Tag Archives: financial crisis

Points of View: UK interest rates

Another week on and we continue to face more surprises following the UK’s vote to leave the European Union. Last Thursday the Bank of England (BoE) decided to keep interest rates on hold at 0.5%, despite strong expectations of a 0.25% cut.

No one knows the precise impact that Brexit will have on the UK economy, but the BoE has highlighted that business and consumer confidence has fallen significantly both before and since the vote. Specifically, data suggests that many businesses have frozen investment decisions and the fear is that this will lead to an economic slowdown and possibly a recession.

The rationale for an immediate cut in interest rates is that this would in theory mitigate any slowdown by encouraging spending and investment. So why has the BoE decided against such action? Essentially, it is on the basis that that the loss of confidence could prove temporary as the Brexit shock recedes. Nevertheless, the BoE has stated that it will do everything within its power to reduce the downside risks facing the UK and, unless there is some evidence that confidence is rebounding, a 0.25% interest cut seems likely in the coming months.

It remains difficult to predict how the economy will be affected by the Brexit vote, but unless rising inflation becomes a greater concern, the BoE looks set to keep interest rates “lower for longer” in the face of uncertainty. From an investment perspective, we would again highlight the importance of creating robust, diversified portfolios that are not overly sensitive to any one scenario in an uncertain environment.



Points of View: The Impact of Brexit

The UK has voted to leave the EU, surprising many in global markets who had expected a narrow win for the “Remain” camp. In the short term this has triggered a fall in the pound and weakness in global markets as investors digest the political and economic ramifications of this momentous decision.

The market was not expecting a Leave vote and so we are now in a state of flux and heightened volatility. Thus far the biggest moves have been seen in the currency markets with the pound falling significantly against both the dollar and euro. In contrast, UK equities have initially been quite resilient compared to other global equity markets – not least because the large, international companies that dominate our market derive a large proportion (c75%) of their earnings from abroad, and a weak currency means that these overseas earnings will now translate into markedly higher sterling earnings. Having said this, certain sectors and businesses have of course been more volatile than others. Within the UK market the biggest fallers have been the housebuilders, property companies, retailers and financial services companies with domestically-focused businesses.

In the UK gilt market, long-term government bond yields have thus far edged downwards (meaning prices have edged up). So long as the question marks about sterling do not turn into questions about the creditworthiness of the UK government, the prospect of an interest rate cut and further quantitative easing from a supportive Bank of England may now keep bond yields “lower for longer”.

Overall, we expect volatility to continue for some time until the political and economic implications are better understood.  At NW Brown we are confident that our portfolios are well placed for surviving and prospering post Brexit – something we expand in a fuller commentary that can be found on our website at http://www.nwbrown.co.uk/document/June2016MarketReview.pdf

Points of View: Inflation

Consumer prices in the United Kingdom increased 0.3 percent year-on-year in May. At this low level, and after years of falling headline numbers, investors may be forgiven for not giving this too much thought. However, despite the historically low inflationary environment, the longer term effects and the power of compounding cannot be ignored – the value of £100 ten years ago, for example, is worth less than £80 today.

Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it.” Inflation can be seen as a compound interest which we are all forced to ‘pay’, and by understanding it we should seek to find assets which consistently protect against it in the long term.

Equities, property, inflation-linked bonds and commodities are often championed as hedges against inflation, but none of these are perfect; property is illiquid and vulnerable to prolonged periods of depressed values; inflation-linked bond prices are influenced by inflation expectations, which are only loosely correlated with changes in actual inflation; and commodities can be volatile and do not provide an income. Equities are also volatile in the short term but are arguably the most reliable source of real returns over the long-term, not least because the underlying companies buy and sell products at prevailing market prices. In any five year holding period over the last 30 years, for example, UK equities produced a real (above inflation) return 80% of the time.

It is this relatively reliable ability to generate attractive real returns over time that leads us to build long term portfolios around a dominant core of equity exposure.


Stocks in Focus: Interserve

This week I am looking at Interserve, the UK-based support services and construction company that operates predominantly in the UK but also has international exposure, including substantial operations in the Middle East. Having begun primarily as a construction and equipment services company, the business has gradually transitioned to focus on support services in recent years and this division now accounts for roughly 64% of operating profit.

Of late, Interserve has fallen out of favour with investors due to concerns over its exposure to the Middle East, where decreasing oil revenues seems likely to put pressure on spending budgets and the construction industry. In addition to this, management credibility has come into question following a £70m exceptional provision made on a mispriced construction contract in the UK.

Despite this setback, management continue to focus on the transition towards what is now the core part of the business – UK support services.  Drivers of this division seem favourable as more customers want to specialise in their core activities and outsource the likes of cleaning and security in order to reduce costs. With contracts lasting multiple years the business also enjoys relatively good earnings visibility. Furthermore, management have announced a strategic review of the equipment services division, which designs, builds, sells and hires specialist scaffolding equipment for major infrastructure projects. This seems likely to result in its sale and would allow management to simultaneously reduce their Middle East exposure whilst raising funds for reinvestment into the UK support services division.

Investors must consider whether the depressed valuation offers a good entry point into a business that is becoming ever more focussed on UK support services. If this transition can be successfully managed then the shares should earn a significant re-rating from their current valuation. However, investors cannot ignore the potential for deterioration in the Middle East and/or the risk of other contracts becoming unprofitable.


Stocks in Focus: Next

This week Oliver Phillips looks at Next plc, a former stock market darling that has recently fallen out of favour with investors.

Next is divided into two divisions, Retail and Directory. The Retail division represents the bricks & mortar side of the business which sells to consumers on the high street and in retail parks. The retail sector as a whole is under strain and this division has seen a modest decline in recent years – management have attempted to cushion this by focussing on their retail park offerings and increasing average store size. The Directory division, the online business which has evolved from a mail-catalogue offering, has been the main driver of growth in recent years and has enjoyed a reputation for setting industry standards for logistics infrastructure and delivery capabilities.

Having reached a high of £80 last October on the back of consistently strong growth within Directory, the share price has since slumped to around £54 – so why have investors decided to take such a different view on the business? First and foremost, growth has been beginning to slow in the Directory division and there is a fear that the business has reached maturity in the UK market. Trends in the retail sector are also uncertain, and some predict the polarisation of consumers towards either premium or value products, away from the middle ground that Next currently occupies.

Looking forward, investors need to consider whether or not the business can continue to drive profitable growth. On the one hand, management has a strong track record of delivering, even in tricky circumstances. On the other hand, the fate of BHS shows that failure is punished hard in the retail sector.


Points of View: Witan Investment Trust

This week I am focusing on Witan, an investment trust aiming to provide investors with a balance of capital growth and income over the long term through a portfolio of global equities.

Witan’s structure has been significantly overhauled since 2010 following the appointment of Chief Executive Officer Andrew Bell, who selectively employs reputable, specialist fund managers to run different portions of the portfolio. The managers are considered by Mr Bell to be the best in their assigned regions and likely to generate long-term outperformance. Indeed, the strategy has proved successful thus far given that Witan’s net asset value (NAV) has grown by 53% over the past five years compared with 39% from the IMA Global sector.

Despite this outperformance, the price at which Witan’s shares are trading has shifted from a 2% premium to NAV in January to a 5% discount at the time of writing. While turbulent stock markets have led to many investment trusts’ discounts widening year-to-date, for Witan this is only part of the story. Specifically, the price weakness can also be attributed to a large shareholder that was recently forced to sell their 16% stake due to the holding no longer being compatible with its new mandate.

On the one hand, it could be argued that Witan is relatively expensive as it has historically traded at significantly wider discounts to its NAV. On the other hand, it could be argued that wider discounts are unlikely to be reached again given the Board’s ability to buy back shares as part of its discount control mechanism as well as the fund’s excellent track record under Mr Bell.


Points of View: Valuation Dispersion

Whilst we remain confident in the ability of equities to continue to deliver attractive real returns for investors over the long term, there is no doubt that care is needed in the current financial markets. First and foremost, quantitative easing looks to have created asset bubbles in certain areas of the market – most notably in conventional fixed return assets (when vast swathes of bonds trade on negative yields, it is not hard to determine that the long-term returns from this point will be poor) but also in certain areas of the equity market.

US equities, for example, have enjoyed an exceptionally strong run of outperformance since the nadir of the financial crisis in March 2009.  However, a significant part of this outperformance has come at the cost of increasing valuation risk. Indeed, the valuation discrepancy between the US and other major equity markets is now striking. European equities, for example, currently trade at a discount to their US counterparts that is close to historical extremes. There are of course good reasons for this – economic growth in Europe is slow to non-existent (despite negative interest rates in many European countries) and the EU looks ever more like something of a failed experiment. However, one of the most counterintuitive aspects of investing is the fact that bad news is almost always required for things to get cheap enough to create good long-term investment opportunities. From this starting point a reversion to mean would result in underperformance of the US market for a period.

Having said this, it is worth noting that fundamentals in the stock market do not work to a set schedule and assets can remain cheap or expensive for extended periods.  The challenge for us as investors is to balance the merits of quality and value within a diversified and resilient portfolio.