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For those readers interested in financial news (some might call it noise), the unfolding story of Chinese property developer Evergrande (a name which is ironic given its dire financial position) has spooked global equity markets.

The short version of the story is that the company is very highly leveraged i.e. it has borrowed US$300 billion from banks to fund its property developments and has hit material cash flow problems, leaving suppliers and debt repayments at risk.  Property prices have risen dramatically in urban China over the past few years and the Chinese Communist Party (CCP) is now clamping down on bank lending to slow the boom, which is part of Evergrande’s problem.  To add to the drama, Evergrande has also sold high risk retail products to its wealth management arm’s clients, which it appears to have misrepresented as low risk investments.  Some of these investors’ funds have been diverted to shore up the company’s own working capital and some has allegedly been used to pay off other investors, which is the hallmark of a Ponzi scheme.   More acutely, the company needs to meet an interest payment of US$84 billion this week and the markets are waiting with bated breath to see if they manage to do so.  Its bonds are trading at 25 cents on the dollar and its equity has fallen by 85% in value in 2021.  Not pretty.

IF Evergrande default – some have suggested this could be the equivalent of Lehman Brothers collapse that set off the market falls leading into the Global Financial Crisis – AND if this then leads to the collapse of the company with repercussions for lending banks (most of which are Chinese), AND if there is a resultant fire-sale of properties, AND suppliers go unpaid AND this all precipitates a collapse of other development firms, THEN this could cause a major challenge for the CCP (not least that 1.4 million buyers who have put down deposits on unfinished properties) AND impact on Chinese growth on which the world depends.  Could it THEN cause a contagion in global markets resulting in a major decline in stock markets around the world?

BUT, hold on a minute, what started as a potential corporate default has grown – in this story – into a major decline in world growth and a stock market crash!  BUT in this case, much of the debt is in local currency and lent by banks that are mostly owned by the CCP, which can force them to roll or forgive debt and provide unlimited liquidity to the banking system.  It does not mean that things will be easily resolved, BUT it does not mean that the conflated IF, AND, THEN story of conditional probabilities is likely to occur.

It is important to remember that many material world events occur on a regular basis, but do not always end up in negative market outcomes.  Even COVID, which put a dent in equity market valuations in early 2020, has failed to turn into a prolonged downturn.  Global markets are now well above their highs before the COVID-induced falls.  Certainly it is true that on occasion a single event precipitates a market fall, but the problem is that we, as investors, have absolutely no chance of knowing which event this might be and position portfolios ahead of any anticipated fall.  If this were possible, the market would already have fallen! In this particular case, it is important to note that Evergrande’s market cap is under USD6 billion – or put another way, Apple is over 400 times larger – so any portfolio holding would be miniscule at worst.  The company represents around 0.01% of global equities and China is only 4% of the global equity markets. Our suggestion: don’t pay too much attention to the financial ‘news’!

If you have any questions, thoughts or actions relating to the content of this article please get in touch with us by calling us on 028 9099 6948 or by emailing info@pacem-advisory.com

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security 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.

Don’t run out of money

Of all the financial challenges and concerns that we face over our lifetimes, avoiding running out of money in retirement probably sits at the top of the list.  No-one wants to end up relying on meagre state benefits and eating own-brand baked beans every day.  Retirement Rule 1 is crucial but not guaranteed.  As Warren Buffett might say, Retirement Rule 2 is not to forget Retirement Rule 1!

In the good old days, retirees could rely on defined benefit pensions and/or annuities to provide lifelong retirement income. Today, many retirees rely, to a varying degree, on taking money from accumulated pension pots for their retirement income.  That makes outcomes less certain and decisions far tougher.

From time-to-time scary data surface about the state of retirement planning in the UK. Recently, LV – the insurance company – published the results of a survey of 4,000 people relating to how they intend or are handling their pension arrangements[1].  LV estimate that there are around 30 million pension holders in the UK.  The results are a little startling, to say the least. Take a look at the chart below.

As one third (or effectively 10 million people) do not know how to make their retirement pot last, it implies that two thirds apparently do know.  Perhaps these are the two thirds who plan on taking advice!  Not running out of money is a complex problem that taxes even the best financial brains.  It would seem that many people may be overconfident in their assessment of how much they truly know about retirement planning.

The figure below provides an overview of just how tricky this process is and how it must be an ongoing, dynamic process, not a one-off decision at retirement. Knowing what you cannot control and understanding what you can, provides some insight into the complexity of – and solutions to – retirement planning.

Retirement is meant to be a time of financial freedom allowing you to do the things you want to do, when you want to do them and who you want to do them with.  It is a great shame that many people in the UK will fail to achieve even a modicum of financial freedom and lifestyle choice.  As a broad rule of thumb, today, £1 million will buy an inflation-linked annuity income of around £27,500 a year[1].  Yet the median UK pension pot is around £91,000[2] (for those 55-64 years old), which on the same basis will deliver only £2,500 a year.

Taking an income from an investment portfolio may allow a withdrawal rate that is potentially a little higher but needs a lot of care and attention to reduce the risk of running out of money.  Making sure that you optimise the decisions that need to be made – and control all the things you can control – will allow you to maximise the stability, level and longevity of retirement income you need.

That is what a good adviser will help their clients do and where they earn their fees.  The best way to achieve Retirement Rule 1 is to take proper financial planning advice.

If you have any questions, thoughts or actions relating to the content of this article please get in touch with us by calling us on 028 9099 6948 or by emailing info@pacem-advisory.com

[1] https://www.scottishwidows.co.uk/retirement/retirement-explained/taking/pension-options/guaranteed-income/index-linked-annuity/

[2]     Office for National Statistics. https://www.ons.gov.uk/peoplepopulationandcommunity/personalandhouseholdfinances/incomeandwealth/datasets/pensionwealthwealthingreatbritain

[1] 10m pensioners risk running out of money, FT.com 26^th August 2021

Investing is all about tradeoffs. Each choice made is paired with an implicit decision not to do some alternative; the ‘opportunity cost’. For example, by investing solely in a basket of UK companies one accepts the risk of losing out if the UK market struggles relative to the rest of the world, and vice-versa. An investment portfolio could be constructed to reflect other preferences, such as the appetite to have exposure to certain companies or industries, adopt a specific level of equity or fixed income risk, or attempt to adjust the average fee paid to managers, to name a few. Choices come with consequences.

Recently, insight provided by Hargreaves Lansdown – the UK’s largest fund platform managing around £120bn[1] – and Interactive Investor – the UK’s largest flat-fee platform[2] – shed some light on the preferences of younger investors coming to market[3].

“The younger generation want things they are passionate about, that they can engage with, that resonate with their particular desires and preferences, whatever those may be. They want things they can be passionate about.”

The data suggest that younger investors have tended to invest in companies they feel strongly about, a standout theme being the electric car industry at present through firms such as Tesla and NIO. Gavin Corr, head of manager selection and due diligence services at Morningstar, went on to say:

“The younger generation will not be happy in a multi-asset balanced 60/40 portfolio, sitting alongside another million other investors that are profiled exactly the same way. This democratisation or mass customisation is coming”
Gavin Corr, Morningstar[4]

The challenge is that preferences naturally come with their own tradeoffs. This is crucial to remember. To avoid a traditional balanced portfolio and instead own a portfolio of ‘clean energy’ firms, perhaps with electric cars, wind turbines and solar energy as themes, one must accept that they own a highly concentrated portfolio of stocks with low levels of diversification, large sector biases and likely with high management costs. This is likely to negatively impact returns in the medium to longer term.

The aim of this short note is not to suggest that these preferences are wrong, in fact investors may benefit from an ‘emotional dividend’ to compensate investors and make the tradeoffs worthwhile[5]. This emotional dividend, however, is rewarded at the cost of actual investment returns and investors may not realise the magnitude of this cost.

A key pillar of our investment philosophy is to accept that capital markets do a good job of pricing securities and therefore markets are difficult to beat. The table below demonstrates this belief by comparing a simple two-fund developed equity and bond portfolio[6] against the cohort of managers running ‘balanced’ portfolios Corr (2021) referred to. Each of the other managers in the figure will have had their own preferences, which evidently come with consequences.

Figure 1: Multi-asset peer group performance – 10 years to Jul-21

Morningstar Direct © All rights reserved. Morningstar category: EAA Fund GBP Moderate Allocation.

The tradeoffs are well demonstrated in the chart above. A traditional 60/40 portfolio holds up exceptionally well. Only 3 of the 116 funds in the sample provided a superior return to the 60/40 ‘balanced’ portfolio, that is without accounting for any funds that may have closed in the last 10-years! Investors who wish to express their preferences in portfolios should be aware they are at a high risk of market underperformance. Sticking to sound, well researched investment principles is key to a successful outcome.

[1] Money to the Masses (2021) https://moneytothemasses.com/saving-for-your-future/…

[2] FT Adviser (2020) https://www.ftadviser.com/investments/…

[3] Citywire (2021) Everything you need to know about young investors. https://citywire.co.uk/…

[4] Citywire (2021) Morningstar: Impersonal 60/40 portfolio won’t impress young clients. https://citywire.co.uk/…

[5] Rational Reminder Podcast (2021) Episode 156: Climate Change vs. The Stock Market.

[6] Portfolio: 60% Vanguard Global Stock Index, 40% Dimensional Global Short-dated Bond. Rebalanced annually.

The late, great Jack Bogle – the founder of Vanguard and the grandfather of index investing – left us all with a simple mantra that he repeated almost every time he wrote an article or gave an interview ‘costs matter’.  He also often used to say, ‘in investing you get what you don’t pay for’. And therein lies the rub.  In day-to-day life, we tend to make a connection – largely correctly – that you get what you pay for.  If you need a good lawyer, it will probably cost you.  If you want the paint to last on your windows, employ a decorator who costs more because they will spend more time prepping the surfaces and uses better quality products.  Buy cheap, buy twice!  Yet when it comes to investing, broadly speaking, the exact opposite applies.  The more you pay in ongoing charges to invest in a fund and on all the costs associated with owning the fund over time, such as those it incurs when buying or selling shares, means, on average, that there is less money left to put in your pocket.  It would be easy to select a good fund if all you had to do was pick the most expensive manager, which might set you back significantly more than 1% a year.  Yet we know, for example, that over 85% of all US equity funds failed to beat the market over 20 years, not least because of the high costs they incur[1].  Trying to pick – in advance – skilled managers who will beat the market in the next 20 years is extremely taxing.

In fact, if you reverse your strategy and pick the cheapest fund, it is likely (although never guaranteed) to be a better option. Taking equity funds available for sale in the UK[2] – both index funds delivering the market return (295 in all), and non-index funds (4,969) seeking to beat the market return, the average costs and the difference between them are set out below.

Figure 1: Equity funds for sale in the UK – Ongoing Charges Figure (OCF)

Source: Morningstar Direct © All rights reserved. Data as at 30^th June 2021.

If we assume that both sets of managers (index and non-index) capture the same market returns before costs – a reasonable position to take, in aggregate, as winners and losers have to net out to zero – we can calculate the differential wealth outcomes over time between the less costly index funds and the more costly non-index funds.  The seemingly small difference of 0.85% make a huge difference to what an investor’s retirement might look like.  The chart below shows you how much more money you would have with the lower cost strategy over different time frames[3].

Figure 2: Wealth outcomes differ depending on costs – lower = generally better

Source: Albion Strategic Consulting using Professor William Sharpe’s Terminal Wealth Ratio calculation.

Put another way, at the end of 40 years – not an unreasonable investing horizon – if the high-cost strategy ended up with £1 million, the lower cost strategy would have £410,000 more to spend, all else equal.

Perhaps we should also take heed of another investing titan, Warren Buffet of Berkshire Hatahway, who reflects on the trouble the wealthy sometimes have in buying something cheap, in this case index funds:

‘The financial “elites” – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is – on an expectancy basis – clearly the best choice.’

Warren Buffett (2016) Berkshire Hathaway Shareholder Letter

As investors we should not lose sight of the fact that we put up 100% of the capital and take 100% of the risk of doing so.  Surely, we deserve to pocket the bulk of the returns on offer.  So, all together now, one last time, ‘costs really matter!’

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security 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]  US Scorecard 2021. http://us.spindices.com/resource-center/thought-leadership/spiva/

[2]  As of 30^th June 2021.  Open-ended, UK domiciled funds and ETF, or funds with UK reporting status, publishing KIID OCF data.

[3] This uses Nobel Laureate William Sharpe’s Total Wealth Ratio calculation

Pacem was delighted to, once again, support the Belfast Business Idea Award 2021. The Idea Award, supported by Belfast City Council, Danske Bank, Pacem, Enterprise NI and Innovation Factory, differs from other awards in that it is the strength of the idea that is assessed, rather than the achievements of the venture so far. The competition is designed to unearth, recognise and help to fast track the best business ideas in Belfast and means that people who have yet to set up a business have as much chance of winning as those who have already started to trade successfully.

For the first time, the 2021 Belfast Business Idea Award was open for ‘Video Entries’ and applicants sent their submissions electronically to be judged by an independent panel. Each applicant had 120 seconds to explain why their business/idea is great and why they should win the competition.

Speaking at the judging day, Daniel Glover, MD at Pacem spoke of his support of the initiative;

“We are delighted to support the Belfast Business Idea Award again this year and we have been extremely impressed and enthused at the quality of submissions received. It has been difficult to shortlist to five winners today, and there was much deliberation and discussion within the judging panel, which is a testament to the calibre of entries received. Belfast has a great entrepreneurial spirit, and we are thrilled to do our bit to help early-stage businesses flourish in Belfast. It is great to be able to share our experience and financial expertise to new entrepreneurs who are setting out.”

The competition seen entries received from a diverse range of applicants across Belfast with the five shortlisted winners announced at the finalist’s night which took place on 22nd June 2021. On the night, the five winners each had to pitch for 120 seconds and explain why they think their business/idea should win the overall prize; a cash injection of £2,500 to help their business grow. The overall winner was decided live on the night via public vote. Each of the five winners also received an impressive support package worth over £3,000 which includes:

• Six months free accountancy services (including software) from Pacem Accounting and Tax Advisory
• 1 year Innovation Factory membership (including an open plan co-working desk, access to masterclasses and on-site bespoke business mentoring)
• 1 year membership of the ENI Plus online resource

The 2021 Belfast Business Idea Award Winners announced at the finalist’s night on 22nd June were:

• Network Fit – Overall Winner
• Tsang Sauce
• Hearty Growers
• Baby Fresh UK
• Linc Technology

All finalists present on the night also had the opportunity to hear from, and put questions to, three of NI’s most successful entrepreneurs and founders of, BLK BOX, Bperfect Cosmetics and Suki Tea, gaining some welcome advice from those who started in a spare room in Belfast and have gone on to compete, and win, on a global scale.

Speaking at the finalist’s night, Daniel commended all applicants and expressed his enthusiasm towards working with the winners,

“We are looking forward to working alongside the newly crowned winners of the 2021 Belfast Business Idea Award by providing six months free accountancy services. We love helping new businesses develop and grow and to play a part in their journey is a real privilege. We can’t wait to see what is in store for these blossoming businesses and predict great things ahead –  watch this space”.

Investing is simple, but not easy.  The decision to invest in the first place requires foresight, as well as the discipline to deny oneself spending today so that you don’t have to eat own-brand baked beans out of the tin in retirement.

The second is deciding how much you want, need and are able to invest in equities, which will act as the drivers of positive portfolio returns, above inflation, that will help fund future spending goals.  Getting this right is key and where good advisers can add value.

Next an investor needs to decide the broad structure of their equity and bond components of their portfolio.  A good place to start for equities is the structure of the global markets, which defines the basic country, sector and company weights and offers broad diversification. As Eugene Fama, who won the Nobel Memorial Prize in Economic Sciences, said in a recent webinar:

‘You need to be able to talk your way out of a market cap-weighted portfolio’.

By this he means that any decision to move away from this structure needs to be based on evidence and provide a good chance – although never the certainty – to improve the risk and return characteristics of this portfolio.  That is a bit trickier and requires a reasonable degree of investment knowledge.  Occam’s razor suggests that the simplest answer to a complex problem is often the most effective.  It certainly is in investing. Start with market capitalisation.

The final step is picking funds to implement the strategy.  Yet for many DIY investors, this is one of the first steps they take, heading to the ‘best buy’ fund lists in the Sunday papers or some investment website.  Here is where the fun and danger start.

Some funds – usually measured over short time frames such as three years – can have great looking track records.  At this point many investors’ decisions are driven by common behavioural biases.  Hindsight bias is the most obvious – it’s easy to identify a fund that has done well in the past, but difficult to pick one that will do well in the years ahead.  Extrapolating the past into the future is rarely a successful strategy.  The fear of missing out is strong but needs to be resisted.  Overconfidence in the ability to pick a ‘market-beating’ fund manager goes against the grain of the bulk of the evidence we have to hand. Over the past 20 years, for example, over 85% of all US equity funds failed to beat the market index and only around one third actually survived the whole period![1]

Different parts of the market do well at different times, but no-one really knows who the future winners are, not even the professionals.  Naïve investors take good short-term performance as a sign of skill.  Yet the reality is that much of the seemingly ‘good’ performance may be down to the part of the market that has performed well that happens to gel with the style of a specific fund.   There is an old industry saying that markets pick managers, not the other way around.  ‘Good’ performance may also simply be luck.  You need at least 16 years of performance data to be 95% certain that skill rather than luck is the driver of outperformance, even for highly skilled managers[2]. Three- or five-year performance records are largely worthless in identifying good funds.  Yet that is where best-buy lists and many IFAs tend to focus.

Spot the ‘dog’

One example of the noise investors face is the ‘Spot the dog’ report published by Bestinvest (owned by Tilney) every six months – and often highlighted in the Sunday papers – naming and shaming a list of funds, coined ‘dogs’, that have performed poorly relative to a broad market benchmark over three years[3]. Simultaneously, ‘pedigree’ funds are celebrated based on strong recent outperformance. By and large the ‘dogs’ were value funds (made up of cheaper stocks relative to some fundamental company metric, like book value or earnings), and the ‘pedigree’ funds were growth-oriented[4] (more expensive companies) in their latest report.  Over the three years, growth stocks in general outperformed value stocks.  Without this context, investors risk making decisions based on hindsight, picking investment styles that have done well and potentially lucky managers within those styles. So far this year, many of the UK ‘dogs’ have outperformed the ‘pedigree’ funds, as value stocks have performed better than growth stocks[5].

‘Expert’ picks

Investors Chronicle also tends to provide an annual Top 100 Funds list by broad investment category.  Its 2012 global growth list identified nine funds and investment trusts[6].  Over the past ten years, only two out of the nine selected funds beat the market index, but did so handsomely.  They are both highly concentrated, high conviction funds holding just a handful of companies.  One of the funds suffered a fund-specific 50% fall within the period, which would have taken a strong stomach to live with.  The other has experienced a couple of years of explosive growth, driven by a handful of companies and one electric car manufacturer in particular!  Will they continue to do so well in the future?  No-one knows, not even the managers of these funds and certainly not the pundits creating best buy lists.  And that is the point.  Basing an investment strategy on ‘I don’t really know’ seems a bit like gambling.

Capturing the market return with a well-diversified, low cost, systematic fund makes good sense and allows investors to ignore the best-buy and fund tips tables noise. Thank goodness for Occam and his razor!

Risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security 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]     S&P Dow Jones Indices – US SPIVA Report Year end 2020. http://us.spindices.com/resource-center/thought-leadership/spiva/

[2]    An information ratio measures how much skill-based return a manager delivers relative to a representative benchmark and how much relative risk they took to achieve this.  A ratio of 0.5 (i.e. half a unit of return for each unit of additional risk taken on) is deemed to be outstanding.

[3]    Bestinvest (2021) Spot the Dog. https://www.bestinvest.co.uk/research/spot-the-dog

[4]    Albion Strategic Consulting April 2021, Governance Update 21.

[5]    Refer to footnote 4.

[6]    https://www.investorschronicle.co.uk/2012/07/03/funds-and-etfs/ic-top-funds-2tJw2RT28T6GH04lkFVcEL/article.html