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Evidence Based Investing

Why market timing is futile and it’s time in the market that counts

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There’s a lot for investors to worry about.  High market valuations, rising interest rates, the prospect of a no-deal Brexit and escalating trade tensions fuelled by Donald Trump, all raise the likelihood of greater market volatility.

When markets are more volatile and investor sentiment turns negative, resulting in short-term falls in value, it can be tempting to try and time the markets.  Timing the markets involves attempting to sell before equity markets hit the bottom and then buying before they start to rise.  This sounds good in theory but, in practice, it doesn’t usually work out that way.  Instead, investors can find themselves selling low and buying high!  If investors repeat this process enough times they will soon run out of money to invest.  At the very least, the value of their portfolios will take a big hit.

One of the biggest problems with attempting to time the market is that you can easily miss out on a few of the best days of returns.  Do this, and your overall long-term returns will be significantly worse.  According to a study from Fidelity International a couple of years ago, an investor who invested £1,000 in the FTSE All-Share index 30 years ago, but missed the best 10 days in the market, would have achieved an annualised return of 7.09% and ended up with a total investment of £7,811.55.  This compares with an annualised return of 9.38% and an investment worth £14,733.64 if they had stayed in the market the whole time – an opportunity loss of £6,922.09.  If an investor had missed the best 20 days, their annualised return would be 5.55%, which would have resulted in an even worse shortfall of £9,676.56.

This research should remind us that volatility is the price we pay as investors, for long-term outperformance from equities, relative to other investment asset classes.  The potential for long-term returns comes from risk in the form of market volatility.

There are significant risks associated with trying to time the markets.  This is because it is so difficult to predict the best time to get out and then get back in to equity markets, during periods of market volatility.  These risks are magnified by the impact of the very best and worst days of market performance tending to be grouped together during periods of increased market volatility.

A more sensible approach to investing is to keep your money exposed to the markets throughout the entire market cycle, during the ups and the downs.  There’s an old stock market adage which says time in the market matters more than timing the market.  At Wells Gibson, we would tend to agree.

When markets are especially volatile, the value we add as financial planners, is to guide our clients and keep them focused on their long-term, lifestyle, financial and investment objectives.  Furthermore, because we can demonstrate the value of time in the market, and the futility of market timing, we are able to secure the best long-term results for our clients.

If you have been tempted to try market timing in the past or perhaps, during the current bout of market volatility, why not give us a call and see if we can keep you on the right track.

Is the tax tail of EIS and VCT investment wagging the investment dog?

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Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCTs) represent tax-advantaged opportunities to invest equity capital into very small and often very early stage, or even start-up, privately held businesses.  The words ‘equity’, ‘privately held’, ‘small’ and ‘early stage’ immediately point out some of the risks.

There is a certain human appeal towards investing in the next potential Google or similar tech start-up or to own a share of a biotech firm commercialising some aspect of research for the good of mankind.  Intuitively, one knows that this is a risky, dice-rolling business and that for every winner there are bound to be some losers and some also-rans.  However, the tax breaks afforded by HM Government, for these schemes, risk clouding the due diligence that these investments duly deserve.

It is a mistake to think that these tax breaks are noble in nature.  Their purpose is to encourage the supply of capital to these companies in the hope that they will employ more people, who will pay income tax, make NI contributions (individual and company) and pay VAT on goods bought with their wages – and that they will generate higher corporate earnings on which corporation tax can be charged.  The tax breaks are provided to improve the risk-return relationship that potential investors in these companies face.

EIS was launched in 1993-1994, as an evolution of the Business Expansion Scheme that went before it.  Since it began, it has raised billions of pounds for thousands of small companies.  In fact, according to the EIS Association, the official trade body for the Enterprise Investment Scheme, in May 2018, HMRC released the first of its estimates in respect of the number of companies raising funds and the amounts raised through EIS for 2016-17:  3,470 companies raised a total of £1.8mn of funds under the EIS scheme in 2016/17.  Remember this is an estimate and judging by previous years, we can expect these numbers to increase.

The VCT scheme was first introduced in 1995.  VCTs are similar to investment trusts, raising capital by the sale of shares in the trust, which is then invested into qualifying trading companies.

Researchpoints out that around three quarters of advisers recommend EIS investments and a great majority of these advisers stated that tax benefits were one of the main reasons why they recommend EIS to clients. These findings are surprising and even alarming to us.  The tax tail seems to be wagging the investment dog, particularly because a majority believe these investments should be considered before other more mainstream tax breaks (e.g. ISA and pension) have been fully utilised.

Furthermore, it seems a high percentage of private investors who regard themselves as sophisticated or experienced hold EIS investments and an even greater percentage had considered them.  When choosing an investment, a high percentage stated that the expected level of return was one of the most important criteria.  This alarms us.  Even self-selected ‘sophisticated’ investors would appear to be taking far higher risks than they are aware of, not least the risk of real disappointment that returns are poor (or their capital is lost entirely, before the tax breaks they receive).

The fees on EIS and VCT funds are, as one might expect, high in comparison to passive or systematic mutual funds.  Annual management charges in the region of 2% to 3% and around 3.5% in terms of total costs strip out considerable upside, and that is before any form of performance fee is deducted.  Don’t forget that there are often arrangement fees representing around 2% of each transaction.  In the end, investors only receive returns net of costs.  When costs are high as they are in this case, intermediaries take an unjustified share of the upside.  The proof of the pudding is in the eating.

The risks of EIS and VCT investments are varied and considerable as they both invest in very small unquoted companies.  It is our belief that many investors do not have a clear insight into the risk they are taking on.  These range from the risk of failure, to owning minority stakes in illiquid private businesses and the risk of changes in the tax regime that may affect the attractiveness of the tax breaks on offer.

The conclusion that we arrive at is that we would not recommend EIS and VCT investments in the event that a client’s other tax reliefs (e.g. pension, ISA, CGT) have not yet been fully utilised.  When it comes to investing, diversification, keeping costs low and only taking risks supported by evidence is what matters, yet EIS and VCT products don’t tick these boxes!

These high-risk, tax planning products should only be considered and recommended in very client specific circumstances where all other avenues have been explored, and only for those clients who meet stringent net worth and investor sophistication criteria.

Is the tax tail wagging the investment dog in the UK?  From what we can see the answer is yes.

Investing can bring you closer to your financial goals than cash

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Should you invest your money to achieve long-term financial goals or keep the money safely in cash?

This is a common dilemma and can be a difficult decision, especially for first-time investors who are yet to experience the ups and downs of stock market investing.  Yet, history tells us that investments typically outperform cash over longer periods of time.

New research has shown that those who invested in a stocks and shares Individual Savings Account (ISA) 15 years ago could have enjoyed gains of almost double those experienced by individuals leaving money in cash over the same period.  The research from Fidelity International also pointed out a gender difference when it comes to the preference to invest or leave money in cash.  Almost half of women prefer to save in cash, which could be detrimental to achieving their long-term financial goals.

This is supported by new figures from HM Revenue & Customs (HMRC) which show more women subscribing to cash ISAs than men.  More men than women were shown to invest their ISAs than open a cash ISA.

Fidelity carried out the analysis based on using the full ISA allowance invested in an index tracker fund which aimed to track the performance of the FTSE All Share and compared this to average cash savings rates over 5, 10 and 15 years.  This analysis demonstrates the cost of cash, with the investment worth £20,174 more over 5 years, £55,541 more over 10 years and £104,217 more over 15 years.  They concluded that, by investing in the stock market, women (and men) can reach their financial goals sooner.  These financial goals might include building up a deposit for a first home, paying school fees or saving for retirement.

Earlier research from Fidelity in their Financial Power of Women report found that 43% of women were likely to save using a cash ISA in the next two years compared to the 19% who said they would invest via a stocks and shares ISA.  This finding was based on a survey of more than 1,000 men and 1,000 women, who were asked about their views on money and investing.

Maike Currie, Investment Director at Fidelity International, said:

“Many women will have long-term goals and diligently stick to these whether saving for a child’s education or putting something away for a comfortable retirement.  But while we tend to be diligent and committed savers, we often steer clear of the stock market altogether.

“Factors such as the gender pay gap, time off work to cover childcare and more women engaged in part-time work already contribute to a significant gap in women’s’ earnings versus their male counterparts.  That’s why it’s important not to put yourself at a further disadvantage by not making your money work as hard as you are.  With interest rates at record lows for almost a decade now and inflation rapidly rising, anyone holding an investment in cash will struggle to achieve a decent real return – that’s a return that keeps abreast of rising prices.

“Granted, the stock market is a riskier option than cash, but it is a well-established fact that over the long-term equities tend to outperform cash.  Women risk falling into a glaring ‘investment gap’ by leaving their money languishing in cash.  Don’t lose out over the long term and run the risk of missing out on your long term financial goals – take the plunge and get invested.”

There is of course an important role for cash in long-term financial planning.  It’s usually recommended to hold a short-term cash emergency savings fund in order to cover between three to six months essential expenditure.  Cash is also often preferable to investments where there is a short time horizon for your financial goals, such as buying a property in the next few years.

As investments can go down as well as up in value, the certainty of cash is important where a known amount of money is required in the short-term however, for longer-term financial goals, including retirement planning, the buying power of cash will typically be eroded by price inflation over time.

Investing money does involve risk and exposure to volatility, so you need to have sufficient tolerance for risk, capacity for any losses and the need to experience investment returns to achieve your financial goals.

Please get in touch if you would like to talk about the difference between saving in cash and investing your money, and how to determine a suitable allocation of cash and investments within your portfolio.

Hidden value of great financial planning

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Almost everyone worries about money, what the future may hold, and the decisions and choices that they will face along the way; yet few realise that financial planning is the key to sorting it all out.  It is the World’s best kept secret.  Everybody needs it, but only a few have unlocked its true value.

For those who have, the equation between the value that they receive from their financial planner and the fees that they pay needs to make sense.  Yet, because the benefits of good advice are often received in the far-off future, it is sometimes easy to miss, or dismiss, the value received along the way.  Market noise, emotions and periods of what may seem like inactivity on an adviser’s behalf, can also impact on the perception of value.  It is often easy to appreciate the value received in the first year, and easy to forget or appreciate the value on an ongoing basis. The financial planning relationship can be broken down into three key phases of value.

Value phase 1: Sorting out the mess and building the plan

New clients often arrive with a proverbial suitcase of bits and pieces collected over the years, such as a number of pension plans, with-profits bonds, endowment policies, life insurance and a stock broker or IFA managed portfolio.  This collection of ‘stuff’ often has little structure and rarely provides comfort that the future will be bright.  That’s a stressful place to be.

The first and most vital step is to help clients to set out their vision for the future, both in terms of lifestyle goals and the money needed to fund them.  Next comes the analytical work, which may involve using financial forecasting tools, to help empower clients to make sensible strategic choices.  The resulting ‘plan for the future’ becomes a joint effort between client and planner.  Once sorted and implemented, the client is then back in control of their future and their finances.  The value is easy to see.

Value phase 2: Plan progress and progressing the plan

Financial planning is not a ‘set-and-forget’process, far from it, in fact.  Regular review meetings or Progress Meetings as Wells Gibson prefers, help to provide clients with an insight into how things are going relative to the plan.  What is more important is the future and how the plan needs to progress from this point forward.  Some issues and consequent decisions faced may relate to events in the client’s life, or may be more technical or market issues that sit in the financial planner’s area of expertise.  Clients have better things to be doing with their time than trying to understand and tackle these issues alone!

Some years may be quite uneventful, while others are momentous.  In the former, not much may appear to happen, but that does not diminish the value of the financial planner, who is – behind the scenes – constantly on the lookout for issue that may threaten the successful outcome of the plan, or ways in which it can be refined.  At times of crisis, understanding the issues faced, finding a solution that makes sense, facilitating decisions that need to be made and having the fortitude to execute under pressure, is where great financial planners come into their own.

Value phase 3: Long life, death and immortality!

There are also some more subtle areas of the value of a long-term relationship with a trusted financial planner.  For many people, living longer is a two-edged sword.  On the upside, we can all now expect to live materially longer than our grandparents’ generation.  On the downside, we also know that with longevity comes attendant health and financial challenges.

For example, long-term health care costs are rising rapidly and simply knowing that they can be met is a great comfort to many.  A financial planner, who knows the family and their financial circumstances well, is well-placed to provide advice, support and to facilitate the financial consequences of the new change in circumstance, when it is needed.

Many clients, often one of a couple who takes more interest in the finances than the other, worry about what will happen to their partner on their death.  Having a trusted financial planner (and an up-to-date plan), allows them to be confident that, in the event of their death, their partner will be well cared for financially and that their affairs are in order.

Most people would like to feel that they will, in some way, leave behind a lasting legacy.  For some, that can mean spending time and money supporting their philanthropic works and for others it may mean passing on wealth from one generation to the next.  Again, financial planners can play an important role in helping clients to make decisions surrounding such issues.

In conclusion

It is easy to forget when you meet with your financial planner for your review meetings that the scope and value of the relationship is far deeper and more important than worrying about the 12-month market noise that has resulted in your portfolio going up and down, or the fact that neither your portfolio nor the plan has changed much.  Meeting your goals, feeling confident in the future and having the time to enjoy the opportunities that your money provides you, your family and your community are what really matter.

Delivering ‘peace of mind’may sound a bit trite, but that is the goal, consequence and value of great financial planning and at Wells Gibson it’s our mission to bring clarity, contentment and certainty to your financial life.

 

Where’s the Value?

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From 1975–2017 the value premium[1]in Europe has had a positive annualised return of approximately 2.2%.[2]In six of the last ten calendar years, however, the value premium in Europe has been negative. The same trend has been seen across developed markets globally.

[1]. The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).

[2]. Computed as the return difference between the Fama/French Europe and Scandinavian Value Research Index and the Fama/French Europe and Scandinavian Growth Research Index. Fama/French indices provided by Ken French. Index descriptions available upon request.

This has prompted some investors to wonder if such an extended period of underperformance may be cause for concern. But are periods of underperformance in the value premium that unusual? We can look to history to help make sense of this question.

There are numerous empirical studies documenting the value premium using different empirical techniques on 90 years of US data as well as over 40 years of data for developed markets outside of the US that point to reliably positive premiums in the long term.

SHORT-TERM RESULTS

Exhibit 1 shows yearly observations of the US value premium going back to 1928. We can see the annual arithmetic average for the premium is close to 5% in USD terms, but in any given year the premium has varied widely, sometimes experiencing extreme positive or negative performance. In fact, there are only a handful of years that were within a 2% range of the annual average—most other years were farther above or below the mean. In the last 10 years alone there have been premium observations that were negative, positive, and in line with the historical average. This data helps illustrate that there is a significant amount of variability around how long it may take a positive value premium to materialise.

[1]. The value premium is the return difference between stocks with low relative prices (value) and stocks with high relative prices (growth).
[1]. Computed as the return difference between the Fama/French Europe and Scandinavian Value Research Index and the Fama/French Europe and Scandinavian Growth Research Index. Fama/French indices provided by Ken French. Index descriptions available upon request.

1

In US dollars. The one-year relative price premium is computed as the one-year compound return on the Fama/French US Value Research Index minus the one-year compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actualportfolio.  Past performance is no guarantee of future results.

LONG-TERM RESULTS

But what about longer-term underperformance? While the current stretch of extended underperformance for the value premium may be disappointing, it is not unprecedented. Exhibit 2 documents 10-year annualised performance periods for the value premium within the US market, sorted from lowest to highest by end date (calendar year).

This chart shows us that the best 10-year period for the value premium was from 1941–1950 (at top), while the worst was from 1930–1939 (at bottom). In most cases, we can see that the value premium was positive over a given 10-year period. As the arrow indicates, however, the value premium for the most recent 10‑year period (ending in 2017) was negative. To put this in context, the most recent 10 years is one of 13 periods since 1937 that had a negative annualised value premium. Of these, the most recent period of underperformance has been fairly middle-of-the-road in magnitude.

  • Exhibit 2. Historical Observations of 10-Year Premiums, Value minus Growth: US Markets 10-Year Periods ending 1937–2017

2

In US dollars. The 10-year rolling relative price premium is computed as the 10-year annualised compound return on the Fama/French US Value Research Index minus the 10-year annualised compound return on the Fama/French US Growth Research Index. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.Past performance is no guarantee of future results.

While there is uncertainty around how long periods of underperformance may last, historically the frequency of a positive value premium has increased over longer time horizons. Exhibit 3 shows the percentage of time that the value premium was positive over different time periods going back to 1926 for the US market and 1975 for developed markets outside of the US. When the length of time measured increased, the chance of a positive value premium increased.

  • Exhibit 3. Historical Performance of Premiums over Rolling Periods, US Markets, July 1926–December 2017

3

Historical Performance of Premiums over Rolling Periods, Developed ex-US, January 1975–December 2017

4

In US dollars. Based on rolling annualized returns using monthly data. Rolling multiyear periods overlap and are not independent. Fama/French indices provided by Ken French. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no guarantee of future results.

For example, we can see that the realised value premium over a one-year horizon (using overlapping periods) has been positive around 61% to 69% of the time across US and developed ex US markets. When the time period measured is lengthened to 10 years, the frequency of positive average premiums increased to 84% and above.

CONCLUSION

What does all of this mean for investors? While a positive value premium is never guaranteed, the premium has historically had a greater chance of being positive the longer the time horizon observed. Even with long-term positive results though, periods of extended underperformance can happen from time to time. Because the value premium has not historically materialised in a steady or predictable fashion, a consistent investment approach that maintains emphasis on value stocks in all market environments may allow investors to more reliably capture the premium over the long run. Additionally, keeping implementation costs low and integrating multiple dimensions of expected stock returns (such as size and profitability) can improve the consistency of expected outperformance.

Source: Dimensional Fund Advisors LP.
The views and opinions expressed in this article are those of the author and not necessarily those of Dimensional Fund Advisors Ltd. (DFAL). DFAL accepts no liability over the content or arising from use of this material. The information in this material is provided for background information only.  It does not constitute investment advice, recommendation or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision.
The content, style and messages the material delivers are presented for consideration and should be tailored to your firms own beliefs, message and brand.
DFAL issues information and materials in English and may also issue information and materials in certain other languages. The recipient’s continued acceptance of information and materials from DFAL will constitute the recipient’s consent to be provided with such information and materials, where relevant, in more than one language.
Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to an affiliate of Dimensional Fund Advisors Ltd.
The Dimensional and Fama/French Indices reflected above are not “financial indices” for the purpose of the EU Markets in Financial Instruments Directive (MiFID). Rather, they represent academic concepts that may be relevant or informative about portfolio construction and are not available for direct investment or for use as a benchmark. Their performance does not reflect the expenses associated with the management of an actual portfolio. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Descriptions of the Dimensional and Fama/French indexes available upon request.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful. Results shown during periods prior to each Index’s index inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.