Property versus Pension

Bank of England Chief Economist, Andy Haldane stated in his latest interview, that property is a better investment for retirement than a pension.  But what are the facts? Is this view misguided?

Since Andy Haldane’s comment last Sunday, I have read self-interested nonsense from a pensions expert claiming that Haldane was wrong because pensions were cheap to run, typically costing around 0.75% pa as compared to up to 10% pa to run a property. 

This is patent nonsense as many can simply choose to buy a larger house to live in rather than have to have someone else manage a property.  It was pretty obvious that Mr Haldane was talking about houses rather than commercial properties.  Similarly, this expert seems to have forgotten the costs that his own platform that charges of up to 0.45% a year on top of any fund costs (let alone the hidden fund manager dealing costs). 

Instead of focusing on the costs and the associated taxes of one option against the other, which will vary enormously for each individual depending on how (and who) they choose to manage their pension or their property, it is worth interrogating the actual facts of house price returns vs share returns.

I have looked at long time periods to reflect that pensions tend to have a long term investment horizon (unlike Andy Haldane).  I researched both the UK and the US house prices vs equity prices using the main equity indexes (S&P 500 for the US and FTSE All-Share for the UK).  Then compared this with two leading house price indexes, the Federal Housing Finance Agency US House Price Index for the US, and the Nationwide All Houses Price Index for the UK.  I compared the US index from March 1988 and the UK since January 1986 (being the longest period in which I could obtain detailed total return data for both the FTSE All-Share Index and S&P 500 Index).

Critics may find reasons why such start dates are unfair, so I then compared the returns of UK and US house prices against UK and US share prices over every quarterly 20-year period since the start, and calculated the chances of shares beating property in each market.

Here are the results:

UK shares Vs UK houses – annualised return UK shares 9.5% pa vs 5.9% pa UK houses

Sources: SCM Direct, Nationwide, Bloomberg

 

US shares Vs US houses – annualised return US shares 10.1% pa vs 3.3% pa US Houses

Sources: SCM Direct, FHFA, Bloomberg

Looking at the 20 year periods

UK – the average outperformance of UK equities against UK house prices over 20 years, analysing 43 quarterly 20-year time periods since the start of 1986, was 184% and shares beat houses in 91% of the periods analysed.

Sources: SCM Direct, Nationwide, Bloomberg

US – the average outperformance of US equities against US house prices over 20 years, analysing 30 quarterly 20-year time periods since the end of March 1988, was 402% and shares beat houses in every single period analysed.

Sources: SCM Direct, FHFA, Bloomberg

Maybe Mr. Haldane as a trained economist should look at the data before making damaging and irresponsible comments and conclusions.  Of course, he might say that this was the past and it will be different in the future – however given the statistics on house price data against incomes, it is hard not to conclude that UK house prices are already ridiculously over-valued:

If we forecast future UK share price returns over the next 10-15 years based on the ratio of UK share prices to the smoothed corporate earnings of UK Companies (known as the CAPE Ratio), this would predict UK shares to grow at 7.5% pa[1].  In comparison, were the ratio of house prices in 10 years-time to simply fall back from 5x to a more normal 4x and the average income rose by 3% pa (the growth in average weekly earnings since January 2000), this would imply that UK house prices would rise by just 0.7% pa.  Thus over 10 years you would be 99% better off having bought UK shares than a UK House. 

Sorry Mr Haldane – looks like you’re going to have to delay your retirement if you choose to buy that house rather than those shares.

[1] https://www.researchaffiliates.com/en_us/asset-allocation/equities.html

 

Alan Miller – CIO, SCM Direct.com

alan@scmprivate.com

Tel: 020 7838 8650

Please Note: Past performance should not be seen as a guide to future returns. The value of investments and the income from them can go down as well as up and investors may not recover the amount of their original investment.

SCM Direct is a trading name of SCM Private LLP which is authorised and regulated by the Financial Conduct Authority to conduct investment business.

The IA’s ‘C’ Conundrum – SCM investigates

 

 

Background

For years we have suspected that the Investment Association (IA) has been bereft of what we call the 3 C’s – Common sense, Clarity and being Consumer Centric; particularly in the darkest days of the IMA when it found it impossible to logically analyse any set of data, unless it was seriously biased and therefore portrayed their members in a good light. 

It now appears that it is actually the brain of the IA which is faulty, and has collapsed under the weight of something, psychologists refer to as ‘cognitive dissonance’. 

 

Cognitive Dissonance or Denial and Deceit

In psychology, cognitive dissonance is the mental stress or discomfort experienced by an individual who holds two or more contradictory beliefs, ideas, or values at the same time; performs an action that is contradictory to one or more beliefs, ideas, or values; or is confronted by new information that conflicts with existing beliefs, ideas, or values.

For years the IA has protested that its members do put clients’ best interests first rather than last.  It has also pretended there are no hidden fees whilst recognising the published cost numbers do not include numerous costs, that it will address excessive boardroom pay whilst knowing the pay of senior fund managers is out of control, and it has pretended high cost active fund management outperforms low cost passive when it knows that after costs, this is mathematically impossible over the long term.  This cognitive dissonance (one might call it denial and deceit) has put severe mental pressures on the few grey cells remaining within the brains department of the IA.

 

The IA Brain Dysfunctionality Was Exposed on 9^th August 2016

On the 9^th August the IA produced a work of fiction dressed up as analytical research, entitled ‘Investment costs and performance – Empirical evidence of UK fund industry delivery’[1].  This amateurish work of fiction attempted to illustrate how wonderful active funds’ performance was and how there were no hidden fees.

An investigation by us via our True and Fair Campaign[2] and by a leading expert[3], discovered the IA report was fundamentally flawed and intellectually bankrupt.  It must have been tough for the IA’s brain to cope with the faulty logic of pretending there are no hidden costs by adding back some of the transaction costs (not all of course) buried within fund accounts that few see in the first place i.e. which are hidden.  Then it had to cope with data compilation so inept that even something as simple as the time periods are incomprehensible and random – the report says it’s analysis is from ‘From July 2012 To May 2015’ but the data tables are simply labelled 2012-2013, 2013-2014, 2014-2015.  

It then transpires these periods are not calendar years or even all 12 month periods as the first period includes ‘annual reports’ that ‘date from 2011’ and the last period analysed is just 10 months.  It must have been very stressful and time consuming having to artificially create performance data by annualising data when actual data did not exist for the time period under review, thereby creating illusionary performance.   They even resorted to replacing the actual benchmarks for funds with a different benchmark when they did not have the data for the original benchmark. Of course any professional would have simply excluded data comparing a fund performance with a benchmark over a set time period if the performance did not actually exist for the entire period and/or the actual benchmark return was not known.  Not the IA.

This shoddy report exposes the IA’s lacks of Cs – no Common sense, no Clarity and is never Consumer Centric. 

 

[1] http://www.theinvestmentassociation.org/assets/files/press/2016/IAInvestmentCostsPerformance.pdf

[2] https://scmdirect.com/sites/default/files/SCM%20Direct%20-%20True%20and%20Fair%20Campaign%27s%20Response%20to%20the%20IA%20Research%20on%20Costs%20-%209%20Aug%2016_0.pdf

[3] http://www.ipe.com/news/asset-managers/con-keating-the-investment-associations-offensively-bad-fee-report/10014701.article

 

Alan Miller – CIO, SCM Direct.com

alan@scmprivate.com

Tel: 020 7838 8650

Please Note: Past performance should not be seen as a guide to future returns. The value of investments and the income from them can go down as well as up and investors may not recover the amount of their original investment.

SCM Direct is a trading name of SCM Private LLP which is authorised and regulated by the Financial Conduct Authority to conduct investment business.

Absolute Return Funds Return Absolutely Zero in 2016

As you might naturally expect, we keep a close eye on our competitors and funds that are similar to our various portfolio strategies.

For many years, I have been cynical of the performance of many Absolute Return Funds that produce precious little returns for investors.  What is also mystifying is why advisers are sending clients hard earned money to this sector despite the dismal performance.  The Investment Association (IA) Targeted Absolute Return sector was the best-selling sector in June with net retail sales of £445m; with net retail sales for the asset class having risen by £333m year-on-year since June 2014. 

“Survival of the fittest” is a phrase that originated from Darwinian evolutionary theory as a way of describing the mechanism of natural selection.  This does not seem to apply to the IA Targeted Absolute Return sector, which appears to operate on the adage “survival of the fattest” in terms of huge fees, often including performance fees.

I looked at performance to the end of last month (end July 2016) to see whether the performance of these retail funds was less shockingly bad than usual. The IA Targeted Absolute Return sector has achieved a return of precisely 0% in 2016 – to the end of July, with the below showing the best and worst returns so far:

Looking at the bottom three funds, they seemed to have taken a significant Brexit hit.  One of these is a conventional long/short equities fund concentrating mainly in UK equities, which fell 8.6% in June, another is long/short portfolio with significant exposure to small and medium sized companies which fell 12.7% in June. 

They are not alone, the sector giant, the Standard Life Global Absolute Return Strategies Fund (GARS) – worth £26,840.7M as at 31/05/2016 – also suffered a Brexit hit and fell by 3% in June.  The manager in a recent interview ascribed to being “caught off guard by Brexit and the surprising returns and dispersion of returns across the sectors“.  He then talked about the realised volatility of the fund over one year as being just 5% compared to 14% for global equities.  However, over the last 12 months to end July, the GARS fund fell by 4.8%, whilst global equities in sterling increased by 18.2% (MSCI World in GBP). 

Is this the real issue with some of these funds? The fixation of some investors and advisers with volatility has made them forget about returns?  Are some of these funds either too complicated for their own good or trying to eke out small individual returns to reduce risk, but when added up, these either cancel each other out or do not offset the various costs involved?

Another reasonable question is, how is it possible for some of these funds to lose so much in 2016 when virtually every single investable asset category apart from cash and UK small companies has risen between 3 and 26%?

Of course, it is right to say you can’t judge a fund over such a short period, so here are the IA Targeted Absolute Return funds with the worst performance over the last 5 years to end July with Fund Sizes:

Since we started our SCM Absolute Return Portfolio in 2009, this is how it has fared against the average IA Targeted Absolute Return fund – see table below.  Of course there are funds in the sector that have met their objectives and investors aspirations, but these are few and far between.

Conclusion

It seems to be that many fund group marketing departments are benefiting from the old adage that ‘bull**** baffles brains’ to allow their clients to forget the lousy performance of many funds.

Alan Miller – CIO, SCM Direct.com

alan@scmprivate.com

Tel: 020 7838 8650

Please Note: Past performance should not be seen as a guide to future returns. The value of investments and the income from them can go down as well as up and investors may not recover the amount of their original investment.

SCM Direct is a trading name of SCM Private LLP which is authorised and regulated by the Financial Conduct Authority to conduct investment business.

 

 

High Yield Used to Be Called Junk for a Reason

The investment industry devises product names designed to reassure, but are often either semi or fully detached from reality. “Junk Bonds” grabbed the headlines in the 1980s when investment scams and high-flying financiers such as Ivan Boesky and Michael Milken, who were known as “junk-bond kings” hit the news.  These days “junk bond” funds are known as “high yield” funds – although they are fundamentally the same.  These bonds can be volatile and risky, with a typical US high yield bond falling by 24% in 2008.

According to the bond rating agencies, who specialise in predicting the past rather than the future, high yield bonds tend to be those rated by Standard & Poor’s or Moody’s as lower than BBB- or Baa3 respectively.  You would logically presume that a so called “High Yield” fund would not hold these lesser quality bonds.  Think again.  Here in the UK, one of the main investment sectors is the “Strategic Bond” sector – overall we have calculated by analysing the various funds on Bloomberg, that excluding any bonds not rated by S&P, about 37% of a typical strategic bond fund is invested in junk, sorry high yield bonds.

We have been more cautious, with approximately 19% of the SCM Bond Reserve Portfolio holding bonds rated less than BBB-.  Even so, we have decided to substantially reduce our exposure to these bonds by selling our one high yield bond ETF within our portfolios.  Why?  In short, when the price of something goes up fast whilst the fundamentals are deteriorating fast, it’s normally time to get out (fast).

High Yield Performance – 9%+ YTD returns in US and Europe high yield:

Source: SCM, FE Analytics

US high yield bond yields have fallen from 9.5% yields at their February 2016 peak to 7.5% recently, so better value is available elsewhere; particularly when the lowest quality, CCC rated high yield bonds now represent c. 40% of the entire market.  The US high yield oil & gas sector (green line) has closely followed the oil price (pink line) but if the recovery in the oil price from the February lows is now going to peter out, so might the performance of the sector.

As someone who has less than no faith in the ability of Goldman Sachs to predict anything generally, and the oil price in particular, it is interesting to note that around the March 11^th, they cut their price forecasts of average Brent crude, then around the 16^th May, after it had risen by 26%, they announced they were turning more bullish on oil!  Good old Goldman Sachs.

As the chart below illustrates, the recovery in the world’s largest high yield market, the US, has benefited from the sharp rise in oil & gas credits, which itself have closely followed the oil price, the average yield of US energy junk bonds has fallen from 21% in February to 11% recently:

Source: SCM, Bloomberg

US high-yield spreads are estimated by Deutsche Bank to price in default rates of about 3.5% by year-end but as recently as May, the overall US high yield default rate was 4.5%, the first time it has exceeded 4% since July 2010, according to Fitch.  The exploration and production (E&P) trailing 12-month U.S. high yield bond default rate is at a record 27% helped by four major E&P companies defaulting in May. This is already close to the 30-35% rate expected by Fitch for the E&P subsector by the end of 2016.  In 2015 there was $17.5 billion of defaulted energy-sector debt, so far in 2016, it’s already $26 billion.

Source: Bloomberg Finance LP, Datastream, Moody’s Deutsche Bank

 

Alan Miller

02078388650

alan@scmprivate.com

www.scmdirect.com

 

Today’s Great Investment Myths

It is the job of marketing departments to come up with new investment terminology, fads, and revelations.  The problem is that their slick advertising create and then perpetuate investment myths that have no basis in reality, and often take unsuspecting consumers down the wrong investment path.

Myth #1 – Index funds always do worse than active funds as they are forced to buy ‘bad’ stocks

Since index funds invest in the whole market, they must, by definition, include good, bad and average quality stocks.  Similarly, the sum of all the non-index funds holdings must also be exactly in line with the market, and must include the same good, bad and average quality stocks.

Furthermore, the stocks regarded as high quality are normally highly valued and therefore prone to disappointment.  The reality based on data from 1997 – 2015, is that so called low quality stocks have considerably outperformed high quality stocks.

 

Myth #2 – Active managers protect you in a downturn

The spiel is that active fund managers will know when the market will crash and protect their investors by running to cash.  However, Professor Sharpe found that whilst indexing guarantees all of the market’s losses, active investors, in aggregate, will experience even greater losses when their higher costs are factored in.

In the US, Lipper studied the six market corrections – i.e. a drop of at least 10%, August 1978 – October 1990, and found that the average large-cap growth fund lost 17.0% vs the S&P 15.1%.

Standard & Poor’s found that: “The belief that bear markets favor active management is a myth.”

In the UK, the results are remarkably similar with the average UK retail fund having underperforming the market by 2% in 2008.

Myth 3# – Investment committees make better investment decisions

Many advisers and consultants are fixated with the size of investment teams or committees.  However, I have always believed that committees are wired to make the worst investment decisions.

The main problem is Groupthink, when members of a cohesive group are more interested in avoiding conflict and maintaining unanimity, than realistically appraising the various courses of action. Groupthink can lead to failure to analyse the alternatives, inadequately examine risk, failure to analyse information, and failure to set contingency plans. The result is consensus decision making which is often suicidal in investments.

Myth 4# – It’s all about ‘outcomes’

Many fund groups say it’s the end result that matters, nothing else; including costs.  My view is that it’s not just where you arrived, but how you got there – in terms of both costs and risks.  The premier consideration is balancing Cost, Risk and Returns.  Questions should also include how liquid are the investments? How volatile is the strategy? What is the chance of significant loss? How high are the real costs from start to finish?

Myth 5# – Risk is best measured by volatility

The god think about volatility is that you have a measure to make consistent comparisons between different investments.  The bad thing about volatility is that it does not capture much of the true measures of risk – how much is it likely I will lose and how hard will it be to sell, and how long might it take to recover any losses?

Also one can think of many investments that may not change much over a long period of time, then experience a sharp price adjustment e.g. many illiquid stocks or unquoted companies.  Are such investments really not more risky than others?

Myth 6# – Risk profiling tests can steer investors to a clear choice (sorry robot advisers)

In 2011 the FCA assessed risk tools and found that 9 out of 11 risk-profiling and asset allocation tools were flawed.

Moreover, how many people simply take the middle option?  How many of these tools magically classify users as medium risk and suitable for the middle portfolio?  Are they adjusted for the fact that investors answer differently according to their mood, recent headlines, cultural bias, and recent events?

 

I believe these risk tools are about as insightful as horoscope predictions and contain the same amount of common sense.

Myth 7# – Next year will be a stock pickers market

This statement is based on whether or not particular markets or range of stocks will have a close correlation or not next year.

The fact is there are thousands of stocks in every single major market, and there will always be certain stocks that perform brilliantly and some disastrously.

Therefore it must always be possible (normally only with the advantage of hindsight) to have picked the best stocks and produced stellar performance.  To blame one’s performance on it not being a stock pickers market or saying that you should buy this particular active fund as next year will be a stock pickers market would appear to  suggest an IQ of approximately 0.

Myth 8# – Indexes automatically buy more of something as it gets more expensive

This can be true but there will be many times when the opposite arises.  For example, Apple.  As the graph shows, its price and market capitalisation nearly doubled over a three year period but because its earnings grew even faster, its valuation based on the P/E ratio actually became more attractive:

Alan Miller

02078388650

alan@scmprivate.com

www.scmdirect.com

As safe as bricks and mortar? Only if you pay the right price at the beginning.

As safe as bricks and mortar used to be the description given to large property funds before several funds were suspended in 2008 because they could not cope with large redemptions when the underlying commercial property market weakened and liquidity dried up.

Now I read that every fund manager is turning bullish and recently I had the mis-fortune to watch a long video from one such manager proudly talking of how he managed to invest £100s of millions into various sites without him ever mentioning the actual yields.

It always amazes me that so many people think that the long-term returns from investing in property funds are great when they generally tend to be worse than equity markets.  This is partly because the costs of buying and selling property are substantial so when money flows into a fund buying direct property it can either mean that the fund returns are a) diluted by holding too much cash or b) diluted by the significant costs associated with buying such properties.   According to one direct property fund, the difference between the buying and selling prices for their fund is currently 4.9% which it attributes to the high costs of buying and selling, including the 4% Stamp Duty Land Tax when any commercial property is purchased.  Investors are often fooled into believing that they are going to receive the returns from the growth in commercial property, but due to these costs the actual returns they receive are much less.

I found it intriguing to investigate the long established insurance funds investing in property, whether directly or through shares, against UK government bonds and equities.  My findings below show that the underlying returns, as shown by the IPD Property Index, are quite illusory.  In fact it shows investors are much better off investing through the property stocks rather than through direct property funds.  Being a cynic, I can’t help thinking that the talented and shrewd property investors are more likely to be found within an entrepreneurial quoted property stock than a sleepy insurance company. Investors would also gain from much higher liquidity and an element of gearing.

So why does everyone think, returns have been so great?  Because of a concept, known in behavioural economics as anchoring.  Anchoring describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. In investment, this tends to be recent returns and as you can see, since the credit crunch these have been stellar:

My own view is that you need to be more opportune when investing in property since the best opportunities normally come when property prices are depressed and property share prices even more depressed.  This would mean investors get a ‘double whammy’ on the way up as property prices recover and their discount to their asset values narrow.

We regularly buy property shares (via ETFs) but only when the values are low and the average discount to their underlying assets are attractive.  The graph below shows the change in the ratio of market capitalisation (i.e. share prices) to the published net asset value for UK property stocks since December 1989. The average discount over this period has been 16.5%, but today these shares actually stand at a premium of 7.9%.  This means property shares are now already discounting future growth in asset values.

According to the CBRE, the average property yield at the end of Q3 last year was 6.3%, but this was before costs. The question is ‘what is fair regarding costs’? I looked at three large property stocks, British Land, Land Securities and Hammerson and divided their administrative costs by their gross rental income over the last few years and found that these costs were typically over 20% of the income. So if the gross yield of commercial property is say 6.3%, then the yield after costs is likely to be closer to 5.0% pa. According to IPD, 86% and 81% of total property returns over the last 10 and 20 years respectively have resulted from the rent receivable from commercial properties, with only 13% and 18% respectively resulting from capital value increases.

I do not claim to be a property expert but sometimes too narrow a focus can be a dangerous thing.  Fund managers are piling into this asset, advisers are recommending it, the prices have just gone up significantly, the yields are much less than they used to be and the quoted property prices now stand at a premium to their historic asset values.  The totality of all of these indictors does not sound great to me.

Next time you see a tedious video from a property fund manager telling you to buy their fund, ask if they have bought any themselves recently.

 

Alan Miller

02078388650

alan@scmprivate.com

www.scmdirect.com

Time to Ratchet Up The Market Cap?

Our research shows that the average UK equities fund holds 48% in small/mid-caps vs. an index weighting of just 16%, with the mid-cap FTSE 250 rising by 33% vs. 19% for the blue-chip FTSE 100 in 2013; with many of the best performing UK funds owing their outperformance to their size bias rather than stock picking expertise.  In fact four of the top ten performing UK funds analysed held zero in the largest blue-chips. Most fund managers or strategists have a love affair with these stocks extolling the attraction of their greater exposure to the UK or lower exposure to mining stocks.  True, but they rarely mention the valuation relative to the growth rate.

Last year, the earnings from mid-caps was 7% more than the blue-chips, but they out-performed by 14% so their inherent valuation has risen.  Arguably this growth differential was exaggerated in 2013 due to the extreme underperformance of the oil & gas/commodity sectors that account for 25% of the FTSE 100, but accounts for less than 9% of the FTSE 250.  Also the strength of sterling in 2013 affected the blue-chips more given that the typical FTSE 100 stock has 81% of its sales overseas.

My view is that sterling will gradually depreciate from here, especially against the US$ which tends to be the key currency.  Based on the current Purchasing Power Parity i.e. the exchange rate at which a ‘basket of goods’ would be the same price, according to OECD statistics, the US$ is over 13% undervalued against Sterling.

In addition, the degree of excess growth by the UK mid-caps appears to be slowing.  Based on analyst bottom up forecasts, the average earnings growth for the mid-caps over the next two years will be 12.3% pa, which is just 2% pa above the same forecast for the blue-chips.  This extra growth comes at a 25% valuation premium based on Price/Earnings ratios which I think is demanding.

Outperformance by the mid-caps is not a constant, in the UK during the 90’s the FTSE 100 actually beat the FTSE 250 by nearly 2% pa.  And even during the next decade, the mid-cap outperformance averaged 6% pa, which was much less than the gains we saw last year.  Interestingly at the start of 2000, they stood on an almost identical P/E to the blue-chips so investors received premium growth thereafter without paying a premium price.  This is no longer the case.

The academics, Dimson and Marsh wrote in a 1998 paper called Murphy’s Law and Market Anomalies, ‘Many researchers have uncovered empirical regularities in stock market returns. If these regularities persist, investors can expect to achieve superior performance. Unfortunately, nature can be perverse. Once an apparent anomaly is publicised, only too often it disappears or goes into reverse.’

Isn’t the current mid-cap euphoria just another example of fund managers arriving at the party too late?  Isn’t it time to focus on UK blue-chips again?

 

Alan Miller

02078388650

alan@scmprivate.com

www.scmdirect.com