With managers such as Anthony Bolton talking about a possible recession in the US, do you think we are reaching the top of the equity markets? Witcombe:
Witcombe:There were plenty of people predicting doom and gloom when the FTSE fell below 6,000 points in August. Now that the market seems to have recovered, those investors who panicked and sold at that point will be regretting it.
It is impossible to make accurate short-term market calls with any consistency. People should understand that investments are for the longer term and not try to predict markets on a day-to-day basis. Research shows that those who miss even just a handful of the best days in the market suffer drastically reduced overall returns.
Perry: No, I do not think that we are reaching the top of the equity markets. This is probably the second leg of the bull market that has been in place since 2003.
We also have to bear in mind that the FTSE 100 is still 500 or so points below its all-time high and that earnings have grown very strongly over the past four years. This puts many parts of the UK equity market on attractive valuations. Interest rate cuts are likely in the UK and this should prove supportive for equities. The recent “crisis” is unlikely to be a precursor to the end of the bull market.
Sofat: I do not think we are reaching the top of the equity market but I think we will see much more volatility going forward than for the past two or three years.
I think the markets will be much more diverse and there will be areas of growth and success, such as China, India, and Brazil, which will continue to grow albeit at a slower pace. These countries are no longer so reliant on the developed world but have internal consumer demand fuelling growth.
Other economies are becoming more multidimensional, the Middle East and Africa, in particular. Africa is showing some very encouraging growth and is benefiting from big Chinese investment in its infrastructure. Finally, I think we will see growth from large multinationals. These companies have been out of favour for the past couple of years when the small and mid caps have done so well. However, these companies are now trading at reasonable PE ratios of 12-14 per cent and many have good cashflows.
We will continue to see value from elements of the markets and the trick is to focus on value stock and not have unrealistic expectations.
How much has the fallout from the US sub-prime mortgage market affected retail investor confidence? Do the images of queues outside Northern Rock adversely affect people’s confidence in all financial institutions? Witcombe:
Witcombe:I don’t think that the average retail investor has any understanding of the link between sub-prime mortgages in the US and queues outside of the Northern Rock bank in the UK. However, such images don’t help investor confidence. Nevertheless, this episode serves as a useful reminder that we should not have all of our eggs in one basket. This means not only diversifying cash holdings (bearing in mind compensation scheme levels), but also making sure that our other investments are diversified too. A houseprice crash would have a much greater detrimental effect on consumer confidence.
Perry: Yes, the images of people queuing at obscure hours of the morning do affect peoples confidence, but then this industry does not have a very good reputation amongst private investors/savers – which is a shame because I’d like to think it does generally try and do a good job of improving peoples financial circumstances. There will always be events which knock confidence in financial markets, but investors need to look at fundamentals and ignore the “noise” in the short-term. Corporate UK is in good shape so the public should retain confidence in the markets and industry.
Sofat: It has definitely shaken many people’s confidence in the banking sector and also in cash as an asset class. Investors, I think, will be more cautious about placing all their money with one institution. I already have clients now spreading their investment among different banks.
The ABI is warning that the Government’s attempts to extend the existing guarantees on the safety of bank deposits will alter people’s perception of risk and attract money away from the investment markets. Do you agree? Witcombe:
Witcombe:The FSA has increased the limit of Financial Service Compensation Scheme cover for deposits up to 100 per cent of the first £35,000 of each depositor’s claim. The increase applies from October 1, 2007. The existing guarantees have, therefore, been extended, but not by much considering there had been talk of guaranteeing 100 per cent of savings without limit. This is an exercise in political spin and I don’t believe it will make any real difference to people’s perceptions of risk. If the compensation scheme had been extended to cover 100 per cent of all savings, then that would have been a different matter.
Perry: We could well see money attracted away from investment markets, which is a shame because markets fundamentally look attractive, and investors should be being told to hold their nerve. I do believe that the compensation scheme should be extended to cover more of savers’ deposits, but this should not be at the expense of IFA levies. Longer-term investors should not worry. Likewise, savers should not be overly concerned about the recent “crisis”. The best thing to do is to ensure that you have a fully diversified portfolio both in terms of assets and organisations.
Sofat: No, I don’t agree. Clients invest in cash for different reasons, but most do know that over the longer term cash often fails to keep pace with inflation and a capital guarantee will not change that. I think that the guarantee will also act as a reminder that not all banks/building societies are safe institutions and diversification is essential.
I think that investors will continue to take a more balanced approach. The last five years have been a good reminder that no asset class can outperform all the time and most advisers now diversify their client’s investment between asset classes as a matter of course. This should see them through any short-term jitters.
Property was knocked off top spot last month after 19 months as the best-selling fund sector. Are investors right to be more cautious on the asset class? If so why? Witcombe:
Witcombe:In general, people have been rather nervous about property for a while and this includes both residential property and commercial property. While both types have different return characteristics, they are still property investments at the end of the day. Most people have the vast majority of their overall wealth in residential property, and with mortgage costs rising, US sub-prime issues and property funds imposing penalties on withdrawals, there is a general nervousness about property markets. Clearly, this asset class has had an exceptionally strong run and, as believers in mean reversion, we think it makes sense to lock in to some gains and be more cautious in adding further exposure.
Perry: We have been recommending that investors should reduce their direct bricks and mortar property weighting for some time given the exceptional returns of the past five years. We are not bearish on UK commercial property. We think returns should revert to the mean and that implies a period of lower returns. Demand still exists, but we expect a slowdown in the commercial property market and other areas of the globe offer better potential returns. The fact that the yield available on commercial property is lower than the cost of borrowing implies that there is not much value in the UK market.
Sofat: Yes, I think so. No asset class can continue to outperform others. I hope it will also bring some realism to advisers. Many have been investing far too much in this asset class without understanding the dynamics of the commercial market.
The yields on some of the funds are now pretty low – lower than equity funds. In addition, some of the funds have a fair exposure to property shares and that is making them more volatile than the traditional property funds. So, yes, investors should be more cautious.
Having said that, I think that property as an asset class is here to stay and will continue to develop. We are beginning to get funds investing in overseas property – not just via property shares, but via bricks and mortar. This will provide opportunities to diversify across the world and allow advisers and investors to continue to invest in property without over-exposure to the UK market.
The IMA has said it is trying to develop a standard yield calculation for equity income funds in an effort to introduce greater clarity for funds’ performance. How useful would you find such a development? Witcombe:
Witcombe:Anything that can be done to improve clarity and reduce the chances of misinterpretation of information is to be welcomed. We prefer to adopt a total return strategy incorpor-ating both equities and fixed-interest holdings, rather than looking at equity income funds as a one-size-fits-all solution, so the change in calculation methods will, therefore, not be of great use to Evolve Financial Planning.
Perry: Very useful. You need to be able to compare apples with apples otherwise it creates investor confusion. Funds also need to meettheir sector requirements, otherwise what is the point of a sector? More importantly, investors should be receiving well-researched advice on funds that are appropriate for their circumstances so advisers should be able to know exactly how a fund invests.
Bypassing this process by using fund of funds is not an answer as this is fraught with its own problems. The more knowledge investors have the better. It creates confidence.
Sofat: I think that would be a useful yardstick to measure the performance of individual funds against its sector compatriots. Equity funds are supposed to have yields of at least 110 per cent of the dividend yield of FTSE All share but many have yields of below this level and rely on capital growth to provide returns.
Currently, you can look at total returns, but you do not necessarily know how much of the returns are down to the yield and how much down to capital growth. It would be very useful to get this break-down and understand where the value is being added and if the funds are doing what they are supposed to be doing.
The FSCP has said that many with-profits investors are being excluded from advice on their policies because the investments are too small for advisers to bother with? Is this a fair accusation? Would you welcome the introduction of a specialist with profits advice service that would be able to deal with the thousands of small with profits policyholders? Witcombe:
Witcombe:This is the big problem with a commissionbased approach. Where full up-front commission was taken at the outset (and this includes not only investments set up through advisers, but also investments made directly with insurance companies) there is no ongoing remuneration stream from the investment and, therefore, no real incentive to provide ongoing advice. Where clients are paying their adviser an ongoing fee for an ongoing service across all of their assets, then advice on any with-profits policies that they might have, however small, should be included.
The problem with with-profits policies is that they are so opaque. Therefore, it is a time-consuming process for an adviser to analyse a holding properly and make appropriate recommendations. Advisers are right not to take on unprofitable business, but I don’t think that a specialist with-profits advice service is the solution.
Perry: You will probably find that investors with smallprofits policies are being overlooked by advisers because of concerns about giving advice on such funds.
However, these people still need advice and advisers need to think about the bigger picture. This is unlikely to be their sole investment. They may require advice on other aspects of their financial circumstances and they may be able to refer the adviser to an acquaintance whose situation may be different.
However, I do not think that a specialist service should be introduced as the IFA community should be able to deal with this.
Sofat: I do not think that the claim is entirely unfair. Many advisers have found it hard to balance the need for advice with the compliance risk. In some ways, this has been the result of the FSA approach on this whole issue. The FSA initially discouraged advisers being more proactive by placing too much emphasis on the risks of churning and advisers reacted by sitting on the fence.
Second, I do think that many advisers just do not have the tools to provide comprehensive, but cost-effective advice on this area.
Some companies have provided with-profits analytical tools but, whilst these are useful to an extent, I think it is all too easy for there to be bias. I have preferred actuarial-based analysis, which basically provides an estimate of what the “real” value of a policy is within the overall context of a fund.
If a low-cost service can be based round this concept, then I think that would be very useful and may encourage advisers to be more proactive.