Topic: Our views and beliefs

Why Simple Beats Complex

One of Carpenter Rees’ guiding principles of investment is ‘keep things simple’.  Ben Carlson, a very well respected Financial Adviser in the USA, wrote a whole book on the topic aptly named ‘A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan’.

Ben’s view is that a simplicity-based framework can lead to better investment decisions and whilst he couldn’t prove that as an 100% fact, below are what he believes are the main reasons why simple beats complex in the investment world –  and being a fan of simple, who are we to argue:

Intelligent people are drawn to complex solutions. There are plenty of intelligent people in the world of finance, but that intelligence often comes at a cost because smart people can more easily fool themselves into believing they have all the answers. Simple is not stimulating enough for some people, therefore intelligent people tend to overthink things and that can get them into trouble.

Complexity is about tactics; simplicity is about systems. Tactics come and go but an overarching philosophy around the way the world works can help you make better decisions in multiple scenarios. Simple doesn’t go out of style but complex does.

Simple is harder. To keep things simple, you have to fight harder because our human nature makes us susceptible to stories and narratives. Simplicity is more of a psychological exercise while complexity is more about trying to be cleverer than anyone else.

Trying harder does not guarantee better results. Outsmarting the competition is easier said than done because putting in more

10 Tips for surviving inevitable market falls

It is an inevitable part of investing that at some point markets will fall by an alarming, if not unexpected, degree.  We haven’t seen large market falls for a decade but should expect that at some point we will.  When, and in what magnitude, no-one knows, but remembering the following can help:

  1. Embrace the uncertainty of markets – that’s what delivers you with strong, long-term returns.
  2. Don’t look at your portfolio too often. Once a year is more than enough.
  3. Accept that you cannot time when to be in and out of markets – it is simply not possible. Resign yourself to the fact. Hindsight prophecies – ‘I knew the market was going to crash’ – are not allowed.
  4. If markets have fallen, remember that you still own everything you did before (the same number of shares in the same companies, and the same bonds holdings).
  5. A fall does not turn into a loss unless you sell your investments at the wrong time. If you don’t need the money, why would you sell?
  6. Falls in the markets and recoveries to previous highs are likely to sit well inside your long-term investment horizon i.e. when you need your money.
  7. The balance between your growth (equity) assets and defensive (high quality bond) assets was established by your adviser to make sure that you can withstand temporary falls in the value of your portfolio, both emotionally and financially, and that your portfolio has sufficient growth assets to deliver the returns needed to fund your longer-term financial goals.
  8. Be confident that your (boring) defensive assets will come into their own, protecting your portfolio from some of equity market falls. Be confident that you have many investment eggs held in several different baskets.
  9. If you are taking an income from your portfolio, remember that if equities have fallen in value, it is likely that your adviser has set up your portfolio so that you will be taking proportionately more of your income from the cash held within your portfolio or your bonds; not selling equities when they are down.
  10. Your adviser is there – at any time – to talk to you. He or she can act as your behavioural coach to urge you to stay the course.  They are a source of fortitude, patience and discipline.  Be strong and heed their advice.

Warning – The above information is provided for information only. It does not constitute investment advice, a recommendation or an offer of any services and is not intended to provide a sufficient basis on which to make an investment decision.  The value of investments may go down as well as up and you may not get back the full amount invested.

What is Normal?

The sketch above from Carl Richards reminds us of the fact that the calm serene rise of markets year on year does not exist.

Carl explains his sketch as follows: –

“Imagine being in a boat in the ocean on a very still day. No wind. No swell. The water is as flat as a mirror. The calm goes on for a just long enough for you start to feel like it’s normal. Then when a small wave comes, it feels huge, and regular waves feel enormous. As scary as it might feel…remember waves are normal. Occasional storms are normal. And the last thing you want to do when you get into one is abandon ship.”

I know I am probably going over similar ground to last weeks blog but it is important to remember Volatility is the price you pay for participation in equity markets and for the potential for higher returns than cash.

As always, we are bound to see the media and industry commentators put forward lots of very plausible reasons for this sudden spike in market volatility.  No doubt many will point to fears of rising interest rates due to Trump’s tax cuts ‘turbo-charging’ the economy…however, we should regard this purely as white noise and ‘sit tight’

Market corrections are a normal part of the market cycle and happen from time to time.  It’s nothing to fear, just a part of how equity markets operate.

Our clients with money exposed to global equity markets all share many important attributes:

  1. They are long-term investors.  This attribute makes short-term market volatility less important.  Rather than looking at how an equity market performs during the course of an hour, day, week, month or even year, we’re interested in multi-year investment returns.
  2. We ensure that our clients remain suitably diversified.  This means that equities are not the only element within their investment portfolios.    This diversification is important because different investment types tend to behave differently at different times.    Having a well-diversified portfolio softens the blow of any short-term volatility in equity markets, as you are never fully exposed to UK, US or global stock price movements.
  3. We take careful steps to assess attitude towards investment risk, your risk capacity and your need to take investment risk in order to achieve your financial goals…including determining the degree of short-term falls that can be tolerated in pursuit of longer term gains.

This deep understanding of investment risks means that the volatility we are witnessing should be tolerable in terms of your emotional response to the event and your financial ability to withstand falls within your portfolio.

Despite these three very important attributes, it’s only natural that market volatility prompts some nervousness.

If you’re feeling at all unsettled, we want you to call us and chat about it…. that’s what we are here for.

In fact, as we have said on many occasions, our job as Financial Planners is less challenging during periods of rising markets, it is when markets experience falls that we work harder and really earn our fees by promoting investment discipline, explaining what is happening, and demonstrating how this fits into your overall financial planning.

 

The above information is provided for information only. It does not constitute investment advice, recommendation or an offer of any services and is not intended to provide a sufficient basis on which to make an investment decision.

 

Testing Time in the Markets and Testing Market Timing

The falls in Global markets overnight and this morning emphasise the fact that equity markets do have periods of volatility. Positive periods are followed by negative periods, which are then followed by positive periods. Because of this, it is common when markets are falling to ask whether it is possible to time investment decisions to sell at the peaks and buy back at the troughs.

One way to do this might be to analyse forward-looking information such as economic and corporate data and make predictions about the direction of the markets. But it is hard to make predictions, especially about the future.

Another approach might be to look back at data from previous cycles and identify patterns that could be repeated going forward. Researchers at Dimensional Fund Advisors did exactly this, running almost 800 tests on data from 15 world equity markets to identify signals that might point to a change of market cycle and simulating the trading activity that might improve investment returns.

Most of the 800 tests failed and resulted in worse performance than would have been achieved by just going with the flow of the market. But some of the tests worked and produced positive performance results.

You might think this is good news for investors—that they can replicate the trading patterns suggested by the positive tests. Unfortunately, the number of positive results was no greater than one might expect with such a large number of tests.

As the researchers explain, the odds of one-person coin flipping 10 heads in a row are small. But if you asked 100 people to try, you would expect around five of them to be successful. The same proportion of the 800 market tests were positive and the research was unable to determine if any of them were more than just a sequence of lucky coin tosses.

The conclusion of the research is that, on average, investors are better off sticking to their long-term investment goals and riding out short-term market volatility, rather than trying to time their trading to coincide with the peaks and troughs of the market. This is also the approach we advocate at volatile times such as these.

The main defensive assets within our portfolios are short term, high quality bonds, these bonds are less volatile than long term bonds and their prices will be less effected by any rise in interest rates. High quality bonds tend to be where money flows to at times of equity market trauma and this has indeed been reflected today.

It is easy to become concerned about the present and life as an investor will involve many of these days making life less comfortable unless you view them in context so remember:

  • The value of your portfolio simply tells you how much money you would have if you liquidated everything immediately which you do not intend to do. Losses are only made if you sell assets but if you don’t do this they remain in your portfolio to generate future returns.
  • Your portfolio has a well thought out structure and is designed to provide you with the best chance of a long term favourable return.
  • Some assets will be doing well at times and others not so well and nobody can predict which assets will be doing what at any given time.
  • Your adviser cannot control what markets do and neither can fund managers.

In a nutshell, try not to worry about the short-term impact on your portfolio and instead, focus on your longer term financial plan.

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.

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!

Planning a business exit: Eight ways to maximise value and attract buyers

As a business owner, you will have a passion for what you do but when it comes down to it, the reason most people go into business is to make money. They focus on maximising the value of the business for the point when they come to sell it. Despite this, we come across many examples where business owners fail to either maximise or extract their business’ value, because they simply don’t have the strategy to do so.

Your business may be your pride and joy but when it comes to the time that you want to exit from it, you need to be able to convince someone else of its value too.

So we thought it would be helpful to draw up this handy checklist:

  1. ‘Size does matter’ – you need to have developed your business to a level of turnover that will maximise value.
  2. Your business model needs to be reflected in the day to day business operations – is it delivering consistently, in terms of customer service; online presence; the workforce; pricing strategy; materials and suppliers?.
  3. Repeat business is crucial – do you have clients on long-term retainers, extended contracts or some type of residual income trail? We all know it’s easier to keep an existing client than to find a new one.
  4. Is your business able to generate new business leads, enquiries and sales without relying entirely on you or one key person’s skills and sales ability?
  5. Businesses that are centred around systems are simpler to run, less stressful and generally less risky. This makes them more attractive to a potential buyer and, usually, more valuable.
  6. How are your employees incentivised? How is their performance measured and rewarded? If you have a profit share-based plan or an employee share ownership plan, this substantially reduces one of the key risks for buyers – that your employees will exit when you do.
  7. Effective corporate governance and compliance can also add considerable exit value because they are seen as reducing risk.
  8. The business must be able to operate independently of your personal involvement. To put it simply, will your business survive when you’re no longer a part of it?
planning a business exit

Three types of financial management in business owners

types of financial management

Every business owner is different with their own unique style. But they all have one thing in common – the finances will be fundamental to the success of their business.

Depending on their personality, however, they will all have a different way of approaching financial management.

From our experience of working with various business owners, we have identified three key types. Do you see yourself in any of these?

The fantasist – is great at coming up with the next Big Idea and is full of creativity and vision. While this may be good news for the business, it might not be the best approach for the finances. This type of person will tend to make decisions based on gut instinct and intuition rather than looking at the hard data or evidence. The danger can be that, without a sound grasp of the figures, those brilliant ideas may never stand a chance of becoming reality.

If the fantasist sounds a bit like you, it’s a good idea to make sure you have someone else in the business who can provide some balance and rein you in from time to time. Enjoy being a visionary by all means but make sure you have a ‘detail merchant’ on board as your financial director or accountant too!

The gambler – loves an opportunity and is to be applauded for their spontaneity. On the positive side, this entrepreneurial business type can make the most of their circumstances at the right time and get ahead of the competition. However, their impulsive nature can also lead them to jumping in without thinking and taking the business in a direction that may not be the best financially.

If you’re someone who is always spotting the next ‘golden opportunity’, make sure you have someone who can manage your financial data accurately and can present the figures to you right away so you can make informed decisions.

The disorganiser – we’ve no doubt all come across business owners like this. Their office is the hub of the operation but it’s often a veritable Aladdin’s cave, piled high with stacks of paper. Financial management is not a priority for them but rather something that gets in the way of the operational side. It’s only when they need to find that all-important receipt that they will turn their attention to the neglected paperwork, panicking over every other invoice and bill they come across as they search.

It doesn’t mean they’re not a good business owner, just someone who needs a good accountant to keep things in order.

So which are you most like?

If you recognise certain traits of any of these in you, are there things you could do to change your approach? Or could you get others in the business who are of a different temperament to provide some balance?

types of financial management

Eight ways to improve your relationship with your financial adviser

Who would you say is the most important person you have a relationship with, when running your own business? Your bank manager, accountant or lawyer? Maybe your best client, your preferred supplier or your spouse and family? No doubt all of them, to varying degrees. But the one we’re going to focus on here is the one with your financial adviser.

We’ve identified eight key ways you can be a good client:

  1. Be honest – share your goals, objectives, setbacks, triumphs and successes with your adviser so they can best help you achieve your aims – and keep them informed if your circumstances change.
  2. Don’t keep shopping around just based on the lowest fee but look for competitive and reasonable rates in light of what is being offered. Yes, the fee structure should be fair and and transparent but good advice deserves appropriate compensation.
  3. Don’t judge investment results based on just one year’s return – three or five years is a much more realistic timeframe – what is more relevant is whether your investments are on track to meet your goals.
  4. Don’t expect the impossible – in the current climate you’re not going to get 10% returns so don’t expect them – also accept that there will inevitably be some ‘down’ years.
  5. Make sure you compare like with like and understand the different types of advice being offered: for example, an adviser can offer both financial planning and investment advice; DIY advice doesn’t carry a fee but means you are entirely on your own in terms of investments, portfolio building, taxes and estate planning. Online tools can help with investments but usually do not provide financial planning.
  6. Be aware that small portfolios may get less attention – ask an adviser what level of service a portfolio like yours would get. If you only have a small amount to invest, for example, less than £75,0000, it may be that online advice would be more appropriate.
  7. Try not to chop and change adviser too frequently – it cancels out all the preparatory work done in getting to know you and your requirements. As a result, an adviser may be reluctant to take someone on who moves around a lot as it suggests it is very difficult to meet their long term goals and expectations.
  8. Prepare for any meeting with your adviser as you would for a business meeting – review your investments before the meeting and jot down anything you want to ask.
running your own business