BE ON GUARD! How much cash should your portfolio hold?

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Understanding the multiple roles cash has to play in investment portfolios can help investors overcome the often-criticised downside of holding cash. For example, money currently earns very little yield and it remains subject to inflation risk.

For the purpose of this article, I am only referring to cash held within portfolios, and not to other and separate reserves that investors must retain to meet unexpected expenditure.

I’ll start by tackling the shortcomings of holding cash. Of course, in this financially repressive period of low interest rates and mildly positive inflation, cash is indeed costly. Still, we believe that asset allocation decisions should be made through a valuation-driven framework.

Cash provides stability

If valuations of risk assets appear extremely rich, we argue it is better to hold some cash and potentially accept temporary purchasing power erosion from inflation than to hold overvalued assets and risk substantial losses in an attempt to earn a higher portfolio yield.

Cash performs three main roles in portfolio construction. First, and most obvious, is that it provides stability and readily available funds to meet known liabilities, such as regular fixed drawdowns. It therefore avoids the need to sell investments at inopportune times.

Second, holding cash provides defensive diversification benefits. The principle of diversification remains a key building block of effective asset allocation.

graph 1

The idea that introducing imperfectly correlated assets to a portfolio can both decrease risk and enhance opportunities for return is well established in academic literature and among investment managers.

Serious warnings

Correlations between asset classes, however, change over time. A closer look at historical correlations shows an important trend has emerged and even strengthened: correlations of most risk assets to global equities have increased remarkably over time, as shown by the chart above.

From a portfolio perspective, we think some serious warnings are in order. The fact that these risky asset classes tend to move in tandem with each other, rather than being a counterweight, indicates that the potential for diversification is low.

Central banks can affect sentiment, risk-taking and flow of capital into (and out of) risk assetsDuring the 2008-2009 financial crisis, most asset classes moved in one direction (down) and most short-term correlations strengthened. Spikes in cross-correlations have certainly become more pronounced, exacerbated by risk-on, risk-off trading and high capital mobility.

It is also apparent that central banks have the ability to influence stocks in the short run, alter historical asset class correlations and fuel contagion within them.

By controlling liquidity injections and influencing the rate of return on “safe” government bonds, these monetary institutions can affect sentiment, risk-taking and the flow of capital in (and out) of risk assets.

As a result, asset class diversification, which aims to help mitigate portfolio losses, has tended to fail exactly when it’s needed the most.

‘Dry powder’

Amid this secular rise in correlations, cash and short-term bonds are the only asset classes that have reliably delivered low to negative correlations with risk assets, especially during times of market stress.

There are other defensive assets that can provide low correlation relative to stocks, such as gold. But while gold provides a similar level of diversification as cash, it comes with significantly higher volatility.

A third function for cash is to serve as “dry powder” for opportunistic investment. In order to be successful, we need to be prepared to navigate some pretty choppy waters without losing sight of our long-term objective, which is to protect and grow our clients’ capital.

During periods of market overvaluation, cash allows us to both avoid the negative impact of downturns and take advantage of future opportunities that offer better risk-adjusted returns.

It’s prudent to hold enough cash to  commit to situations with exceptional risk/return profilesWhat’s interesting about the three main roles cash has to play in portfolios is how closely they are interlinked. The need for liquidity is often highest when correlations among assets are spiking, diversification is failing and forced deleveraging is occurring.

In these situations, valuations become distorted due to forced selling and investor panic, which can be just the right time to put dry powder to work and acquire assets at discounted valuations.

So, how much cash should a portfolio hold? The answer will vary depending on the objective and risk profile of the portfolio, but consideration for absolute and relative value, expected returns on competing assets (bonds and equities) and market conditions will contribute to the decision-making process.

In the current climate we feel it’s prudent to hold sufficient cash to be able to commit to special situations which are deemed to have exceptional risk versus return profiles should they present themselves.

 

SOURCE: Ryan Paterson – www.iii.co.uk
Ryan Paterson is research analyst at Thesis Asset Management.

Savers are being tempted by complex ‘structured products’

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SAVERS looking to get more from their money may have been tempted by complex investments called “structured products”.

Often seen as a halfway house between cash and shares, they aim to deliver a better return than savings accounts while limiting the risks of investing directly in stocks.

New figures suggest that lower-risk structured deposits have been fairly successful, producing an average return of 3.7 per cent a year.

But structured products remain controversial as they can be difficult to understand.

Some have also been mis-sold or collapsed in the past, stunning investors who believed their capital was guaranteed.

Milestone

Structured products are sold directly by banks and building societies as well as through independent financial advisers.

Ian Lowes, managing director of IFA Lowes Financial Management, claims they can help savers beat today’s dismal returns on cash.

His website CompareStructured Products.com has compiled data that shows the market recently passed a “milestone” with a total of 500 structured deposits sold by IFAs over the last 15 years now reaching maturity.

He says none lost money: “In total 390 made a profit while another 110 returned the investor’s capital in full but with no profit.”

Many underperformers matured between 2010 and 2012 after being hit by the financial crisis, he says.

How they work

Structured products link your returns to the performance of a stock market index such as the FTSE 100 or other measurement such as the Halifax House Price Index.

These products run for a set term, say, three to six years and the amount you get at maturity depends on the performance of the index.

The safest type are known as “structured deposits” which aim to return your money whatever happens to markets.

Your capital is protected by the Government backed Financial Services Compensation Scheme (FSCS), which guarantees the first £75,000 if a company goes bust.

However, structured investments are riskier as your capital is threatened if markets tumble and there is no FSCS protection.

Precipice collapse

A structured product known as a precipice bond brought the sector into disrepute a decade ago after it triggered a big mis-selling scandal.

The high-income bonds were marketed to 450,000 mostly elderly savers promising to pay up to 10 per cent a year, but this was often gouged out of the saver’s original capital, which eroded to nothing.

Of the £7.4billion invested between 1997 and 2004, £5billion was lost.

This sector suffered another shock after the financial crisis with the collapse of products by Keydata Investment Services, Arc Capital & Income, NDFA and DRL, whose capital guarantees were underpinned by doomed Wall Street investment bank Lehman Brothers.

Lowes says this affected just 1 per cent of all structured products at the time: “Many investors have since missed out by dismissing the whole sector.”

Index call

The big problem is that structured products are difficult to understand, as your returns may rely on markets performing in a pre-defined way over a set period.

Many products use “auto calls”, so for example if the FTSE 100 is higher after three years then you get 30 per cent.

Otherwise you might get 40 per cent after four years or 50 per cent after five years.

The risk is that if the index falls sharply and is much lower at maturity after six years, you may not get all your capital back.

Lowes argues that none of the 374 products linked to the FTSE 100 over the last five years made a loss.

Risk and reward

Patrick Connolly, certified financial planner at Chase de Vere, says many criticisms of structured products are unfair, but his company still does not recommend them.

“They can be complex making it difficult for investors to understand the underlying workings and charges.”

He says a danger with promoting them is that people then buy an inferior product from their bank without advice.

Justin Modray, an IFA at Candid Financial Advice, says that structured products range from good to bad to downright ugly.

“Approach with caution and check which bank or counter-party is underpinning our capital guarantees.”

This article was written by Harvey Jones and published on Express.co.uk on 20th April, 2016.

Ready to blow!

READY TO BLOW? Stock market more volatile than in any other post-election period since 1987

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The FTSE All-Share index has been more volatile over the past year than during any other post-election period since 1987, research has found.

The Share Centre, the broker, has totted up the number of times the index either gained or lost 1 per cent in a single trading session.

It found that over the past year, one year on from the general election, this has occurred on 87 occasions – much more often than in other post-election periods.

The broker carried out the same exercise looking back at recent decades. It analysed the previous six governments, stretching back to 1987 when Margaret Thatcher won a landslide victory to become prime minister for the third time.

ECONOMIC CONCERNS

Concerns over the health of the global economy, including China, have been one of the main reasons behind the high levels of volatility over the past 12 months. This, in turn, has unsettled investors, who since the start of the year have been reducing their exposure to equity funds.

Over the past year the FTSE All-Share index has lost 8 per cent.

Year of general election Prime minister elected
Political party No. of days where market moved by >1% (+ or -)
No. of days where market moved by >2% (+ or -)
2015 David Cameron Conservative 84 24
2001 Tony Blair Labour 74 19
1987 Margaret Thatcher Conservative 72 24
2010 David Cameron Conservative 69 17
1997 Tony Blair Labour 64 9
1992 John Major Conservative 45 7
2005 Tony Blair Labour 17 1

But it is not all doom and gloom. Other post-election periods have been worse. In 2001 for instance, when Tony Blair was re-elected, the index fell by 17 per cent in his first year following the tech bubble popping.

EXCepTIONAL YEAR

Another less rosy post-election period for markets occured in 1987, when the index lost 11 per cent. Most of the losses came in October of that year, when Black Monday sent stock markets around the globe into a spin.

Year of general election Prime minister elected Political party Performance of FTSE All-Share in first year (%)
1997 Tony Blair Labour +32
2005 Tony Blair Labour +28
1992 John Major Conservative +19
2010 David Cameron Conservative +14
2015 David Cameron Conservative -8
1987 Margaret Thatcher Conservative -11
2001 Tony Blair Labour -17

Richard Stone, chief executive of The Share Centre, adds: ‘The data shows that 2015/16 has been an exceptional year and it is hardly surprising that investor sentiment and activity has been relatively weak.

‘Investors have had to face into a falling market, trading in a narrow range but with high volatility, in other words high risk. With the market lacking direction but risk high, many investors have chosen to sit on the sidelines.

‘We hope that some of the uncertainty driving these market characteristics will lift during 2016 and investors’ confidence will return, enabling them to take advantage of the many positive steps the government has taken to encourage them in their endeavours.’

SOURCE: www.moneyobserver.com

BEWARE! Brexit will put UK plc revenues at ‘significant’ risk

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A British vote in favour of leaving the EU next month will have a “significant” impact on the revenues generated by the UK’s largest companies, potentially damaging investor returns in the process.

UK-listed companies collectively generated £350bn of revenues from the EU last year, and these revenues could be put at risk by a British exit or “Brexit”, according to research by Old Mutual Asset Management, the $218bn institutional investment manager.

The US-listed asset manager, which is majority owned by Old Mutual, the Anglo-South African insurer, said certain sectors were more vulnerable than others. Telecoms, information technology and consumer discretionary companies derive the highest proportions of revenues from continental Europe.

These companies would probably benefit most from a vote to remain when the UK goes to the polls in June.

Olivier Lebleu, head of international business at Omam, said investors need to be aware that many UK companies generate large chunks of their revenues from the EU.

“There is a gap between what [investors] think they are invested in — which is UK plc — and where these companies actually do their business,” he said.

British pension funds are heavily exposed to UK equities, with more than 40 per cent of the assets in the country’s defined contribution funds invested in domestic companies, according to Omam.

Mr Lebleu said: “If you are of the opinion that Brexit could happen and its affect would be negative, you should probably take a close look at your holdings.”

Global fund managers have already taken steps to mitigate the risk of a Brexit on their holdings.

Fund allocations to UK equities have dropped to their lowest levels since November 2008, according to Bank of America Merrill Lynch. They fell 16 percentage points in May compared with April.

However, some big investors believe UK equities now look attractive, because uncertainty around Brexit has improved the valuation of British stocks in recent months.

NN Investment Partners, the Dutch fund house, said the average dividend yield of a UK stock is now around 4.5 per cent, well above the long-term average of 3.5 per cent.

“Although uncertainty remains until the vote has passed on June 23, adding UK stocks to a European equity-dividend portfolio makes sense already today,” said Manu Vandenbulck, a senior portfolio manager at NNIP.

Omam’s report said listed companies that have a strong domestic focus are likely to benefit most from a UK exit from the EU in the longer term, although they could be harder hit than their more globally focused counterparts in the shorter term.

The report, which used figures from MSCI, the data provider, also suggested that some UK companies might move their headquarters and list in other parts of the EU in the event of an Out vote, which would have a “significant potential impact” on investors.

 

SOURCE:  – Financial Times

FTSE 100 defensive favourites could face years of underperformance

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Mean reversion is one of the most powerful forces in investing. The idea that over time valuation multiples will revert to the mean, or simple average. Right now the valuation multiples in the consumer staples sector are near record highs. We take a look at what is driving them and why it might be a good time to review the weighting of investors’ portfolios to this part of the market.

Peak p/e ratios

The stock market is a complex mixture of a discounting machine for future profits and a mad collection of people desperate to make a profit. It is these two factors which underlie the basis of mean reversion. Firstly the profits in a company will rise and fall with business cycles. Secondly investors make emotional decisions about investing in stocks that fall in and out of favour. Most importantly, and over time, they will average out.

The consumer goods sector is enjoying a valuation peak right now. Some of the biggest and safest names on the FTSE 100 have seen their shares steadily rise for the past two decades leaving their price to earnings, or p/e ratios also at extreme levels. Reckitt Benckiser is currently trading on a forecast p/e of 24 times, Unilever is on 21 times earnings and Diageo is on also on 21 times.

PE ratioReckitt Benckiser price earnings history20042006200820102012201420161015202530Friday, Feb 26, 2010● PE_RATIO: 16.9497

However, the macro economic forces and financial engineering that allowed the earnings multiples to reach record levels are now beginning to turn against these giants.

Deflation bites back

When the world economy hit a road bump back in 1999, and the dotcom bubble unravelled, the central banks turned on the money supply taps to keep consumer spending buoyant. This was a boon for consumer staples giants as they could steadily push through price increases backed by huge marketing budgets which pushed branded goods. This allowed steady revenue increases from the core portfolio of brands at Dove, Domestos and Lynx owner Unilever, and also at Durex and Gaviscon maker Reckitt Benckiser.

When the 2008 financial crisis came along, it knocked the consumer groups hard, but more money flooded the system and allowed consumer spending and prices to quickly recover. What’s more, it also provided the basis for extreme cost cutting, which in turn helped profit margins soar. As revenues increased and profit margins expanded the earnings multiples used to value these companies also steadily increased from around 12 to more than 20 times earnings.

However, the central bank largesse is now going into reverse and as the money dries up the prices of consumer goods are now falling in developed markets across Europe and North America.

Emerging market slowdown

As the developed markets slowed the baton was picked up by rapidly expanding emerging markets such as Brazil, India, Nigeria and China. The growing middle classes in these regions demanded branded products due to concerns over the quality of local equivalents. The double digit rise in sales and ability to push through price increases easily offset the slowdown in developed markets at first. This underpinned the revenue and earnings growth needed to justify the ever increasing valuation multiples.

However, this success story is now also unwinding. The sharp rise in the value of the dollar during the past 18 months has seriously hit the spending power of emerging markets. The emerging market economies have also been battered by a commodity selloff. Spending power now seriously denuded these regions will struggle to provide the sales momentum required going into next year.

Financial engineering

Another feature of the past two decades has been the extraordinarily low and falling interest rates. This has allowed FTSE 100 companies with solid balance sheets to borrow incredibly cheaply. Cheap borrowing has inflated valuation multiples in two ways. Firstly it has funded the takeovers necessary to keep revenue and earnings growth at the levels required to justify valuation multiples. Secondly as the interest payments on the debts have fallen the benefits of excess profits accrue to the holders of equity.

% YieldUK 5yr Gilt yield an indicator of the cost of debt2002200420062008201020122014201601234567

The interesting feature on the debt side is that while interest rates look set to increase extremely slowly, the cost of debt may increase at a much faster rate. The commodity collapse is causing default rates to steadily rise, and as this happens investors will demand higher rates of return on debt. The cost of corporate debt can therefore increase independently of central bank interest rates.

Time to rebalance

The process I have described took place over more than two decades as investors increasingly viewed consumer staples as a one way bet to returns.

The problem for those approaching retirement is that they can ill afford to chase the 2-3pc dividend yield in a consumer staple trading on 24 times earnings, only to watch that rating unravel over the next five years. Applying a more prudent rating of 14 times earnings would equal a 42pc loss of capital on your pension pot, for example.

(p) pence per shareUnilever shares are near all-time-highs201020052015500100015002000250030003500Wednesday, Mar 14, 2007● Last Price: 1 402

There is no need for drastic action. The unwinding of these factors is likely to be a gradual process. However, investors should take a good look at how much of their savings is in these consumer stalwarts such as Diageo, Reckitt Benckiser, Unilever, PZ Cussons and Nestle. Now might be a good time to bank those excellent returns.

SOURCE: John Ficenec – telegraph.co.uk

Danger

DANGER! Why The FTSE 100 Is In Danger Of A Horrible Correction

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Another week, another baffling rise for the FTSE 100 (INDEXFTSE: UKX).

Britain’s foremost index stepped above the 6,400-point landmark for the first time since early December on Tuesday, taking total gains in the past three months to 13%.

Despite the FTSE 100’s resilience, however, I remain convinced that a severe retracement remains very much in the offing.

Built on creaking commodities

One of my major concerns over the fate the FTSE 100 is that index is being kept afloat mostly by a resurgence in commodities-related stocks. Indeed, nine of the Footsie’s top ten risers during the past three months are involved metals or fossil fuels excavation.

Diversified producer Anglo American — a company heavily upon the worsening iron ore market — has led the chargers, the stock gaining an unfathomable 257% since hitting multi-year troughs in January!

Fellow diversified diggers Glencore, BHP Billiton and Rio Tinto have also torn higher during the past few months. And dedicated oil play Shell has also performed exceptionally, its share price rising 42% during the period, while gold excavator Randgold Resources‘ share value has advanced almost 50%.

Overvalued

I reckon Randgold Resources’ rise may hold up better than its peers in the near-term, however, the prospect of further macroeconomic bumpiness possibly prompting further ‘safe haven’ buying into precious metals.

But the worsening supply/imbalances washing across most major commodities markets is leaving much of the resources sector on shaky ground, in my opinion. Each of the commodities plays described above is now sailing well above a P/E rating of 10 times, territory reserved for stocks with high risk profiles. This leaves plenty of room for a stark correction.

And a huge reversal is a very real possibility should Chinese economic data continue to disappoint, and the US dollar regains strength thanks to fresh Federal Reserve monetary tightening and weakening emerging market currencies.

Developing regions on the rack?

Indeed, wider concerns over the health of developing markets provides another lever for a harsh retracement. Data this month showed China’s economy expand just 1.1% between January-March and the previous quarter, casting fresh doubts over Beijing’s 2016 growth target of between 6.5% and 7%.

Stocks with a huge emerging market bias like Standard Chartered, Unilever and British American Tobacco have also punched huge gains in the past three months, these stocks rising 18%, 17% and 19%, respectively, since mid-January.

So while I believe many such companies remain strong long-term buys, signs of fresh economic choppiness in far-flung regions could send these shares — and with them the broader FTSE 100 — sinking again.

Think of England

And of course there are plenty of worries closer to home that could send the FTSE 100 shuttling lower.

The run-up to June’s EU referendum is likely to prompt plenty of volatility across share markets, particularly if polling data suggests that voters are leaning towards a possible ‘Brexit.’ And an eventual ‘leave’ vote could send investors packing as Footsie companies large and small tackle a range of issues, from escalating labour costs to the financial impact of future trade deals.

Meanwhile, concerns that the British economy is losing steam are also gaining momentum. Data on Wednesday showed UK unemployment increase for the first time since mid-2015, a 21,000 rise taking total jobless to 1.7m. And earnings growth slowed to 1.8% from 2.1% in the prior three months.

But while I am fearful over the fate of much of the FTSE 100, that is not to say there are not pockets of opportunity for shrewd investors to make a fortune.

Indeed, The Motley Fool’s 5 Shares To Retire On wealth report highlights a selection of incredible stocks in great shape to provide sensational shareholder returns in the near-term and beyond.

Among our picks are top retail, pharmaceutical and utilities plays that we are convinced should deliver stunning dividend growth.

SOURCE: www.fool.co.uk

Waterfall

FREEFALL! Why FTSE 100 needs a miracle

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We’d given criteria for a possible drop to 6,100 in our feature at the start of this week and, to be honest, April had finished with a fairly optimistic note. So, it was with horror we watched the FTSE 100 scraping the bottom of the barrel all afternoon at the 6,100 level.

Despite neither the FTSE nor FTSE Futures breaking below our 6,100, the precision of the drop target worried us as, had there been some hidden strength, the market should have bounced at 6,100. Rather, the index behaved like a fly hitting one of these sticky fly traps – unable to take off but making a lot of noise about it.

The situation now is of weakness below 6,100 leading to an initial 6,070 with secondary, if broken, at 6,023 points. While both aspirations may sound fairly harmless, it’s important to remember the market has broken its immediate red uptrend (see chart below).

This results in the situation where we’re viewing 5,750 as the ruling drop attraction currently. The FTSE needs to better blue – currently 6,255 – to rubbish such a potential.

strang FTSE 100 5 may g1(s)

The chart does offer a straw of hope at the 6,023 level, if for no other reason than that folk will look at the lows of March and hope a “double bottom” has happened.
Reasons for a miracle

Realistically, we now need to start looking for reasons why the market may experience a miracle recovery above 6,255 and into relative sanity. Normally we’d hope to view market movements since the start of the month and pronounce, wisely, that the immediate downtrend is at “x” and only a movement of “y” will beat it.

Unfortunately, during the session on 4 May, the immediate downtrend was at 6,136. The market bettered it for 30 minutes, then once again plunged to the 6,100 level. As a result, we’re forced to measuring movement strengths.

Near-term, if the FTSE betters 6,153, it is supposed to achieve a useless 6,161 points which, if bettered, allows for 6,182 points. The important thing about this series of numbers comes if our 6,182 is exceeded. Such an event will tend to confirm any bounce has real strength, allowing us to speculate about a further rise to 6,253.

Ironically, this does not take the market to safety, but only to the edge, a point where we need to re-examine our tea leaves. If the FTSE were indeed to suffer such a recovery, we would tend to anticipate some future strong movements.

SOURCE: www.iii.co.uk

SHOULD BE DOING MORE? FTSE 100 has underperformed for more than a decade

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This year FTSE 100 has broken records left right and centre.  The index smashed through the 7,000 barrier, set numerous record highs and ended the first quarter of this year as its best level in the last two years. It all sounds quite impressive. But when compared with the rest of the world, London’s blue chip benchmark has lagged worryingly behind.

This year FTSE 100 has broken records left right and centre.

The index smashed through the 7,000 barrier, set numerous record highs and ended the first quarter of this year as its best level in the last two years.

It all sounds quite impressive. But when compared with the rest of the world, London’s blue chip benchmark has lagged worryingly behind.

In the US, a continually strong dollar and low interest rates have seen the Dow Jones Industrial Average rise to 17,881 from 16,457, an increase of 7.9% for the 12 months to March.

The rise in that index, which consists of the top 30 US companies, compares to Footsie’s 2.5% rise over the same period.

Both pale in comparison to the German DAX, however, which has risen by 20.1% to 11,966 despite, or perhaps because of, concerns over a Greek defection from the Eurozone and a plummeting euro.

A plummeting euro has meant European exporters have been at a reduced price, while the uncertainty in the Eurozone has meant investors have been looking for less risky investment.

Coupled together has led to the persistant rise of the DAX compared to the others.

Going farther back makes for even grimmer reading. In the last 10 years, the Dow has improved 76% while the DAX has risen by an almost outrageous 181%. FTSE 100 is up just 36%.

Oliver Wallin of Octopus Investments said he is not surprised the FTSE 100 has underperformed the other two.

The investment director said: “The obvious thing to look at with the FTSE 100 is that it is highly geared to mining and oil companies compared to the Dow and Dax.

“The FTSE has almost double the exposure of the Dow, something like 14% to 7%, while the DAX has very little if any.”

Over the past 12 months, the Brent Crude Oil price has dropped to US$55, a barrel a near 50% fall, while the gold spot price has fallen by nearly 8% to US$1,183.

Both have a big impact on the resource-heavy UK share index, according to Garry White, at City broker Charles Stanley.

He said: “Footsie is too based on energy and oil. There are no bigger contributors [to the index] than BP and Shell apart from maybe HSBCwhich has had its own issues.”

BP and Shell combined account for more than 12% of the index and a plummeting oil price has sent their share prices tumbling by 9.7% and 13.7% respectively.

The top seven companies, Royal Dutch Shell (LON:RDSB), HSBC(LON:HSBA), BP (LON:BP), GlaxoSmithKline (LON:GSK), Vodafone(LON:VOD), AstraZeneca (LON:AZN) and British American Tobacco(LON:BATS), account for almost 35% of the index.

There are similar concentrations of power overseas. In the US, the Dow’s six main companies account for nearly 34% and the German DAX’s top four are 36% of the index, but their main constituents are less reliant on commodities leaving them relatively unaffected by recent changes in prices.

Charles Stanley’s White points out the FTSE100 is not really a proxy for UK PLC with 85% of its earnings coming from abroad.

While the DAX and Dow were (to an extent) proportional representations of the US and German economies, the FTSE 100 is far more global and less likely to benefit as much from shifts in the UK economy.

Piling on the misery for the FTSE 100, data shows even the FTSE 250, an index of the next 250 biggest companies outside the top 100 and far more representative of the UK overall, has left its bigger brother trailing.

The mid cap index has risen 4.8% over the past year, almost twice Footsie’s gains and an astonishing 240% over the last decade.

Octopus’ Wallin said: “The FTSE 100 is no longer the best place to look to for investment in the UK economy. We recommend investors move away from FTSE 100 and look at companies in the FTSE 250.”

 

SOURCE: Jonathan Jones – proactiveinvestors.co.uk

FTSE 100 DRYING UP? Barely 20% of funds have managed to turn a profit after the FTSE peak

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It’s been a year since the FTSE 100 reached its historic peak of 7,122. As soon as the stock market broke the 7,000 marker, bullish experts started placing their bets for when it would make 7,500 or even 8,000.

Instead, what followed was an incredibly torrid 12 months for the index. A crash in China, a commodity rout and ongoing uncertainty around the EU referendum soon saw the market tumble from its heady highs.

By August it had plummeted more than 1,000 points to 5,898. If you had invested £10,000 in the FTSE 100 at its peak, you would have had just £8,281 left by August 24.

If you had hung on until February 11, you would have had just £7,774.

And if you had clung on until yesterday, you would have about £9,000. Of course, investing at the top of the market is, as everyone knows, a terrible idea. So what if you had put your faith in an expert fund manager instead?

The top-performing fund since the FTSE’s peak is MFM Techinvest Special Situations. It has returned 28.4 per cent since April 27 last year, turning £10,000 into £12,840.

If you had invested the same amount in Sarasin EquiSar UK Thematic Opportunities on the same day, you would have £8,350 left – a loss of 16.5 per cent.

According to data from investors Wealth Club, just 89 of 429 funds managed to provide a positive return since the top of the market. That means 340 lost savers’ cash.

So what has been the driving force behind the top performers? They are all focused on smaller companies.

Ben Yearsley, director at Wealth Club, says: ‘Banks and commodities firms aren’t as prevalent in this space. If you add to that some quality stock-picking from a good manager, you have a recipe for outperformance.’

Investing in smaller companies can be incredibly risky as their share prices tend to swing more wildly, making for a rocky ride. And when big companies are doing well, smaller ones tend to suffer. But when the conditions are right, they can deliver stellar performances.

Darren Freemantle, co-manager of the MFM Techinvest Special Situations fund, likes technology firms – around 25 per cent of the fund is in them. One of the strongest-performing companies in the portfolio has been Datalex, which provides online software for airlines.

Freemantle says: ‘Airlines don’t actually make much money on their ticket sales so this software helps them drive other revenue streams. For example, when you pay more to pick your seat, to get priority boarding or for additional baggage.’

The top-performing fund since the FTSE’s peak is MFM Techinvest Special Situations. It has returned 28.4 per cent since April 27 last year, turning £10,000 into £12,840.

If you had invested the same amount in Sarasin EquiSar UK Thematic Opportunities on the same day, you would have £8,350 left – a loss of 16.5 per cent.

According to data from investors Wealth Club, just 89 of 429 funds managed to provide a positive return since the top of the market. That means 340 lost savers’ cash.

So what has been the driving force behind the top performers? They are all focused on smaller companies.

Ben Yearsley, director at Wealth Club, says: ‘Banks and commodities firms aren’t as prevalent in this space. If you add to that some quality stock-picking from a good manager, you have a recipe for outperformance.’

Investing in smaller companies can be incredibly risky as their share prices tend to swing more wildly, making for a rocky ride. And when big companies are doing well, smaller ones tend to suffer. But when the conditions are right, they can deliver stellar performances.

Darren Freemantle, co-manager of the MFM Techinvest Special Situations fund, likes technology firms – around 25 per cent of the fund is in them. One of the strongest-performing companies in the portfolio has been Datalex, which provides online software for airlines.

Freemantle says: ‘Airlines don’t actually make much money on their ticket sales so this software helps them drive other revenue streams. For example, when you pay more to pick your seat, to get priority boarding or for additional baggage.’

SOURCE: Holly Black – ThisIsMoney.co.uk

GOT ENOUGH? How much cash should your portfolio hold?

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Understanding the multiple roles cash has to play in investment portfolios can help investors overcome the often-criticised downside of holding cash. For example, money currently earns very little yield and it remains subject to inflation risk.

For the purpose of this article, I am only referring to cash held within portfolios, and not to other and separate reserves that investors must retain to meet unexpected expenditure.

I’ll start by tackling the shortcomings of holding cash. Of course, in this financially repressive period of low interest rates and mildly positive inflation, cash is indeed costly. Still, we believe that asset allocation decisions should be made through a valuation-driven framework.

Cash provides stability

If valuations of risk assets appear extremely rich, we argue it is better to hold some cash and potentially accept temporary purchasing power erosion from inflation than to hold overvalued assets and risk substantial losses in an attempt to earn a higher portfolio yield.

Cash performs three main roles in portfolio construction. First, and most obvious, is that it provides stability and readily available funds to meet known liabilities, such as regular fixed drawdowns. It therefore avoids the need to sell investments at inopportune times.

Second, holding cash provides defensive diversification benefits. The principle of diversification remains a key building block of effective asset allocation.

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The idea that introducing imperfectly correlated assets to a portfolio can both decrease risk and enhance opportunities for return is well established in academic literature and among investment managers.

Serious warnings

Correlations between asset classes, however, change over time. A closer look at historical correlations shows an important trend has emerged and even strengthened: correlations of most risk assets to global equities have increased remarkably over time, as shown by the chart above.

From a portfolio perspective, we think some serious warnings are in order. The fact that these risky asset classes tend to move in tandem with each other, rather than being a counterweight, indicates that the potential for diversification is low.

Central banks can affect sentiment, risk-taking and flow of capital into (and out of) risk assetsDuring the 2008-2009 financial crisis, most asset classes moved in one direction (down) and most short-term correlations strengthened. Spikes in cross-correlations have certainly become more pronounced, exacerbated by risk-on, risk-off trading and high capital mobility.

It is also apparent that central banks have the ability to influence stocks in the short run, alter historical asset class correlations and fuel contagion within them.

By controlling liquidity injections and influencing the rate of return on “safe” government bonds, these monetary institutions can affect sentiment, risk-taking and the flow of capital in (and out) of risk assets.

As a result, asset class diversification, which aims to help mitigate portfolio losses, has tended to fail exactly when it’s needed the most.

‘Dry powder’

Amid this secular rise in correlations, cash and short-term bonds are the only asset classes that have reliably delivered low to negative correlations with risk assets, especially during times of market stress.

There are other defensive assets that can provide low correlation relative to stocks, such as gold. But while gold provides a similar level of diversification as cash, it comes with significantly higher volatility.

A third function for cash is to serve as “dry powder” for opportunistic investment. In order to be successful, we need to be prepared to navigate some pretty choppy waters without losing sight of our long-term objective, which is to protect and grow our clients’ capital.

During periods of market overvaluation, cash allows us to both avoid the negative impact of downturns and take advantage of future opportunities that offer better risk-adjusted returns.

What’s interesting about the three main roles cash has to play in portfolios is how closely they are interlinked. The need for liquidity is often highest when correlations among assets are spiking, diversification is failing and forced deleveraging is occurring.

In these situations, valuations become distorted due to forced selling and investor panic, which can be just the right time to put dry powder to work and acquire assets at discounted valuations.

So, how much cash should a portfolio hold? The answer will vary depending on the objective and risk profile of the portfolio, but consideration for absolute and relative value, expected returns on competing assets (bonds and equities) and market conditions will contribute to the decision-making process.

In the current climate we feel it’s prudent to hold sufficient cash to be able to commit to special situations which are deemed to have exceptional risk versus return profiles should they present themselves.

Ryan Paterson is research analyst at Thesis Asset Management.

 

SOURCE: Interactive Investor – iii.co.uk