Wealth management: Smart investments for the new year

Property investment
By Martin Morris, CA magazine

19 January 2017

With interest rates low and markets unstable, Martin Morris asks how wealth managers would advise investors.

The aftermath of the global financial crisis has driven interest rates down to historic lows. One major consequence of this has been income instruments, such as cash deposits and bonds, providing progressively poorer returns to investors.

High net worth individuals (HNWIs), despite the financial resources at their disposal, haven’t been exempt. Yet those resources, due to their scale, present an opportunity – the principal question being how far up the 'risk curve', in terms of asset allocation, they are prepared to go to generate better investment returns.

As John Godfrey, Director of Barclays Wealth and Investment Management in Scotland, put it: “Attitudes to investing and appetite for risk are traits very specific to the individual.

John Godfrey, Barclays“We use behavioural finance – a combination of psychology and financial theory – to help shape our understanding of clients’ needs and develop a suitable approach to their investment portfolio.”

He added that, traditionally, wealth advisers tend to focus only on an investor’s attitude to risk, but the reality is more complex than that. Self-control and decision-making are also key.

“Our Financial Personality Assessment measures clients on six personality dimensions, not only allowing us to understand their attitudes to investment in detail but also how they make investment decisions, their tolerance of risk and what they want their wealth to achieve.

“An investment strategy and portfolio is then tailored to the clients’ needs, so rather than managing clients up or down the ‘risk curve’, we are providing a holistic approach to wealth management and investment.”

A break from tradition

According to MoneySupermarket, the highest yielding five-year fixed term deposit currently pays 1.95%.

Head of Portfolio Specialists at Lloyds Private Banking, Jon Wingent, said: "That would barely be enough to maintain the value of the capital invested, never mind leaving the investor with an income. This is due to three key factors: inflation, taxes and costs.

“Investors are looking beyond traditional fixed income assets for income. Equities may be yielding higher than inflation and traditional fixed income, and this has driven up price and capital at risk. Sterling weakness also diminishes purchasing power, and imports inflation – which has been seen in the recent bond sell-off.”

If you are an HNWI, then knowing what you can afford to lose is the first obvious consideration. You should ask yourself how your personal circumstances would be affected in the event of some of your investments falling in value. What are your financial commitments and will they be met under a worst case scenario?

Andrew Forrest, InvestecAndrew Forrest, Senior Investment Director with Investec Wealth & Investment argued that diversification across asset classes reduces volatility and helps investors achieve their long-term objectives within their risk parameters.

He said: “While many market commentators continue only to equate risk with market volatility, we are equally focused on risk being defined as ‘the permanent loss of capital’, and make our asset selections accordingly.”

He added that, for HNWIs, income is rarely a consideration, unless in tax-free vehicles such as ISAs and pensions – a bigger priority being capital preservation.

It is important, therefore, not only to work out your objectives, as well as the timescales involved, but also to address the core issue of balancing your investments to meet them. The more ambitious your objectives, the higher your risk profile will probably need to be.

For example, if you accept no volatility risk  in the quest for bigger investment returns, your objectives might never be met. An over-ambitious risk appetite could equally lead to failure to meet such objectives because you lose too much capital in the process.

Planning to profit

If you have specific short-term objectives, these will best be met by investing in products with low volatility risk, such as cash instruments.

Longer-term goals will be better met by investing in products likely to provide inflation-beating returns, such as stocks and shares, though they come with their own risk of markets going down.

As long-term goals draw closer, however, the risk balance will need to be adapted accordingly, typically by moving into less volatile asset classes as you look to lock in gains to protect your overall portfolio against unpredictable events.

Samantha Boy, RathbonesSamantha Boyd, Investment Director of Rathbones, said that given the current tax regime and economic climate, the company is encouraging clients to look at 'total return', not separating out capital growth from income growth but instead viewing the whole picture as one.

“Double-digit returns, which may have been the norm in years gone by, are no longer to be expected. Most people should now be looking at CPI plus low- to mid-single digit growth,” she said.

She added that while some clients have long received income payments and don’t like the idea of eating into their capital, so long as the payments are kept at a reasonable level, capital protection should be achievable too.

One general investment approach is the so-called “core-satellite” strategy that places a substantial 'core' portion of an individual’s investable assets in a long-term passive investing strategy, the aim being to minimise costs, tax liability and volatility.

Additional 'satellite' investments can be used around the core and, while significantly smaller components of the investor’s overall portfolio, they may include actively managed funds, hedge funds, structured instruments, or even concentrated single stock positions.

These investments will likely mean more risk and volatility for the investor as well as higher management fees and potentially a higher tax burden.

In addition, this strategy may include alternative investments such as art and collectibles; precious metals and futures/options contracts, all of which come with their own attendant risks.

Thinking outside the box

Nicholas Hawkins, Associate Director of Quilter Cheviot Investment Management, argued that these alternatives are good portfolio diversifiers, given their low correlation with traditional investments. Moreover, potentially high returns are achievable via an illiquidity premium.

On the downside they may incur high due diligence costs – extensive research requirements, as well as illiquidity and problems associated with obtaining a fair market value. In addition, there may be difficulties in measuring performance owing to complex benchmarks.

Nicholas Hawkins, Quilter CheviotHe said: “Clients’ risk profiles should be determined before committing to such investments. Their willingness and ability to take risk should be carefully considered and generally, the lower of the two will be used as an indication of their overall risk tolerance.”

He also noted that alternative investments aren’t always suitable for clients with a lower risk profile. For example, investors may be subject to lock-up periods, during which no part of the investment can be withdrawn, making them unsuitable for those with a short time horizon.

There are other practical considerations as well. In the case of art and collectibles, for example, strong returns may only be available if the given artefact is in a market where there is strong, possibly temporary, demand from collectors. Moreover, provenance is a very real issue, as is the possibility of damage.

Precious metals, meanwhile, may have inherent value and be seen as a long-term store of value; especially given ongoing global geopolitical instability. Notably, gold leaped following Donald Trump’s victory in the US presidential race.

It would be wrong, though, to assume that bullion, given its price behaviour in recent years, is a one-way bet. Poor timing may have its consequences and the price of gold fell from its all time peak of $1,889 per ounce in 2011 to just $1,050 by December 2015.

Fine wine and property are also worthy of consideration, although again, each comes with its own particular risk.

For those looking to invest in fine wine, the Liv-ex Fine Wine Investables Index is the investor benchmark for the industry. As with collectibles, provenance is a major issue, as may be the credentials of the trader.

Clients’ willingness and ability to take risk should be carefully considered.

Other issues to consider include the cost of insurance and how/where the product is to be stored, in order to protect its value.

Property investment, on the other hand, may offer relative stability, tax benefits and leverage. The downside is that real estate is typically illiquid, which is especially useful if you have to reposition your portfolio quickly.

In addition, once estate agent and surveyor fees, stamp duty, land tax, solicitors’ and conveyancing fees are factored in, there are substantial buying and selling costs.

There’s also no guarantee the investment will provide enough rent to cover loan repayments, if applicable. And, of course, loan repayments themselves may rise if general interest rates head north.

Also worth noting is that investors now have to pay an extra 3% on top of each existing stamp duty band if purchasing an additional home or a residential buy-to-let property.

Exercising caution

Lee Moran is Senior Investment Proposition Manager at 1825, the specialist financial planning business that is part of Standard Life. He noted that over the last number of tax years the company has built up mature venture capital trust (VCT) portfolios for a selection of its clients that now pay out a tax free income stream of around 5%.

“When placed alongside their standard pension planning, clients who would ordinarily have been restricted in saving for retirement have much greater flexibility,” he said.

The company invests in enterprise investment schemes (EIS). But, according to Lee, small unquoted companies within VCTs and EISs provide a higher investment risk profile. There is also the possibility of illiquidity at the time of exit if these vehicles are used. The investor has no guarantee that locked-in benefits can be realised immediately.

Lee added: “Investment managers will do their best to align disposals with client expectations; however it can take a number of years to come to fruition."

Outside of traditional equities and fixed income structures, investors may also consider allocating capital to private markets, including private equity, private debt, real estate and hedge funds.

Debjani Raffan, Regional Head Scotland at UBS Wealth Management, said that these markets offer particularly attractive returns in this persistently low-yield, low-return environment.

“But investors should approach this with some caution,” she commented. “Successful investing in private markets requires a longer-term mindset, as well as a significant degree of expertise.”

In broad terms, the temptation to chase better investment returns by taking on added risk is always going to be present in a low interest rate environment. The big issue needing to be addressed is whether it’s advisable to do so, given that the environment, such as the one we have now, reflects global economic instability. Factor in political 'black swan' events such as Brexit and the election of Donald Trump and it may be smart to ignore such a temptation.

The counter argument of course is that chasing income in this environment is perfectly feasible, simply by exploiting factors such as the post-referendum fall in the value of sterling, for example. The knock-on effect here has been to make those UK companies with substantial overseas operations, yet reporting in sterling, more attractive, due to boosts in their earnings and, by extension, their dividend streams.

Either way, the importance of portfolio diversification as a general principle should never be underestimated.

The full version of this article is available in the December 2016/January 2017 edition of CA magazine.

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