Topic: Investment

Legal Entity Identifiers (LEI’s) – Do you need one?

If you hold any form of investment, whether it be stocks, company shares, investment bonds, etc., you may well have heard of a Legal Entity Identifier (LEI) – but what is it, what does it do, and more importantly … do you need one?

In January 2018, the UK will become subject to new legislation brought about by the Markets in Financial Instruments Directive II (MiFID II) regulations.  MiFID first came into force in the UK in November 2007 when its aim was to increase competition and consumer protection in the financial services sector across the European Economic Area (EEA).  However, lessons learned from the ‘financial crisis’ along with the desire to strengthen consumer protection have led to the updating of the regulations.

Transaction Reporting & Unique identifiers

Perhaps one of the biggest changes to be brought about by MiFID II relates to the transaction reporting rules, which are designed to ensure that Investment Firms report post-trade information to the Financial Conduct Authority (FCA) to help them to detect and deter market abuse. In addition to this, from the 3rd January 2018, Investment firms must also ensure that prior to trading in any ‘reportable financial instrument’ they hold an appropriate unique identifier.  For individual’s this will be their N.I. number, and for a Legal entity, this will be a Legal Entity Identifier (LEI).

Legal What is a Legal Entity Identifier (LEI)?

Legal Entity Identifier’s (LEI’s) are unique alphanumeric 20-character codes that are used to

Pack up your troubles in your old kit bag and smile, smile, smile…

This week I thought I would share with you a blog written by Tim Hale of Albion Strategic Consulting.  Tim is engaged by Carpenter Rees as a consultant and has helped design and develop the investment strategies we put in place for our clients. Tim is well known  for his investment knowledge and is author of the book Smarter Investing. 

Modern life provides us – some would say swamps us – with so much news, information and punditry, which focuses on the here-and-now, that it is easy to be overwhelmed with the feeling of doom and gloom. The list of things to concern us is long and worrisome; Donald Trump leading the free world, a nuclear-armed North Korea; an increasingly fractious Brexit process and looming cliff-edge, to name a few.

The natural extension of this is to worry about what the impact of all this uncertainty will have on your portfolio and in turn, on your future wealth and expenditure goals. The first mistake is to believe that the world is falling apart around our ears.  It most certainly is not.  The second mistake is to think that the portfolio needs to be repositioned to mitigate these events. There are six key reasons why portfolio tinkering is unlikely to be a sensible course of action.

Reason 1: today’s ‘unprecedented’ turmoil is no different to how it’s always been

Today’s worries dominate our thinking; but can you remember what you were worrying about a year ago, or two years ago? Probably not. It has ever been thus.  Take a look at the chart below. The overwhelming take-away is to acknowledge the relentless upward trajectory of purchasing power for those patient enough, and disciplined enough, to stay the course.

Figure 1: The relentless growth of purchasing power, despite World events

Source: Albion Strategic Consulting[1]

Reason 2: bad news sells – so don’t ignore the underreported good news

We are all aware that bad news sells. For example, the Office for Budget Responsibility (OBR) delivered a ‘gloomy’ forecast for growth of ‘only’ 1.4% for 2018.  Yet, the UK economy is still growing; remember too that this slow down comes after a period of growth that has outstripped much of the developed world – particularly the rest of the EU – for the past few years.  It is not all bad news.

Reason 3: the danger of conflation of ‘what ifs’

The human mind likes stories and in themselves these stories may lead to what appear to be rational outcomes on which some action, or another, could or should be taken. What we often fail to realise is that the seemingly logical outcome is highly unlikely; we have failed to multiply the probabilities of each sequential outcome together.  Think hard about the stories you read and hear.

Reason 4: the futility of futurology

Futurology is the financial markets’ version of astrology. There is a huge industry out there from the IMF and the UK’s Office for Budget Responsibility (OBR) to investment banks, academics and BBC reporters all peddling their own view of the future.  These futurologists have one thing in common; they are nearly always wrong in their predictions, and are rarely held to account for their poor forecasts. Take forecasts with a pinch of salt.

Reason 5: the framing of data

As we all know, data is used to score points in support of the data-user’s viewpoint. Be aware that simple statements of fact can be both very influential and misleading.

Reason 6: the news is already in market prices

It is normal to be worried about the potential impact of what is going on in the world and how this will affect markets. The reality is that you are not alone; in fact, all active investors have some view on how Trump, Brexit, Merkel’s problems in Germany, or the Federal Reserve in the US – to name a few – will impact bond and equity prices.  These global, diversified view-points are already reflected in the equilibrium price of securities, agreed freely between buyers and sellers.

Your portfolio is already structured to manage uncertainty

Today’s concerns such as Brexit, Sterling’s weakness, potential tax rises in the event of a Labour government, and Donald Trump in general, are endlessly recycled through the 24/7 media soundbite process, alarming some who are invested in the markets. Well-structured investment portfolios seek to ensure that any market conditions can be weathered in the future, whatever drives these storms.  Your highly diversified portfolio, balancing global equity assets with high-quality shorter-dated bonds, is well positioned to do so.  Try not to worry.  Start by watching the news less.

If you are feeling concerned, please feel free to get in touch to talk further.

 

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1]     Global balanced portfolio: 36% MSCI World Index (net div.), 26% Dimensional Global Targeted Value Index, 40% Citi World Government Bond Index 1-5 Years (hedged to GBP) – no costs deducted, for illustrative purposes only. Data source: Morningstar Direct © All rights reserved, Dimensional Fund Advisers.

Your financial adviser will now take you through the safety procedures

Whilst listening to the safety procedures on a recent flight with friends on our annual Barons golf trip (Incidentally, I won the Barons trophy for the second year running!) it reminded me of the importance of planning clients investments.

Fasten your seat belts

As we hover around market highs for world equity markets and the 10-year anniversary of the crisis at Northern Rock, the media is again stoking up concerns about current market levels. We have had several conversations on this subject recently with clients.

The truth is that at some point the markets will fall. So, if the markets do fall what do you do?

Adopt the brace position

If you have planned your investments correctly, absolutely nothing is the answer. This may not be your natural reaction as you may feel an urge to take control; but what do you do? Do you sell?  if you do decide to sell, what do you sell, when do you sell and where do you invest the proceeds?   You then need to decide when to go back into the market. Getting these decisions right is practically impossible and even the so-called experts can make the wrong calls.

There is no doubt it can be scary, and at such times there is no comfort in reading the newspapers or listening to the news.

The emergency lights will direct you to your closet exit

So, what do you do? Well you stick to the plan that we have worked on with you, which will have built in the possibility of market falls; the scale of which is dependent upon the risk you wish to take with your investments.

When we design your plan, we ensure that you have a level of cash that you feel comfortable to hold and in addition, we ensure that you have cash within your portfolio to cover normally 12 month’s requirements. There will also be a certain amount of short term fixed interest stock within your portfolio, the level of which is again dependent upon the level of risk you wish to take. Most of our clients have 30% or more in these safer investments, so it is important to remember that if the stock market fell by 30% and you have 60% of your investment portfolio invested in equities, then your portfolio value will reduce by around 18%.

Sit back and enjoy the flight

These lower risk investments enable you to leave your long-term portfolio untouched when markets fall enabling you to sit back relax and wait for your portfolio to recover and fall comfortable in the knowledge that you need not stress about making the right calls.

Show me the money?

Where will the money come from? This is a question often asked by our clients as they think about working less or stopping work (you will note from previous blogs that I do not like the term retirement!).

It is certainly an understandable concern as most of us are used to getting a monthly salary or drawings, so it is vital to know what happens when that stops.
This is where the financial planning process comes in, especially if the hard task of saving and investing has been done along the way and we can prove using our financial modelling that you have enough!

If properly planned during the saving and investment period, it is probable that we as financial planners will have suggested you invest across a broad range of tax efficient investments to help achieve a tax efficient and sustainable income stream. These investments are likely to include ISA’s, Pensions, General Investment accounts, Life Assurance Bonds and sometimes a buy to let investment or two.

The tax allowances available are likely to include: –

  • Income tax personal allowance
  • Dividend Allowance
  • Savings allowance
  • Capital Gains Tax allowance

When working with a couple, then we have two lots of tax efficient investments and exemptions available. It is best to illustrate what can be done by way of an example; let me introduce you to Harry and Rachel.

Harry has just sold his publishing business and Rachel recently retired from her own separate business earlier this year. The children have all left home. Over the years we have helped them build a pot large enough to let them stop working for money and follow their dreams of travelling combined with their interest in art.

When they both worked they paid a lot of tax at higher rates however post retirement we can structure their income and their savings and investment to get them to a position where they have all the income they need whilst paying minimal tax, which is a massive boost as it ensures their pot can last for longer and they feel great about paying minimal tax after all those years.

Their income and tax position looks something like this:

Income Source Harry Rachel
Pension £30,000 £0
Interest £1,500 £1,500
Dividend Income £3,000 £3,000
Rental Income £0 £26000
Total Taxable Income £34,500 £30,500
ISA Dividends £5,000 £5,000
Pension Tax free cash £10,000 £0
Capital withdrawal within

CGT allowance

£5,000 £5,000
Total Tax-free Income £20,000 £10,000
Total Income £54,500 £40,500
Tax paid (£4,700) (£3,000)
Net Spendable income £49,800 £37,500
Overall tax rate 8.62% 7.41%

The above figures are based on 2017/18 tax allowances and exemptions which are subject to change, but as the financial plan should be reviewed annually, then we can adjust where funds come from to minimise tax and meet requirements from year to year.

So, the answer to the question is that the money post work is likely to come from a multiple of sources. This can take a bit of getting used to when you are used to one monthly salary payment but that is where working with a Financial Planner really helps in creating the income you need, saving tax and taking care of the administration surrounding your plan. This then allows you to get along with having the life you want, happy in the knowledge that your finances are in good hands.

 

Ongoing governance of the investment process

At Carpenter Rees, our investment philosophy adopts a systematic buy-hold-rebalance approach to investing.  This approach could prompt some of our clients to question why their portfolio seems to be largely unchanged from one period to the next and what the firm is doing for its fee. That would be unfair.

Wear a risk manager’s hat, not a performance manager’s hat

A good place to start is to look at the investment process, not from a performance perspective – as most stock brokers and investment managers tend to do – but from a risk perspective. Performance-focused managers inevitably look busy as they regularly change portfolio allocations and fund holdings; yet more activity does not equate to better outcomes.  Plenty of evidence exists to back this up.  Those who focus on chasing returns are at susceptible to taking unknown or poorly understood risks and getting it wrong.  They also incur higher costs. On the other hand, focusing on taking risks that are fully understood and adequately rewarded offers an investor every chance of a successful outcome.

Your portfolio, as it stands today, should provide you with the comfort that it is robust under the wide range of testing scenarios that could be thrown at it by the markets. Let’s consider some of the key risk decisions that have been made when establishing it.

  • Key decision 1: own a highly diversified pool of global companies to avoid concentration risks and capture the broad returns of capitalism.
  • Key decision 2: tilt the portfolio toward higher risks, such as value (less financially healthy) and smaller companies to pick up incrementally higher returns
  • Key decision 3: own shorter-dated, higher quality bonds to balance equity downside risk. Chasing higher yields in bonds simply dilutes their defensive qualities. The lower the credit quality the more these bonds act like equities.
  • Key decision 4: use systematic rather than judgemental fund managers. Although picking a manager who promises to beat the market sounds appealing, the stark reality is that true skill is hard to discern from luck, it is extremely rare, and it is almost impossible to identify in advance. Employing managers who capture the returns delivered by taking on specific market risks makes good sense.
  • Key decision 5: avoid owning an increasingly risky portfolio by rebalancing. Over time, the riskier assets (equities) in a portfolio tend to rise in value and begin to overpower the more defensive assets (bonds) in the portfolio. Periodically realigning – or rebalancing – a portfolios back to its original structure avoids this risk.

The role of the Investment Committee

The firm’s Investment Committee is responsible for the oversight of these risks in client portfolios and the wider investment process. Meetings are held regularly and minutes are taken, which include all action points to be followed up on.  Third-party inputs and guest members provide valuable independent insight, where necessary.  Its responsibilities include:

  • Responsibility 1: ongoing challenge to the process. If new evidence suggests that doing things differently would be in clients’ best interests, then the firm will revise its approach. The investment process is evolutionary, but change is most likely to be rare and incremental.
  • Responsibility 2: review of the best-in-class funds recommended. Each fund has a role to play in a portfolio and its ability to deliver against this objective is regularly reviewed. Any fund-related issues are raised and resolved, although this is pretty rare.
  • Responsibility 3: review the portfolio structure. Risks (asset class exposures) and their allocations within a portfolio are evaluated and from time to time these may change as the firm’s thinking evolves, given the latest evidence.
  • Responsibility 4: screen for new funds. New, potential best-in-class funds face detailed due diligence and approval, before they are recommended to clients. It would take a material improvement to knock an incumbent fund off its perch, but it can and does happen from time to time.
  • Responsibility 5: reaffirm or revise the investment process. Risk (asset) allocations and fund changes are approved by the Investment Committee. Any actions arising from portfolio revisions will be undertaken, after discussion with, and agreement by, clients.

Conclusion

It is entirely possible, and likely, that your portfolio will look much the same between one time period and the next with little activity, except for rebalancing. That most definitely does not mean that nothing is happening.  In fact, it takes quite a lot of work to keep our portfolios the same!

All that glistens …….

Gold has always held a certain appeal for humans. Its lustre (due to a lack of oxidation), makes it pleasing to look at and to handle. Yet, it is simply a lump of metal that generates no income and will only be worth what someone else wants to pay for it at any point in time.  Given the lack of cash flow, common valuation models are not useful.

Warren Buffett is not a big fan, stating: –

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Gold has suffered lengthy, negative real returns over periods as long as 20 years. Between 1987 and 2017 it delivered an annualised return of just 1.5% p.a. after inflation – around 5% lower than equities – yet with similar volatility.  In its favour, gold prices are uncorrelated to equity markets.

Yet many investors seem enamoured by Golds fabled investment properties. So, do these claims stack up?

Claim 1: Gold is a good defensive asset at times of global equity market crisis

In the period under review, there were three

What is Evidence-Based Investing?

Often in my blogs, you will hear me refer to ‘Evidence-Based Investing’ which reflects the investment philosophy adopted by Carpenter Rees Ltd.    This week, I thought I would share with you an Infographic which explains how this differs to ‘Traditional Active Investing’.   Whilst the two offer very different approaches to investing, at Carpenter Rees we don’t believe in timing markets, making knee-jerk reactions or acting on ‘expert’ opinions; we prefer to work with long term academic evidence in order to allow investments the time they need to do what we feel is most important to our clients ….achieve long term returns aimed at meeting their personal aspirations and financial goals.

Click here to view in detail our one page investment philosophy comparison.

 

 

UK General Elections and the Stock Market

Last week’s election was the first vote in the UK since the EU referendum – aren’t we the lucky ones…. and who is to say how soon the next one will be?

In this blog, we explain why investors would be well served avoiding the temptation to make significant changes to a long term financial plans based upon predictions as to who may be in number 10. The data below has been provided by investment firm Dimensional Fund Advisers.

Exhibit 1: Growth of a Pound Invested in the Dimensional UK Market Index

January 1956–December 2016

2017 06 13 - no 10
 For illustrative purposes only. Past performance is not a guarantee of future results. Index is not available for direct investment, therefore, their performance does not reflect the expenses associated with the management of an actual fund. Dimensional indices use CRSP and Compustat data. See “Index Descriptions” in the appendix for descriptions of index data.

 Trying to outguess the market is often a losing game. Current market prices offer an up-to-the-minute snapshot of the aggregate expectations of market participants— including expectations about the outcome and impact of elections. While unanticipated future events (genuine surprises) may trigger price changes in the future, the nature of these events cannot be known by investors today. As a result, it is difficult, if not impossible, to systematically benefit from trying to identify mispriced securities. So it is unlikely that investors can gain an edge by attempting to predict what will happen to the stock market after a general election.

 The focus of this election was Britain’s exit from the EU. But,

Turn Down the Noise

The Investment and Financial Services industry is noisy and is especially so in the middle of an election. Every day, thousands of articles, blogs, broadcasts, podcasts and webcasts are published, shouting for your attention and trying to make investment sexy.

It’s easy to fall into the trap of thinking that if you do not listen to the noise carefully and sift out the best ideas, i.e. the one’s that could help you find the highest returns—then you will not achieve your financial goals. Actually, we find the opposite to be true; trying to keep up with the latest investment fads can be detrimental to your long-term performance rather than beneficial to it. The noise can drown out the signal.

So what is the alternative?

We believe that it starts with having a strong evidence based investment philosophy that, over a long period of time, will prove to be rewarding for our clients. Our philosophy is based around some of the most enduring ideas in finance, these are ideas that help us achieve your financial goals by harnessing the power of capital markets in a systematic way. At the core, these fundamental concepts have remained the same for decades, but as research evolves into how markets work, our understanding improves and we develop our approach accordingly.

Added to this, we use investment managers that really take care over the details of implementation of the ideas. They understand that investment returns are precious and easy to lose in day-to-day management. They know it does not make sense to pay 5% in fees and costs to go after a 4% return.

This combination of a robust, enduring philosophy and a steady, disciplined application has helped us provide our clients with a way to turn down the noise.

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These foolish things

I thought that this week I would share with you part of a document which was issued by Tim Hale of Albion Strategic Consulting who have recently helped us develop and refine our investment portfolios. It is a longer blog than usual but I think it is well worth the read.

We are all prone to making mistakes when investing, not because we are foolish, but because we are human. It does appear that a switch inside even the most sensible person seems to flick and rationality disappears in a cloud of emotion, when we begin to think about the markets.  This note highlights some of the dangers and provides some tips on how we can attempt to behave better.  In short, the answer lies in adopting a disciplined process.

Trap 1: I know that I am smarter than the other fools out there

The human being is, by and large, overconfident in his or her abilities. For example, out of 600 professional fund managers asked in a study (Montier, 2010), almost three quarters said they were better than average (in the same way that 80% of us believe that we are better than average drivers). A number of studies have shown that overconfidence leads investors to overestimate their knowledge, underestimate the risks involved and increase their perception of their ability to control events.

Mitigation strategy: Have some humility – plenty of very clever people get beaten up by the markets.

Trap 2: There is a distinct pattern emerging here

An easy-to-understand example of this behaviour can be seen on the roulette tables of Las Vegas. A rational gambler knows that the chance of any number coming up has the same odds as any other number of coming up.  Yet, a sequence of three or four ‘red 9s’ in a row, or other similar pattern, can create quite a stir at the table.  In investing, we often mistake random noise for what appears to be a non-random sequence.

Mitigation strategy: If you detect a pattern in shorter-term data it is probably meaningless and that includes active fund performance data.

Trap 3: Problems with probability (and maths in general)

As humans, we seem to really struggle with probability calculations and outcomes. For example, many people are willing to pay more for something that improves the probability of a specific outcome from, say, 95% to 99% than from 45% to 49%, yet the two outcomes are financially equivalent.  We shy away from even the simplest