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Banking on a rescue

Is the Investment Management Association’s decision to introduce a new absolute return sector a welcome move?

Hall: It is welcome from the perspective that absolute return funds will be taken out of existing sectors and thus avoid the confusion of having these funds shoehorned into sectors where they have the closest fit.

The problem is, however, that apart from having a common goal of produ-cing an absolute return, the strategies employed by managers to achieve them may vary greatly from one manager to another, along with the levels of risk they carry.

It would be similar to creating a single sector named hedge funds and trying to compare these against each other despite that fact that arbitrage as a hedge strategy is not the same as a long-short strategy.

Bradshaw: I generally welcome the move by the IMA and see it as being helpful to some extent.

However, the IMA, in its release of April 28, said “Performance comparisons are inappropriate due to the diverse nature of the objectives of the funds populating this sector, including differing benchmarks, risk characteristics and timeframes for delivering performance”, which could beg the question, what then is the point of creating this new sector?

There are, in fact, some similarities between some funds and therefore it will be easier to identify and compare these funds than it has been.

The IMA points out the obligation to treat customers fairly by those companies listing in the sector. It is essential that said companies are transparent and provide clear explanations using plain English.

Halling: Yes, it allows investors to make a much clearer, like for like comparison with similar profile funds.

Absolute return funds are here to stay, although there will continue to be much evolution and development of new products and investment styles.

Their advent partly reflects the enormous change that has taken place over the last 10 years in developed equity markets. The major influence of hedge funds and their knock-on effects on the traditional long-only fund industry has transformed markets irreversibly in our view.

In the UK, CFDs have become a major factor in UK share trading so it is entirely appropriate that, as absolute return funds have emerged in numbers, that they have a benchmark and recognised sector.

Does the Bank of England’s £50bn rescue package do much to increase the attractiveness of the financial sector?

Hall: It may remove the spectre of a significant failure but a debt is a debt is a debt, is it not?

Whether or not the debt is with the Bank of England or with another bank, the financial sector must still find ways to repay these debts and remove them from their balance sheet.

Of course, to try and protect the taxpayer, the Bank of England has had to create sufficient protection around this package that only the best collateral will be available to offset against this new funding, leaving the financial sector still having to deal with the most toxic debt on their books.

Yes, it may stave off a bank failure but the big rights issues that we are seeing demonstrate that the £50bn package is not enough.

Continued on p56Bradshaw: Thanks to the conditions that the Bank of England placed on its rescue package, I do not think it will do much to increase the attractiveness of the sector.

It certainly will not do much to ease Libor rates if the US is anything to go by. Instead, what we are seeing is banks building up capital rather than lending.

I do not think that we have yet got to the end of the turmoil and, despite the conditions on the rescue package, I still have concerns if house prices fall further, as I believe they most certainly will, that the taxpayer will lose out.

We should remember that the banks created this mess in the first place and have been rewarding themselves handsomely for years of reckless behaviour. They should now feel the pain and not expect the taxpayer to come in and bail them out.

Unfortunately shareholders, that is, ordinary people with pensions, will not fare so well as a result.

However, their anger should be directed at the banks and the people who invested in them on their behalf who also have been rewarding themselves handsomely over the years and perhaps have not been paying sufficient attention to the investments they have been charged with managing.

Halling: Clearly, the answer is yes. This is an epochal move, and unthinkable a mere six months ago and it should help restore, over time, the strength and viability of the whole banking sector.

As to how attractive bank shares are as investment ideas right now, that is a largely separate issue. Many fundamental questions remain to be answered, therefore in our view there are much better areas of the market to evaluate right now on a risk/reward basis where you can make intelligent assessment of the fundamentals and restrict the guesswork to manageable proportions.

As a punt, perhaps there is a case. If you absolutely need to be in banks as part of a portfolio weighting exercise, again there may be a case. Otherwise, a wide berth for now is the sensible route for now.

According to the Investment management Association, Isa sales in 2007/08 were almost half the previous year. Why do you think sales are down this year?

Hall: Studies into investor psychology repeatedly show that investors buy at the top and sell at the bottom. With markets falling in the run-up to this year’s Isa deadline, investors are simply demonstrating that they are ruled by their hearts and not their heads. It does not apply just to investors but also to their advisers. Anecdotal evidence seems to indicate that advisers have been unsure about what to say to clients, many of whom are still bruised from the market meltdown at the turn of the millennium.

Bradshaw: There are a number of reasons why Isa sales are down over the previous year, not least of which is the fallout from the credit crunch which has helped fuel volatility in equities.

Added to this, ridiculously overpriced property and increased mortgage costs have put significant strain on household finances. Well above inflation increases in food and energy costs have also done nothing to help people save.

On top of this, we are seeing a general downturn in confidence, with people worried about a recession and job losses. To the general public, it hardly appears to be attractive conditions for investing.

Halling: Why? People are, in no particular order, scared, confused, have lost money in recently hot areas that have gone freezing in short order – we all know which sectors we are referring to – looking at the wrong measures – too much attention on short-term performance and sectordriven performance versus looking through the headline numbers at more important aspects of a fund, such as consistency, quality of management anda sensible spread of risks. Still surprised?

With the head of Opec predicting that the price of oil could hit $200 a barrel, is oil an area where investors should be increasing their exposure?

Hall: I am wary of clients taking direct exposure in oil, or indeed any other commodity, because prices have been historically very volatile. Investors in equity funds will doubtless already have significant exposure to the oil and gas sector, as it comprises nearly 20 per cent of the FTSE 100 and over 15 per cent of the FTSE All Share index.

The head of Opec has a vested interest in talking up the price of oil but investment decisions should not be made on the back of these comments alone. With Shell & BP between them reportedly making over £3m of profit per hour, our index-tracking investors are getting their share of the cake.

Bradshaw: Most investors already have significant exposure to oil via conventional funds that hold stocks of major oil producers. There is a good possibility that oil could reach $200 a barrel but it does not necessarily follow that clients should be increasing exposure to any great extent. That decision would depend on the individual client and their appetite for risk. That said, if a client did want greater exposure to oil they could consider investing via ETFs or an energy fund.

Halling: The simple answer to this question revolves around the fundamental difference between investing and momentum riding. Most people confuse the two to a remarkable degree.

Unless an investor is prepared to engage in the fundamental analysis of risk to reward, duration of trend, valuation and a host of other measures that provide a rational basis for investing, then only the latter style of market engagement is available to them.

There is nothing inherently wrong, per se, with riding momentum. What is, in our view, clearly suspect is riding said momentum and not recognising it and crucially, at point of entry. On that basis, investing in oil or gold or any other potentially mature trend is by definition, an investment idea as such.

What is clear is that no one has a crystal ball on where this whole commodity play ends up and, on that basis, a value investor would not invest in any serious capacity at this stage of the cycle.

Continued from p55

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