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Presidents Change, Markets Remain

Another four years have flown by, and here we are again, on the morning of the 60th U.S. presidential election.

The U.S. president is often considered one of the world’s most powerful figures, wielding substantial influence over the world’s largest economy and one of its most formidable militaries, albeit limited by a system of checks and balances through Congress. Perhaps it is understandable that the media, politicians, celebrities and business owners alike wish to make their voice heard during campaign season… it is noisy time of year!

At the time of writing, the race remains extremely close. Former President Donald Trump is pursuing a second term for the Republicans, while Vice President Kamala Harris hopes to make history as the first female president for the Democrats. Polls and betting markets are sharply divided; predictive sources like The Economist and other major polls lean toward a Harris victory[1], yet many prominent bookmakers see Trump as the frontrunner[2].

It has been a roller coaster, what with President Biden’s withdrawal from the race, an assassination attempt that thankfully failed, Elon Musk coming in to bat for Trump and Taylor Swift for Harris, and the usual fierce partisanship from both sides. One way or another, we will soon wake to the news of the victor and the serving president for the next four years.

For investors, it is natural at times of political uncertainty to wonder whether they ought to act, perhaps altering their portfolio to position for a specific outcome, or to move money into cash deposits until things ‘settle down’. Some choose to invest this way, mostly at their peril, as very few managers possess the ability to consistently predict such events[1].

A better strategy, as is adopted in your portfolio, is to outsource this guesswork to the market itself, relying on the millions of daily participants to come up with their expectations and reflect them in prices. Thankfully, given both democrats and republicans support capitalism and believe in personal freedom and property rights, this strategy is a tried and tested approach to investing.

The chart below shows the Global equity market return over the last century or so, where the colours represent whether the sitting US president was Republican (red) or Democratic (blue) at the time. There is little to draw from the red and blue sections, both parties have resided over some fantastic periods, and some not so fantastic ones. However, the ability of capitalism to create wealth despite the ups and downs is evident, with $1 invested in 1926 becoming nearly $10,000 by 2024.

Figure 1: Democratic (blue) and Republican (red) Presidents and equity market returns

Source: Dimensional Returns. Index: Albion World Stock Market Index[1]. Date: 07/26-09/24. Returns in USD.

The challenge is that it is not enough to know what the outcome of this election will be, one also needs to know – without the benefit of hindsight – how the market will react once the event occurs. Would a Trump victory be good or bad for markets? What about a Harris win? Answering these questions is akin to guesswork, despite what some of the financial press might have us believe.

Whilst guessing against randomness is impossible, taking on the known risk that equity returns are far less certain than holding cash rewards investors who ignore this short-term noise and focus on the long-term.  The choice of the US President is important to some, but to the long-term investor it is largely irrelevant.

“He who lives by the crystal ball will eat shattered glass.”

Ray Dalio, CIO of Bridgewater Associates

 

Important Notes

This is a purely educational document to discuss some general investment related issues. It does not in any way constitute investment advice or arranging investments. It is for information purposes only; any information contained within them is the opinion of the authors, which can change without notice. Past financial performance is no guarantee of future results.

Products Referred to in this Document 

Where specific products are referred to in this document, it is solely to provide educational insight into the topic being discussed. Any analysis undertaken does not represent due diligence on or recommendation of any product under any circumstances and should not be construed as such.

[1] The Economist (2024). https://www.economist.com/interactive/us-2024-election/prediction-model/president

[2] Oddschecker – US Presidential Election. https://www.oddschecker.com/politics/us-politics/us-presidential-election/winner

[3] Albion GAMETM 24.5 – 90% of US equity fund managers were beaten by the MSCI USA IMI Index 20Y to Jun-24.

[4] https://smartersuccess.net/indices

Autumn 2024: Budget Round-Up

National Insurance 

On an employer level (class 1 NIs) the rate will increase from 13.8% to 15% from 6th April 2025. This will apply on employee earnings above £5,000 (rather than £9,100 at present) with this level frozen until 6th April 2028.

Employers with an NI bill of less than £100,000 can get £5,000 relief from the charge. From 6th April 2025 this will be replaced by a flat £10,500 allowance for all businesses.

In practical terms this means a company will not pay class 1 NIs where the total remuneration bill is £75,000 or less.

Class 2 and Class 3 NI rates will also see changes from 6th April 2025. The Lower Earnings Limit (LEL) and Small Profits Threshold (SPT) which underpin these rates will increase by 1.7% from 6th April 2025.

 

Capital Gains Tax (CGT)

The rate of CGT will align with the rates currently applied to property. Effective immediately (and so on transactions from 30th October), the rates will be:

  • 18% for gains within the basic rate tax band (up from 10% currently)
  • 24% for gains above the basic rate tax band (up from 20% currently)

There is to be no change to the annual exemption of £3,000.

 

Pensions 

Pension funds will become subject to Inheritance Tax (IHT) from 6th April 2027. This will mean that funds left in a defined contribution pension on death will form part of the estate for IHT purposes.

For deaths after the age of 75, the income tax charge will continue to apply so funds being inherited in this way will potentially be subject to IHT, first, and income tax when accessed thereafter.

These changes do not affect Defined Benefit (DB) / Final Salary pensions in terms of the spouse/dependent pension provided on death. Lump sums paid out would potentially be subject to IHT, as would lump sums paid as part of a death-in-service plan.

 

Inheritance Tax (IHT)

The thresholds, allowances and tax rates are all unchanged. This means the Nil Rate Band (NRB) remains at £325,000 and the Residential Nil Rate Band (RNRB) at £175,000 unless tapering applies.

Business Relief (BR) and Agricultural Property Relief are being reformed with only the first £1 million being eligible (from 6th April 2026) for full IHT relief. Amounts above £1 million are only relievable at 50% (which gives an effective IHT rate of 20% on these assets).

Shares in Alternative Investment Market (AIM) companies only receive IHT relief on 50% of the amount held (again from 6th April 2026).

Pensions, as mentioned above, are brought into IHT from 6th April 2027.

 

Tax and Saving Allowance 

All tax and saving allowances will remain frozen until 5th April 2030. This means no changes to:

  • Personal allowance
  • Personal savings allowance
  • Starter rate for savings allowance
  • Dividend allowance
  • CGT exemption
  • ISA allowance
  • LISA allowance
  • JISA allowance

The British ISA will be scrapped.

 

General

The additional dwellings surcharge on Stamp Duty Land Tax (SDLT) will rise from 3% to 5% from 31st October 2024.

Minimum wage increase from £11.44 to £12.21 from 6th April 2025, and an increase from £8.60 to £10.00 for 18-20 as part of a plan to phase this rate with the main rate.

Setting Sensible Expectations for Investment Returns

“Man has the hardest job of all, the job of making decisions on incomplete data.”

Henry Kuttner

When market returns are kind, as they have been in recent times, it can be too easy to forget that bad times in investing will come along at some stage, leading to large and/or protracted falls in value. We hope markets are kind, but without a crystal ball no investor possesses any ability to accurately forecast the ‘whats, whens and hows’ of such downturns.

As your adviser, part of our role is to stress test your financial plan – using what we understand about markets – to ensure that your ability to achieve your financial goals is built on reasonable expectations. We recognise that markets give and take.

One important element of planning for the future is building a reasonable understanding of what a portfolio of investments can deliver. We follow a logical framework to achieve this, illustrated in the graphic below. Following such a framework helps us form central case expectations of future returns. The words ‘central case’ are important here – these assumptions sit at the centre of a wide distribution of possible outcomes.

Figure 1: A logical framework for setting sensible expectations for investment returns

Source: Albion Strategic Consulting

To illustrate the point that returns from stock and bond markets are not expected to come in straight lines, consider the figure below. We take the average calendar year return of global stock markets[1] from the past 30 years (1994 to 2023) – which was an impressive 9.4%, before inflation – and the volatility (a measure of how bumpy the ride was) over the same period of 18%. The figure shows one hundred 10-year simulations with the same average return and same volatility as inputs – perhaps the futures of one hundred alternative universes!

Figure 2: One hundred 10-year return simulations, growth of 100,00

Source: Albion Strategic Consulting. One hundred 10-year Monte Carlo simulations using arithmetic average return of Albion World Stock Market Index (https://smartersuccess.net/indices) from 1994-2023 (9.4%) and standard deviation of annual returns (18%), priced in USD in nominal terms.

Ultimately, an investor won’t know which one of an infinite number of possible paths they are on until after the fact. This is why it is important to make sensible expectations about the future returns markets could deliver, and crucially meet with your adviser on a periodic basis to see which path markets could be taking.

During tough times, this might mean curtailing spending or saving more – part of the role of your financial planner is to advise if and when this might be necessary. The longer one remains invested, the greater the opportunity for shorter term noise to subside and longer term expected outcomes to prevail. A financial plan built on sensible assumptions and maintained through time gives investors the best chance of achieving their financial goals.

 

Important Notes

This is a purely educational document to discuss some general investment related issues. It does not in any way constitute investment advice or arranging investments. It is for information purposes only; any information contained within them is the opinion of the authors, which can change without notice. Past financial performance is no guarantee of future results.

Products Referred to in this Document

Where specific products are referred to in this document, it is solely to provide educational insight into the topic being discussed. Any analysis undertaken does not represent due diligence on or recommendation of any product under any circumstances and should not be construed as such.

The Golden Illusion

By its very nature, the investing industry is full of differing views on how one ought to invest their hard-earned cash. One of the more polarising debates is whether an investment in gold, physically or synthetically via an investment fund, makes good sense. The debate tends to flare up each time gold experiences a rapid growth in value, such as in the last couple of years.

The Pros

Gold is believed to form during cataclysmic events like supernovae, when massive stars exhaust their fuel and explode, or during the collision of two neutron stars – ultra-dense remnants of supernovae. Due to its lustre and durability, gold has long been prized for jewellery; however, its uses go beyond being just a desirable accessory. It is an excellent conductor, highly malleable, stable at high temperatures and inert, meaning it does not rust. These properties make gold invaluable in industries like electronics, medicine, and aerospace.

Perhaps it is no wonder that humanity has coveted gold for well over 6,500 years[1]. This enduring demand is where the value of gold comes from, and its attractiveness to investors. One impressive quality of gold is that it has retained purchasing power across the centuries. For example, in gold terms a Roman centurion of 2,000 or so years ago was paid broadly the same as a US army captain today[2]. It is this that leads some to propose physical gold as a long-term hedge against the collapse of fiat currency and global capital markets.

Other positives are that gold offers uncorrelated returns to traditional assets such as bonds and equities, providing potential diversification benefits. Unlike many investment opportunities, gold is a relatively simple concept – being a lump of metal with a market value – and is easily accessed via physical purchase or low-cost open-end funds.

The Cons 

As a commodity, gold prices are simply a function of supply and demand. Investors in gold assume that others will desire it even more avidly in the future, with each new buyer hoping that others will follow. If this sounds quite speculative, it’s because it is!

Estimating what to expect from an investment in gold, even over extended periods, is a difficult task. Unlike traditional asset classes, gold produces no income stream[1], it does not pay dividends and usually costs owners to store and insure it. As a result, many assume its long term expected return to sit somewhere near cash, which is underwhelming from a growth perspective compared to sensible alternatives.

The chart below shows the increase in value of 1 ounce of gold from 1926 to August 2024, rising from around $20 to just over $2,500. Investing the same $20 in global equities during this period would have delivered a substantially superior outcome, nearly 50 times the cumulative gain. It’s also important to note that this time frame includes extended periods where government policies, such as the Bretton Woods Agreement, influenced gold prices.

Figure 1: Annual gold spot prices against global equities: 1926-2024

Data Source: Gold.org. Inflation: US CPI. Albion World Stock Market Index. https://smartersuccess.net/indices 

As an Armageddon hedge, investors face a dilemma. Due to its bulk, weight, and the associated costs of storage and management, many opt for synthetic products like gold-backed funds or ETFs instead of owning the metal directly. If the goal is to hedge against a collapse of the financial system, relying on that system to achieve exposure to gold makes little sense. Owning physical gold comes with its own challenges too, such as storage and risk of theft.

Gold proponents may point to inflation hedging as the main attraction, but the evidence is unconvincing. While gold has maintained its value over millennia, across more useful time horizons to investors the results are less impressive. The table below shows that, after inflation in USD terms, gold has yet to get back to its February 1980 high nearly 45-years ago. It also suffered an 83% fall in value over the subsequent two decades – hardly a reliable inflation hedge!

Table 1: Real gold price declines 

Data Source: Gold.org. Inflation: US CPI.

The Portfolio

Like any investing decision, gold has its pros and cons. Assessing whether it belongs in your investment portfolio is the job of our investment committee. Each asset class must fill a specific role in your portfolio and is weighed up against the alternatives. Gold has some favorable characteristics, but you must take something out to put another thing in. Superior options exist, such as shorter-dated high-quality bonds and inflation-linked bonds on the defensive side and developed and emerging market equity as well as commercial property on the growth side.

Table 2: Assessing the role of gold in your portfolio 

As Warren Buffet succinctly puts it:

“If you own one ounce of gold for eternity, you will still only own one ounce at its end.”

(Warren Buffet, 2012)

 

Risk Warnings

This article is distributed for educational purposes only 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. Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. 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] Whilst gold itself does not produce an income stream, financial institutions may try and claw back some of the storage costs through gold lending revenues.

[1] Smithsonian (2016) https://www.smithsonianmag.com/…

[2] Erb, Claude B. and Harvey, Campbell R., The Golden Dilemma (May 4, 2013). Available at SSRN: http://ssrn.com/abstract=2078535 or http://dx.doi.org/10.2139/ssrn.2078535

The Importance of Rebalancing

Rebalancing is the practice of realigning the components of a portfolio of investments back to a target allocation from which it has drifted away. Naturally, the process is a contrarian and results in selling the things that have done well and buying more of what has done less well. To some, this may feel painful, but it is good practice and sensible behaviour your adviser can certainly support you with.

Left unrebalanced, a portfolio comprising 60% global equities (‘growth assets’) and 40% short-dated global bonds (‘defensive assets’) would have drifted to nearly 80% in growth assets over the past 10 years. This is a material change in risk exposure.

Figure 1: Drift in growth/defensive asset exposure of 60/40 portfolio from Sept-14 to Aug-24

Source: Albion Strategic Consulting. Data Source: Morningstar Direct © Growth Assets: Vanguard Total World Stock Index Fund Admiral VTWAX, Defensive Assets: Vanguard Global Short-Term Bond Index Fund VGSTBGA. Monthly returns in GBP. 

The figure above illustrates the primary need for rebalancing i.e., to prevent unwanted asset allocation drift. Evidence supports that this is the main role of rebalancing[1]. It is a process which encourages good investor behaviour and helps one avoid falling foul of biases. Rebalancing helps systematic investors maintain a well-diversified solution through time, enabling them to benefit from exposures to imperfectly correlated assets.

“Investors hoping to profit in the short-term from rebalancing trades face certain long-run disappointment. The fundamental purpose of rebalancing lies in controlling risk, not enhancing return.”

David F. Swensen, Pioneering Portfolio Management (2000)

Figure 2: The process of rebalancing requires selling what has performed best.

Source: Albion Strategic Consulting 

In some cases, contributions to and withdrawals from your portfolio can be used to nudge the allocation towards the target to keep risk in line. Keeping a watch on how far your portfolio drifts from its target is something your adviser will help with. At times of market turmoil, the issue of a potential rebalance may be considered – in order to realign risk – and don’t be surprised if we raise this with you at such a time.

Do you really need to rebalance? The answer for most investors is likely to be ‘yes’ when the time comes. If we feel a rebalance is necessary, we will be in touch to discuss this with you.

 

Risk Warnings

This article is distributed for educational purposes only 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. Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. 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] E.g. Albion, (October 2023). ‘Governance Update 26: Assessing rebalancing strategies’

 

Investing is Simple, but Not Easy

It is a simple statement that the decision to invest in the first place provides an opportunity to protect hard earned savings from inflation, and perhaps grow further. It is not easy, however, to have the foresight, as well as the discipline to deny oneself spending today for the opportunity of a better tomorrow. It is also not easy to work out how much one might want, need and be able to invest in stock markets to help fund future spending goals. Getting this right is key and where good financial advisers can add value.

It is simple that stock markets act as a core driver of returns in an investor’s portfolio, and that a good place to start for stocks is the structure of the global markets, which defines the basic country, sector and company weights and offers broad diversification.

It is also simple that high quality bonds act as protection from economic turmoil and help to smooth returns.

It is, however, not easy to know what evidence to look for in order to gain an understanding about what types of long-term investments typically improve a portfolio’s structure. This comes with the need to build an understanding of the risks one wants to be exposed to through time.

It is also not easy to decide which bonds are deemed to be defensive enough in nature to be considered an insurance policy against the uncertainty inherent in stock markets.

Finally, it is a simple concept that a low-cost fund structured to capture the target strategy gives investors a better chance of achieving their investing goals relative to a high-cost one.

It is, however, not easy to regularly screen for which funds might be best positioned to capture the returns of each part of the market, or to understand the trade-off between the management costs of a fund and the opportunity cost (i.e. what could have been) of omitting an investment. It is harder still to implement a thorough and regular investment oversight process, which is required to maintain confidence in the approach.

Figure 1: Investing can be simple, but that does not mean it is easy to do

Source: Albion Strategic Consulting

We can consider a simple formula to describe what we expect from an investment outcome, shown in the figure below.

Figure 2: A simple formula to describe an investing outcome

Source: Albion Strategic Consulting

Starting with taking on sensible risks, such as owning a diversified portfolio of investments, we expect a market rate of return.

Depending on how different a portfolio is to the broad market, the portfolio return will come in higher or lower than that of the market. This is what is known in the investment industry as ‘alpha.’

To achieve a return above that of the market portfolio (a positive alpha) an investor must own a portfolio of stocks and bonds that returns higher than the corresponding market. This can be done through picking stocks, timing markets – neither of which are expected to deliver reliably positive outcomes – or it can be more reliably achieved by overweighting areas of the market the academic evidence would suggest reward investors for owning them over the long term, such as tilting to value and smaller companies.

Next, the financial cost of accessing the desired solution is taken away from the outcome achieved. Controlling financial costs makes good sense.

Finally, there is also a cost associated with bad investing behaviour, such as falling foul to biases, illusions or acting on inadequate information. Good process and discipline, as well as having a good financial adviser for additional support, can ensure such a cost is eliminated.

Investing using a well thought-out, evidence-based and systematic investment process helps to reduce the emotional pressures involved and deliver investors with the highest probability of a successful investment outcome. It does not guarantee that the outcome will always be favourable; it cannot, given the uncertainty of the markets. What it does do is to help us make strong, rational decisions and to avoid the silly mistakes that prove to be so costly, so often. In particular, chasing markets and managers in search of market-beating returns and being sucked into the latest investment fad by recent trends, plausible marketing stories and press coverage. Bad process, or a lack of process, has an upside outcome that is down to luck rather than judgement.

Wise words to leave you with:

Perhaps reflect a while on these wise words written by Charles D. Ellis on his excellent book ‘Winning the Loser’s Game’ (Ellis, 2002):

“The hardest work in investing is not intellectual, it’s emotional. Being rational in an emotional environment is not easy. The hardest work is not figuring out the optimal investment policy; it’s sustaining a long-term focus at market highs or market lows and staying committed to a sound investment policy. Holding on to sound investment policy at market highs and market lows is notoriously hard and important work, particularly when Mr. Market always tries to trick you into making changes.”

Simple but not easy. A systematic process and a guiding hand from your adviser are the keys to success.

 

Risk Warnings

This article is distributed for educational purposes only 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 particularly security, strategy, or investment product. Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. 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.

 

In Investing, Time is Your Friend

One of the great challenges that all investors face is that there is no easy or quick way to investment success. Aesop’s fable of the tortoise and the hare is a useful metaphor. You have to use the time on your side – which could be over multiple decades – to capture the returns of the markets effectively, but often slowly. In the short-term, market returns can be disappointing. The longer you can hold for, the more likely the returns you receive will be at worst survivable, and hopefully far more palatable. It is time that allows small returns to compound into large differences in outcome for the patient investor. The reality is that markets go up and down with regular monotony.

The stock market is a device for transferring money from the impatient to the patient. – Warren Buffett

If you want to be a good investor, you have to be patient. On your investing journey, you will spend a lot of time going backwards, recovering from the set back and then surging forward again, often in short, sharp bursts of upward market movement. You just have to stick with it. Remember that you have to be in the markets to capture their returns. Impatient investors tend to lose faith in their investments too quickly, often with painful consequences.

There are no certainties in investing, but investors can give themselves the best chance of achieving their expectations by allowing the passage of time to let short term uncertainty be overwhelmed by long term expected outcomes.

In the short run, the market is a voting machine but in the long run, it is a weighing machine. – Benjamin Graham

The figure below is a powerful graphic demonstrating the benefit of convergence towards stock market expectations enjoyed by investors who befriend time.

Figure 1: Converging Stock Market Outcomes as Holding Period Increases, Jul-1926 to Jul-2024

Source: Albion Strategic Consulting. Periods on an annualised, monthly rolling basis. Omits ‘Best Return’ outcomes for 1 year to May-33 and Jun-33 due to axis limitation. See endnote for details on data used. 

 

Risk Warnings

This article is distributed for educational purposes only 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. Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. 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. 

Data Used:

Albion World Stock Market Index: Jul-26 to Dec-74 – Fama/French Total US Market Research Index. Jan-75 to Jun-89 – 40% Fama/French International market Index, 60% Fama/French Total US Market Research Index. Jul-89 to Jun-08 – 5% Fama/French Emerging Markets Index, 65% Fama/French International market Index, 30% Fama/French Total US Market Research Index. Jul-08 to present – Vanguard Total World Stock Index I VTWIX. Data in nominal terms and presented in USD.

 

Employee Spotlight: Patrick Bateson

Every few weeks we will be spotlighting a member of the team so that you can get to know the people behind the Pacem brand. This week we feature our Planning Analyst, Patrick Bateson. Patrick joined the team in March 2024, from RSA Insurance Ireland. Having completed his degree in Finance at Queen’s University Belfast, Patrick now works as a Planning Analyst at Pacem and supports our Financial Advisory team in achieving client’s financial goals.

Patrick tells us a bit more about himself below.

Employee name
Patrick Bateson

Your role at Pacem
Planning Analyst

How long have you been with Pacem?
5 Months

What does your day-to-day role entail?
Helping to build client reports, ad hoc tasks to specifically meet client needs, ad hoc business level data gathering and analysis.

How would you describe yourself in three words?
Organised, Enthusiastic, and Friendly

Tell us something that might surprise us about you.
I have 3 dogs and a cat!

What do you like most about your job?
I really enjoy the wide range of work and the people I work with.

If you won the lottery, what is the first thing you would do?
Become a client of Pacem!

What would you do (for a career) if you weren’t doing this!
I’d become a professional golfer.

Where is the best place you’ve travelled to and why?
Probably Lake Come in Italy – the views there are great!

What interests/hobbies do you have outside of work?
In my free time, I enjoy playing Football & Golf.

The Big Bond Bounce – Back (For Some)

Most investors would probably like to forget the poor performance of both bonds and equities in 2022 and early 2023.  For many investors it was their first real experience of bonds falling in value, particularly at the same time as equities.  Different investors would have experienced different outcomes in 2022 (and subsequently) depending on the type of bonds that they held. It is worth revisiting what has happened since then.

Going back to first principles, we can remind ourselves of several characteristics that apply to bonds: bond prices move in the opposite direction to bond yields i.e. when bond yields rise, bond prices fall; the prices of bonds with maturities further into the future are more sensitive to changes in yields than shorter-maturity bonds, making their prices more volatile; the lower the quality of the borrower issuing the bonds, the more like equities they behave; and finally, bond markets do not like inflation, generally driving up yields in the face of rising inflation.

In 2022, with the growing threat of high inflation following Russia’s invasion of Ukraine, exacerbated by the instability of the unfunded tax promises of the Conservative government under Liz Truss, bond yields rose dramatically and substantially.  The bond see-saw moved violently, with those owning longer-dated bonds suffering material and painful falls in value.  Those who owned shorter-dated bonds fared better, but even so delivered falls in value. Yet, bond owners from that point on began to benefit from the higher yields that their bonds now delivered, recouping some of those falls in value.  Take a look at the chart below which shows how far bonds fell for different maturities and what the return has been in cumulative terms since the start of the fall. As one can see, a big bond bounce-back for shorter-dated bonds has occurred, back to where they started, while longer-dated bonds still sit deeply underwater.

Figure 1: Bond falls and recoveries vary depending on what you own.

Source: Morningstar Direct © All rights reserved – see endnote for details. 

It is evident that shorter-dated bonds have recovered far more quickly than longer-dated bonds as the prices of the former fell less far, and the consequent higher yields have helped to recoup these falls, at least in nominal, pre-inflation terms.  At their worst, shorter-dated global bonds were down around -7% in 2022. However, they delivered just over +5% in 2023, and around +1% to the end of June this year following small yield rises across major markets.

We have always tended to favour shorter-dated bonds for this reason believing that the small premium available in lending for longer is outweighed by the downside protection that comes from owning shorter-dated bonds alongside their bounce-back-ability!

Risk Warnings:

This article is distributed for educational purposes only 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.  Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. 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.

Use of Morningstar Direct © data

© Morningstar 2024. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information, except where such damages or losses cannot be limited or excluded by law in your jurisdiction. Past financial performance is no guarantee of future results.

Data Series Used:

Instrument Asset class proxy
L&G All Stocks Index Linked Gilt Idx Tr, GB00B84QXT94 UK inflation linked gilts (longer-dated)
L&G All Stocks Gilt Index Trust, GB00B8344798 UK gilts (longer dated)
Vanguard Global Bd Idx, IE00B50W2R13 Global bonds (intermediate-dated)
Vanguard Global S/T Bd Idx, IE00BH65QG55 Global bonds (shorter-dated)
Albion Constant Maturity Bond Index (3Y, real) UK inflation linked gilts (shorter-dated)

Politics and Portfolios

It feels like 2024 is the year of the election with over 64 happening in various countries around the world covering around 50% of the world’s population[1]!  These range from the farcical pretense of the re-election of Putin, to that in the UK.  At this time, it looks like a probable victory for the Labour party over the incumbent Conservatives, seemingly with a large majority.  In the previous election in 2019, British politics was polarised between Boris Johnson’s ‘getting Brexit done’ mantra and a very left-wing alternative of Jeremy Corbyn and his ‘magic money tree’. Today, the two main parties are vying for far more central ground that tends to win elections. Who said democracy does not work?

In India, the world’s largest democracy, the people have spoken and have put a dent in the BJP and Modi’s ambitions of an overwhelming 400 seats.  They gained just 240 instead, without a majority.  The EU Parliament elections are due to begin, with concerns over the growing impact of the far-right.  Throw in the US election chaos in November and investors might wonder how to process all of this in terms of what might happen to their portfolio.

Well, the good news is that the markets have done this already for you!  It is no doubt, for example, pricing in the probability of a Labour government and what it thinks about its policies, as far as they are known. That is what markets do.  They incorporate all public information into prices quickly and efficiently, meaning that prices only move on the release of new information, which is random.  The stock market tends to be pretty resilient for those with the patience to sit out any passing market storms.  It seems to be obligatory at these times to roll out a chart with the colours of the different parties indicating the periods they are in power – say in red for Labour and blue for Conservative – and showing the growth of the market.  It does not tell you much, apart from these events have little impact, as the market prices in events well before they happen.  So here it is.

Figure 1: The UK market’s growth of wealth over time, irrespective of who is in power.

Source: Albion Strategic Consulting. Data: CT FTSE All-Share Tracker 1 Inc (GB0008464199) from 01/10/1988, Vanguard FTSE UK All Shr Idx Unit Tr£Acc (GB00B3X7QG63) from 01/01/2010. Not a recommendation. Data in GBP in nominal terms. Election results data from House of Commons Library.

It really is pointless to try to predict an outcome any different to that already reflected in today’s market prices.  What is your thesis? How have you interpreted the information that you have to hand? How is your view different to everyone else who is thinking similar thoughts?  The reality is that is really hard to outguess the market view reflected in prices.

As you see from the figure above, these periods of political power are plotted against the UK market. But what does that tell you? Over 80% of the earnings of the UK market come from overseas, so how meaningful is it to just look at UK politics. Not only that, but the UK is likely to represent only a fraction of your global portfolio, as it only represents around 4% of total world market capitalisation.  So, you will need to factor in all 64 elections, all other world events known and as yet unknown and decide how to position your portfolio accordingly.

Alternatively, you could be patient, trust that the markets work pretty well and reflects the aggregate view of all investors and believe in the power of capitalism to deliver rewards due to you as the part owner of companies (equities) and as a lender (bonds).  We advise the latter approach.

The most important thing you can do is to vote.

 

Risk Warnings:

This article is distributed for educational purposes only 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.  Reference to specific products is made only to help make educational points and does not constitute any form or recommendation or advice. 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] TIME (2023) The Ultimate Election Year: All the Elections Around the World in 2024. https://time.com/