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Asset class outlook for 2011

by The Investor on January 4, 2011

I am not so foolish as to expect anything from any asset class in 2011. All markets are unpredictable, especially in the short-term.

That said, a money blogger is duty bound to make a stab on the outlook for asset classes, however futile. Otherwise he risks losing all his readers to more excitable blogs that promise gold will hit $10,000.

Also, while expensive looking assets can always get more expensive and cheap ones even cheaper, in the medium term these things tend to revert to the mean.

Mechanically rebalancing your portfolio is a sensible way to take advantage of this. If you’re a more active investor though, you’re forced to employ your judgment. So with all these caveats in mind, here’s some thoughts:

UK shares look reasonable value, with the FTSE 100 on a forward P/E of about 13, and not too pricey on a longer-term basis. I’m worried by growing fund manager optimism, rising gilt yields, and potential sterling strength. Set against that there’s clearly plenty of retail money sat on the sidelines, and corporate earnings are strong.

Overseas shares are a mixed bag. US shares have done well in 2010 – they’re more expensive than the FTSE 100, but arguably more exposed to mid-cycle growth. European shares might be a decent contrarian bet; Germany has done very well, but Spain and Italy have slumped. Japan looks cheap as ever. Please do remember currency risk if you invest abroad.

Emerging markets are starting to look frothy, but as I wrote in my article on emerging market funds, such trends can take years to play out. I’m not chasing performance, but I’m not selling the exposure I’ve got, either. Beyond that I think buying the likes of Diageo and Caterpillar offer a cheaper way to benefit from global growth.

Government bonds have looked expensive for two years: I was right in 2009, and wrong for most of 2010. With the 10-year UK gilt yield now up to 3.6%, they’re becoming better value. I’d probably have a nibble at 4% (previously I wanted 5%, which incidentally you can now get on perpetual Consols).

Corporate bonds don’t offer much appeal – I’d rather buy shares. Some of the bank preference shares may still be bargains, if you’re after long-term income, but make sure you know the company-specific risks you’re taking on.

Cash isn’t returning much compared to inflation; even Zopa interest rates have crashed. Nevertheless I can see myself saving more cash in 2011, particularly as I’m over-invested in shares. Cash is the king of asset classes.

Gold fans talk a great game, but it’s a complete wild card. I wish I hadn’t sold my Gold and General Fund back in 2007 – not so much for the performance since then, but so I wouldn’t have to worry about whether I should buy some now to protect me from the indisputable currency games going on. There’s a lot of fear and momentum in the gold price, in my view.

Commercial property didn’t do much in 2010; bellwether Land Securities is flat on the year, though some of the smaller outfits have done better. I continue to think the big REITs are an attractive asset class that offer some protection from inflation, plus an income, for a fair price. The headwind is fears that banks will dump their written-down property at bargain levels, but I think that’s probably in the price.

Residential property remains my bête noire, with the London bubble seemingly immune to even global recession. If I was buying a home outside London, I’d probably buy now on a ten-year fix to lock-in low rates. But whereas the froth has come off in the provinces, prices in London are already back to 2007 levels. It seems unsustainable, but I’ve been wrong about that for years. I wouldn’t buy an investment property anywhere in the UK at current yields, but parts of the US might get attractive if the pound strengthens.

For me then it’s a murkier picture than at the start of 2010, in that the big fears are still around, but it’s harder to buy cheap assets that reflect those uncertainties in their price.

Personally, I’m minded to stay near-fully invested, but to save new money and dividends into cash and to possibly rebalance my portfolio towards more sensible asset allocation as the year progresses.

As ever, Monevator house policy is that the average investor will do better with a cheap and largely passive diversified portfolio from day one. Please take all this speculation therefore with a pinch of salt, wherever you might read it.

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Weekend reading: Happy New Year!

by The Investor on January 1, 2011

Reflections on the year just gone, and links to some of its highlights on Monevator.

With a sprightly 2011 bowling through the front door even as 2010 is stretchered out the back, I’m reflecting it on a good 12 months for UK investors:

The All-Share index is up 12% on the year ¹, or 15% with dividends. Take that bears! Optimists like me were rare for most of 2010.

We’ve got a Coalition Government and a Central Bank striking a balance – however acrimoniously – between cuts and stimulus.

Europe threatened to blow up, but the countries that matter didn’t, and Germany and France are now on notice.

Lord Young was right: If you’ve not lost your job, you’ve never had it so good. Mortgages are very cheap, and UK house prices haven’t crashed like they should have – they’ve actually risen in London. UK PLC recovered, at least compared to what most expected in 2009.

The emerging world is growing great guns.

There were disasters, of course, from the BP oil leak to formerly high-flying FTSE companies going bust and shareholders losing the lot (see Rok and Connaught).

High unemployment, especially among the young, remains a big worry, and a personal disaster for those affected. We better hope it’s not structural, and do something about it if it is.

Personally I expect reducing benefits will help in the medium term, but then I’m often called a right-wing old duffer in waiting by my overwhelmingly Labour voting friends.

Please Sir, I’d like some more

Sensible investors would happily take 15% returns every year. Such a result in 2011 would hardly be outrageous given current valuations, improving sentiment, and stronger growth.

As ever though, emotions and stock market volatility makes short-term prediction a mug’s game. Anything could happen.

2011 will certainly not be plain sailing, for all the well-known reasons – Europe’s woes, weak US house prices and state indebtedness, and tax increases and spending cuts in the UK.

Then there are the ‘unknown unknowns’ – perhaps an emerging market meltdown, a new conflict, or a big terrorist attack in the West (I fear we’re overdue the latter).

As for the longer term, the truly huge issues – energy transition, over-population, and environmental concerns – still lurk in sight but generally ignored, like wrinkly Grandmas poised to steal a toothy kiss. Agreements on deforestation reached in Cancun in December are a start, but biodiversity (including that in the sea) should be at the top of the agenda for everyone’s sake, especially the poor.

Finally on the future, despite the futility of making short-term predictions I’ve written up my outlook for specific asset classes in 2011 in a separate post to go live next week. Please do pop back to check it out.

My 28 favourite articles from 2010

Now a confession: I am engaged in year-end hedonism this weekend, and so I’m not around to do my usual Saturday morning media wrap.

Instead, I’m going to offer up 28 articles posted on Monevator in 2010 that I humbly submit are still worth reading if you missed them.

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As of 29th December, which is when I’m penning these words.[↩]

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Warning: Income investment trusts trading at a premium

by The Investor on December 29, 2010

The price of income investment trusts have risen to trade at a premium

Few of us worry when our shares go up. But with income investment trusts trading at a premium, do remember that what goes up can easily come down.

This is especially the case with investment trust premiums and discounts. Because they reflect investor appetite, they can be reversed even more quickly than the usual rises and falls in the stock market.

Everyone loves a good discount

A couple of years ago you could buy income investment trusts at a 10% or more discount to their net assets.

In other words, for every 90p you spent, you effectively bought £1 of the trust’s underlying investments.

Such a discount is great if you’re buying income, since a trust’s income is generated by its underlying investments. All things being equal, a 10% discount means roughly a 10% higher income for you.

Indeed, as I wrote back in the glorious days of summer 2008, since most income investment trusts hold blue chip dividend paying shares, if you owned a portfolio of such shares, it made sense to swap them for an income trust going cheap.

As well as getting the discount, by swapping for the trust you probably got extra diversification, too, and the benefit of the trust’s income reserve, which smooths out the income payments in poor years.

The downside, apart from trading fees, was taking on the trust’s annual charge, and also some management risk.

Investment trusts, going cheap expensive!

Two years on, this pleasant situation has reversed. Popular income investment trust now trade at a premium ¹:

Edinburgh – 5.7% premium

Merchants – 4.6% premium

City of London – 3.4% premium

When you pay a premium for an investment trust, the bargains have vanished. In the case of Edinburgh, you’re paying £1.05 for £1 of its underlying assets.

I’ve written before about the reasons why investment trusts trade at a premium. In the case of income trusts, I am pretty sure it is due to fashion, in that people sick of poor returns from cash or bonds have been buying the trusts for income.

Nothing wrong with that, but it’s important to realize the premium is not due to the underlying income paying shares doing especially well in recent months, nor a reflection of rising faith in manager’s skill.

For instance:

The Edinburgh Trust had a NAV ² of 390p on January 4th 2010. As of December 24th it had increased to 438.5p, an increase of 12.4%.

Over this period, the shares rose from 381.5p to 460p, an increase of 24%.

As you can see, the share price performance of the Edinburgh Trust has been much stronger than the growth of its investments! As a result, the trust has moved from a discount to a premium.

You can see this divergence in its performance graph on the Trustnet website:

(Click to enlarge)

At the start of 2010, the share price and the NAV are all rebased to zero. Looking at the blue line, we can see how the share price has increased faster than the NAV (the yellow line).

The red line shows the average performance of trusts in the growth and income sector. As you can see, Edinburgh’s performance is smack in line with the sector average, so it seems very unlikely that the trust is being bid up in value because investors expect it to outperform.

Rather, I think it’s very likely that investors looking for equity income have been drawn to the trust by its (historically excellent) fund manager Neil Woodford, and have bought in regardless of the NAV.

What should you do if you hold such an investment trust?

Just because you hold a trust trading at a premium doesn’t mean you need to do anything about it. It all depends on why you bought the trust, and what kind of investor you are.

You invested for long-term income…

If you bought the trust for income, you will be happy to hold. Trading in and out of investment trusts can be expensive. The premium doesn’t effect the trust’s ability to pay dividends (if anything it enhances it by enabling it to issue new shares on good terms) and if you were happy with an initial 5% yield, say, nothing has changed.

Also, premiums are not unusual for income investment trusts, perhaps due to their historically steady performance. If you only hold them when they’re on discounts, you might not hold them much at all.

Just keep in mind that the premium could dissipate as quickly as it came (reducing the capital value of your shares) should investors get nervous.

You bought for discounted income, but you usually own shares…

If you’re a confident and practiced investor in individual company shares, you may see an opportunity to swap the trust for a high yield portfolio.

The two largest holdings of the Edinburgh Trust are the big drug makers AstraZeneca and GlaxoSmithKline, which offer a yield of 5.2% and 4.8% respectively. The yield on the trust is 4.5%.

Do you want to pay Neil Woodford a premium (and an annual fee) to buy blue chip shares like these? Perhaps not, but remember if you do it yourself you’ll need to diversify your high yield portfolio and take on more risk by running your own money.

You don’t own an income investment trust, but would like to…

Tricky. If you buy a trust when it’s trading at a premium, you have to accept you’re paying over the odds.

That doesn’t mean your shares will inevitably fall in value. It may be that the share price just increases more slowly in future than the underlying NAV, thus reducing the premium.

Also, if we are into a true bull market, then yields are only going to fall in the years ahead. You could be waiting for some time to buy on a discount, and the yields on offer from trusts are still pretty good in historical terms.

Personally, I’d rather buy high yield shares directly with the trusts trading at a premium, but that’s not an appropriate choice for most investors.

You’re an active share trader…

Finally, if you bought specifically for the discount, as a trading opportunity, you might want to consider selling up and swapping into growth-focused investment trusts that may offer better value.

Big growth trusts such as British Empire and General, Hansa, and the Mercantile Trust are still trading on reasonable discounts. Others, such as the Rothchild’s RIT Capital Partners, are no longer a bargain, but have historically done very well in bull markets and offer great diversification.

Bottom line: The varying discounts and premiums on investment trusts are an extra opportunity thrown up by Mr Market to do with as you will.

It’s one thing that makes buying investment trusts more complicated and risky than an index tracker, but also more interesting (for good or ill) to devotees.

Note that there are various ways to calculate the discount and premium. My figures come from Digital Look, which seemingly takes the toughest line, which is to use the investment trusts NAV with all its assets rated at marked-to-market values. But this was the same methodology I used back in late 2008 when we saw big discounts on the same trusts.[↩]
Valued cum income[↩]

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The best of the Wealth Pilgrim blog

by The Investor on December 28, 2010

A blogging friend of mine, Neal Frankle, has had some extreme technical issues with his Wealth Pilgrim blog over Christmas. As a result, his posts have lost their shine in the eyes of mighty Google.

Given how hard it is to buy presents, survive Christmas ‘fare’, navigate choppy family waters, and to still keep blogging over the holiday period, even without your website falling over, my heart goes out to him.

Plus Neal is a fellow member of the Money Mavens network. This means he is a keeper of one of the eight ingredients of the antidote to the poison consumed by all Mavens. If I don’t answer his call when he beams the MM logo onto the side of his nearest Wal-Mart, all my toes could shrivel up and fall off.

Bottom line – it gives me great pleasure to plug ten of Neal’s favourite posts, both for those of you fed up with Christmas TV, and to give the mighty Google a reboot up the backside.

[continue reading…]

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