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From April 2019 most VAT registered businesses will need to comply with new legislation requiring them to submit their VAT returns electronically using an Application Programme interface (API) between their accounting and HMRC software.

Keeping financial records will become digital and most businesses will need to use software or apps to keep their records – the days of manual record keeping are over!

HMRC have now issued their detailed guidance on the digital record keeping and return requirements for Making Tax Digital (MTD) for VAT.

VAT Notice 700/22 clarifies that spreadsheets may still be used to keep business records provided that there is bridging software that links to the Government gateway.

There will however be a one year “grace” period during the first year of MTD when businesses will not be required to have digital links between software programs, referred to in the VAT Notice as a “soft landing”.

The VAT notice includes a number of helpful examples illustrating different accounting systems and the digital links required to comply with MTD for VAT.

The VAT notice is essential reading for all VAT registered businesses. https://www.gov.uk/government/publications/vat-notice-70022-making-tax-digital-for-vat

WHEN DOES MTD FOR VAT START?

The Making Tax Digital rules apply from your first VAT period starting on or after 1 April 2019. A ‘VAT period’ is the inclusive dates covered by your VAT Return.

For example, where a business submits quarterly returns covering the periods to 28 February, 31 May, 31 August and 30 November, the business will need to comply with Making Tax Digital rules for the VAT quarter starting 1 June 2019 and ending on 31 August.

“SOFT LANDING” FOR MTD FOR VAT FOR THE FIRST YEAR

For the first year of MTD for VAT (VAT periods commencing between 1 April 2019 and 31 March 2020) businesses will not be required to have digital links between software programs. The one exception to this is where data is transferred, following preparation of the information required for the VAT Return, to another product (for example, a bridging product) that is Application Programme Interface (API) – enabled solely for the purpose of submitting the 9 Box VAT Return data to HMRC. The transfer of data to this product must be digital.

For the first year of MTD for VAT (VAT periods commencing between 1 April 2019 and 31 March 2020), where a digital link has not been established between software programs, HMRC will accept the use of cut and paste as being a digital link for these VAT periods.

However, for VAT periods starting on or after 1 April 2020, there must be a digital link for any transfer or exchange of data between software programs, products or applications used as functional compatible software.

USE OF SPREADSHEETS IN PREPARING VAT RETURNS

Example 3 in the VAT Notice describes a business that uses a spreadsheet and bridging software from April 2019, which allows the information to be transferred to HMRC via an API.  It uses a spreadsheet to record all sales, purchases, and expenses in a digital format. The VAT Return is then prepared within the spreadsheet, using formulae already written into the spreadsheet.

The VAT Return information is then sent via a mandatory digital link to bridging software, which digitally submits the information directly to HMRC.  Example 6 shows how a spreadsheet would be acceptable in order to consolidate VAT information prior to submit a Group VAT return.

We can work with you to make sure that your accounting systems will comply with the new VAT rules before they start in 2019. Note that MTD for VAT will not be mandatory where turnover is below the VAT registration limit, currently £85,000 per annum.

Modern life provides us – some would say swamps us – with so much news, information and punditry, which focuses on the here-and-now, that it is easy to be overwhelmed with the feeling of doom and gloom.  The list of things to concern us is long and worrisome; Donald Trump leading the free world, a nuclear-armed North Korea; an increasingly fractious Brexit process and looming cliff-edge, to name a few.

The natural extension of this is to worry about what the impact of all this uncertainty will have on your portfolio and in turn, on your future wealth and expenditure goals.  The first mistake is to believe that the world is falling apart around our ears.  It most certainly is not.  The second mistake is to think that the portfolio needs to be repositioned to mitigate these events. There are five key reasons why portfolio tinkering is unlikely to be a sensible course of action.

Reason 1: today’s ‘unprecedented’ turmoil is no different to how it’s always been

Today’s worries dominate our thinking; but can you remember what you were worrying about a year ago, or two years ago? Probably not.  It has ever been thus.  Take a look at the chart below. The overwhelming take-away is to acknowledge the relentless upward trajectory of purchasing power for those patient enough, and disciplined enough, to stay the course.

Figure 1: The relentless growth of purchasing power, despite World events

Source: Albion Strategic Consulting[1]

Reason 2: bad news sells – so don’t ignore the underreported good news

We are all aware that bad news sells.  For example, the Office for Budget Responsibility (OBR) delivered a ‘gloomy’ forecast for growth of ‘only’ 1.4% for 2018.  Yet, the UK economy is still growing; remember too that this slow down comes after a period of growth that has outstripped much of the developed world – particularly the rest of the EU – for the past few years.  It is not all bad news.

Reason 3: the danger of conflation of ‘what ifs’

The human mind likes stories and in themselves these stories may lead to what appear to be rational outcomes on which some action, or another, could or should be taken.  What we often fail to realise is that the seemingly logical outcome is highly unlikely; we have failed to multiply the probabilities of each sequential outcome together.  Think hard about the stories you read and hear.

Reason 4: the futility of futurology

Futurology is the financial markets’ version of astrology.  There is a huge industry out there from the IMF and the UK’s Office for Budget Responsibility (OBR) to investment banks, academics and BBC reporters all peddling their own view of the future.  These futurologists have one thing in common; they are nearly always wrong in their predictions, and are rarely held to account for their poor forecasts. Take forecasts with a pinch of salt.

Reason 5: the framing of data

As we all know, data is used to score points in support of the data-user’s viewpoint. Be aware that simple statements of fact can be both very influential and misleading.

Reason 5: the news is already in market prices

It is normal to be worried about the potential impact of what is going on in the world and how this will affect markets.  The reality is that you are not alone; in fact, all active investors have some view on how Trump, Brexit, Merkel’s problems in Germany, or the Federal Reserve in the US – to name a few – will impact bond and equity prices.  These global, diversified view-points are already reflected in the equilibrium price of securities, agreed freely between buyers and sellers.

Your portfolio is already structured to manage uncertainty

Today’s concerns such as Brexit, Sterling’s weakness, potential tax rises in the event of a Labour government, and Donald Trump in general, are endlessly recycled through the 24/7 media soundbite process, alarming some who are invested in the markets.  Well-structured investment portfolios seek to ensure that any market conditions can be weathered in the future, whatever drives these storms.  Your highly diversified portfolio, balancing global equity assets with high-quality shorter-dated bonds, is well positioned to do so.  Try not to worry.  Start by watching the news less.

If you are feeling concerned, please feel free to get in touch to talk further.

[1]     Global balanced portfolio: 36% MSCI World Index (net div.), 26% Dimensional Global Targeted Value Index, 40% Citi World Government Bond Index 1-5 Years (hedged to GBP) – no costs deducted, for illustrative purposes only. Data source: Morningstar Direct © All rights reserved, Dimensional Fund Advisers.

All investors know that they need to take risks in order to achieve returns higher than cash.   If you asked ten investors if equities were more risky than cash, most would agree; but that depends on how one understands risk.  The investment industry has done a poor job of explaining risk as it relates to an investor and tends to equate risk with return volatility.  William Bernstein – a neurosurgeon-turned-adviser and prolific investment writer – wrote a great, short booklet on risk[1], where he explained the different risks that equity investors face, as follows:

‘Risk, then, comes in two flavors: “shallow risk,” a loss of real capital that recovers relatively quickly, say within several years; and “deep risk,” a permanent loss of real capital.’

Shallow risk – precipitous equity market crashes that recover relatively quickly

This first level of risk is the one that most investors focus on, yet is perhaps the least relevant, particularly for those with long investment horizons.  These are the scary and emotionally fraught times when equity markets fall dramatically, the latest example of which was the Credit Crisis of 2007 to 2009.  We illustrate below, the five largest equity market falls in the US market, since 1927 (in US$ terms).

Figure 3: Five largest falls in the US equity markets between 1927 and 2017

Data source: Ibbotson SBBI US Large Stock TR, Jan-25 to Apr-17. Morningstar © All rights reserved.

Deep risk – a permanent loss of wealth

Bernstein defines deep risk as the permanent loss of purchasing power on account of four events: hyperinflation, such as that of the Weimar Republic, where from 1921 to 1924 bonds and cash lost nearly all their value; prolonged deflation causing a depression and high unemployment; devastation i.e. wars and geopolitical events, such as the Bolshevik revolution (almost 100 years ago to the day) resulting in the closure of the Russian stock market and default on Tsarist government debt; and finally confiscation, which still happens today e.g. the Argentinian government’s expropriation of the Spanish oil company Repsol’s assets in the country in 2012.

There are two investment behaviours that translate shallow risk into deep risk. Being shaken out of the market by a precipitous rapid fall (shallow risk) and then failing to get back in again – as there never seems to be a good time to do so – crystallises a real loss (deep risk).  Owning concentrated stock portfolios can do the same; a recent study[2] in the US shows that 26,000 listed companies have been in and out of the US equity exchanges since 1926, with a mean life of only seven years.  Only 36 companies have made it through from 1936.  Owning high exposures to stocks that fail is deep risk.

The best mitigants of deep risk are to own a globally diversified portfolio of several thousand stocks distributed predominantly across developed equity markets of democratic countries with a sound legal frameworks.  Equities provide the prospect of strong, long-term inflation-plus returns.

In conclusion

Investors know that placing money in the bond and equity markets carries risk.  Yet the way in which many look at, and measure, risk is disconnected from investors actual longer-term investment horizons, focusing on shallow risk, rather than deep risk.  Unless one understands the probability of an adverse event (hazard) happening and the effect of this exposure, due to a specific hazard on the individual investor, then it is likely that the real risks faced by an investor are masked by the shallow risks that have more emotional impact.  Owning more ‘low risk’ bonds (or cash) is not necessarily always the right answer when trying to avoid the deep risks that investors face.

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1] Bernstein, W.J., (2013), Deep Risk: How History Informs Portfolio Design. Available at www.amazon.co.uk

[2] Bessembinder, Hendrik, Do Stocks Outperform Treasury Bills? (May 22, 2017). Available at SSRN: https://ssrn.com/abstract=2900447

Gold has always held a certain appeal for humans. Its lustre, due to a lack of oxidation, makes it pleasing to look at and to handle.  Yet, it is simply a lump of metal that generates no income and will only be worth what someone else wants to pay for it at any point in time.  Given the lack of cash flow, common valuation models are not useful. Warren Buffett is not a big fan:

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

Gold has suffered prolonged, negative real returns over periods as long as 20 years and delivered an annualised return of just 1.5% p.a. after inflation – around 5% lower than equities – between 1987 and 2017, yet with comparable volatility.  In its favour, gold prices are uncorrelated to equity markets.  Yet many investors seem enamoured by its fabled investment properties.  Do these claims tack up?

Claim 1: gold is a good defensive asset at times of global equity market crisis

In the period under review, there were three substantial equity market crashes.

Figure 1: Gold as a defensive asset from 1/1979 to 6/2017

Data source: MSCI World Index (net div.), Citi WGBI (1-5) hedged GBP from Morningstar © All rights reserved.

The spectacular return of gold during the credit crisis was perhaps driven by fear, pushing up the price of gold.  If you are able to guess how others are going to behave in the future, you would be able to take advantage of gold’s hedge against fear, buying and selling it at appropriate times.  Market timing is exceptionally hard to do, without the luxury of hindsight.  Holding gold as a strategic diversifier in a portfolio carries with it a punitive, long-run zero real return assumption. Gold may be a good hedge against fear, but it is hard to exploit in practice.

Claim 2: gold is a good inflation hedge

Perhaps one of the most quoted properties of gold is its supposed ability to provide a hedge against inflation.  The evidence does not support the assertion, at least over normal investment horizons.  Over the long-term gold keeps up with inflation; A US army private gets paid almost the same – in terms of gold – as a Roman legionary did 2,000 years ago!

The belief that gold is a good inflation hedge is anchored on its performance during the late 1970s when gold prices and high inflation rose in tandem.  James Montier of GMO undertook an analysis that demonstrated the 10-year inflation for each decade and the gold price return were uncorrelated except for the 1970s[1].   In terms of an inflation hedge, stocks and index-linked gilts provide better opportunities to achieve this objective.

Figure 2: The real price of gold and underlying annual inflation 1/1979 to 6/2017

Data source: www.gold.org.  UK Retail Price Index – Bank of England

Claim 3: gold is useful store of wealth in an Armageddon scenario

A case can perhaps be made for holding some physical gold in the form of coins or ingots, in the liquidity reserves of those who fear the breakdown of fiat (paper) currencies at times of extreme market events, such as those surrounding the collapse of Lehman Brothers or even greater global calamity such as another world war.   In the extreme collapse of the financial system, paper gold (e.g. via a gold fund or ETF) would be less favourable given the risk of counterparty failure and the potential inability to access the underlying gold when it is truly needed.  Don’t forget that gold is very heavy and if you bury it, you need to be able to find it again; our museums are full of gold Roman coins, buried and lost two thousand years ago!

Conclusion

Enjoy your gold jewellery, perhaps hide a few Krugerands in the airing cupboard, but don’t believe that owning gold will improve the structure of your portfolio.  From an investment perspective, all that glistens is not gold. 

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

[1]      Montier, J., (2013) No Silver Bullets in Investing (just old snake oil in new bottles), GMO White Paper, December 2013

As investors, we have to contend not only with the erratic and unpredictable nature of markets but also the erratic and irrational way in which we think and behave.  A lack of knowledge, combined with a number of illusions and biases can lead to errors in making decisions that can turn out to be very costly.  Some of the common behavioural traps – and how to avoid them – are set out below:

Trap 1: Believing you are better than average

Human beings tend to be overconfident in their abilities. For example, out of 600 professional fund managers asked in a study almost three quarters said they were better than average.

Mitigation strategy: Have some humility – plenty of very clever people get beaten-up by the markets.

Trap 2: Mistaking random noise for patterns

A rational gambler playing roulette knows that the chance of any number coming up is the same as any other number.  Yet, a sequence of three red ‘9s’ in a row, can create quite a stir at the table.

Mitigation strategy: If you detect a pattern in shorter-term data it is probably meaningless.

Trap 3: Problems with probability (and maths in general)

For example, many people are willing to pay more for something that improves the probability from 95% to 99% than from 45% to 49%, despite the financial benefit being the same.  Virtually no one can compound in their heads.

Mitigation strategy: Do not ignore the maths.  Sit down and spend a little time teasing out the numbers.

Trap 4: The Monday morning quarter-back – hindsight delusion

With hindsight we often honestly think we could have predicted what has happened, such as a fall in the markets.  The evidence suggests that we cannot.

Mitigation strategy: Do not believe that you have predictive powers – it is unlikely that you do.

Trap 5: I will throw my anchor out here thanks

The human mind really likes to use mental ‘anchors’ when forming opinions, which in many cases leads to extraordinarily inaccurate estimates of outcomes.  The level of the FTSE 100 is a common investment anchor for clients, even if their investment portfolio is very different.

Mitigation strategy: Do not allow yourself to get hooked on meaningless anchors.

Trap 6: It is more familiar to me, and I get it

Humans tend to make spontaneous generalisations, based on how they are influenced by recent events, press coverage, their own experiences, and the vividness with which a situation is portrayed.

Mitigation strategy: Stand back and seek a broader perspective.

Trap 7: I like a good story

We all love a good story and there are few better story-tellers than fund managers.  The danger is that the narrative of a plausible sounding script, often full of contingent probabilities, tends to persuade us to assign a higher likelihood to the story coming true than is realistic.

Mitigation strategy: Be a sceptic – take everything you hear or read from the industry with a pinch of salt.

Trap 8: Short-termism and obsessive portfolio monitoring

Many investors find it difficult to see the long-term wood for the short-term trees. Their focus tends to be on the effects of recent market conditions on their wealth and this affects their ability to make good decisions for the long-term success in meeting their lifetime purchasing power needs.

Mitigation strategy: Given the 2:1 ratio of pain to gain, the longer the period between peeks at a portfolio the better!

The solution: process, process, process.

Investing using a well thought-out, evidence-based and systematic investment process helps to take much of the emotion out of investing.  A good process won’t always deliver a good outcome, but over time it raises the chances of one.  While investing is simple, it is never easy, largely because of how we behave.

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

We tend to regard wealth as financial assets, large houses, and nice cars accumulated through a life of hard work.  Yet that is to view wealth in narrow terms; on the very day we are born we are wealthy in terms of our human capital, or in other words, the present value of all the future earnings that we will generate over our working lives.  This needs to be reflected in how we invest during the accumulation phase of investing.

As younger people have a long time to go before they will need the money, the advice they receive is often that excess earnings should be invested predominantly in equities.  A subtler approach takes into account the attributes of each person’s human capital, which ranges from bond-like to equity-like in nature.  Take for example a university professor and a fin-tech entrepreneur; the former has stable income, linked to inflation and job security; the latter has little income stability and, most likely, a high correlation to the equity markets. The professor’s human capital acts like a bond, the entrepreneur’s as an equity.

So, if they are both 40 years old and have the same level of financial capital, should they invest in the same way?  Intuitively, the answer is no.

Human capital should be treated like any other asset class; it has its own risk and return properties and its own correlation with other financial asset classes.

Ibbotson, Milevsky, Chen and Zhu (2007)[1]

Those with more bond-like human capital could well take on more risk and those with more equity-like human capital should, perhaps, take on less risk with their financial capital.  Ironically, it is also possible that those who choose steady, stable jobs may have lower tolerance to losses than the entrepreneur, and vice versa.  One can see the risk of this scenario.  Additionally, two partners may also have different levels of risk in their human capital. Imagine a professor married to an entrepreneur; together they form a balanced portfolio between bonds and equities and their investable portfolio of financial capital should reflect this.

Figure 1: How human capital attributes influence asset allocation

Source: Albion Strategic Consulting

Cash-flow modelling can help those in the accumulation phase of investing to understand the financial impact of changes to their human capital.  Owning sufficient life cover to protect the outstanding human capital should be an important part of the discussion.  It is difficult to see how a stockbroker or investment manager can structure a portfolio sensibly, particularly where the investor still has substantial human capital, without the insight into, and modelling of, the client’s total asset picture.  No financial portfolio is an island.

[1]      Ibbotson, Milevsky, Chen and Zhu (2007), Lifetime Financial Advice: Human Capital, Asset Allocation and Insurance, Research Foundation of CFA Institute publication.

Other Notes and Risk Warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any product for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated.