Tag Archives: portfolio construction

Any reference to benchmark should be tailored to individual client preference. These could, for instance, be 

1. Absolute return based. 
2. Cash/ LIBOR/SONIA ,or equivalent, based (0.70%). 
3. Inflation based. (UK CPI 1.9% May 2019). 
4. Index based (FTSE 100, FTSE All-Share, MSCI, S&P etc.). 
5. Peer group based (Private client index, Morningstar, IMA category etc.). 
6. Theme based e.g. Ethical. 
7. Bespoke list…e.g. list of other funds held/monitored/local competitors. 
8. Factor based. 

The above list is not exhaustive. 

Furthermore, it may be appropriate to apply differing benchmarks to differing risk categories, and or adopt internal and external benchmarks. 

Further macro details and individual investment ideas, model portfolios for varying benchmarks and risk profiles are available on request. These can be in direct, OEIC, investment trust or ETF form or a combination. As ever, portfolio construction should take full account of risk, return and degree of asset correlation appropriate to the individual client. Other client assets/liabilities should also be considered. 

Cash –Neutral, Higher than normal. 

Where appropriate, diversify some sterling cash into major overseas currencies, especially after considering the ongoing BREXIT process. The US dollar should certainly feature amongst the alternative currencies. 

UK Equities-Neutral/small overweight 

Economy 

After reporting 1.4% GDP growth for 2017, and a similar figure for 2018, growth in 2019 is also expected to be anaemic, with risks to the downside, at the time of writing. Most recent data quarterly data showed GDP contacting by 0.4% to end Apri,while the June PMI reading at a level of 48,was at the lowest since 2013. Well publicised reasons include a more uncertain domestic consumer environment, weaker business investment, slowing global trends and political uncertainty, all interrelated. There is no doubt that the “BREXIT” has and will continue to affect many areas of the economy in different ways. Recent data has been mixed with improving employment (wages +3.4%, unemployment 3.8%), slow real wage growth, mixed industrial production figures, volatile 

retail sales, very poor automotive sector and a flat housing market. The residential housing market is continuing to show slower year on year growth, especially in London and the South East, where many properties are now showing negative year on year price comparisons. The lower volume of activity and increased time to completion have been all too evident in the recent sector profit warnings and cautious guidance from estate agents, house builders, domestic construction companies. Commercial property has also been very sluggish, especially in the area of retail (see more detail below). One bright area for the economy has been the better than expected progress in government finances, possibly giving scope for some fiscal relaxation, although recent statements from Chancellor Hammond show some resistance to the idea. 

Forecasts for 2019 GDP growth span a range of 0.5% to 2.0% with an average of 1.5% (30 forecasts), although most forecaster agree that in the event of UK crashing out of the EU, the country could experience a sizeable recession. It is highly likely that quarterly GDP figures will be heavily distorted by Brexit related factors, and Q2 2019,due imminently, is widely expected to show negligible growth. 

At the mid-March “mini-budget” speech Chancellor Hammond also guided GDP forecasts towards about 1.5% and re-iterated caution over relaxing the fiscal stance despite the budget improvement referred to above. 

Inflation, currently 1.9% (May 2019), by the widely used CPI measure, appears to have stabilised and forecasts of around 1.8% seem to be the consensus is currently running at about 3% year on year. 

The Monetary Policy Committee is edging towards a more hawkish stance despite the sluggish economic growth and Brexit/political uncertainty, focussing more on the inflation target. At the December 2018 meeting the MPC left interest rates unchanged at 0.75% warning that Brexit uncertainties “had intensified considerably”. 

At the time of writing, both Prime Ministerial candidates, Boris Johnson and Jeremy Hunt, are presenting their Brexit ideas to party members before the important votes this month. However, it is far from clear how both parliament and EU members will react to some of the proposals. Many options, including no-deal, snap General election, referendum or request for an extension are possible. In addition, Chancellor Hammond has cautioned against using some of the Budget “Surplus” for some of the pre-election spending plans. 

The one thing that is certain is that uncertainty will continue to prevail in the short term in economic, political and corporate terms and UK asset volatility, particularly in the foreign exchange market, is likely to remain high! 

Market 

On a valuation basis, the UK equity market remains at a relatively “cheap level”, compared to its history and significant underperformance, versus world equities, since the Brexit vote in June 2016 has already taken place. Corporate profits however, especially amongst the more international companies have continued to grow, as have dividends. The prospective PE multiple for 2019 is about 12.5, falling to an estimated 11.6 in 2020, with a dividend yield of 4.9%. (Source Morgan Stanley, June 2019). However, two notes of caution. The “E” of the PE ratio, at the time of writing, is subject to more than usual variation as company earnings are likely to be adjusted, both ways, following the BREXIT effect and related uncertainties. Income seekers should also pay extra attention to 

sustainability/growth potential rather than just absolute levels of dividends. Profit warnings/dividend cuts are increasing. 

On a technical market note it should be re-emphasised that the FTSE 100 has a relatively large oil/mining weighting and that approx 2/3 of the FTSE earnings derive from overseas. The table below summarises the main differences between the three main UK indices. 

Broad Sector FTSE100 FTSE 250 FT All-Share Financial-incl property 19% 40% 18% Consumer(goods/service) 22% 16% 25% Energy 17% 0 % 14% Health 11% 4% 11% Material 10% 5% 9% Industrial 8% 19. % 8% Telco &IT 7% 8% 3% Source: i-share,Lyxor.December 7th 2018.Leading sectors only. 

In a Morgan Stanley research note, it was estimated that 41%, 26% and 18% of FTSE 100 company sales were derived in Developed Europe, Asia-Pacific and North America respectively. The corresponding figures for the FTSE 250 were 67%, 10% and 14 

At the time of writing I would recommend overweighting banks/insurance while maintaining lower than average positions in certain highly priced consumer stocks, domestic building and construction, housebuilding, tourism and airlines. I would keep neutral position in the oil majors while, Telecom stocks, pharmaceuticals and utilities(selectively) may also perform better than average on a mixture of defensive positioning, yield and value. As suggested above, in the short term I would also take some profits from the recently outperforming smaller stock sector and re- allocate towards FTSE names, either directly or through appropriate pooled vehicles. 

These factors emphasise the need to be flexible and frequently check positioning on a see-through basis. 

Overseas Equities–Neutral 

Expect increased currency volatility to continue during 2019 

Japan- overweight 

US- underweight 

Europe ex UK- small overweight 

Other –neutral 

Economic 

The global recovery is set to continue in 2019, although growth estimates have been reduced in recent months. 

The IMF reduced its global forecast to near 3.3% (from 3.5%) in its recent April 2019 presentation, while the OECD, in its March 2019 statement also mentioned a figure of 3.3%, their forecast changes largely based on weaker than expected development in China and Europe. 

As well as the fading effect of US fiscal incentives, weaker indications from several European, developing, and Asian countries, including China, point to more sluggish economic development. 

Core inflation is also developing at a slower than expected pace with most leading nations experiencing price increases well below Central Bank targets. 

The two factors above, in combination with certain geo-political concerns, are behind the more dovish monetary/fiscal policies/statement currently being adopted. 

Major risks could include inappropriate Fed/Trump action e.g. further protectionism, Chinese growth/deflation/management, further commodity/forex price volatility, and reaction to many political developments (Hong Kong, Venezuela, Libya, Ukraine, Russia, Iran, Turkey, Korea being current examples). 

Christine Lagarde, IMF Managing Director, reiterated that rising protectionism and debt levels remained the biggest global risks. 

United States 

After 1.6% GDP progression in 2016 US economic growth recovered to 2.3% in 2017 with 2.9% for 2018 and a figure of 2.4% provisionally pencilled in for 2019.The Federal reserve itself expects growth of about 2.3% in 2019, highlighting strong job gains and buoyant consumer spending and corporate investment. Better than expected first quarter 2019 growth of 3.2% does however include a large element of inventory build. The employment situation seems to have moderated somewhat, the most recent May figures slowing sharply and bringing the monthly average to 164000 for 2019, well below the 223,000 2018 figure. The unemployment rate is holding steady at about 3.6% 

Most recent inflation figures show May 2019 prices rising at 1.8%, and forecasts of around 2.3% for 2019 seem to be the consensus. The increase in average hourly earnings for December 2018, the fastest rate of growth since June 2009, was above expectation and prompted some observers to suggest that labour shortages could become more widespread, although more recent wage figures have shown slower growth. 

The Federal Reserve raised short term interest rates in March ,June ,September and most recently on December 19st ,taking the target rate for the Federal Funds rate to 2.25%-2.5%.However recent shorter term economic data coupled with certain current geo-political uncertainties e.g. US/China,Brexit,Europe,South America have introduced a much more dovish tone to Fed thinking. According to current projections of top officials, it now seems likely that there could be no rate increases in 2019, with rate cuts being more likely, and the Fed also announced an end to quantitative tightening for this September. As at 11th June 2019, Fed Funds futures now anticipate 

at least two Fed rate cuts before the end of this year, with the first possibly coming as early as this month. At its most recent June 19th meeting, the Federal Reserve held interest rates steady but shifted towards a more dovish stance and pointed to possible interest rate cuts in the future, citing rising “uncertainties” about the economic outlook. 

Europe 

European economic growth forecasts have shown a marked decline since mid-2018 levels and most forecasts for 2019 now fall in the 1.0% to 1.5% range, with the ECB itself looking for the lower end of this range. During the last quarter of 2018, Italy contracted while Germany showed negligible progress and the situation seems to have deteriorated further during the first months of 2019. Going forward, global developments in the area of trade will be particularly important for the likes of Germany while a precarious political climate (Italy, Spain) could be another source of investor uncertainty for the region. Analysts expect inflation between 1.2% and 1.8% i.e. still below the ECB target. Interestingly, wages grew at 2.4% during the first quarter, the fastest in a decade. 

Recent MEP election have continued to show an erosion of support for the traditional central parties, and while some of the more extreme political groups fared worse than expected, the Greens and Liberal Parties showed good gains. Partly as a result of these elections, there have been significant personnel/party developments in Germany, Italy and, Austria. Various ECB roles also must be filled over coming months, including the appointment of Mario Draghi’s successor. 

At recent meetings, Mario Draghi and other European leaders have stressed that economic risks were “moving to the downside”. Interest rate increases have been pushed back in the calendar (mid 2020?) At the June 18th ECB symposium in Sintra,Draghi referred to the possible expansion of the Euro2.6 trillion QE programme, if the inflation outlook failed to improve. 

Japan 

Japanese growth stalled in the first quarter of 2018 after eight consecutive quarters of improvement and then rebounded during summer months, before some recent softness largely due to natural disasters. Strong PMI figures and Tankan surveys, covering more than 10000 companies, near an 11-year high, however, confirm ongoing economic expansion. Current calendar 2019 economic forecasts are for about 1% GDP growth, the first quarter positive surprise probably being a one-off. At recent meetings the BOJ pledged to maintain the current negative interest rates, yield curve management and asset purchase programmes for the time being. 

Politics tilted in a pro-reform direction, after the October 2017 election landslide, which should help various economic and political initiatives. The political situation was strengthened further by the leadership victory late September 2018, which would make Shinzo Abe one of the longest serving Japanese PM’s since the job was created in 1885. The initiatives will include more focus on the quantitative actions, including higher care wages, pension reform, targeted infrastructure and some moves to tweaking the pacifist constitution. The re-appointment of Central Bank Governor Kuroda was helpful to the continuation of accommodative fiscal and monetary policy, a stance reinforced in the spring. 

Inflation is still well below the official target (0.9% in April 2019) although oil price strength and early signs of wage and recent price growth are expected to accelerate the upward trend. Japan’s 

November jobless rate at 2.3%, is the lowest since 1994, and there are labour shortages in a growing list of sectors, including construction and elderly care. The parliament recently voted to allow more than 250000 foreign workers into the country on five-year visas, and with the improved electoral mandate, it is widely expected that the subjects of female participation and pension age changes will also be studied. 

Monetary policy will remain dependant on inflation developments, and currently no major changes are expected to short or long-term interest rates until at least end-2019.At the recent BOJ meetings, the Board have voted to keep the benchmark short term interest rate at -0.1%. One of the key economic debates for 2019 will centre of the proposed consumption tax increase currently scheduled for October 2019 

Asia excl- Japan 

Efforts to boost domestic demand, either through monetary policy, banking reform and structural issues are bearing fruit in some areas, but are also currently hindered by currency volatility, high debt ratios, disinflation, politics etc. The spectre of a tariff “war” between USA and China, could of course, impinge adversely on some of the more open economies in the area and specialist zones e.g. Taiwanese semi-conductors. Other opportunities may also arise e.g. Vietnamese textile producers. 

Overall estimates for growth in the region have slipped over recent months, (now around 6%-6.2% for 2017,2018 and 2019), but the aggregate figure masks large individual country differences. For example, Australia and Singapore are likely to register growth below 3%, while China, India Indonesia are likely to register rates around 6% this year. 

At the National People’s Congress held in early March 2018, Chinese Premier Li Keqiang outlined an economic growth target of 6.5%, with a minimum target of 6.3% p.a over the 2018-2020 period, in additional to a lower fiscal deficit goal. At the conference there was more emphasis on quality of growth, pollution control and risk control, than numerical targets. Most independent analysts feel that this growth figure remains realistic, and that rebalancing the economy, stabilising property prices and further liberalising the financial system remain major long-term objectives. Recently announced quarterly GDP growth of 6.5% reflects some of the qualitative improvements including a welcome decline in “shadow” lending, although current economic indicators (PMI’s, retail sales and factory orders) suggest risks lie to the downside. At the early March 2019 official meeting, a GDP forecast of “just” 6% was perceived as disappointing. However, at the time of writing Chinese moves to stabilise growth through a mixture of tax cuts, infrastructure spending and bank lending support, appear to be working, although the ongoing tariff discussions impose an air of uncertainty. 

In India, which has experienced a sizeable stock market and currency recovery, much is still riding on the “Mondi” reform programme where long-standing concerns in the areas of infrastructure, bureaucracy and fiscal inconsistency need resolution. Current estimates of over 6.5% growth for 2017 and 2018 are not overoptimistic (surpassing China, above!). The recent election (May 2019), won by Narendra Modi with a landslide victory, gives the leader power to forge on with building a “New India”, although detailed economic reform proposals have yet to emerge. 

Regional Equity Recommendations 

Japan remains a favoured equity market, despite the global sterling adjusted outperformance in 2017 and 2018, though relatively poor 2019 so far. Regarding the investment arithmetic, the prospective PE (12.4 falling to 11.6 in 2020 as at June 08,2019) is still lower than the world average and the price book ratio is near the lowest of all the major regions, at a level of 1.10. Corporate results for recent periods have been higher than estimated and further growth is expected over the 2019/2020 period. Analysts point to further scope for Return on Equity to converge on the average for developed markets over coming years. On a technical note, Japanese institutions are undergoing a bond/equity switch and the market tends to be under owned by overseas institutions. Regarding domestic demand, the BOJ and other buybacks amount represent a growing percentage of market cap on an annual basis (4% latest CS estimate) while public and private pension funds are steadily increasing their equity weightings. Individual households hold approximately 50% of their financial assets in cash, extremely high by international standards, another source of equity demand. Finally, corporate governance (independent directors etc), buy backs, dividend hikes and current valuations on upgraded earnings are helping sentiment. About dividends, current low pay-out ratios (around 33%), give scope for above average income gains going forward. Currency strength/weakness is of course a double-edged sword regarding Japanese portfolio strategy. I recommend that some Japanese equity exposure, currently, be hedged back to sterling and or US dollar. 

Europe (ex-UK) warrants a continued small overweight in my view. 

With the current accommodative monetary policy, stronger consumer sentiment and a more stable Euro, the market continues to deserve longer term attention. At corporate level, earnings are being helped by nominal sales growth, margin expansion, and lower tax and interest charges. There are many situations in exporters, capital goods, financials where equities appear good value on PE and Price/ Book considerations and offer reasonable dividend yields. However, at time of writing an escalation in the tariff “war” could have adverse effects on the margins and sales volumes of certain products e.g. German cars, luxury goods, and more than usual investor due diligence will be required. On the sectoral point for example it should also be remembered that the EuroStoxx 50 weighting in oil and mining is approximately half of that in the FTSE 100. On a cyclically adjusted price to earnings ratio (CAPE) often used by longer term investors the Eurozone trades at a considerable discount to the US market. The shorter-term PE ratio currently stands at about 14.3 for2019, dropping to 13 in 2020, with a prospective dividend yield of 3.6%. By historic comparison the market is fairly valued on a price earnings and price cash flow basis and good value on price/book and dividend yield considerations. 

Asia (ex Japan) is currently dominated by China and related China plays such as Hong Kong and Taiwan in MSCI index terms. Over the longer term, the Chinese weighting could increase significantly, when more local shares may be included in the major index benchmarks.JP Morgan estimate that the Chinese A-share weighting could move from just under 1% in May 2018 to nearly 14% by 2025.This is in addition to the approx. 25% to 30% of the index already represented by mainstream Chinese stocks. As discussed elsewhere, the consensus is for a Chinese economic slowdown to around 5%-6% per year, but possible risks could emerge from several directions including excessive credit expansion, shadow banking, currency volatility, tariff escalation and geo- political tensions aggravated by president Trump. Equity investing as an overseas investor also faces hurdles in the shape of government control (including the stock market itself), currency policy, corporate governance issues and sometimes less than ideal accounting. A well-diversified portfolio 

could however include some longer-term exposure to the China region, directly or indirectly (Hong Kong, overseas plays, ETF, investment trusts etc.), but shorter-term volatility is expected. Amongst other countries, India remains an investor favourite, even though valuations are becoming quite full, Korea looks reasonable value, but the competitive situation should be monitored, and Australia, whose economy and currency are closely tied to the fortunes of the commodity sector, offers some interesting yield situations. Finally, Vietnam warrants attention as a high growth economy and possible beneficiary of any US/China tariff war. In aggregate the region has a prospective PE of just over 13.4 with a dividend yield of 3.2% 

During 2018 US investors were able to enjoy above-trend earnings and economic growth. The 20% plus profits growth and near 3% GDP growth were fuelled by tax changes, government stimulus and other non-recurring items. Looking forward, 5%-10% earnings per share growth, coupled with an uncertain interest rate background and considerable geo-political noise are likely to hinder share price progress. On equity valuation, shares look slightly overbought on current metrics including shorter term price earnings ratio (17.5 times forward earnings-2019), price book ratio and yield, and longer-term Schiller PE look a little more stretched. Corporate share buybacks, one of the significant market support factors, over the 2010/2016 period, are slowing and household ownership of equities is high relative to Europe and Japan, for instance. However, equities are not priced in the bubble territory which occurred in 2000, multiples have retreated since early 2018 and sentiment indicators remain in neutral territory. Corporate earnings growth was upgraded following certain aspects of proposed Trump policy especially in corporate taxation, but dollar strength, higher interest rates and overseas supply chain disruption should also be considered. The peak in US quarterly earnings growth (20% plus) has passed, however, and 8%-10% covers the consensus range for 2019. If current tariff proposals come to fruition (a big IF), several US companies expect to be affected by disruptive volume and input pricing effects late 2018 and into 2019. 

There continue to be wide divergence between the economies of the emerging universe with, for example, Russia, Brazil and South Africa experiencing much slower growth, the latter also recently experiencing a credit downgrade and new political era, and many countries suffering from disproportionate commodity exposure (Russia), unstable/changing political situations (Venezuela, Turkey, Mexico, Brazil) and or/ high dollar debt levels. The changing US political regime clearly adds more uncertainties deriving from a volatile dollar, and selective protectionist policies. India is currently one of the rare outliers with minimal commodity or deflation worries but other issues that need addressing and hopes that the recently appointed Finance Minister continues to adopt the discipline imposed by her predecessor. However, on balance, developing economies which had been detracting from global growth for several quarters are now starting to stabilise. 

Investors could consider some selective exposure to the region, which currently trades on a prospective 12.2 multiple on 2019 earnings, a considerable discount to other zones. Foreign Exchange could be an important issue from both currencies of investment and individual corporate effects. However, investors should also be aware the considerable risks that are plaguing the asset class, whether commodity pricing, debt, political change etc. In terms of industry sector, earnings are expected to be strongest in consumer discretionary, healthcare and information technology, although several analysts detect more “value” in the oversold financial sector. According to recent Morgan Stanley research, aggregate 2019/20 emerging market earnings growth currently stands at a level of around 10% p.a. It should be noted that many emerging 

market companies are also rapidly increasing dividends, from a low level and there are some interesting pooled vehicles to exploit this. Morgan Stanley estimate dividend growth of 7% and 11% for the region over 2019and 2020 respectively. By contrast, developed markets are estimated to have dividend growth of approx. 7% p.a over the same periods. Despite the current volatility, Russia remains worthy of speculative attention on the basis of low valuation, well above average dividend yield, better commodity price trends, but clearly a higher risk/return play, while Vietnam is likely to remain an Asian favourite despite the rating and recent performance, and emerging Europe may receive more attention going forward. Weightings in China and India still seem appropriate and South Korea has also moved back to the attractive zone. South American politics are playing an increasing role in investor sentiment, e.g. Venezuela, Mexico and most recently, Brazil. 

Fixed Interest 

Government Conventional Fixed interest-The medium-term fundamental prospects for core government bond yields (UK, USA, Japan, and Germany) continue to depend primarily on inflation and Central bank policy outlooks. External “shocks” also introduce spikes in volatility from time to time and related hunt for perceived safe havens. At the time of writing, conventional government bonds have staged a large rally (see graph), largely on declining growth/inflation expectations taking large swathes of the European and Japanese 10 year government bond yields into negative territory. 

On the first point, current inflation, as measured by the year on year rates in USA, Continental Europe, Japan and several emerging markets has started to drift down again after a period of 

stabilisation and is now further away from Central Bank “targets”. The Federal Reserve quantitative tightening programme seems likely to end this autumn while ECB is maintaining current policy on bond purchases, and the Bank of Japan pressure is very unlikely to change it’s QE in the short term. 

Region Updated 10-year Govt yield Spread versus T- 

Bond Germany 28/06/2019 -0.40% -2.39 Japan 28/06/2019 -0.15% -2.14 UK 28/06/2019 0.79% -1.20 USA 28/06/2019 1.99% 0.0 

Other Fixed interest 

It is forecast that the total returns from certain fixed interest outside the conventional core government bond space will yield further relative outperformance of the government sector, but allowance should be made for higher volatility liquidity, credit quality, dealing spreads etc. Some yield spreads still provide enough “cushion” versus conventional government bonds and may additionally have part equity drivers e.g. Preference shares, convertibles or be sector specific e.g. energy related. 

The search for above average regular income continues, with several participants forced to move up the risk curve. 

In general, a word of caution that using the ETF route for obtaining fixed interest exposure currently requires an extra level of due diligence regarding liquidity, spreads, degree of physical cover, tracking experience and of course full understanding of the underlying index. 

Corporate Debt-Although many investment grade issues appear fully priced there may be opportunities in other grades if the risk/return/maturity/liquidity criteria suit. These may also be available in pooled form through ETF or OEIC or investment trusts. Selected US high yield (5.46 on 28/06/2019) may offer FX as well as bond spread and income gains, and it must not be forgotten that with corporate dynamics improving and a more favourable supply demand balance there is good scope for outperformance over the government sector. 

ETF Yield p.a TER Dividend 

payments 

Physical cover 

UK corporates 2.52% 0.2% Quarterly Yes US High yield 5.46% 0.5% Six monthly Yes Emerging local 5.50% 0.5% Six monthly Yes 

Emerging market Debt-higher risk but also potentially higher return but remember to analyse currency as well as income and capital. Also, available in ETF form, I-share SEML, holds over 200 securities with above 8% weightings in Polish, South African, Mexican, Brazilian, and Indonesian debt. Currently over 90% of the fund’s assets are rated A,BBB or BB and the fund yields 5.5%. 

Preference Shares-Above average yields are still available, despite the large total return outperformance over the gilt sector over recent periods and remember the more favourable tax treatment for basic rate payers. Some of the UK bank issues look particularly interesting in this sector after recent/ongoing capital strengthening exercises and the results of the “stress tests”. Depending on risk appetite, annual yields around 6% to 6.5% are currently available on selected financial issues suitable for balanced accounts while, like corporate bonds, some higher yields can be found in more speculative issues. 

Floating rate-provide an element of hedging against rate increases. Available in direct or investment trust structures and currently offering about 5% annual yield and priced at discount to assets. These instruments outperformed conventional government stocks last year as short-term rates were increased, particularly in the USA, but have had a more cautious start to 2019, partly due to more dovish Central Bank rhetoric. 

Index Linked– These instruments continue to attract interest from both longer-term institutions with asset/liability issues and, more recently, from some shorter-term tactical funds. Linkers do offer some investment advantages such as low volatility and low correlation with several other asset classes and they are in relatively short supply. However, they currently do not look particularly good value either domestically or by international comparison on most reasonable inflation assumptions or by comparison with other alternatives. In my view, there are other instruments that offer some degree of inflation protection/diversification at more reasonable price levels. The real yield on the UK FTSE All Index Linked Gilts is currently -1.88% 

Zero-Coupons-Capital only, yields of over 2.6% p.a (annual equivalent) to November 2020, or 3.7% p.a. to November 2022 or 4.2% to November 2024 on recommended issues at time of writing. May suit event planning/higher income tax situations. 

Convertibles-UK market relatively small but some funds are available. A few issues at relatively low yields and high conversion premium have been made recently. My favoured pooled play currently trades at a discount (currently 7.0%) with an annual yield over 5%. The fund recently (end May 2017) announced a tighter discount control range which has successfully reduced volatility even further and, at the time of writing, the company is buying its own shares. 

Corporate Bonds, UK order book-Selected issues may warrant attention. In the expanding London retail bond market, running yields between 5 % and 6.0% on LSE quoted companies with between 4 and 7-year maturities are available on more stable underlying businesses, while much higher flat(e.g. 10%) and redemption yields apply to certain more speculative issues, especially in the energy area. A growing number of ultra-long issues are becoming available. 

Property-Neutral 

Following the historic decision on June 23,2016 to leave the EU, property markets, especially in London felt the aftershocks. Volume of activity and pricing were immediately affected and within days, property funds holding £15 billion of assets had closed the gate to redemptions. Three years later, the markets have not settled, although some of the more drastic revisions and rumours have been softened. Amongst the main sectors, shopping centres are struggling with stalling consumer confidence and on-line competitors while the office sector, especially in London, is experiencing varying trends. The mergers recently announced between Hammerson and Intu,and Unibail/Westfield and recent Land Securities/British Land figures highlight the need to reduce costs in a troubled shopping centre sector. Interestingly, figures and statements from quoted company Segro PLC, by direct contrast, show the growth in logistics centres, warehousing as online shopping accelerates. 

Over 2018, the MSCI IPD UK Index showed a total return of 7.5%, although this growth slowed to just 1% in the last quarter. Of the 7.5%,5.2% was attributable to income and included rental growth of 2.7%. By sub sector industrial values rose faster than retail values every single month. Over the first four months of 2019 the Index has continued to show sluggish total return progress (income rather than capital gain) and further relative weakness in the retail related sector. The Index shows total return growth of just 0.74% for the first 4 months of 2019, or 2.3% annualised. 

The IPF current estimates are for total return growth of about 3% for 2019, income offsetting a small decline in capital values. Industrial is expected to be the strongest sub-sector. 

In the post BREXIT environment, investors in commercial property funds should be increasingly aware of “value adjustments” suddenly imposed on their unit holdings, large unproductive cash holdings, as well as perhaps a tightening of redemption procedures (see recent FCA paper), which is improving the relative attractiveness of closed end funds and direct equities. As ever however, watch location, management and balance sheets carefully! In major commercial property sectors,” tech” friendly features are increasingly demanded, while retailors juggle with the physical/online balance. In the specialist areas of student, logistics, medical, retirement accommodation and self- storage there is still good demand and in the medium term these sub-sectors are expected to become more “mainstream”. Many international investors have switched their attention away from UK towards Continental Europe, where rental levels, capital values and prospects are deemed more attractive. Remember also that property corporate bonds may suit some client objectives. 

Alternative Income/Other-Overweight 

This “catch all” sector is taking on increasing significance during this current phase of volatile bond and equity performance. It is noticeable that during the weaker equity periods, many renewable/private equity/infrastructure plays held their ground, and in some cases showed absolute returns. Funds which may fit the characteristic of better capital protection and above average yields and low correlation with other asset classes include 

• Infrastructure, including recent issues in the renewable sector, offering income yields around 5%- 6% p.a. Corporate activity e.g. John Laing, is an additional positive factor. 
• By way of comparison, certain listed vehicles in the areas of private equity and specialised lending currently offer yields of 6%-8%, but careful due diligence and extra considerations of transparency, holding period and liquidity in differing market conditions should be considered. 
• Certain liquid transparent structured products, although special client permission may be required, and full understanding of the maths and counterparty risk are essential. These can be useful for hedging e.g. infinite turbo puts/covered warrants against a fully invested equity portfolio. 
• A mixed 2018 for various absolute return funds and hedge funds. The higher volatility experienced in recent months will be welcomed by several Funds. Going forward extra due diligence will be needed to fully understand fund benchmarks, and take full account of charges, liquidity, transparency. 

GOOD LUCK FOR THE BALANCE OF 2019! – Ken Baksh 

Ken has over 35 years of investment management experience, working for two major City institutions between 1976 and 2002.

Since then he has been engaged as a self-employed investment consultant. He has worked with investment trusts, unit trusts, pension funds, charities, Life Fund, hedge fund and private clients. Individual asset managed have included direct equities and bonds pooled vehicles currencies, derivatives and commodities.

Projects undertaken in a number of areas including asset allocation, risk control, performance measurement, marketing, individual company research, legacy portfolios and portfolio construction. He has a BSc(Mathematics/Statistics) and is a Fellow Member of the UK Society of Investment Professionals.

Disclaimer 

All recommendations and comments are the opinion of writer. 

Investors should be cautious about all stock recommendations and should consider the source of any advice on stock selection. Various factors, including personal ownership, may influence or factor into a stock analysis or opinion. 

All investors are advised to conduct their own independent research into individual stocks and markets before making a purchase decision. In addition, investors are advised that past stock performance is not indicative of future price action. 

You should be aware of the risks involved in stock investing, and you use the material contained herein at your own risk 

The author may have historic or prospective positions in any securities mentioned in the report. 

The material is provided for information purpose only