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What caught my eye this week.

I think my favourite Shakespeare play is Coriolanus. It’s certainly not the best Shakespeare play, but it’s shot through with a bitter edge that appeals to my inner cynic.

You can keep your Danish snowflakes, your passive-aggressive wizards, and your talking walls – it’s this Roman riches-to-rags-to-dead-in-a-ditch story of what happens when you court the mob that ticks my boxes.

No, I’m not (yet/only) referring to Brexit.

I’m not even thinking about the Extinction Rebellion protestor who was mildly lynched this week for interrupting a horde of London commuters.

I’m talking about the spectacular fall from grace of formerly famed fund manager Neil Woodford.

Told you so

Now, you might think this would be the perfect opportunity for a passive-championing blog like Monevator to cough politely and say: “Ahem, we told you so.”

And obviously we did.

Not that Woodford would fail, particularly, nobody could know that for sure. But we’ve written many times that you can achieve everything you need to by investing in index funds and getting on with the rest of your life.

Recap: There’s always a few winning fund managers at any one time. Mostly they don’t win forever, and even if they do you’re very unlikely to invest all your money with them throughout. Mathematically you’re better off in index funds.

Or, as The Evidence-based Investor writes:

I don’t mean to sound smug or clever. I had no reason to believe that Woodford would perform quite as badly as he did.

I was just pointing out that the odds were heavily stacked against him beating the market on a cost- and risk-adjusted basis over any meaningful period of time.

And that is all very well.

But ploughing through outraged article after outraged article this week, I started to feel almost sorry for the bloke.

Why oh why did he have to do different?

Woodford’s flagship fund is to be wound down, his second fund frozen, and his company is to be shut down.

Winding up the big Woodford fund wasn’t his choice, but to be honest it’s a bit late for that. His investment trust is trading at a ginormous discount because his reputation is trashed. The man who was lauded by the masses is now feeling their wrath.

They feel like they were scammed, they say. How does Woodford sleep at night? He has his millions, they’ve lost thousands. It’s not fair. They blame the platforms, too. And the media! The same media that now reports on him like he’s been discovered with 40 barrels of nuclear waste in his wine cellar that was only to happy to gush about his new company five years ago.

It might sound like sour grapes, but of course that’s not it. Because we can be sure (can’t we?) that had Woodford lived up to the hype and outperformed the markets by as much as he actually lagged them, then there would have been equal outrage from the same people.

Wouldn’t there?

It’s not right, they’d shout! Woodford’s winning gains came at someone else’s expense! Also he cheated by including all that illiquid and unlisted stuff in his funds – so it wasn’t a fair fight. In fact, they’d like to give their winnings back!

What’s that? You think people wouldn’t have said such things if he’d actually outperformed? You believe the way Scottish Mortgage – the UK’s largest investment trust – is praised for its private equity holdings shows nobody cares as long as you’re winning?1 You think the fact that the masses still invest in open-ended property funds shows they only care about inappropriate investment vehicles if they get bitten on the ass?

Well well, I guess you might be right.

Own it

Look, I agree with UK Value Investor that there are lessons to be learned from the fall of Neil Woodford. When things go this badly wrong, Questions Must Be Asked.

And I don’t enjoy seeing ordinary people lose money. Quite the opposite – I write this blog to try to help ordinary people end up wealthier.

But at the end of the day, the story is pretty simple. People let him do what he wanted – and applauded it – when they believed he could beat the market. As he faltered they began to withdraw their money, and this induced a doom loop that ultimately trashed the wealth of everyone involved.

Woodford certainly cannot escape the lion’s share of the blame – in retrospect at least he created a doomsday device. Full transparency, hot retail money, massive funds under management, Brexit, a contrarian position, and a series of off-piste investments all exploded when they met the catalyst of poor returns.

But people didn’t need to buy into his fund. This shouldn’t come as a newsflash. We’ve been writing about passive investing since 2007.

If you want to fly closer to the sun – if you must try to do better than the market – then sometimes you’re going to get burned. End of.

P.S. So Boris Johnson has negotiated a slightly new withdrawal agreement, giving us a second chance at an orderly escape from the best deal we’ll ever have – the one we’ve already got. Hands up, I didn’t think he’d bother, so some credit is due. But I doubt he’ll get it through Parliament (the FT’s maths suggests he’ll miss by three votes) and I don’t think he’ll mind. A wet sock would jump at the chance of taking on Jeremy Corbyn in a General Election, with or without a dangerously populist rallying cry of Parliament versus the People at its back. Ultra Brexiteers will see another chance for a no-deal Brexit, everyone else will weep into the ballot box. As things stand I believe a super-soft Brexit best reflects the very close 2016 advisory vote, but on balance I also think we’ve all learned enough since then to justify a second chance. Hence I’ll be marching in London on Saturday for a new, informed Referendum. See some of you there!

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  1. I own a few shares in Scottish Mortgage. And before you say anything, I fully agree it’s a more appropriate way to invest in unlisted holdings. But it’s not hard to imagine that if these had failed then people would ask why a mainstream investment trust had put money into such ‘exotic’ fare. []
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10-year retrospective: Commodities – the lost asset class

This post is one of a series looking at returns in the decade after the financial crisis.

Commodities were hot in the early noughties. Prices boomed, they became easily accessible through the invention of Exchange Traded Commodities (ETCs), and the broad commodities story was amazing:

  • Long-term returns approaching equities.
  • Low to zero correlation with equities and bonds.
  • High correlation with unexpected inflation.

That list of selling points made broad commodities the dream diversifier.

Unfortunately it really was a dream, at least so far as the past ten years is concerned. Trustnet provides the chart that tells our story1:

Commodity returns 2009 - 2019
Subsequent research has poured hot and cold hogwash over the claims of equity like returns and reliable inflation hedging from commodities.

Meanwhile anyone living the dream woke up to high volatility and a decade of losing returns: -2% annualised over the last decade, or a -5% real return (see lime line C).

I looked at the ETFS Energy ETC due to its exposure to oil and gas (cyan line B). Oil’s boom during the 1970s was used as evidence that it’s a strong hedge against stagflationary recessions.

The oil price hit nosebleed territory in 2008 and despite the 2009 pullback, the rise of those energy-hungry emerging markets meant the oil price could only go one way, right?

That’s right, it went down. Subsequently the ETFS Energy ETC lost -9.5% annualised (-12.5% real), the worst performer of all in this review.

Goldie lots

Maybe the gold bugs were right along? Physical gold had a tremendous Global Financial Crisis returning 90% between November 2007 and February 2009. Since then it’s brought in a 7% annualised return (4% real).

Not bad for an asset with an expected real return of zero.

Gold is meant to be valuable because of its low correlation with other assets and that bears out in the chart above. Compare the pink line D (gold) with the black line A (MSCI World).

I’ve stayed out of gold in my accumulation years due to its lack of expected return and dividends but there’s a case for it in a deaccumulation portfolio.

Note that in our last 10-year retrospective recap we discussed in some detail getting gold exposure via the gold miners. That’s as opposed to owning the metal itself, which is what we’re talking about here.

Are any readers keeping their faith with broad commodities as an asset class over the next ten years? Let us know in the comments below.

Take it steady,

The Accumulator

We’ll continue to gaze back 10 years to see how several other passive-friendly strategies have fared. Subscribe to get all the posts.

  1. Trustnet provides annualised and cumulative return data for periods of up to 10 years. The results below are quoted in nominal £ returns, with dividends reinvested from 14th September 2009 to 13th September 2019. []
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How to get a 14% return from RateSetter

Mixing RateSetter’s £100 bonus offer and high interest rates should deliver a tasty return

Good news! RateSetter has brought back its £100 bonus for investors who put away just £1,000 for a year. To get the bonus, follow my links to RateSetter in this article. I will also be paid a bonus by RateSetter if you sign up via one of these ‘refer a friend’ links to claim your £100 bonus. This doesn’t affect your returns – it is paid by RateSetter.

I won’t cause any readers to fall to their knees screaming “No! How can it be? Why didn’t somebody tell me!” if I say it’s been hard to get a decent interest rate on cash for the past few years.

Even the Bank of England’s rate rises haven’t done much. High Street banks always drag their feet in passing on rate rises.

But in this article I’ll explain how you can effectively get a 14% return on a chunk of your cash by taking advantage of a bonus offer from RateSetter, the peer-to-peer lender.

True, this very attractive potential return does not come without some risk.

In practice, no Ratesetter investor has yet lost a penny. Every lender has received the rate they expected.

Nevertheless, peer-to-peer does not have the same protections as traditional cash deposits, so you should think about it differently to cash in the bank. More on that below.

If you can accept the risk and have the spare cash to hand, I believe this is a pretty safe – though not guaranteed – way to make a good return.

It also exemplifies how being nimble with your money can enable you to achieve higher returns – even in today’s low rate world.

Not a few Monevator readers have taken advantage of this win-win RateSetter offer over the past couple of years!

About RateSetter

RateSetter is one of the new breed of peer-to-peer lenders aiming to cut out the banks by acting as a matchmaker between ordinary savers and borrowers like you and me.

Rates change all the time, but as I write you can get up to 5.4% as a lender with RateSetter by putting your cash into its five-year market.

Since March 2018 you’ve also been able to open a RateSetter ISA, which means you get your income tax-free.

Meanwhile borrowers can get a loan charging less than 4%. RateSetter claims that rate is competitive with the mainstream banks, and says banks are its competition (rather than it simply getting all the bank rejects).

RateSetter charges no lending fees, which is great news for savers like us. Borrowers do pay a fee.

Over £2.5 billion has now been lent through the RateSetter platform. This is no longer a tiddly operation.

And importantly, of the 66,942 investors who’ve lent money with RateSetter not one has yet lost a penny of their investment.

In 2010 RateSetter set-up a ‘Provision Fund’, which is funded by charging all borrowers a risk-adjusted fee.

Money from the Provision Fund is used to repay lenders whose borrowers miss a payment, for as long as there’s money in the fund to do so.

It’s a different model to the initial approach of rivals like Zopa. Back then you were encouraged to spread your loans widely and accept a few would go bad, reducing your return.

The RateSetter approach is different.

But as sensible people of the world, we should understand there’s no magic here.

Downside protection

Some loans will still go bad. And those bad loans will still reduce the returns enjoyed by lenders in aggregate – because the Provision Fund fee levied against borrowers as part of the cost of their loan could otherwise have gone to lenders through a higher interest rate.

However what the Provision Fund does is share those losses between all lenders, reducing everyone’s return a tad.

This makes your returns predictable. Your outcome should be dependent on the interest you receive – rather than being distorted by the poor luck of being personally hit by an unusually high number of bad debts.

Note that the Provision Fund does not provide complete protection against a situation where all the loans made at RateSetter default. Far from it!

Rather the Provision Fund aims to cover the bad debts predicted by RateSetter’s models, with a margin of safety on top.

At the time of writing, Ratesetter says:

In the event that credit losses were to increase significantly, the following things would happen:

  • The Provision Fund would reduce in value as it reimburses investors for missed payments.

  • The Provision Fund is large enough to cover credit losses up to 116% of expected losses. If credit losses rose above this level, the Provision Fund would be depleted and investors would earn less interest than they expected, but their capital would be unaffected.

  • If credit losses rose even further and exceeded 231% of expected loses, investors would start to lose capital, which means that they would get back less money than they put in.

  • In this instance, it may take longer than expected for investors to receive their money back and access to funds may be restricted.

What would happen if losses did exceed the RateSetter projections?

First the Provision Fund would be used up, and ultimately exhausted.

After that interest payments could be redirected to repaying capital. You’d lose on interest payments, but it could cover lenders’ losses on capital unless the default rate got too high.

Finally, in a doomsday scenario with very high default rates, capital could be eroded. I’d expect other investments like equities and corporate bonds would also be taking a pummeling. But cash in the bank would not.

At the end of the day, I believe for most people the Provision Fund approach is preferable to the lottery of individual loans defaulting. But don’t mistake it for a panacea or a guarantee.

You could conceivably lose money if defaults are much worse than expected. More on that below.

How to bag that 14% return from RateSetter

At last, the good bit!

RateSetter is currently offering a £100 bonus to new customers who invest at least £1,000 in any of its markets and keep it there for a year.

This £1,000 minimum investment can be made up of new subscriptions and/or transfers from other ISA providers.1

The £100 bonus is paid once that year is up. It will be deposited into your RateSetter account, after which you can choose to do with it (and the rest of your money) as you please.

Clicking on any of the RateSetter links in this article will take you directly to the sign-up page for the £100 bonus.

For full disclosure, RateSetter will also pay me a £50 bonus if anyone does sign-up via my links, which would obviously be very welcome! My bonus doesn’t affect your returns. It’s paid by RateSetter.

As for your £1,000 investment, you can put it into any RateSetter market, which range from a rolling one-month option to a five-year lock-up. But you must keep it within RateSetter for a year to get your £100 bonus.

To keep things simple, let’s assume you invest your £1,000 in the one-year market, which matches the period required to qualify for the bonus.

The one-year market is paying 4.7% as I type.

So after one year you’d have your 4.7% interest on your £1,000 and you’d also receive your bonus, which works out as a return of 14.7% on your £1,000.

Very nice!

I’ve ignored taxes here because everyone’s tax situation is different.

The good news on taxes is that:

  • You can now open a RateSetter ISA and collect the bonus. You can fund this with a transfer from another ISA provider. In an ISA the income you earn is tax-free.
  • Most people even outside of an ISA will pay no tax on cash interest, thanks to the new-ish Personal Savings Allowance that covers the first £1,000 of interest earned by basic rate taxpayers, and £500 for higher-rate payers.

Is this bonus too good to be true?

A great question.

Clearly it’s not sustainable for RateSetter to lend your money out at, say, 4%, while paying you an effective rate of nearly 15%.

(The cost is even higher to RateSetter if it pays me a bonus, too.)

RateSetter must be hoping this is the start of a multi-year relationship with its new sign-ups, after they become comfortable with its platform.

Once you get over the initial hurdle, peer-to-peer is straightforward. I’ve used these platforms for ten years now.

RateSetter will hope many customers deposit more than £1,000 and ultimately prove profitable in the long-term.

Like all peer-to-peer lenders, RateSetter will be aiming to scale as quickly as possible. Greater size will improve its margins and enable it to continue to meet demand in both the savings and loans market. Scale is a critical factor in virtually all money-handling businesses.

Finally, I expect the cost of this offer is allocated internally to its marketing department.

If 5,000 people sign-up for the bonus that’s clearly a lot of money – but it wouldn’t buy very much TV airtime. At least this way RateSetter can precisely calculate the return on its investment.

I do think it’s a smart question to ask, though, and it neatly brings us back to risk.

A final word on the risks

I have already stated that peer-to-peer lending is not a straight swap for a cash savings account.

The risks are higher.

Firstly and crucially, there’s no Financial Services Compensation Scheme coverage for peer-to-peer lenders. If you lose money, the authorities will not bail you out like they would for up to £85,000 with a High Street bank savings account.

That’s important because even though no savers have yet lost a penny with RateSetter, that’s not a guarantee they will not do so in the future.

The economic situation could change markedly, say, or RateSetter could get its sums wrong on bad debt.

In the most likely (in my opinion) worst-case scenario, the Provision Fund would not be able to cover all the bad debts. This would mean some loss of interest.

  • According to RateSetter, as of August 2018 the loss rate experienced to date is 2.29%.
  • It currently projects this to rise to 3.33%. (Loans take a while to go bad.)
  • If credit losses rose to 127% of expected losses, RateSetter‘s model indicates the Provision Fund would still cover interest.
  • In what RateSetter terms a severe recession, you’d get no interest but it believes you’d get your initial money back.
  • If we saw 400% expected losses, investors might lose 5.6% of their capital.

This illustration is summarized in the following chart:

Provision Fund figures correct as of 1st August 2018. (Click to enlarge)

Source: RateSetter

As for the worst worst-case scenario, like with any business it is possible to imagine catastrophic situations where you’d lose much more.

But to my mind these would probably require fraud or massive incompetence within the company, and/or a far deeper recession than anything we saw in 2008 and 2009. (Probably both at once – as Warren Buffett says you only see who has been swimming naked when the tide goes out.)

Obviously I don’t think that’s at all likely, otherwise I wouldn’t have put any money into RateSetter.

But a hint of what might have gone wrong came in 2017, when the company intervened to restructure several businesses and cover repayments from one via its own funds. This prevented its bad loans from being defaulted to the Provision Fund. This decision to intervene reportedly2 delayed authorization from the FCA. It has subsequently been granted.

RateSetter says: “This intervention was an exception and will not happen again.”

As I understand it, RateSetter has since withdrawn from the wholesale funding operations that produced this situation. (Wholesale funding is when a company lends money to third parties, who then lend those funds on themselves.)

You invests your own money and takes your choice.

Personally, I am happy with the risk/reward here. Not everyone feels the same. My co-blogger, for instance, doesn’t use any peer-to-peer platforms.

As a halfway house to reduce risk one could perhaps only invest in RateSetter’s monthly market, in the hope this would give you more chance of getting money out relatively quickly if say the economy was coming off the rails. The price is a lower interest rate, of course.

I think it’s worth stressing again that nobody has lost money so far with RateSetter. And even if the economy turns very far south, you probably won’t lose more than a small percentage unless something very bad or criminal happens.

That would be a much worse situation than with cash, but not a catastrophe.

However we all know by now that bad things can happen, and every investment can fail you. Do not invest money you cannot afford to lose.

RateSetter and your portfolio

Personally I have always taken a pick-and-mix approach to spread the risk with these sorts of alternative opportunities.

For instance, I have used both RateSetter and Zopa, I’ve invested a little in mini-bonds and retail bonds, I have money with NS&I, and I have taken advantage of high interest rates and cashback offers with accounts like Santander 1-2-3 to boost my returns.

When putting money into the riskier alternative options, I only invest a low single-digit percentage of my net worth with any particular platform. Like this I aim to mitigate the risks of being hit by some sort of systemic or company failure.

I’m not going to labour the point on risk further. Most peer-to-peer articles barely mention it, and I’ve devoted half this piece to it. Consider yourself warned, and read the company’s extensive material if you want to know more.

I think peer-to-peer and other cash alternatives are interesting additions to our arsenal as private investors. But they’re not slam dunk safe bets. I size my exposure accordingly.

Get your £100 while it lasts

So there you have it – a hopefully even-handed assessment of the risk and reward potential of this £100 bonus offer from RateSetter.

From here you’ll have to make your own mind up.

I do hope some of you found this article interesting and enjoy those bonus-boosted returns.

  1. Note: Terms and conditions apply with transfers, so check the small print. The money must be transferred over within a certain time period, which may be down to the ISA provider you’re transferring from. Just setting up a new RateSetter ISA with a fresh £1,000 should be straightforward. []
  2. See this article at Reuters: https://uk.reuters.com/article/uk-interview-ratesetter/ratesetter-recovering-after-asteroid-strike-bad-loan-discovery-idUKKCN1BN1PF []
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Weekend reading logo

What caught my eye this week.

I am away from my (home) office again today, so it’s another premature round of Weekend Reading links.

When I go early with these I sometimes miss good stories. If you do see anything others should read, please add it in the comments below.

A few people have said they’d prefer to always get the links by early Friday afternoon. Apparently these paragons slackers are done with their working week by then. I admire the spirit, but when we publish early we don’t really see much of an uptick in views or comments so it seems to be a minority who can start the weekend early.

If you are reading this before 6pm on Friday and you wish you always could – at the cost of some missing links – let me know below. It will all be evaluated and taken into consideration, Sir/Madam.

Have a great weekend! 🙂

p.s. If we do get a Brexit resolution where Northern Ireland is in the single market but not the customs union – with an ocean border with mainland Britain and no physical checks on the border with the Republic of Ireland – then I suspect there may be a case for buying investment property in Belfast before the boom! There will surely be arbitrage opportunities in such a scenario.

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