Summer 2016 Fiducia Weath Management interview between John Millican and Michael Hughes transcription:
John: Michael, Hello. I know you are very busy. You must be much in demand with BBC and other radio stations wanting to get your view, obviously, on what’s been happening recently. We do appreciate you finding the time to come and talk to us again. Michael: Thank you very much. John: What can we say really? We are living in very interesting times. I doubt whether you can recall a time of previous events that will bear comparison with what’s been happening over the past couple of weeks or so?
Michael: I think it would be very hard put to find anything that’s comparable to the last two weeks in the U.K.
John: Before we go on to talk about the economic issues arising, I know that our clients will have been concerned and they may still have some concern, about the recent events and effect on their portfolios. So I have taken the precaution just to double check all the numbers before our discussion, and it’s really quite interesting. In terms of the first half of the year, all of the portfolios are up in value, with the exception of the cautious portfolio which is the least risky, which is down 0.94% so far, and then, since Brexit, which unbelievably was a fortnight ago, very, very recently, the picture is the same, with all of the portfolios being up, apart from cautious which is down 0.24%. So hopefully, there is a reassuring message in terms of where we are. Obviously now, what we really need to talk about is what happens going forward? Just as an aside, I can remember going to a presentation which Mrs. Thatcher did in Colchester a number of years ago. And after the dinner when she stood up to speak, she said, famously, “I’m only going to talk about three things: Europe, the economy, and the world.” I’m not going to set that as the full agenda, but some of the questions are going to be broadly in the same area. I’ve got three questions. One is about Brexit, how and when is that going to affect the U.K. economy and market? Secondly, on volatility, because so far, I think it’s fair to say, it’s not been what we would’ve expected it to be. And then, thirdly, emerging markets. Most of the comments about what is going to happen is in the global economy to do with Brexit and elsewhere. There’s really been the focus, on established global economies and markets, so it’s really understanding whether it’s good or bad news as far as emerging markets are concerned.
John: An easy, easy agenda.
Michael: A very easy agenda! Let’s start with the U.K. The obvious response to Brexit is that economic growth will be lower for the next year or two than it otherwise would have been, and inflation would be higher because of what we’ve already seen in terms of the fall and the exchange rate. So, it wasn’t so surprising with the deteriorating growth outlook and with higher inflation prospects that the market’s immediate reaction was to sell off quite aggressively. But then you got to valuation levels that people thought; “Well, actually, that’s an aggressive sell-off. Maybe it isn’t so bad.” And suddenly, for the large-cap companies, they’re focusing on hundred, they suddenly started to look much more attractive. We nearly got to say that that index was producing a 5% dividend yield, which in a very low interest rate world, was very attractive. So it’s not so surprising that you started to see people take advantage of those low valuations, you know, really. I think for the medium term, the thing I would focus on is not so much the downgrade in economic growth for the next year or two, because I think we may find that that is more of a relief than some fears we now have. The concern that I have is that inflation might prove to be much more problematic than we are currently thinking about. The last few years, we haven’t thought of inflation as a particular problem. But this shock has come at a time when wages are already starting to go up, where you are starting to see higher food prices, where you see increase in taxes on insurance, and if you dare see a further increase in imported goods right across the board, then there is the fear that we will see an inflation rate that is three, four, even possibly higher than that in a year or two’s time. And that is going to be a dilemma because the Bank of England has a 2% inflation target, and it looks as if inflation is going to be well in excess of that for any length of time, then you have to start raising interest rates rather than giving a boost to the economy as they’re now doing. So that is the medium-term dilemma that I see for the U.K. In the moment, I think we need to bear in mind in our planning for portfolios. John: In terms of Bank of England review in terms of incomes and interest rates, if the economy does slow to a degree because of Brexit, then the governments would have been talking about further easing the terms of the economic conditions, hasn’t it?
Michael: What divisions have already is allowing changes to the interest rates, both by foreign exchange rate but also by the removal of the capital buffer on the commercial ends which effectively allows them to lend much more than they otherwise would have been able to. That potentially is a risk as well. So from the U.K.’s perspective, I would say, I’d worry less about the growth slow-down and more about the pick-up of inflation. As far as the world is concerned, well, the world naturally is the sum of many parts unfortunately, and in the United States, because they have had a fairly lengthy recovery, it wouldn’t be so surprising if they started to see a degree of slow pattern going into 2017. To some degree, you have started to see an element of that, but it won’t be worrying. And indeed, in the case of other parts of the world, like Japan and the Far-East generally, where they are also able to reduce interest rates, they are also able to give a boost to their economies, and basically where the underlying growth rate is higher, anyway, those areas, I think will be relatively secure. One area which, inevitably, always falls into our concerns is Europe, partly because of the news from the U.K. is a shock to Europe as well, and some of the expectations of Europe have also been wound down. But you have got a series of very specific problems in Europe. At the moment, the Italian Banks are a focal point. They need a great need of support. You’ve got many elections and referendums coming up through Europe so the whole political vision might be threatened, and that obviously implies that there will have to be a higher risk premium to governments in Europe. Then finally, when we look at the bigger picture of emerging this has developed, the interesting thing this year, has been that the emerging stock markets have really bounced back. If anything, they have been overshadowed by the developed markets in the last two or three years. But this year, they really have come back. There are three reasons for that. The first is that they were cheap. And indeed, if you look at the Asian markets, their valuation was the lowest relative to the rest of the world since 2003, so really looking very attractive. Secondly, the dollar stock rising and the dollar starting to fall means that you are pushing out acridity to the rest of the world. And that’s particularly important to the emerging area, many of whom have their currencies linked to the dollar. But thirdly, you started to see a bounce back in commodities, particularly the oil, because a lot of emerging markets clearly are very oil-dependent in terms of exports. So all those three conditions together have given a reasonable bounce to emerging, which in the case of Asia, I think, is likely to continue because they are still looking relatively cheap, they still have got better economic fundamentals, and frankly, I don’t see the oil price actually flying to very high levels that would be disruptive to them. I think the new range for oil is somewhere in between $30 to $60 a barrel, which rewards the top end of that range now. But certainly, if they stay below $60, they won’t be very adversely affected. So put all of that together, and the emerging story, I think, does have more legs, particularly as I say, within the Asian community.
John: Could you just say one or two words about what you think things we’ve done in the recent past in terms of the portfolio, any adjustments in terms of asset allocation, and what sort of ways we would look at more closely going forward in terms of taking into account all the things you just referred to?
Michael: Well, I think the biggest thing for us to take note of, usually always, but particularly relevant this year, is the volatility of markets. And for many years, even with interest rates being quite low, markets weren’t particularly volatile. They were pretty well correlated. They all moved together and they weren’t actually particularly volatile. That isn’t the case this year. The volatility in virtually all the asset markets are between a third to a half higher than the average in recent years. So faced with a much greater risk in portfolios, the importance of diversification really matters. And that’s why we look at more than 12 asset classes to spread the risks across the spectrum, particularly for low-risk averse investments, but equally for high-risk investments. In these conditions, diversifying your risk is really quite important. So if you look at the Fiducia portfolios, the risk levels are much lower than those that you’ve seen in the stock markets generally.
John: The challenge for us is to maintain the positions.
Michael: That’s right, indeed it is. The other thing we’ve featured in previous interviews is that if you look at the very long term, there are some companies coming through, large quality companies, that are going be the winners of the future. And within a 5, 10-year framework, the biggest 500 companies in the world, half of those will come from the emerging areas so that’s quite an important focus. So to have within our portfolios an exposure to large-cap quality companies actually is much more important a decision to make than deciding between country ‘X’ and country ‘Y’ because these are global companies that will be successful globally and hence you want to ensure that you’ve gained access to those through the funds we buy in the portfolios.
John: So although, as you said, volatility is an issue, it certainly doesn’t mean that we significantly move away from our interest in emerging markets. I’m sure the focus on individual markets will change, but broadly as a sector…
Michael: We’ve added to our exposure in emerging markets in the early part of this year partly because we thought the valuations are attractive. But that has obviously paid off because of what has happened to the reform packages. And if you look at some of the Indian reforms, Indonesian reforms, Philippine reforms, it isn’t all about China and Japan. It’s spreading out right across Asia taking different forms, admittedly, but it’s a sort of reform that allow shareholders to benefit because it’s a much more commercially-friendly, corporately-friendly environment for these companies to thrive in. So we are trying to take advantage of that.
John: Thank you for all of that. Next time we meet, a new Prime Minister will be well and truly installed, and who knows what other events we may have to talk about next time. But anyway, thank you ever so much for your explanations and your time once again. Michael: Thank you John. John: Thank you.