You pay stamp duty on UK property when you buy a home that costs more than £125,000.

There is no stamp duty payable if you’re the seller of the property.

Stamp duty is a transaction tax (the long name is Stamp Duty Land Tax), which you need to take into account when working out your budget for moving or buying a home for the first time.

Buying a property in Scotland? From April 2015 stamp duty is replaced by a levy called the Land and Buildings Transaction Tax.

Stamp duty on UK property rates

The stamp duty rate paid by home buyers varies depending on the purchase price of the property.

There are five stamp duty rate bands. You pay stamp duty at the indicated rate on the portion of the price lying within each band.

The stamp duty rate bands are as follows:

Purchase price band	Stamp duty rate
£0 – £125,000	0%
£125,001 – £250,000	2%
£250,001 – £925,000	5%
£925,001 – £1.5 million	10%
Over £1.5 million	12%

Source: GOV.UK

For instance, if you were buying a home for £400,000 you’d pay:

No stamp duty on the first £125,000 of the total £400,000.

A 2% stamp duty rate on the next £125,000 up to £250,000.

The 5% rate on the final £150,000 of your £400,0o0 purchase.

This works out as:

£0 (up to £125,000) + £2,500 (2% of £125,000) + £7,500 (on £150,000)

= £10,000 in total stamp duty.

Incredible! An improvement to the tax system

Under the old stamp duty system, stamp duty was payable at the highest applicable rate on the total purchase price of a property.

That was a really stupid way of doing things.

Stamp duty inevitably adds friction to the home buying process by making it much more expensive to move house, and it doesn’t do much to restrain prices.

But the old system also distorted asking prices.

For instance, there was a 3% band that kicked in if you bought a property worth more than £250,000. Stamp duty on a £250,000 property was £2,500, but were you to pay just £1 more you’d face a stamp duty tax bill of £7,500.

You’d pay an extra £5,000 in stamp duty because of that measly £1!

In reality few people would do that, so house prices were distorted around the different bands by sellers trying to take into account these warping effects when setting their asking price.

Similar one-bedroom Zone 3 London flats stayed priced at £250,000 for many months even in the rising market, for instance, before leaping up to £275,000 as a group. Very few people ever paid £255,000 in the meantime.

Buyers also resorted to ruses to reduce stamp duty.

The new stamp duty rates introduced in December 2014 did away with the distortions of the old ‘slab’ stamp duty system, because the higher rates are only chargeable on the portion of the property price that falls within each rate band. (It’s similar to what happens with your salary and income taxes).

In addition, the total stamp duty you’ll pay on a particular property price is lower in the vast majority of cases under the new system.

Chancellor George Osborne says you’d have to spend more than £937,000 to see your bill go up under the new system.

The £10,000 payable in my example above would have been a £12,000 stamp duty bill before – that’s a saving of £2,000 under the new stamp duty rules.

But put the Aldi prosecco back on ice – I’d expect any such savings in the cost of buying a home to be quickly reflected in house prices moving higher.

The main benefit of the 2014 overhaul of stamp duty will therefore be the removal of those cliff-edge distortions, which may make the market a tad more liquid, too.

Stamp duty on UK property calculator:

• You can work out your stamp duty bill under the new system using this handy HMRC stamp duty calculator.

That calculator also shows you what was payable under the old rules, which may be handy to know if you’re in the midst of a move.

Ever been passed over for promotion by some smooth-talking stuffed shirt? Then take heart from the profitability factor. Also known as the quality factor, this is a real-world example of the triumph of the best over the rest.

The profitability/quality factor reveals that companies that make the best use of their capital outperform their less efficient brethren over the long-term.

In fact, the most profitable companies can bring home a return premium that has hitherto beaten the market by up to 4% a year.

The trick is to invest in the companies that are rippling with the signs of financial prowess most likely to predict profitability in the future.

Like a Moneyball chief scout or an international Top Trumps player, you need to know which stats matter most…

…or you could just pick an Exchange Traded Fund (ETF) with Quality in its name.

Quality over quantity

There are only three quality factor ETFs currently available to UK investors. Choosing one shouldn’t take long, right?

The snag is that financial engineers have more definitions of quality than the Eskimos have words for snow.

True, every kind of return premium can be formulated in different ways

But quality comes in so many flavours that you just know some must be watered down.

How do you choose the right version of quality? Is there a right version? Which has performed best historically? Does it even matter?

A trip down quality street

First of all, it’s important to understand that quality can be defined by a single measure, or by a cocktail of stats as drawn from a company’s annual report.

Here’s a snapshot of the yardsticks used by different industry practitioners:

• Return On Equity (ROE) – One of the most commonly used quality metrics.

• Gross profits / assets – This is gross profitability as defined by Professor Novy-Marx and widely considered to be the champagne of quality factors.

• ROE, debt to equity and earnings variability – Used by the MSCI Quality Indices.

• Stability of earnings and dividends over the last 10 years – The S&P formula.

• Gross profits / assets and gross profit margins plus free cash flow / assets – The preference of US fund house AQR.

• Net income, operating cash flow, return on assets, stability of earnings, leverage, liquidity equity issuance, gross margins and asset turnover – The Piotroski F-Score financial health test.

Novy-Marx’s work caused a stir because his gross profitability metric trounced the market by 4% a year between 1963 and 2011. As a single quality metric it’s tough to beat and I’d want it or a close proxy in any quality fund I bought into.

However even Novy-Marx thinks that the best quality metric will be a blend of measures. For example, cash flow / assets is unpolluted by some of the accounting inconsistencies that can interfere with the gross profitability signal.

The question then is do the available ETFs offer us the finest quality cuts, or are they slipping in some horse meat?

(Or – worse – horse output!)

Quality ETFs

The three ETFs I mentioned earlier all track developed world equities, using a blended metric to tilt their holdings towards the quality end of the spectrum.

The higher a stock scores on the fund’s quality scale, the greater its presence, subject to any applicable cap.

Note: These ETFs are so new that it’s not even worth considering their track record – they just haven’t been around long enough for their track record to be relevant.

ETF	OCF (%) 1	Ticker	Quality metrics
iShares MSCI World Quality Factor	0.3	IWQU	High ROE, low leverage, stable earnings growth
db X-trackers Equity Quality Factor ETF	0.25	XDEQ	High Return On Investment Capital (ROIC), low accruals
Lyxor ETF SG Global Quality Income	0.45	SGQL	High Piotroski F Score, strong balance sheet, high dividend yield

Source: ETF suppliers

Unfortunately I’m not in love with any of these ETFs.

iShares MSCI World Quality Factor ETF

Let’s start with the iShares offering.

Gross profitability appears to be the most successful of the quality metrics, but the iShares ETF uses ROE instead. Its weakness is that it focuses on net profit.

Gross profitability highlights companies that are investing in future revenues by devoting resources to R&D and advertising. But these beneficial activities subtract from a firm’s net profit and make it look less profitable in ROE terms.

The paper Global Return Premiums on Earnings Quality, Value and Size analysed a suite of quality factors (not including gross profitability) and placed them in the following order of performance:

1. Cash flow to assets
2. Accruals
3. ROE
4. Low leverage

Cashflow was by far the best metric, with little separating the other three.

A second paper – this time by Pimco – criticises the other two metrics used by the iShares ETF: low leverage and stability of earnings growth.

Here’s what the paper’s authors have to say:

There is little agreement that buying stocks of companies with low debt generates alpha. In fact, according to the evidence available in the academic studies of Bhandari (1988) and Fama and French (1992), low-leverage firms tend to underperform.

We are not aware of any empirical link between earnings volatility and expected returns. The only related papers, to our knowledge, are Haugen and Baker (1996) and Huang (2009). The former found no significant relationship between returns and volatility of earnings yields. Huang found the firms with stable cash flows tend to outperform.

Finally, the annual return of MSCI’s quality metrics (as tracked by the ETF) trailed in a lowly fourth place between 1985 and 2012, according to the paper Defining Quality by the asset manager Northern Trust.

It ranked the annual returns of various quality formulas as follows:

• Piotroski F-Score: 8.4%
• DFA’s metric ²: 6.3%
• ROE: 5.5%
• MSCI 4.9%

Overall then, I’m unconvinced that the iShares ETF is using a particularly effective form of quality.

What’s more, iShares optimisation rules mean that it can hold stocks that are not in the index if it thinks the substitutes will give a similar performance.

The whole point of passive investing is to provide a set of rules that remove subjective judgements – rather than to provide enough get out clauses that the fund manager can effectively do what it likes.

db X-trackers Equity Quality Factor ETF

The Deutsche Bank ETF whips up its quality formula from Return On Invested Capital (ROIC) and accruals.

Accruals is okay as a quality factor but hardly a barnstormer according to the Global Premiums paper referenced above.

Moreover, accruals can be calculated in many different ways, which adds an extra level of complexity when you’re trying to work out what exactly you’re getting from the ETF.

ROIC does marginally better than ROE in the return stakes according to Pimco, but it’s still a net income metric that lacks the potential punch of gross profitability.

Once again, I’m left with the feeling that the quality on offer could be better.

And I’ve got even bigger problems with the index the ETF tracks – it’s owned by Deutsche Bank who also own this ETF.

Deutsche Bank can amend its index rules as it sees fit. That lack of independence makes me uncomfortable with a product that is meant to operate according to a strict set of rules. Rules don’t mean much if you can change them at a stroke.

Lyxor ETF SG Global Quality Income

Multi-factor products are probably the future – a single fund that enables you to combine the profitability, value, momentum and market factors all in one.

The Lyxor product feels like an early stab at this. It combines aspects of value (a high dividend yield) with quality (the Piotroski F-Score) and ends up with a defensive tilt that resembles a low volatility ETF.

As we saw earlier, the F-Score has proved pretty successful in the past at capturing the quality premium.

Big tick!

However Lyxor’s defensive recipe then concentrates the ETF in 25 to 75 companies (versus 298 in the iShares ETF) with a 32% allocation to utilities alone, according to its fact sheet.

That’s effectively a bet on a particular sector that we have no reason to believe will outperform. There is no evidence to suggest that any sector delivers excess returns over time, and investors are not rewarded for taking that risk.

So while the asset allocation of this ETF is significantly different from the other two, the lack of diversification makes me wary.

The index used is again the property of its parent company, Societe Generale, with the wheel clamp on independence that implies.

Finally, it’s a synthetic ETF. That doesn’t overly bother me but it does bother many others.

Quality streak

All three ETFs contain an element of quality but not the high-grade stuff I’m looking for.

If they combined gross profitability with cash flow then I’d feel much happier about signing up. As it stands I’d rather wait and see if anything better comes along.

It must be said that different definitions of any risk factor will outperform at different times. For all anyone knows, the quality metrics of these ETFs could hit an amazing streak in the years to come.

For example, ROE weathered the 2000-2002 and 2008 bear markets very well. Low leverage was a star in the late 1990s but fell from the sky after the 2000 tech bubble burst.

But all that is a matter for the gods. Right now, I’m content to watch these first-mover products build up their track record while I wait for other market players to improve upon them with the next generation.

Think of it as like buying a high-quality third-generation Apple wonder-gadget, rather than a first iteration device held together with innovative sellotape.

Take it steady,

The Accumulator

1. Or TER. Learn more about the difference[↩]
2. Operating income before depreciation and amortisation minus interest expense scaled by book value – as practiced by passive investing fund house, Dimensional Fund Advisors.[↩]

Good reads from around the Web.

Moves are afoot to compel active und managers to reveal their ‘active share’ – an indication of the degree to which their portfolios differ from the market.

The greatest benefit would be to highlight closet tracker funds. These are active funds that charge high fees but can only ever deliver less than average returns because they essentially track the market.

Getting market returns while paying high costs is a guaranteed bad deal. A big benefit of market-tracking passive investing is that low charges leave you with more of your own money to compound over time.

The FT says [search result] that some fund managers are already planning to highlight their active share to investors:

Threadneedle Investments, which manages £92bn of assets, said it plans to begin disclosing the “active share” percentage on its fund factsheets and believes others should do the same.

“It’s something would have real merit and we would support seeing developed into an industry standard and normal market practice,” said Iain Richards, Threadneedle’s head of corporate governance and responsible investment.

“There is a valid concern about closet index tracking funds that charge active fees. It’s clear investors need better transparency around this and more consistent disclosure of a fund’s active share measure is one part of the solutions.”

Obviously this could be pressed into service as a marketing ploy for funds that are going through a good spell as much as any noble act of transparency. But it’s still a development I’d welcome.

Some people like to invest in active funds. They need to better understand what they’re buying.

More active might mean better returns…

For one thing, research suggests – at least to some onlookers – that high active share may be a signal that a fund manager has genuine market-beating potential.

I’ve not been convinced by what I’ve read, although I’d stress I’ve not rigorously investigated it all. I’ve simply come across various summaries over the years.

One big hesitancy I’ve had is that it seems obvious that a set of market-beating active funds is going to comprise of mainly funds that don’t look like the index.

If they held the same shares as the index, then by definition they wouldn’t have beaten it!

Yet presumably many of the funds that lose the most also look very different from the index, for exactly the same reason. (This is what gave rise to the practice of closet index tracking in the first place – better for a highly paid fund manager to be safe than sorry).

Perhaps this has all been taken into account in the research into active share. I need to set aside a Sunday to find out.

…but what do you care?

People tend to find what they’re looking for in this sort of thing.

For instance, I like and often link to the writings of the value investing team at Schroders, which has a blog called The Value Perspective.

This week one of their number found comfort in academic research that suggested that as well as a high active share, the best performing fund managers rarely trade:

The great majority of the outperformance of the universe of funds considered by Cremers and Pareek comes from the ‘high active share/long holding period’ group.

In other words, while not specifically on the subject of value, their paper appears to show that being prepared to be contrarian and patient – as value investors often are – plays a big part in achieving strong investment performance.

I sent a link to the article to occasional Monevator contributor The Analyst, as I know he likes to buy and hold for the very long-term.

Yet barely an hour later, I came across other research saying that actually, very high turnover active funds do better.

So I sent him that along as well.

With a shrug.

And that’s another reason to go passive – opting out of all this debate with a smile of ‘who cares’!

[continue reading…]