What issues do you see arising out of the US presidential election?
Adam: I think certainly in the financial institutions in Wall Street and in London we would prefer to see a Republican victory in the November election, if nothing else, for the tax cuts and government spending spree that the current US government has been doing to continue to boost the economy and keep employment levels high.
Although it could be argued whether Bush genuinely won the last time round, the probability is that he will be re-elected despite the adverse press regarding Iraq. Iraq may be a factor in this election but major elections usually come down to the economy and taxes and these are areas that certainly fall in Bush's favour.
A Democrat victory would definitely see a high level of uncertainty and particularly because so far Kerry seems willing to promise anything to anybody to get elected (don't they all?) and then worry about how the economy will cope with all the promises he has made to the electorate.
Patel: I think there is one major issue that needs addressing whichever party wins – America seriously needs to resolve its debt crisis. I also think the current government has led the public into a false sense of security by way of offering tax rebates and low interest rates. As soon as the next election is over, I believe there will be a great deal of policy tightening which will feel more like a bucket of cold water thrown on the consumer. It will definitely be a shock and I think there will be a sharp slowdown in the economy.
Lanning: Whoever the winner is has to get to grips with the twin deficits' problem urgently. The US economy is structurally unbalanced and interest rates and taxes will rise together with a dollar fall in order to bring balance to the economy. In terms of the overall stockmarket level, it will not make any difference who wins but the usual suspects of defence companies doing well if the Republicans win and healthcare stocks doing badly if the Democrats win in the short term will probably happen. We are concerned that both parties look likely to try and rein back consumers, the very people who have been propping up the US economy.
How has the oil price affected the amount of business that you are writing?
Adam: The oil price has had a very minimal effect on the amount of business we are writing, particularly as some of our more switched-on clients have seen this as an excellent buying opportunity. They have commentated on the fact that it is unlikely that all the major oil supplies will dry up, and have seized this as an opportunity to take advantage of the short term blip in the price of crude oil.
It has been more of a concern to risk-averse clients, who have been following some of the comments in the media but we have been talking to our clients to advise of what oil prices went through in 1973/74 and 1982 they can see that the current price of oil is not at a record high on an inflation-adjusted basis.
Obviously, the longer the oil price does stay at high levels, it may have an impact on the markets and therefore investors' confidence but there is certainly no sign in the short term that this is having an impact.
Patel: Sales of investment funds have been pretty poor over the last few months and confidence is rock bottom once again with our investors. A lot of this has to do with the rise in oil prices creating uncertainty but I think sales are also down because the markets are lacking direction so investors do not know what to do in this environment. The rise in interest rates is also beginning to have an impact so it is a combination of factors which are affecting the amount of business that we are doing.
Lanning: Not directly. Clients' investments are for the long term and short-term fluctuations such as the oil price are just noise. More important is clients' risk tolerance to equities/bonds and emotions such as greed (late 1990s bull market) and fear (2000-2002 bear market).
With the FTSE100 index failing to achieve any real progress, do you think bonds will outperform equities, as has been suggested by a number of commentators?
Adam: No and I am always surprised when so-called experts make these comments. If anything I feel that with bonds particularly with further interest rate rises, there is a real danger they will lose value, given they have been locked into a fixed income rate. I think that only bonds with a very high yield will cope with the potential rising rates of the future.
The so-called experts were telling us six months ago that deflation was a big worry, with China and Far Eastern markets forcing prices down of goods and commodities. Now after a very short period of time, the economists are telling us that inflation is a big worry and this would rise to uncomfortable levels and force interest rates to rise much higher than the governments would wish.
I think that both “calls” were equally wrong and that modest-rate inflation is not such a bad thing and could actually help the economy to recover, which I think will also help the stockmarket.
There is a real chance that if we do see a bit of inflation, some companies will be able to see a degree of pricing power returning which has not been seen for some time but we still have the impact of technology and a globally competitive marketplace that will keep inflationary pressures under control.
Taking all these events into account, I believe the equity markets look very good value, certainly in the short term, at current levels, again if the oil price recovers, albeit modestly, and there are no terrorist attacks, the outlook could be much more positive over the next six to 12 months.
Patel: With the way that equity markets have behaved this year, it is possible that there could be a flight to a more defensive asset class and bonds may do well. Furthermore, as we begin to approach the peak levels of int- erest rates for this cycle, bonds could look more attractive on a total-return basis.
However, I think the lull in the market in the last few months should come to an end soon and the equity market will resume its rally as we approach the end of the year. I also think that markets should remain buoyed by the US elections in November so, all in all, I think equities will outperform bonds this year.
Lanning: Not in the long term. All asset classes outperform one another over the short term but in the end only equities and property are real assets that can grow above the overall growth of the economy. Bonds are not real assets and benefited from a multi-year fall in global interest rates which is close to or at an end. Bonds are, of course, an excellent source of income and should be used for diversification purposes in a growth portfolio (income reinvested).
The Treasury select committee has recommended that IFAs should not receive renewal commission. What would be the effects on the long-term service of clients if this recommendation was taken up?
Adam: I would tend to agree to some extent that an IFA should not receive renewal commission for regular-premium contracts that require no action for a considerable period of time. Certainly, more and more contracts these days are set up on a recurring single-premium basis where the adviser will still be remunerated for giving ongoing advice and guidance and I think that is more appropriate.
Undoubtedly, if our company's income were to be affected by reducing or removing renewal commission or fund-based income, we would have to pass the loss of the income on to our clients and increase our fees that our clients have to pay. One of the biggest benefactors of this would obviously be the Exchequer as these fees would need to have VAT charged and maybe I am just being cynical but I think this is what the Treasury wishes to achieve – more income for their coffers.
I know from experience in speaking to IFAs that some do treat renewal commission as “money for nothing” but IFAs who regularly review clients see it as necessary income to help oversee the expenses involved in providing an ongoing service. Regrettably, if this came about, it would be the good IFAs who do the job properly who would lose out or have to charge their clients more. The majority of the industry would probably take the view that they have had this money for doing absolutely nothing and it was bound to end at some stage.
Patel: Renewal commission is a pretty valuable revenue to most IFAs and the loss of this would certainly lead to a lack of service to the client. In the long term, I think this will also inevitably lead to more complaints as clients feel they are not being looked after.I would seriously question the Treasury select committee on whether their proposal will be in the best interests of the client rather than focusing on how IFAs are remunerated.
Lanning: This view appears to be predicated on the basis that IFAs do not earn their renewal. This may be the case among some IFAs but at the professional end, the withdrawal of renewal would be detrimental. Initial commission would rise to offset the fall in income lost by trail commission. Service levels would remain the same and supplemental fees for review work would become more prevalent.
An increasing number of investment houses are offering performance fees where the fee you pay is based on fund performance. What benefits do you see from this tack?
Adam: I think performance fees will become more and more prevalent, particularly as the markets improve, as some companies will treat it as a way to increase income compared with the low remuneration they received during the falling markets. However, you will also guess from some of the statements made by the companies charging performance fees that they are doing it for clients' benefits in that they will only charge higher fees if the performance is at an agreed level. This is fine in theory but so far the performance fees have been at a level that have been so low that there is very rarely any likelihood of a fund management firm receiving less income than before.
If our own in-house research is correct, where the markets will be quite positive over the next few years or so, then some companies could do very well for themselves by arranging performance fees which are pretty easy to achieve in a rising marketplace. I have always thought a fairer basis is to have a set fee for management increasing at the rate of inflation each year, so if you are a bigger investor you are not paying or subsidising the smaller investor who gets charged the same percentage – or is that me just being too radical?
Patel: For the fund managers, performance fees offer a better incentive to deliver strong returns. However, performance fees can only be a good thing if the level of fee set is reasonable and the annual charge starts at reasonable levels. But equally, fund managers should also be penalised for poor performance and I do not believe some of the investment houses cater for this. Investors are generally happy to pay more for outperformance but it is not fair for them to pay high charges also for underperformance.
Lanning: We fully support the idea of performance fees and believe they should be allowed onshore. It encourages fund managers to manage their portfolios more actively and their interests are more in line with their unitholders. Like most things in life, you expect to pay for the best. We have no issue with the concept of paying higher “back-end fees” for net improvements in performance. We would, however, continue to look for reductions in front-end charges from providers.