The Panel: Warren Perry Anna Sofat Keith Churchouse
head of research, Churchill Investments
director, AJS Wealth Management
director, Churchouse Financial Planning
Does the launch of several European bricks and mortar funds in the first part of 2007 indicate that the steam is running out of the UK commercial property market? Perry:
Perry:Yes, completely and utterly. We are encouraging our clients to take profits out of UK bricks and mortar and diversify into global property funds or look elsewhere at places such as Europe where the market has been left behind.
When you have got major players like British Land talking about the end of yield compression and Westbury selling off all its commercial property as it is too expensive, it says something about the marketplace. It will probably be another good year but our contrarian viewpoint says that we should be taking some chips off the table.
Sofat: No, I do not believe that is why the new European real estate funds are being launched. I think that they are being launched for two reasons.
First, there is a recognition that the demand for property as an asset class is here to stay and so the flow of funds will continue. Second, there are already many well established property funds in the UK that are available to retail investors – mostly life and pension funds from insurance companies which dominate this sector – and so for investment companies to compete effectively they need fresh propositions. European or global property funds fit the bill.
From an adviser perspective, it is good news that clients can now diversify within the property class and I think it will reinforce the position of property as a major asset class.
Churchouse: Many pundits have commented that the steam is running out of the UK commercial property market. It is interesting to try to define this. Commercial property is designed to provide rental income and capital appreciation and I agree with the market that some of the capital appreciation in future months and possibly future years may not be as great as in previous times. I do not, however, believe that we will see a commercial property crash as we have done before.
The rental incomes that have been secured by many commercial property funds are excellent, offering high single-digit returns. If this continues to filter through in the performance, with some small capital appreciation, the funds will still be a solid recommendation.
For European funds, you obviously have to take into account currency fluctuation between the pound and the euro and I have some significant concerns over some of the areas in Europe where bricks and mortar funds are being introduced. Therefore, I do not see it as direct competition against the UK commercial property market or it running out of steam to any great extent.
Are you concerned that the growing use of put options in multi-manager funds signals an imminent correction in equity markets? Perry:
Perry:I am all for managers using the full range of tools available to them, particularly if this results in potentially lower volatility. My concern would be over whether most managers have the resources and skills to use put options to their fullest potential and whether there is potential for performance to deteriorate. Either way, the performance record of funds effectively gets torn up as there is an added dimension to the fund management process which has potential to enhance or detract from performance. Advisers and clients need to know who is using what.
Sofat: The markets have had a good run and I urge clients to take profits where appropriate but I am not convinced the purchase of put options signals a correction. I think the fundamentals in equity markets look good at the moment – interest rates are relatively stable, price/earnings ratios look reasonable and merger and acquisition activity continues unabated.
However, I do think the purchase of put options signals nervousness by the funds but instead of conviction investing like Anthony Bolton (who has significantly reduced his exposure to commodities, real estate and so on while increasing his exposure to support services and technology), the multi-managers are taking the lazy route by hedging on a fall. If the markets do fall, they make money. If they do not, then the options fall away with a relatively small cost to the fund. This is how hedge funds make money. It is not what the average long-only fund should be doing in any substantial way.
Churchouse: If we consider the forecasts reported for growth in most equity markets through 2007, all indicate significant increases. According to some, the picture could not be brighter in 2007. I do not agree and I think that 2007 will be a harder year than 2006. I think I am not alone in feeling this, which is the reason why put options are being introduced by multi-manager funds as a highly effective hedge against the risks.
Would the inclusion of put options in a fund you invested in raise concerns over the manager’s judgement? Perry:
Perry:No. A manager should have the full complement of tools available to them when managing a fund. If a manager does not like a stock, he should be able to short it. However, this does have implications for fund performance as this can be exaggerated in either direction depending on the manager’s skills and knowledge.
Sofat: Absolutely. I do not invest in long-only funds for them to effectively bet on the markets although use of options can add value to a fund where there is the potential for things to go wrong. I well remember the losses made by many individuals in the late 1980s when they invested in options without understanding the downside. If it was that easy to make money out of options, hedge funds would have been providing much better returns than they have over the past two to three years.I would rather the managers took investment calls. They might not get it right all the time but it is their skills of investing in good stock that we are paying them for, not to place bets.
Churchouse: No, in fact, quite the contrary. I would see this as a prudent measure. I do think there is unforeseen volatility in the market to come and using options would be an appropriate measure to protect against this. Many fund managers were caught out by the correction in May 2006 and were lucky to see the subsequent recovery. If this happens again in 2007, will they be saved by sustained growth in the balance of the year? Some think not.
What has been the most popular investment option for Isas this year? Perry:
Perry:We do not have an Isa season as clients are encouraged to invest their allowance at the start of each tax year in funds that are appropriate for their circumstances. Unfortunately, property appears to have been very popular although equity income thankfully also seems to have been as popular as ever. Property is coming from a very low starting point in terms of asset allocation but, as usual, private investors and the majority of advisers are about five years too late.
Sofat: I am using the Isa allowance for clients to rebalance their portfolios so typically this means increasing exposure to fixed interest and US equities as these underperformed last year.This means taking profits from equity and property to an extent. I also like India, so, for the more adventurous, I look to emerging market funds with high exposure to India. It is not a short-term call but I do think over the next five to 10 years India will do well. Finally, I am using the opportunity to diversify away from UK property where appropriate.
Churchouse: We have tended to find that people are looking for slightly higher-risk funds. Some of the recommendations that have been used are M&G global basics, JPM natural resources along with other commercial property funds which again confirms that I do not think that the market has run out of steam. These include Norwich property and New Star property. It has so far been a busier season than 2006.
Does last week’s 0.5 per cent increase in Japanese interest rates indicate that 2007 will be a better year for Japanese investments? Do you expect this move to increase interest in Japan? Perry:
Perry:No. The market had a tough 2006 so this year could be equally challenging. It depends on which part of the market you are investing in. Large-cap value had an OK year but smaller company growth stocks had a woeful time of it following the Livedoor scandal. The interest rate increase was broadly anticipated and shrugged off by the market. It does not necessarily imply a good or bad year for Japanese investments but does mean that the economy has finally found some traction. This should mean that we see a sustained period of growth in the market although with a fair degree of volatility.
Sofat: I am fairly bearish on Japan. I do believe that the Japanese economy will fare better this year but I really do not see why I should take risks in Japan when there is so much choice elsewhere in Asia and the emerging markets. I also think that the mainstream Asian market is beginning to replace Japan as a mainstream asset class. I look to diversify among the UK, US, Europe and Asia as opposed to Japan. I also think that with globalisation there is less and less rationale for a geographic diversification so we are going to have to think of different ways of investing.
Churchouse: We experienced a lot more interest in Japan in the last six months of 2006 as an area for investment. The FTSE Japan stocks closed down by around -7.4 per cent in 2006/07and so our belief is that an increase in interest rates will improve circumstances in Japan and make it a better year for Japanese investments. The economy as a whole has been in the doldrums for some time and the recovery position looks good and interesting.
Will Katharine Garrett-Cox’s departure from Morley make the firm less attractive to investors? Perry:
Perry:No. Her role was mostly political and had little impact on day-to-day fund management operations. Morley has little to offer in the retail fund management world outside its hugely successful property trust so this move is broadly irrelevant. I do not think it signals a wave of departures from Morley, nor do I think that the appointment of a new chief investment officer will lead to a flood of new managers to the group. Morley brings little to the investment party so we hardly use any of its funds.
Sofat: No, I do not believe so. Morley has announced a number of new recruits and restructuring of a number of its funds recently. This includes the recruitment of fund managers from Schroders and JP Morgan as well as Chris Phillips from Scottish Widows Investment Partnership. Chris may not have as big a profile as Katherine but he has turned Swip into a success story with focused funds in various sectors.
Morley has some decent funds and a good reputation with IFAs. It needs a higher profile marketing campaign to raise brand awareness of its lead funds.
Churchouse: Katherine Garrett-Cox’s departure to Alliance Trust is going to be a significant blow to Morley, which is one of the biggest UK asset managers. Katherine the Great, as she is known in the City, has achieved major growth in the Morley group and her leaving will be a loss. She only joined Morley as chief investment officer in 2004 and so has had a relatively short term there.
I am sure it is not unexpected for such highfliers in the City to move around and I am sure that the Morley team will have anticipated some form of move at a future date.
Overall, I do not think that the long-terms effects to Morley will be too significant because it has some important fund managers.