Performance

If your investment manager does not share the same timescales as you, can they really deliver the performance you need?  When the tenures of fund managers are measured in months rather than years, it is no surprise that their strategies do not suit investors, for whom investment horizons may be measured in decades.

It is important for investors to realistic about the investment objectives set by their fund manager who is much more likely to be focused on their CV than most investors would believe.  To the average fund manager, an above average return every three years delivers headline grabbing performance for long enough to draw in more funds and to enable them to feather their nest; that career move will leave most of their investors way behind.  However, a good year followed by a couple of poor years does not give them the type of consistency most of them seek, however well it is marketed.

It is certainly worth being a little cynical when assessing the suitability of a fund or investment management service as moral can be sapped in the face of personnel turnover, often bottom of the list of selection criteria.

Is the stock market, as a whole, an inherently riskier place to invest money than the residential property market?  Now, I am not for one second suggesting that either is an appropriate place to put your money, although one or both may be, I am just opening up the discussion.  I am also considering the property market in investment terms rather than housing terms, no share portfolio will keep you dry through the winter or give you somewhere to show off your latest plasma TV.  These thoughts are probably, therefore most applicable to excess property investment, by which I mean a second property, a buy-to-let property or a house larger than your requirements, which you hope to sell to fund your retirement.

Firstly, what do we mean by risk?  It is, I suggest, unlikely that the stock market or the property market will drop in value to zero.  It is, of course, possible to make a bad choice of investment.  Some companies will go bust and some properties may become worthless, perhaps because of flooding or encroachment by the sea.  Now, you would be daft to buy a property without insuring it against these risks but most people will buy a share in a company without any corresponding insurance against loss (i may cover how another time).  This, then, starts to colour our view of the relative merits of the investments; we take more risk with our stocks, for some reason, than we do with our real estate.

The world of professional investors usually expresses risk in terms of the volatility of returns.  An investment which can deliver high returns with periodic big drops in values is considered to be riskier than an investment which is more steady in its delivery, even if they end up at the same spot.

So, how does volatility compare?  My main concern here is one of information delivery.  If you valued your share portfolio every year, it may not look particularly volatile and, indeed, in most years it would have gone up in value, probably even in 1987.  This is where the stock portfolio is at something of a disadvantage when compared against property.  You see, property is not valued by anyone, let alone the market (as distinctly opposed to an estate agent or even a surveyor) in anything like real time.  Depending on how often we move, a property may only be market valued, i.e. bought, once every seven years.  We may read in the press about the general sentiment but no one is able to rub our noses in its value in real time, minute by minute.  If you own a stock portfolio, you can watch it go up and down every minute of the working day, responding instantaneously to investor sentiment, and it can be frightening for some.

Also, I have referred to a stock portfolio as opposed to one stock, mostly, as it would not be rational to hold only a couple of different shares.  Diversification is easy with shares, not so with property as it is expensive and slow to sell, amongst other things.  

What of the returns?  Well, ignoring income form dividends or rent, which I gauge to be similar after costs, I think property and equities have probably delivered similar capital growth.  If you take into account transaction costs and the difficulties of diversifying across a number of properties, it may well be that a property portfolio has lost ground to a share portfolio.  What, though, will the next twenty bring?

After years of stalling, the Government finally caved in to pressure from the property sector and allowed the conversion to and establishment of Real Estate Investment Trusts from January this year (REITs are an established investment in many other countries).  Unfortunately, the year has not been kind to the sector with a loss in share price of almost 25% so far.  They have also been hit by the Governments proposal to introduce a flat rate for Capital Gains Tax of 18%.  Capital Gains realised within the REIT most be largely distributed to shareholders as income, with correspondingly higher rates of tax.

In fairness, most REIT investors would not be buying investment property directly and appreciate the high liquidity of REITs, even if they bring with them higher volatility and slightly higher tax.  it does, though, look as if the hype has proved to be without substance and REITs in the UK may be confined to the fringes for a while.

Is there any end to the pain endured by holders of With Profits funds and policies?  The relentless downward spiral of these once great investments is a sad indictment of the way insurance companies have treated their policy holders over the last twenty years and they (by which I mean WP funds but it could apply to the insurance companies) seem to be in terminal decline.  The inherent lack of transparency and flexibility of With Profits funds have left them struggling for relevance in the modern world and with the possibility looming that the regulator will turn off the commissions tap, there seems little left to sustain them.  Unloved and misunderstood by most, we should not mourn their passing.

Below is a graph showing the history of annual bonuses awarded to the ever suffering investors by a 'leading' insurance company.  Not a pretty sight.

Zombie Funds, so called because the money in them is living in a dead fund, have been hitting the business headlines of late.  In particular, Resolution Life has become the subject of a tug of love between Pearl and Standard Life.  For millions of savers this is of more than a apssing interest because Resolution takes care of many billions of pounds of their money and is itself worth more than £2bn.

Resolution was formed as an acquisition vehicle for funds lying in closed life funds with insurers such as the Royal and Sun Alliance.  These companies had decided that they would be better off getting out of the business of running pension and life funds and simply shut up shop.  Having decided to abandon their many policy holders they then sold off the funds to save them the bother of running them and dealing with disappointed investors.

Whether I would be happy with my life savings being in a Zombie Fund is a moot point, it hard enough keeping track of who exactly is running this unloved pot of cash, let alone being sure they are acting in your interests.  Whoever owns it, it seems to be more profitable than being an investor.

Investing in commodities, by which, it is normally meant the raw materials for industry such as minerals mined, metals refined or agricultural produce, presents a number of practical obstacles.  Private investors can hardly take delivery of several tons of wheat, for example.  

Traditionally, institutions have made money from the commodities markets by trading in forward contracts, futures and options.  These markets are notoriously difficult territory for smaller investors and not generally appropriate for a long term strategy of buy and hold.

So why the interest in commodities?  Well, they can provide the opportunity of an uncorrelated return to add to an investment portfolio, i.e., they do not go up and down at the same time as equity markets much of the time.  Diversification is central to portfolio construction and the search is always on for assets which increase this.  However, as everyone rushes to diversify, assets can start to become correlated.  That said, there is still a case for the inclusion of commodities, even though they have no income generating prospects, important to many investors.

Most will obtain some interest in the commodity markets by investing in companies which derive their earnings from producing them, mining stocks, etc.  Now, however, there are increasing numbers of Exchange Traded Funds (marketed as Exchange Traded Commodities, ETCs) linked to commodities indices.  These give the opportunity to access returns on a broad range of commodities from platinum to oil to livestock and are worthy of consideration for inclusion in a well diversified portfolio for the long haul.

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.