Fiducia Wealth Management
Posted in Investing, Market Commentary on 23.03.20

Investors always have a long list of things to worry about but, in 2020, the coronavirus COVID-19 has very quickly eclipsed them all. With global stock markets gripped by fear and currently languishing far below the levels at which they started the year, we wanted to take stock of the evolving crisis and provide reasoned reassurance where possible.

History suggests, however, that selling is usually an inappropriate response to unfolding events, particularly from a long-term perspective. Selling assets in such a febrile market environment is typically an emotional response, not a disciplined response.

Last week our team met with our de-facto Chief Investment Officer, Michael Hughes, who recorded an audio podcast that you can find on our website. In this, he recaps on all the causes of the stock-market extreme volatility, because there is more than one cause. He explains the measures that Central Banks and Governments are looking to rapidly introduce, much of which has now taken place with yet more announcements to follow. This has enabled the Investment Committee to make informed decisions as to how we adjust our portfolios. The purpose of this update is to explain what those decisions are, their purpose and the core messages we want to share as we navigate this turbulent time.

It’s a core principle of our investment management strategy that all portfolios are widely diversified with up to seven or eight asset and sub asset classes. The purpose is to avoid a situation where an entire portfolio falls at the same time following an unforeseen event in a major economy or global basis. However, the coronavirus Covid-19 situation has been so extreme that virtually all asset classes have reacted in the same way and to the same degree. This has particular significance for the Prudent and the Balanced portfolios, which have a focus on the protection of wealth. The asset class that is considered to have the lowest volatility is Bonds and Fixed Interest, which loan money to Governments and large Corporations in return for a coupon or dividend. However, they do not in normal circumstances protect the real value of capital because the fixed rate of return is eroded by the effect of inflation over time.

Bonds: some historical perspective

Following the credit crisis in 2007/08, there was a rush to Bonds and the rules of supply and demand increased the pricing of Bonds way above the level at which they would be redeemed, creating a bubble. So what seemed safe (i.e. no equity risk), was in reality potentially very risky. As a consequence, we have been underweight in Bonds compared to other portfolio models. The current yield on 10 year Gilts (where money is loaned to the Government ) is 0.55%, meaning that £100 invested in Gilts would return £105.50 on maturity in 10 years. If inflation averages 2% pa over that period it will destroy 20% of the eventual pay out value. There was a sharp rise in Gilt values when the market sell off began but that has now subsided.

We appreciate that this is an uncharacteristically long and rather technical explanation, but we considered it was very important to explain why we are underweight on Bonds and what actions we are taking. We do not believe in following the herd, but base our decisions on our interpretation of all the facts with the perspective informed from experts.

Moreover, we do not propose to make any changes to our current low allocation to Bonds, whether Government issue or not and we feel this is fundamentally important to communicate.

Absolute Return

The next asset class on a rising scale of risk/return are Absolute Return funds. This term covers a wide range of strategies where the core holdings are bonds or equities, which can be long or short. Of course, there are other more complex assets that can also be held. We use a number of funds that employ different strategies in order to diversify risk and timing issues. Some of our fund selections have held up well and others not so well. We have reviewed all and decided on certain fund switches, but in overall terms the percentage allocation is largely the same. What we are setting out to do is to achieve an even lower volatility for this asset class, which will enable us to focus on the opportunities we believe will present themselves as we move to the recovery phase.

Property & Real Estate

In the Commercial Property space we have previously adopted Real Estate Investment Trusts and conventional Investment Trusts which are not subject to liquidity issues that happen at times of market stress. Once again, this has happened with the funds that directly own physical property: nearly all suspended trading in their funds last week. The REITS have suffered pricing swings for trading purposes but nobody has actually re-valued all the properties in a fund in the past week or two, therefore our advice would be to hold those funds until the markets recover.

Hedge Funds

Hedge funds are a diversifier and are not a core element of any of the portfolios. As such, we don’t propose to make any substantial changes here at present.

Equities

All the above constitute the protective element of the portfolios. We will now consider the equities which drive growth over the medium term. Firstly, the UK Equity funds. These are primarily what are referred to as Value funds, as opposed to Growth funds. Value funds invest in mainly long established companies with strong balance sheets which support consistent dividends. They are also likely to be quasi monopolies or control a large segment of a particular market sector sufficient to keep competitors at bay. Growth funds will invest mostly in newer businesses, such as a new product or service, which is considered to have potential. That can produce greater returns over time but there is also greater uncertainty in the short term. Three of our current funds are Income funds selected for the relatively high levels of dividend income they pay which, in normal times, is not prone to change. One of the funds, Schroders, has disappointed and is being replaced by the Finsbury Growth and Income Investment Trust. The latter is currently trading at a small discount to the net asset value, which represents a buying opportunity in our view as it is a long established fund with a high reputation.

In the Global Equity space, we are going to sell out of Japan (this is just 3% of the Balanced portfolio) except for the Adventurous  Portfolio, as well as the Vanguard Global Value fund. In their place, we shall introduce the Scottish Mortgage Investment Trust which invests in high conviction global companies such as  Tesla, Amazon, Alibaba and Netflix. This fits exactly with our views as to how the coronavirus will be (and already is) changing how we work and how we manage our leisure time in future. This is a theme that will increasingly be present in our portfolios in the future.

Emerging Market Equities

We have had a bias in the Global Emerging Market sector towards Asia for some time and that will continue and increase, seeing us already adding to the Veritas Asian fund. However, we have decided to exit India (currently 2% of the Growth fund) and replace Vanguard Global Emerging Markets.

Opportunities

The above changes will also create an additional degree of liquidity, which we want to have available to drip feed into the market as soon as we see signs of the virus being controlled and/or managed. At that time there will be significant opportunities which we want to be able to seize, while being very aware of the changes that will come about in terms of our lifestyles. Technology will receive a very substantial boost as collectively we find a new normal. As you would expect, research is ongoing to identify the funds and managers best placed to exploit those new opportunities.

We hope that we have provided some helpful explanations and given an insight into the current changes to the portfolios as well as our future thinking and areas of research.’

As ever, we consider the wellbeing and peace of mind of our clients of paramount importance and the opportunity to manage your wealth a privilege.

If you have any questions do not hesitate to contact us.

If you wish to listen to Michael Hughes’ podcast – click here

The Directors.

Fiducia Wealth Management
Posted in Investing, Market Commentary on 23.03.20

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