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Investing

Mitigating an Unknown Investment Future

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One of the hardest concepts to grasp in investing is that a ‘good’ company is not always a better investment opportunity than a ‘bad’ company.

If we believe that markets work pretty well, considering few investment professionals beat the market over time, and markets incorporate all public information into prices pretty quickly and efficiently, all of the ‘good’ and ‘bad’ news should already be reflected in these prices.

A ‘good’ company will have to do better than the aggregate expectation set by the market for its share price to rise and vice versa.  If a ‘bad’ company is in fact a less healthy company, it may have a higher expected long-term return, as risk and return are related.

It is perhaps evident that if the market incorporates the aggregate forward-looking views of all investors, it becomes very difficult to choose which companies, sectors, and geographic markets are likely to do best, going forward.

In an uncertain world, where equity prices could move rapidly, and with magnitude, on the release of new information, which is itself a random process, then it makes good sense to ensure that an investment portfolio remains well diversified across companies, sectors and geographies.

Many charts illustrate how deeply diversified a globally equity portfolio can be however if you do not know which companies are going to perform well, own them all.  However, in the US, the concentration risk of the S&P500, is quite different and is increasingly concentrated in a few names.

Given that all the future promise of a company is already reflected in its share price today, it is quite a risk betting a large part of your assets on just a few names, concentrated, for example, in the technology sector.  The top 8 technology shares in the US now have a larger market capitalisation than every other non-US market except for Japan!

Dominance of companies, sectors and markets ebb and flow over time.  What will be the next Amazon?  What regulatory pressures could these dominant companies face?  Is Donald Trump’s recent rage against Twitter the start?  No-one knows.

By remaining diversified, you will own the next wave of market leaders as they emerge and dilute the impact of ebbing companies.  Whilst it is always tempting to look back with the benefit of hindsight and wish we had owned more (take your pick), US tech shares, other growth shares, gold etc., what matters is what is in front of us, not what is behind us.

The safest port in a sea of uncertainty is diversification

As always please get in contact if you have any questions.

Photos by Peter Fogden and Matt Hardy on Unsplash.

Responsible, Sustainable and Impact Investing

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Wells Gibson remains a strong advocate of systematic, evidence-based investing as this continues to stand the test of time and remains a robust, well thought through proposition which investors can understand and stick with, even in challenging market conditions.

For some time now, we have been eager to complement our standard investment proposition with the development of an ESG investment proposition and an Impact investment proposition. These are described as follows:

ESG investing has an increased focus on environmental risks (E); social sustainability (S); and good governance (G); and

Impact investing helps drive solutions to global problems and provides a material effect on important positive outcomes with regards to social sustainability and environmental risks.

The focus of this article is the development of our ESG investment proposition, and a further article will follow with regards to the development of our Impact investment proposition.

The Spectrum of Capital is a helpful diagram which summarises the financial goals and impact goals of different investment approaches, and you will notice this places a broad-based, traditional investment approach at the left-hand side, and, philanthropy at the other side. Wells Gibson’s standard investment proposition would fall into the traditional column i.e. the left-hand side.

Thanks to, UK National Advisory Board On Impact Investing, 2017 & Impact Management Project, 2017

Our ESG Proposition

Wells Gibson has now created an investment proposition which has an increased focus on ESG factors and includes funds whereby the investment approach is deemed to fall into the Responsible & Sustainable columns within The Spectrum of Capital.

We have sought to address the issues that are most important to environmentally focused investors, without compromising on sound investment principles, or requiring investors to accept lower expected returns.

Although this proposition has an increased focus on ESG factors, we will not compromise on the structural integrity of our portfolios because this can expose an investor’s capital to unwanted and unnecessary risks.  In other words, we are determined to apply our systematic, evidence-based philosophy to our ESG proposition.

We recognise there is no ideal single approach to ESG investing.  A number of offerings are continuing to develop such as negative screening; positive screening; a focus on the environment only; and a combination of E, S and G etc.

Our ESG Portfolios

In order to create portfolios with an increased focus on ESG factors, we consulted with Albion Strategic Consulting which provides Wells Gibson with ongoing governance oversight and is a member of our investment committee.

Using Wells Gibson’s standard, traditional portfolios as a sound template, our approach initially is to replace the existing funds used to obtain global, developed market equity exposure, with two new funds which stand out as being worthy of inclusion and are from investment firms we are very familiar with and trust, Dimensional and Vanguard.

We believe the rules based ESG approach of these funds is a step in the right direction, without materially sacrificing capital market returns:

The Dimensional fund [1] claims to reduce greenhouse gas emissions intensity by over 60%, and nearly 99% of emissions from reserves due to the systematic ESG weighting methodology; and

The Vanguard fund [2] excludes companies that do not align with the UN’s Global Compact principles.

As with our standard, traditional portfolios, the ESG portfolios will also invest in global short-dated bonds; global commercial property; and global emerging markets, however as new products emerge, these will be scrutinised before any decision is made to include them in our ESG portfolios.

We asked Albion to run an analysis comparing Wells Gibson’s standard, traditional portfolios to Wells Gibson’s ESG portfolios and this revealed:

A minor increase in cost;

A minor increase in share concentration; and

A minor reduction in the expected return (attributable to the reduction in allocation to small and value companies).

Our conclusion is that Wells Gibson’s initial ESG investment offering provides a meaningful and worthwhile progression towards a full ESG portfolio and will be used when requested by clients.

We continue to develop our Impact investment proposition and as soon as we have a viable solution, we will let you know.

Please don’t hesitate to contact Wells Gibson if you have any questions and if this is an area you would like to discuss please get in touch.

‘Vox Populi’ and the Wisdom of Crowds

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Many of you reading this short note will have, at some time, travelled down to Devon for a lovely summer break amongst the rolling fields, moors and beautiful beaches of this somewhat remote county.  Incidentally, the beautiful and picturesque harbor village of Clovelly in North Devon is just beautiful.

Only a few will have ventured into Plymouth, the famous naval seaport and home to Sir Francis Drake (that famous Elizabethan pirate who so vexed our Spanish friends by stealing their gold) and the site of the departure of the Mayflower with the pilgrims on board heading to America 400 years ago this year.  Even fewer will know that it was the place of an amazing insight into the powerful nature of crowds, which provides us with a wonderful word picture of how capital markets operate.

In 1906 a Victorian gentleman named Sir Francis Galton attended a livestock fair aptly named The West of England Fat Stock and Poultry Exhibition in Plymouth.  One of the many attractions at the fair was a guess the weight of the ‘dressed’ ox on display (similar to the game of guessing how many cookies are in the glass jar).  The competition attracted 800 people all paying 6d (half a shilling) to write down their guess, name and address on the back of the ticket.  The nearest guess to the actual weight would win a prize.  The fair, as you can imagine, attracted many sorts, from the general public (old and young) to farmers and butchers.  Being a statistician, amongst many other things, Galton bought the used tickets off the stall holder.  Of the 800, 787 were usable.  Back home he analysed the guesses and published his finding in Nature, March 7, 1917 in an article titled ‘Vox Populi’[1].  His remarkable finding is illustrated below.

Figure 1: Guessing the weight of the ox – the ‘crowd’ got it more-or-less spot on.

 

Source: Copyright © Albion Strategic Consulting. All rights reserved.

[1] You can view the original article here: http://galton.org/essays/1900-1911/galton-1907-vox-populi.pdf

The range of guesses was wide (-133 lbs. below the average to +86 lbs. above it), the participants were varied, and the numbers involved were quite large.  The ‘crowd’ in aggregate showed ‘wisdom’ compared to its individual participants.

This story provides a great insight into how modern financial markets work.  The markets are made up of many players, from individual DIY investors, day traders, stockbrokers, hedge funds, fund managers, sovereign wealth funds, endowments and other institutional investors.

Each investor holds their own view on the future prospects for a specific security, such as the price of BP or Apple shares.  Some will like a share and others not.  They cannot both be right.  The market, given the vast amount of information available to it, settles on an equilibrium price for every share.  This price will move, sometimes dramatically, as we have seen recently as the ‘market’ reaches a new equilibrium price, given the new information that it has collectively processed.

At times like these, some investors are prone to running ‘what if’ scenarios in their heads such as: ‘if companies are in trouble because their revenues have been cut off, then they will renege on their property lease terms and the landlords will suffer.  It seems likely that things will get worse over the coming weeks.  If property landlords are in trouble that might lead to problems in the banking sector’.  It all sounds plausible.  They may then be tempted to sell out of property or banks or even equities altogether.  The crucial mistake is that they forget that they are not the only person to have thought this through and these very sentiments and views are already reflected in the current price of listed commercial property companies, bank shares and the markets in general.

Markets will move again, down or up, based on the release of new information, which in itself is random.  Second guessing random events is futile.  You might make a guess and be lucky but that is speculating, not investing!

Accepting the ‘wisdom’ of the market helps us to challenge ourselves as to whether we really have superior insight relative to everyone else.  It seems unlikely and as Charles Ellis, the wise sage of investing from the US, states, “In investing, activity is almost always in surplus.”

Activity based on guessing, particularly when it relates to shorter-term issues that sit well within your true investment horizon, is best avoided.

Next time you pass Plymouth on the A38, reflect on one of its great historical events, The West of England Fat Stock and Poultry Exhibition of 1906.

Note: if you are interested in this subject and have time on your hands in the coming weeks, perhaps take a look at The Wisdom of Crowds by James Surowiecki published by Greener Books.

A Cut to the Premium Bond Prize Pot

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Savers in the current low-interest-rate environment face a fresh blow after National Savings and Investments (NS&I) announced a cut to their rates.

 

NS&I customers, including Premium Bond holders, will receive lower returns from 1st May 2020 onwards.  According to the Treasury backed savings provider, rates are to be cut after the organisation failed to meet its income target.

 

For Premium Bond holders, the chances of winning a single prize will fall from 24,500/1 to 26,000/1.  The odds-on Premium Bonds will fall as the effective interest rate used to calculate the prize pot is cut from 1.4% to 1.3%.  It’s a big deal for the approximately 22 million people who, between them, own 70 billion Premium Bonds.

 

Despite a lengthening of odds and lower overall prize fund, Premium Bond holders will still have a chance to win one of two £1 million top prizes each month.  Other Premium Bond prize categories, which range from £25 to £100,000, will have fewer winners from 1st May onwards.

 

The cut in prizes and the effective interest rate means Premium Bonds will mean an estimated 13,448 £100 prizes will be won in May, down from 27,221 prizes this month.

 

The interest rate cuts at NS&I arise because savers are less willing to place money with the state-backed organisation.  They also need to remain competitive in line with other savings providers.

 

Ian Ackerley, NS&I chief executive, said;

 

“Reducing interest rates is always a difficult decision.  We need to ensure our interest rates are set at an appropriate position against those of our competitors.

 

“These changes reflect NS&I’s requirement to strike a balance between the needs of our savers with taxpayers and the stability of the broader financial services sector.

 

“We believe our new rates offer our customers a fair return and the assurance of the 100 per cent HM Treasury guarantee on all their holdings with NS&I.”

 

Other NS&I products facing an interest rate cut include the Direct Saver account.  Interest on this account will fall from 1% to 0.7%.

 

Savers with NS&I Income Bonds will see their interest rate cut from 1.16% to 0.7%, and savers in the Investment Account will experience a rate cut from 0.8% to 0.6%.

 

Interest rates for new Guaranteed Growth Bonds, Income Bonds and Fixed Rate Savings Certificates also face cuts, with interest rates falling by as much as 0.4% depending on the selected term.

 

From a Wells Gibson perspective, although the NS&I rate cuts are disappointing, it’s important savers and investors don’t rely on cash to provide a net return above inflation but rather for short-term expenditure needs, perhaps within the next 3 to 5 years.

 

If savers and investors are seeking a real return above inflation, and can invest for at least 5 years, their portfolio ought to include stocks, shares and property.