maturity high quality UK corporate bonds, where return prospects look particularly limited. We are also taking the opportunity to add an allocation to inflation-linked bonds in our lower risk, fixed income heavy, portfolios. These have little protection against a rise in inflation unlike our higher risk portfolios, which are protected through their equity holdings.
Optimising tax reclaim through tech: What wealth managers need to know in trying times
By Christophe Lapaire, Head Advanced Tax Services, Swiss Stock Exchange
This has been a year of trials: first, a global pandemic and, now, many countries facing the very real possibility of a recession. For investors, private banks, and wealth managers, these tumultuous times have manifested largely in asset price volatility, ultra-low interest rates and uncertainty about when things may level out, as well as questions about what can be done to safeguard portfolio performance.
The answer here lies within identifying and creating efficiencies to maximise performance and minimise cost, and while there is a slew of options as to how to do this, they are often siloed or have a single USP. Tax optimisation, on the other hand, provides benefits to all, not just in increasing returns for investors, but also in creating economies of scale across stakeholders, creating millions – if not billions – in savings for banks.
Evolving tax reclaim
The tax reclaim process used to be a tedious one banks had to manage themselves, and required detailed, industry and country-specific knowledge to stay on top of constantly shifting requirements and regulations. And when we consider that many countries – such as the UK – allow for capital gains exemptions, tax optimisation may not seem like an integral part of the process. However, this isn’t the case for all countries, and can lead to severe after-tax implications on global portfolios.
Furthermore, even if you’re able to avoid double taxation, getting the money back is not always as simple as it sounds. This, combined with the fact that countries often have contradictory taxation rules or requirements, makes navigating the tax reclaim space a challenge even for those with the right expertise and experience.
Ultimately, providing tax optimisation to investors ends up being a heavy lift for private banks and wealth managers, who often don’t have the right solutions, are relying on outdated technology and manual processes. While this is generally fine for business, it is no longer fit for the purpose when it comes to tax optimisation. To date, knowledge and expertise have been the key to protecting and maintaining profitable investments and avoiding tax leakage. However, through tax optimisation services starting to emerge, portfolio managers can now manage and reinvest easily.
Today, technology has evolved the process so that banks are able to access and submit tax reclaim – and the relevant documentation – online, leaving the tech provider to coordinate next steps with custodians and tax authorities behind the scenes. In essence, taking the legwork out of the process while assuring consistency and completeness in execution.
Simplifying tax through tech
While tax optimisation may seem like an easy choice in theory, it is not always the go-to for every private bank or wealth manager. Without the right supports and setup, including innovative technologies and automation, tax reporting must be done manually, leading to labour intensive processes and huge time wastage. Changing these processes can be overwhelming for those used to a certain way of operating.
By making tax reclaim digital, banks will be more able to optimise returns and gain efficiencies while reducing redundancies and unnecessary complexities. Cloud based solutions or platforms can offer a safe and secure solution for banks, wealth managers, and investors to access and submit any information required, processing the data automatically for conformity and completeness.
It is critical that providers who intend to offer tax services are able to do so efficiently with the right software and data processing capabilities. Not only does this drive continuity in service and efficiencies in process, but it is the only sustainable way to handle such a complex landscape sustainably without wasting time or money.
End-to-end, technologically driven tax services offer a huge number of advantages to private banks and wealth managers, the most important of which is the ability to provide continuity through tumultuous times. As we move through the end of 2020 into 2021 this will only be increasingly important as banks, managers and investors look to provide new services to clients and strengthen existing relationships in a difficult market.
As investors seek to find returns amid the global economic downturn, the demand for innovative solutions will only increase. Technology like cloud-based software, AI, and data optimisation can all serve to improve not just the tax reclaim processes, but the overall client experience within capital markets. Private banks and wealth managers are suitably equipped to provide these innovative solutions, but those who do not prepare themselves effectively and keep ahead of trends will run the risk of losing current and new clients to someone who can offer more for less.
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