Asset Management Market Study

I commented previously on the FCA’s Asset Management Market Study, which suggested there was weak competition in this market. Needless to say, most asset managers do not seem to agree.

ShareSoc has now submitted a response to the questions raised in that document which you can read here: http://www.sharesoc.org/Asset-Management-Market-Study-Response-2017-02-21.pdf

In summary, we agree with the general conclusions and support regulatory intervention where necessary. We also note that although the study does not address the issue directly of financial education, it is our view that this needs to be substantially improved if the public is to be able to engage with financial professionals and make their own informed decisions.

Please read our more detailed response for our answers to all the questions posed.

Roger Lawson

FCA Study of Asset Management – Interesting Interim Results

The Financial Conduct Authority (FCA) has published an interim report on its Asset Management Market Study. Some of the results are not that surprising, but others are.

For example, it reports that around half of retail investors were not aware that they were paying fund charges. Needless to point out perhaps that can be linked to another conclusion. Namely that there is weak price competition. How can investors be expected to compare prices when they are not even aware of the charges?

Indeed very few asset management firms told the FCA that they lower charges to attract business, particularly for retail investors. They do not believe that would win them more business. Surely retail investors are suckers for the pitch that goes something like this: “you want the best managers to get you the best returns, and that is more important than the cost”. Retail investors are often like buyers of wine – when you don’t know much about wine you tend to buy on price – the more expensive it is the better it must be. Unfortunately that is not how it works in reality for investment funds. As the FCA report states “there is no clear relationship between price and performance – the most expensive funds do not appear to perform better than other funds before or after costs”.

Even where fund size increases, price does not fall, according to the FCA. They suggest economies of scale are captured by the fund manager, rather than being passed onto investors. In addition they have identified a number of expensive funds which are closet index trackers and hence should really be lower cost.

Retail investment platforms also do not seem to bring pressure on pricing by the pooling of assets and the FCA “also have concerns about the value provided by platforms and advisors, and are proposing further FCA work in this area”. Let us hope they are quaking in their boots over that comment.

The FCA has a number of suggestions for remedies upon which it is inviting feedback (ShareSoc is likely to send in some comments so let us know if you have points you would like made). Some of the proposals include clearer charges, strengthening the duty of asset managers to act in the best interest of investors and providing retail investors with tools to identify persistent underperformance (although they spell out that relying on past performance data is problematic as there is little evidence of persistence).

The full FCA report is available here: https://www.fca.org.uk/publication/market-studies/ms15-2-2-interim-report.pdf . It certainly emphasises that retail investors can be woefully ignorant, but without proposing good remedies for that problem. Now if we could encourage them all to join ShareSoc, we might improve upon the situation!

Roger Lawson

Do Active Funds Underperform? But Costs are the Real Problem

On the 24 October the Financial Times FTfm supplement led with a front page article that was headlined “99% of Active US equity funds underperform”. It also had a sub heading of “Almost all UK, global and EM funds have failed to outperform since 2006″. So I sent a letter to the Editor which said the following, much of which they have published today (31/10/2016) plus letters from other writers making the same point. This is what my letter said:

“Your headline in FTfm that 99% of active US equity funds under-perform might make a good lead story, but perhaps you would care to say how many passive funds under-perform their indices. Would it be 100% by any chance? Bearing in mind that all funds have charges, they are almost bound to under-perform their comparable benchmark and that is particularly so for passive funds.

Indices tend to overstate performance as is well known as poor performing stocks drop out of the index, with better performing ones replacing them.

In addition if your readers failed to read to the end of the article, they would have missed the fact that four out of five active equity funds beat their benchmark over the past five years, even after taking into account management and other charges presumably!

Yes there are poor value active funds, as there are poor value passive funds. And perhaps investors are over optimistic in their capability to pick active managers who will outperform their benchmarks. But it is not as simple a story as made out in the article.”

The real problem for investors is the high charges that can erode their returns. This was highlighted recently in a report published by Better Finance. This is what they say:

“The findings from the 2016 research report released on 27 September 2016 clearly confirm that the long-term performance of the actual savings products promoted to EU citizens (in particular for long-term and pension savings) unfortunately has little in common with the performance of capital markets. This Is mainly due to the fact that most EU citizens invest less, and less directly, in capital market products (such as equities, bonds and low-cost ETFs), but into more “packaged” and fee-laden products (such as life insurance contracts and pension products).

One could argue that insurance and pension products would have similar returns to a mixed portfolio of equities and bonds, since those are the main underlying investment components of the “packaged” products in question. But using this logic to compute returns for retail investor portfolios, like the European Securities and Markets Authority (ESMA) did, implies a “leap of faith” in that it completely ignores realities such as fees and commissions charged on retail products, portfolio turnover rates, manager’s risks, etc. Charges alone totally invalidate this approach.

Overall, a direct balanced investment (50% in European equities / 50% in Euro bonds ) from a European saver in capita! markets at the eve of the century would have returned a substantial +105% in nominal terms (gross of fees and taxes) and +47% in real terms, which means an annual average real return of +2.5%. Unfortunately most pension savings did not, on average, return anything close to those of capital markets, and in too many cases even wiped out the real value for European pension savers (i.e. provided a negative return after inflation).”

Their estimate for the net real returns from pension savings in a range of European countries actually shows the UK third out of 17 with a return of 2.5%. But most countries were much worse.

There is of course a simple solution to this problem. Namely to manage your own investments as ShareSoc regularly advocates. With the availability of “self-select” SIPPs this is now easy to do and your costs will then be as low as you can possibly make them.

Roger Lawson

Cash or Shares. Which is Better?

An interesting article in Saturday’s FTMoney (18/6/2016) by Paul Lewis suggested that you might be surprised to learn that if you had invested £10,000 in a cash account in 1998, you would have done better than investing in a FTSE-100 index tracker. It’s surely odd for the Financial Times to persuade their own readers that cash is better than equities because a choice of cash might mean they no longer needed to read the FT – they could just use a comparison service such as Moneysupermarket.com once a year to pick the best deposit account. But nothing about the editorial policy of the FT surprises me of late after their persistent promotion of the Brexit “Remain” platform. Has the purchase of the FT by Nikkei started to affect its editorial policies one begins to wonder?

But back to the arguments put forward by Paul Lewis because if he is right then ShareSoc (which promotes individual stock market investment) might as well wind up. So it’s worth looking at the facts with some care.

His detail analysis is based on comparing an HSBC FTSE-100 index tracker with the best buy deposit account that was available each year since 1995. The HSBC index tracker is low cost (0.18% in charges p.a. he says) and is one of the few that goes back that far. So that is fair enough, although selecting a specific time period when the stock market is widely variable in level over the years might have been prejudicial. Picking the “best buy” cash deposit also somewhat slants the picture because the deposit accounts offering the best interest rate are likely to be smaller and less known ones which few people might select – for example they might be more risky. Now Mr Lewis identifies that Charter Savings Bank is paying 1.66% for one-year fixed rate bond, and Moneysupermarket suggest OakNorth Bank at 1.61% and Habib Bank Zurich at 1.51% – not exactly household names. The better known Sainsbury Bank only offers 1.30% and that only for deposits of up to £200,000 at the time of writing. As any investor knows, a small difference in interest rates, compounded over many years, will make a big difference to the outcome. But Mr Lewis claims cash beat shares in 57% of the five year periods beginning each month in 1995.

This kind of analysis is not new to me because the author of the book “Monkey with a Pin” (which is on our recommended reading list) came to similar conclusions a few years back. It is difficult for private investors to beat cash returns because their equity investments via funds are eroded by charges, many of which are hidden.

One big defect in this argument is of course that only a fool would have been solely invested in the FTSE-100 in recent years. This is an index dominated by mature companies in sectors that have been strategically challenged – oil/gas, minerals, pharmaceuticals, or which have simply hit an exceptional economic and regulatory crisis such as banks which might be one of those “black swan” events that only happen once in a hundred years.

Mr Lewis does point out that the Barclays Equity Gilt Study, which is published annually, shows equities outperforming Treasury bills or cash over long periods of time (their data goes back to 1899), but he argues that is because the charges on equity funds are not included, and cash does not reflect the real rates obtainable.

Of course there are many more equities that could be invested in than solely the FTSE-100; for example foreign stocks/markets, FTSE-250 and small cap stocks, even AIM stocks. One just has to look at the long term performance of some of the large investment trusts to see that they have consistently beaten inflation, which cash has not. Indeed cash and government bonds have been particularly poor during periods of high inflation while owning part of a business via an equity stake actually inflation proofs your portfolio to a large extent.

Even the editor of Investors Chronicle when commenting on our campaign to improve AIM pointed out that in “pure performance terms, the AIM market has actually outperformed the FTSE-100 over the past year” (Editorial in 10 June edition). Before you get too excited though one of our correspondents pointed out that the AIM index is grossly distorted because it does not take account of companies leaving the index – a lot of which may subsequently have fallen on hard times. So as ShareSoc keeps warning people, you have to be selective about AIM stocks and it is not a market for the inexperienced or unsophisticated investor at present.

But in conclusion, I regret to say I am not convinced by Paul Lewis’s article mainly because I know that I have done a lot better than cash over the years myself. I can only go back in my records (which are very detailed) to 1997 but my average total return (dividends plus capital) have exceeded 20% per year. There are other well known investors such as John Lee who writes for the FT who have achieved similar figures, and Warren Buffett has done even better. Indeed I suspect other ShareSoc directors and members have done as well or better without knowing their exact performance figures. This suggests that you simply have to take a more intelligent approach when investing in equities than simply selecting a FTSE-100 tracker.

Roger Lawson

Can you make money in the FTSE100?

Can you make money by investing in the FTSE100? This thought came to mind when looking at some of the recent market statistics. It’s quite an important question because most stock market investors are heavily biased to that segment of the market (as opposed to FTSE250, small cap or AIM stocks) simply because the market cap of the FTSE100 is a very high proportion of the overall UK market. For example, it’s about 80% of the FTSE AllShare. So if you are invested in a typical UK equity index tracker, or UK focussed generalist investment trust, you are almost bound to have a high proportion of your assets invested in the FTSE100.

But the performance of the FTSE100 over the last year has been very poor – down 11% at the time of writing, whereas the FTSE250 is up 7% and the FTSE AIM index is up 2%. Small cap stocks have definitely been the place to be in the last year.

Another measure of the health (or lack of it) of larger companies was recently reported by The Share Centre. FTSE100 companies overall only have dividend cover of 1.1 times, i.e. reported earnings are only slightly higher than dividends paid out. Whereas FTSE250 companies have cover of 1.5 times which would normally be considered a more prudent level.

The large proportion of natural resource companies in the FTSE100 (miners, oil/gas companies) explains a lot of the problems. Companies such as BP, Glencore, Shell and Rio Tinto are some of the obvious culprits, but then retailers such as Morrisons, Sainsbury, and Tesco have also been badly hit. Then you have more specific company problems in companies like Rolls-Royce. Other large index constituents such as Vodafone are also much where they were a year ago and banks (another major index component) are also flat or lower – Lloyds Banking Group may be doing better but investors are apparently still wary of investing in it even though dividends are returning. Pharmaceuticals such as Glaxo are down, with them taking a hit recently from concerns about possible price controls in the USA. although Terry Smith’s recent article suggesting that their “headline” profits were a mirage because of the regular “exceptionals” can’t have helped – a feature of many large cap companies of course.

But it is still possible to make money holding large cap stocks, so long as you are selective. A good example of this was the results from City of London Investment Trust who recently published their Annual Report (their AGM is on the 23rd October).

Their net asset value total return was up 6.4% in 2014 which was ahead of its benchmark in the year to end of June (the AIC UK Equity Income sector), and way ahead of the FTSE AllShare (up only 2.6%). How did well respected fund manager Job Curtis achieve yet another sound year of performance?

He still held BP, Shell, Vodafone and Glaxo in his top ten holdings. But he also held large stakes in building companies such as Taylor Wimpey, Persimmon and Berkeley Group which clearly helped. He also benefited from holdings in property REITS where rising office rents in London drove returns up.

So it’s more a question of how he avoided the complete dogs. For example, he sold the two holdings in the oil sector he considered the weakest – Statoil and ENI; and although he retained Shell and BP, he was underweight in those versus the index. In commodities, he reduced the holding in Anglo American, but sold South32 (a spin off from BHP Billiton) while retaining BHP Billiton itself and Rio Tinto on the basis they were low cost producers.

In essence, it looks a classic example of where active fund management can achieve improved performance over an index by judicious tactical stock selection even in the megacap stocks that dominate the FTSE100. City of London IT is by its nature an income focussed trust and hence is likely always to have a large proportion of its holdings in larger stocks and reassure many investors by continuing to hold some of the big name companies. But private investors can perhaps be even more selective and by having a stronger weighting in smaller companies (even AIM companies I would suggest) you could achieve an even better result if you care for a wee bit more excitement.

Note this writer does hold City of London IT.

Roger Lawson

A Dream Become a Nightmare – And a Plug for ShareSoc

There was a good article in the Daily Telegraph on Sunday (17/5/2015) explaining how Thatcher’s dream of a share owning population has become a nightmare. She tried to create a nation of investors by privatisations and regulatory changes to improve business competition but instead many companies have ended up being sold to foreign buyers.

Even worse there has been a collapse in private share ownership. The reported proportion of UK shares held by individuals has collapsed from 20% in 1994 to 11% today. In addition private shareholders are being stripped of their rights by the proliferation of the use of nominee accounts. The article rightly mentions the ShareSoc campaign against this and quotes us as saying this “fatally undermines your rights as an investor” which is spot on.

There were also some comments in the article from David Nicol of Brewin Dolphin on the need to encourage long term investing, as opposed to short term trading. He suggests reform of the capital gains tax system. It is indeed unfortunate that the system of indexing capital gains was dropped, and it would surely be wise to introduce a lower rate for longer term holdings. The market is becoming more and more speculative and it would be good to incentivise private investors to take a longer term view. With promises made not to raise income tax, there are rumours that the Government might raise capital gains tax rates instead but any changes in this area should encourage share ownership and savings, not deter it surely?

The article calls for Margaret Thatcher’s legacy not to be squandered. It would certainly be good to consider more reforms after her fashion. To read the full Telegraph article by John Ficenec go to: http://www.telegraph.co.uk/finance/11610490/Thatchers-dream-for-UK-investors-has-become-a-nightmare.html

Roger Lawson

2014 Review and New Year Resolutions

Now’s the time of year to look back on the performance of the stock market in 2014, and look at plans for the future. Last year was undoubtedly a disappointing year for the UK stock market. The FTSE All-Share index was down 2.45%, worse than many other major markets. The cause was undoubtedly that the All-Share index is dominated by large mega-cap FTSE-100 companies such as BP, Shell, Glaxo and Tesco. The first two have been badly hit by the decline in the oil price, Glaxo alone fell 14% and you don’t need to be told the travails of Tesco.

Smaller cap stocks had a particularly disappointing year after a barnstorming 2013. The FTSE Small Cap Index was down and the FTSE AIM index fell by 16.5% on a Total Return basis. Small cap stocks were generally out of favour as investors moved into more defensive holdings or piled into the US market. Stocks such as ASOS and Monitise fell as the froth disappeared. Quindell, Blinkx and Globo suffered from disparaging blogs linked to shorting attacks and the small cap resources companies which were often kept afloat purely on hope, fell into a black hole. There were few major gains in AIM stocks and new listings such as MoPowered and Outsourcery fell very substantially. Avoiding all these disasters was not easy for investors in smaller companies.

New Year Resolutions

Before the end of the year ShareSoc sent out a Tweet asking what ShareSoc should do for investors in the New Year. We got a number of responses, which included:

– Sort out AIM including press hard for reform of AIM, and making Nomads and the boards of AIM companies more accountable.

– There was a also a call to regulate bulletin boards and force people to use real names not pseudonyms (if Facebook can do it why not in the financial sector where it is even more important?). It is clear that on the internet there is rampant distortion of the facts by some commentators, much of which is libellous but where there are no adequate legal remedies for those attacked. Sometimes these commentators are defended on the theory that there is “no smoke without fire”, i.e. there may be some underlying truth in the allegations  – sometimes there is but often there is not. It is impossible to separate truth from fiction in many of these cases, which can be exploited by those who take a financial stake in the companies.

– Push for disclosure of who participates in placings (private shareholders generally don’t like placings in which they cannot participate and there is a feeling that shares are often put into the hands of friends of the board or existing investors).

Comment: Note that ShareSoc has been aware of the deficiencies of AIM for a long time and we have previously expressed our concerns to the London Stock Exchange (LSE) who run this market, and to the Government. The lack of independent regulation and other deficiencies in the regulatory regime, and in Company Law in general, mean that directors and their advisors are rarely penalised for misleading statements and general duplicity.  If anyone is penalised, it tends to be the companies and hence shareholders. Unfortunately there seems to be no great desire in other stakeholders for change. Companies and their directors like the existing “anything goes” playing field. Advisors, corporate brokers and Nomads think it’s just fine. The LSE like it because it minimises regulatory costs and enables them to collect fees from listing new companies, many of which are early stage and immature – many such companies are also based overseas. For example, the problems of corporate governance and regulation in Chinese companies listed on AIM have become very apparent so they are now valued very lowly by the market.

Only the Government could really step in to change AIM, but being an “unregulated” market gives tax advantages and it is unlikely any wholesale change is possible in the short term. So in the meantime, investors need to look very carefully at AIM companies and who is running them. As this writer has said before, you can make a lot of money investing in AIM stocks, but selectivity is the key. ShareSoc will continue to push for improved regulation by the LSE.

As regards the problems of aggressive shorting campaigns and general misinformation being posted on bulletin boards, yes there is surely a need for some regulation of them. How to do this without introducing needless and expensive bureaucracy which might inhibit free speech is the problem. Suggestions would be welcomed on this.

But in the meantime, one New Year resolution that all readers might like to take up is this: “I will only ever post on any bulletin board or social media channel using my own real name“. That way everyone will know who I am and be able to evaluate my credibility. Anyone who is not willing to do so will immediately be suspected of wishing to conceal their motives or interest in the matter under discussion.

This writer will certainly be taking up that resolution.

Roger Lawson