Equity

In Politics, as in Comedy, timing is everything and is seems to be sadly missing at the Treasury.  Not long after Alastair Darling unveiled his much vilified master plan to simplify Capital Gains Tax in an effort to clip the wings of the Private Equity Overlords, it seems that the world has moved on.

Having committed Revenue and Customs and the rest of the country to an expensive and time consuming exercise to change the basis of CGT, the Private Equity outfits are starting to fall upon hard times, if the experience of Blackstone amongst others is anything to go by.  The collapsing credit markets have made it very difficult to make money buying listed companies with borrowed money so the Government will be flogging a dead horse in trying to extract significant revenue.  Any that are making money will probably relocate to somewhere more accommodating.

Once again, policy makers have shown themselves to be ignorant of a couple of truths; that markets will normally move to eliminate excess profits and the law of unforeseen consequences will apply.  For some reason, politicians seem to think it is possible to have free markets and individuals and at the same time stop some people becoming very wealthy indeed.  Still, it does detract from all the muckraking taking place in Westminster now that the spotlight has fallen on that particular gravy train.  Business people are at least honest that they are doing it to become wealthy, our MPs could learn from that candour.

It really is the time for a few well worn clichés, the world's stock markets are having a real roller coaster ride, at the moment.  It is by no means unusual but they seem to be taking their cue from the US and the sentiment over there is all over the place.  No one is quite sure how big a problem the sub-prime crisis is going to be but it starts at huge and goes up to cataclysmic.

The big worry, assuming that the financial system does not implode, is whether the US will slide into recession.  The government, in the form of the Federal Reserve Bank, is pumping vast quantities of cash into the system in the hope that it can prevent it seizing up.  In this, they are being strongly supported by the European Central Bank.

The financial system has shown itself to be remarkably resilient in the past in the face of some very worrying events but, for many investors, this is probably a time to switch off the computer and not look at values for a year or so on the basis that investment portfolios are for life, not just for Christmas.

It is all getting a little hairy in the markets at the moment; all major markets posted significant falls yesterday and the news may not be much better today.  Are we witnessing (or, for those of us with investments, experiencing) the final act in the credit crunch tragedy or merely another scene?  Also, what course of action should a rational investor take?

No one can be sure where this crisis is heading; quite a few problems have been brought to the fore but there may be more to come.  It is almost laughable now that, only a matter of weeks ago, our august politicians were focused on the rate of tax paid by Private Equity to the extent that they restructured our entire tax system in an attempt to penalise them.  Meanwhile, in the real world, things were going pear shaped.

Poorly diversified investors may have the least comfortable experience, particularly those poor private investors who held significant chunks of Northern Rock stock for no real reason.  Also, those with too large a proportion of equities may find themselves ruing their lack of investment spread and property looks set for a difficult period.

What is holding up?  Well, the bond markets, unloved of late, may find themselves viewed more favourably (especially government and high quality) and commodities may continue their climb.  But it seems, oddly enough, that emerging markets may emerge (pardon the pun) the real winners from this period of instability.  A year or so from now, they may look quite grown up, while some of the racier classes of investment, such as private equity, may look a little discredited (another pun?).

As ever, the advice to any investor is to ensure that you are properly diversified.  Do not get drawn into this year's must have (or have not) sector and only invest if you have a long term outlook.

For at least the last three years, actively-managed funds investing in Japan have failed to perform, with the IMA sector average returning 15.1% compared to the MSCI Japan Index, which grew by 35.3%.  Oddly enough, Japan is one of those markets where funds managers seem most stridently to believe active management, rather than index tracking, is important.  One well known management group even managed to lose 44.3% for its investors over the last three years.  Still, the mis-placed confidence of fund managers to deliver out performance is unlikely to be diminished; that would be awkward for their marketing departments and career damaging.  Sales of funds to the public are heavily dependent on optimistic pronouncements about the future and hints of a magic formula delivering exceptional performance.

The rise of ETFs seems to be inexorable and this year, though fraught with difficulties for investors, may see record inflows.  Although they are much used and appreciated by many institutional investors and the more sophisticated financial advisory firms, they are yet to make significant inroads into the retail market.

There are a number of reasons for this:

Firstly, not everyone is sure what an ETF, or Exchange Traded Fund is.  Most investors are familiar with collective investments, such as Unit Trusts and OEICs (Mutual Funs in the US), which are pretty much the same thing, and Investment Companies, as Investment Trusts are now labelled.  These pool investors cash to buy a portfolio of investments sharing out the returns and losses.  Unit Trusts can be purchased directly from the managers or through the many platforms and fund supermarkets now available and most are priced once a day to reflect changes in value.  Investment Companies, on the other hand, are listed on the Stock Exchange and bought through a Stock Broker.  Their price may fluctuate during the day to reflect market sentiment, i.e., they are priced in 'real time'.  ETFs are very much the same as Investment Companies with a couple of differences.  Most, if not all, are not actively managed and simply track an index.  They also have no gearing and do not trade at a significant discount or premium to the value of the underlying assets, i.e., they aim to reflect the true value of the relevant index at any given time, and they are priced in real time. They often have lower annual charges than the equivalent Unit Trust Tracker Fund and most launches of Trackers these days are in the form of ETFs.

The second reason why they are less familiar to retail investors is that many of the popular fund supermarkets do not promote them.  ETFs are not designed to offer the fat commissions that Collectives have inbuilt.  This nice commission enables many of the well known supermarkets to offer 'free' switching and attractive 'discounts' to customers.  They can also bundle extras like a 'free' SIPP (Self Invested Personal Pension).  These platforms are often marketed heavily, indeed, they provide the back bone of comment and analysis in the Sunday Papers, and it is hardly in their interests to encourage too much transparency.

However, the word is out and something like $14bn of investors money will find its way into these funds globally this year.  Expect to hear even more about them in the future.

Why does the Stock Market (and other markets, for that matter) move, sometimes by quite a bit, from one day to the next?  Can it really be that the long term outlook for companies differs significantly between Monday and Tuesday?  To put these movements into context, they are normally not that great; a change in value of 1% is headline stuff as in 'Billions Wiped of UK Stock'.  Hardly confidence building stuff for private investors.

In many ways, investors are much like flocking birds.  If you observe a flock of birds in the evening before roosting, whilst they all move as one, there actual direction seems completely random.  These birds are programmed to follow each other, if one changes direction, the one next to it follows closely and they all change direction.  In nature, this behaviour serves a purpose, these animals stick together for safety and social reasons and it is safer for a bird to follow its neighbour than not, it may have spotted a predator.

Like the flock of birds, the market has no leader showing the way and it seems to move in an entirely random way.  Albeit, we expect a long term upward trend.  The financial press puts a great deal of effort into explaining these market movements afetr the fact but, in truth, investors are just flocking most of the time.  There will, of course, be the odd, random event which greatly changes the long term outlook but, for long term investors, even these should not be seen out of context.  

Sovereign Wealth Fund have become the latest buzz words.  All of a sudden, the press is full of articles about them.  Just in case, a SWF is an investment fund run by a Government for the benefit of the nation.  The best known are those of Norway, Singapore and the Gulf States.   China has also recently burst upon the scene and persistent rumours suggest that Russia is set to launch its own SWF.

Traditionally, these funds have invested in very conservative stocks, providing a ready market for US Government debt, for example.  Of late, however, they have been flexing their muscles and taking a more active role in the equity markets.  Like private equity, some of these funds have started to prey upon Blue Chip listed companies.  J Sainsbury has been a recent, high profile, target.

The emergence of SWFs raises one or two issues:

Firstly, they tend not to be terribly transparent, leading to some worrying that they will exert influence unfairly.

Secondly, there is the possibility that a huge amount of money will hit the international markets.

Thirdly, they are run by foreigner Governments.  Always a problem for much of the press and some worry that unfriendly Governments will exert influence over our economy.

To tackle these in no particular order and incompletely; surely, if someone wants to pay considerably more than it is valued by its current owners, good luck to them.  For some reason, any foreign takeover of a 'cherished' British company attracts criticism, which is odd.  We sell it at a premium and pocket the cash; why would that cause any problems?

Given the liquidity problems and lack of confidence on the markets at present, it is possible that the SWFs will come to the rescue.  They have started to tire of buying US Treasury Stock and turned their attention to more adventurous investments, perhaps to the benefit of other investors.  

In any case,  many will cast an envious eye on these funds; some Gulf funds already generate greater returns than the considerable oil revenues, how nice.  We may see significant holdings in the hands of national funds, which may raise a few eyebrows.  So far, we have been reasonably sanguine at Russian investment in English football clubs but what if strategic companies end up under effective control of the Kremlin?  When companies were privatised, it was never really envisioned that they would end up being renationalised into the hands of foreign states.

Should we care?  Well, in the short-term, we may be thankful for their participation in stock markets.  Over the longer term, the investment world may have changed for ever.

Alistair Darling seems to have achieved the unprecedented in uniting almost every interested group against his proposed changes to Capital Gains Tax.  In essence, from next April, business tax payers, including entrepreneurs and those in holding shares in their employing company will see their tax bills rise in most instances.  Many private investors, including second property owners will pay much lower rates of tax, especially if they are high rate taxpayers.