Ben Salisbury
The consensus over what to invest in if you choose to invest in a stocks and shares ISA for this tax year is moving away from bonds into equities as investors search for a potentially higher return with the bond market depressed and returns from cash at historically low levels.
However, it is important to remember that with an investment ISA you can lose money as well as make gains so you need to choose the funds and type of investment carefully.
You also need to watch out for charges as high management charges can wipe out the gains that you might make.
It is also important to consider whether you can afford to lose any of the money you are investing, whether you can afford to invest for a longer period to be able to ride out the ups and downs of the stock market and what your attitude to risk is.
The contrast between the poor performance of the UK economy and the excellent performance of the FTSE 100 means that investors are choosing to invest in companies listed on the UK index but who garner a high proportion of their profits from overseas operations. The FTSE 100 has risen by 11 per cent since the New Year to reach 6,500.
With the Bank of England’s Funding for Lending Scheme (FLS) and the continued low level of base rate at 0.50 per cent causing saving rates to fall the returns from easy-access cash ISAs are low, down from an average of 1.56 per cent 12 months ago to an average of 1.80 per cent now, according to data from Money facts, investors are looking at riskier options for their ISA investments.
According to the Barclay’s Equity Gilt study which has tracked market
movements since 1899, equities are expected to provide a return of four per cent after inflation over the next five years, compared to -2 per cent for bonds and -1.5 per cent for cash after inflation is taken into account.
Another important factor in determining where to invest is the weakness of sterling. Sterling has fallen by almost eight per cent against the dollar since the turn of the year and experts feel that investing in global equities rather than UK equities as a hedge against the weak pound.
In this feature we look at the key questions to consider in where to invest your £11,280 ISA allowance in an investment ISA, taking the views of experts as we consider which companies and funds to opt for.
The impact of sterling
The weak UK economy, quantitative easing, high inflation and the loss of the UK’s AAA credit rating have combined to push the value of sterling down since the start of 2013.
This has put into question the status of the UK as a safe haven and with the US economy coming out of the global downturn faster than the UK and emerging economies still growing albeit at a reduced rate, many fund managers are increasing their exposure to global equities at the expense of UK equities.
Writing in the Sunday Times last month, Anthony Cross, fund manager at Liontrust Asset Management said: “Sterling weakness may be the best way to make a profit this year because the weaker pound could be good for UK listed stocks.”
Cash or stocks and shares?
With the Bank of England’s Funding for Lending Scheme (FLS) and the continued low level of base rate at 0.50 per cent causing saving rates to fall the returns from easy-access cash ISAs are low, down from an average of 1.56 per cent 12 months ago to an average of 1.80 per cent now, according to data from Moneyfacts, investors are looking at riskier options for their ISA investments.
This means that unless you can tie your money away for at least three years you are not going to secure a rate that beats the current consumer prices index (CPI) rate of inflation which is 2.7 per cent. Even if you do get a rate just above that, inflation is predicted to rise through the first six months of this year.
Tom Stevenson, Investment Director, Fidelity Worldwide Investment says: “The answer this year is a relatively easy one because the rates on cash are so pitiful. This is in part a result of the government’s funding for lending scheme which is designed to encourage banks to lend more by giving them access to cheap funds.”
Bonds or equities?
Over the last few years bonds have been the most popular choice providing faster and more reliable returns but in the last five months according to the latest statistics from the Investment Management Association (IMA) equities have been the leading asset class.
The consensus is that the best days of the bond market are over for now. Whereas previously bonds, in a period of falling interest rates have provided returns at almost the level of equities, now, according to Tom Stevenson, the “relative attractions of shares and bonds are much more finely balanced.”
Jason Hollands of fund supermarket Bestinvest believes bonds look expensive this year.
He said: “In contrast, with the exception of US shares, equities generally look good value compared to where they have traded over the longer term.”
Equities offer income and potential for growth but more volatility, but bonds offer income, lower volatility but less of an opportunity in recent years of making capital gains.
Many investors will opt for a mix of both assets in their portfolios to help spread their overall risks.
Do you invest in the UK or abroad?
The UK economy is performing badly, but the UK stock market has leaped to record highs. This makes investing in UK companies that make many of their profits oversee a good option.
Even though the UK has lost its AAA credit rating, it doesn’t necessarily make the UK a bad place to invest as long as you focus on firms that trade across the globe.
Adding some options from the emerging markets such as India and China will give the potential for higher returns and accessing funds from Japan and the United States means you are able to find technology stocks that are not available in the UK.
However, as with asset classes, investing in funds or companies spread over a wider geographical area makes sense in spreading the risk attached to your portfolio.
Tom Stevenson suggests having a 50:50 mix of home and away stocks. He said: “Many of our leading companies earn a high proportion of their profits overseas and this has led to a mismatch between the performance of the UK economy and that of the London stock market.
“However investing in Asia and other emerging markets remains very popular. Investors seem to be taking a barbell approach – half at home and half away. In an uncertain environment, that seems pretty sensible.”
Emerging or developed markets?
The pace of growth seen from emerging markets has slowed as a result of the overall slowdown in global economic growth. However, there are still higher potential returns available if you are prepared to invest over the medium to long term and can afford to ride out market fluctuations.
It may be time to look at Africa too, as opposed to the usual suspects such as Brazil, Russia, India and China which are down 6.2 per cent over the past 12 months. While the UK and American stock markets have risen by 5.7 and 11.3 per cent respectively, African markets have gone up by 61.2 per cent, according to MSCI studies. Other “frontier” markets such as Bangladesh and Vietnam are also tipped for higher growth this year.
Again, with the US economy recovering faster than many other parts of the developed world, there may be sense in including both emerging and developed markets in your portfolio.
Passive or active?
Passive investments such as index trackers and exchange traded funds are cheaper and easier to understand but they can never outperform the index, so again, it makes sense to combine passive and active funds.
Tom Stevenson comments: “Passive funds are likely to be best suited to well-researched developed markets where gaining a competitive edge can be more difficult for fund managers while in less well-researched emerging markets, or when investing in smaller companies for example, an active approach is likely to be better.”
Returns or growth?
Whether you choose to focus on instant returns or long-term growth depends on what stage of life you are at and whether you need your investments to provide immediate returns or a steady income.
If you are looking to receive regular dividends you should focus on income and choose to invest in companies that have a history of providing reliable returns. Growth investors are keen on companies that grow profits quickly which can make them a more volatile investment.
Alternatives
Gold is an alternative that could still appreciate further in a highly volatile global economy. Although its rise in value has slowed over the last two years, gold has increased in value from just over $400 per ounce in 2005 to just under $1,600 an ounce now.
Daniel Fisher, CEO of Physical Gold, said: “ISAs are normally the first thing that people think of when it comes to making the most of your savings and investments. There is, however, another easy way to keep the taxman’s hands off some of your money, and that is by buying gold.
“Not only is gold tax-free, but there are no limits with the amount of money you can put in, unlike ISAs. Gold still provides a safe haven and many people find it useful to have it in their portfolio to balance risk. Plus, with annual average returns of around 36% it has comfortably out-performed equity ISAs.”
Which companies to invest in?
Bearing in mind the performance of the UK stock market in contrast to the UK economy, Diaego and Unilever are UK listed firms that garner much of their profits from overseas operations.
Helal Miah, investment research analyst at The Share Centre, thinks Centrica are a good option because it is expected to increase production by 12-15 per cent in 2013.
He said: “Centrica is a defensive choice with a yield of about 5% and, from an investment perspective, there is hope for some steady growth potential.”
He also picks BHP Billiton if you are looking for some exposure to the commodities sector though she admits its fortunes depend on better growth from China than was seen in 2012.
He said: “Leading economic indicators from China released in the last few months of 2012 have painted a slightly better picture.”
Which funds to invest in?
Tom Purdie of Fundexpert believes gold mining funds are undervalued at the moment.
He said: “Gold mining shares were horrible performers in 2012 (down 19.38 per cent). In contrast the gold price itself edged up. There is now the opportunity for these relative performances to reverse.”
“This dichotomy is certainly a lesson to be learnt. Gold mining shares are fascinating, cheap, and an interesting punt for contrarian ISA investors at a loss on what to do this tax year. Those looking to invest should drip money into Smith and Williamson Global Gold”.
Andy Parsons, head of research at the Share Centre says this year’s top ISA fund picks are Invesco Perpetual’s Global Smaller Companies fund, Standard Life’s UK Equity Income Unconstrained fund and BlackRock’s European Dynamic fund.
He said: “The Standard Life UK Equity Income Unconstrained fund differs from the traditional UK equity income fund as it looks outside the core UK blue chip income stocks and offers real portfolio diversification.
“We believe the manager, Thomas Moore, is a rising star within the investment world and the portfolio has certainly benefitted since he took to the helm in January 2009.”
Andy Parsons explains why he likes the BlackRock European Dynamic fund: “It provides diversification that a portfolio based solely in UK companies cannot, for example Demark is a world leader in alternative energy solutions and Germany has world class engineering companies and car manufacturers.”
He added: “The Invesco Perpetual Global Smaller Companies fund is suitable for investors looking to diversify their portfolio through geographical representation as well as market cap size.
“This fund tends to have a large number of holdings, providing investors with the comfort that given the often volatile nature of such companies, risk and diversification is spread across not only a vast number of companies, but more importantly across geographical regions as well.”
Drop in value of gold
The relevance of this question is prevalent in the recent fall in value of gold has endured over the last 5 weeks.
“The resurgence of risk appetite over the past month has seen investors sell gold, and position themselves for ‘the worst is over’ scenarios.” This approach may prove to be a little short sighted.
However the smart money should be the only trend to follow. Gold’s lower buying price has prompted a buying frenzy in China, Brazil and India. The recent fall in the gold price has attracted Central Banks around the world to use its current value as a buying opportunity, prompting a gradual rebound in gold positions.
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So why on earth aren’t everyone and anyone previously interested in gold using the current price as a bargain buy? The answer is a psychological one. It might seem strange but the cohorts of the market who are new to this area tend to buy when the market is at its highest. In August 2011 – gold was at an all-time high and this prompted a surge in demand from 1st time buyers and less demand from institutions and central banks. In 2013 – the price has come down and the trend has reversed itself.
Central bank demand for gold
The factors that countries are taking into account when deciding to take additional protection and to use gold’s price as a buying opportunity:
• The UK has just been stripped of its AAA credit rating
• High and rising inflation leaves the UK market with less purchasing power
• PWC has indicated more businesses like HMV, Jessops and Blockbuster to fall into difficulties
• The US economy unexpectedly took its biggest plunge in more than three years last quarter, indicating a new level of vulnerability for the economy
• The US is committing more money to the money supply through increased stimulus measures
• The Bank of England is being pressured to follow suit and kick start a fresh QE programme
Commentators have referred to the recent stock market rise as nothing more than a “W shaped recovery” with strong expectations that a correction is looming. If they are right and if the financial Status-Quo continues – market participants that don’t snap up this buying opportunity may well regret not acting sooner.
German Gold Repatriation
Germanys Bundesbank has officially demanded a gold repatriation of 50% of its total gold reserves back from the United States Federal Reserve. Is this a cause for concern? Does it reflect Germanys inside knowledge of the severity of the Euro crisis? Should the holders or owners of gold ETFs follow suit? And what does this mean for the rest of the world?
Are we really shocked that Germany is starting to wake up to the reality that the dollar is no longer the worlds safe-haven asset and the U.S government is no longer a trustworthy banker for foreign nations?
In a word no.
Germanys request for its gold does not bode well for the future of the dollar. In fact, the Bundesbanks official statements are all you need to confirm the Germans waning faith in the U.S. The Fed has already refused to submit an audit of its holding on Germanys behalf and one cannot help but wonder if there is enough gold available to satisfy Germanys request.
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The Germans have given the U.S seven years in order to complete the transfer. Most would deem this time line as excessive and unnecessary but people in the know understand that this allows the Fed to save face and to prevent other depositors claiming their gold reserves in order to avoid a run on the Fed.
Other commentators are saying that If the US don’t have all the gold necessary to satisfy Germanys request they will have enough time to print more dollars to buy more gold on the open market. However such a move could substantially increase the gold price whilst depressing the dollar. The U.S seems to be in a slight quandary
With fiscal cliff talks looming and discussions over the debt ceiling, this request could not have come at a worse time. To make this all worse The Netherlands and Azerbaijan are also discussing repatriating their foreign gold holdings. How long before the rest of the international community follow suit?
Its not completely accurate to say that were in unchartered territory. Germanys repatriation mirrors what happened in the 60s under Nixon rule. The fear back then was that the U.S was not doing enough to maintain the integrity of its dollar and as a result Germany, France and Switzerland redeemed their gold reserves. This repatriation was coined the Nixon shock which propelled chronic inflation throughout the 70s and a contemporaneous rally in gold.
Are we repeating history? Ironically only time will tell
What is the fiscal cliff?
As America approached the Fiscal cliff, perhaps I’m on my own in saying that the amount of money the U.S government have, owe or print is completely confusing. The Fed’s recent budget cut looks more like a phone number than it does a hair cut off its current debt ceiling. Some of us look at that number ($38,500,000,000) and think that if the U.S can cut spending by that amount then surely things have to start looking better. But – what do we know? How does one empathise or resonate with the running of a country?
Fiscal Cliff put in a much better perspective:
- U.S Tax Revenue: $2,170,000,000,000
- Fed Budget: $3,820,000,000,000
- New Debt: $1,650,000,000,000
- National Debt: $14,271,000,000,000
- Recent budget cuts: $38,500,000,000
Let’s now remove 8 zeroes and pretend it’s a household budget:
- Annual Family income: $21,700
- The money the family spent: $38,200
- New debt on the credit card: $16,500
- The outstanding balance on the credit card: $142,710
- Total budget cuts so far: $38.50
It’s clear that these budgets cuts do little more than confuse us! It’s obvious spending cuts do more harm than good whilst we all know that the inevitability of printing more money shrinks the purchasing power of the annual family income…
Control debts
The New Year has heralded new warnings to Chancellor George Osborne. He already had to admit recently in his Autumn Speech that his austerity measures hadn’t quite hit the mark. This meant they would remain in place for a further two years than planned for the UK to successfully control its debts. The spending cuts and sluggish economy would now remain (at best) until 2018 rather than 2016.
The problem with such plans is that their time-frame is predicated based on everything going to plan. If tax revenues fall, unemployment rises and benefit claims increase, then the plans start to veer off course and our repayment takes longer.
Possible UK downgrade
So the last thing Osborne wanted to hear as a New Year warning from leading economists was that the UK was now set to lose its much coveted AAA rating. This warning itself is partly caused by the Treasury admitting that controlling the national debt will now take longer. The problem is that such a downgrade would have severe implications to Osborne’s plans and indeed to the investment market.
Standard & Poor’s, Moody’s and Fitch – the world’s three largest agencies – have all put the AAA rating on ‘negative outlook’ with a downgrade expected soon.
The major consequence would be to drive up the UK’s borrowing costs meaning it would take far longer to repay debts. This would be passed onto businesses and households, further slowing any chances of recovery. The less transparent effect could be a loss of confidence and sentiment towards the UK – leading to less investment and slower growth.
While this is undoubtedly negative news for those in the UK and a majority of investors hoping markets would pick up soon, it could provide a huge opportunity for gold investors. Firstly, as the world’s safe haven asset, such a UK downgrade in itself would see the underlying gold price rise, as the UK is a major global trading partner. The natural reaction by the investment world would be to seek a safe haven away from traditional currencies and gold provides this. It would also likely see central and commercial banks shift more money out of Sterling and into gold to protect themselves from depreciation.
When the US was downgraded in August 2011 we saw the gold price spike up to record levels. The additional bonus for UK investors would be that a UK downgrade would likely see Sterling fall against the Dollar – meaning further gains in the value of their gold if they bought it in the UK currency. That’s because the value of gold in the UK rises as Sterling falls against the Greenback.
All in all, it makes sense for those in the UK looking to start the New Year with stability and certainty to buy gold if they don’t already own any.
Fiscal Cliff
Fiscal cliff is the widespread term used to describe the paradox that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.
The U.S will face tax hikes and a series of spending cuts which will have a dramatic effect on the economy. A combination of higher taxes and spending cuts would reduce the deficit by an estimated $560 billion but the policies set to create this saving would cut GDP by 4 percentage points in 2013 which could send the economy into a spiral of negative growth.
Estimates predict that unemployment would rise by 1% with the loss of two million jobs.
What strikes me as particular unusual is that the market anticipates the Fed to announce a $45 billion monthly Treasury buying scheme that would push the central banks balance sheet to almost $4 trillion.
It seems that Peter is being robbed to pay for Pauls future anticipated mistakes. People will have to endure tax hikes, spending cuts, unemployment and negative growth for the Federal Reserve to turn around and create a loss far bigger than any saving they are trying to create!
Unfortunately, the fiscal cliff isn’t the only problem facing the United States right now. At some point in the first quarter, the country will again hit the “debt ceiling” – the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff. The summer of 2011 for Gold bugs may be a slightly nostalgic season for 2011 when the market saw more than 25% growth in 8 weeks.
Everyone is expecting the Fed to print more money and keep buying securities, Michael Smith, the president of T&K Futures & Options in Port St. Lucie, Florida, said in a telephone interview. The best hedge against a decline in the value of the dollar, in most peoples minds, is gold and silver.
We all know that gold is set to continue soaring in value over the medium term. All the commodity analysts around the world have revised their expectation upwards now that ‘big spender’ Obama has been re-elected.
It doesn’t take a genius to realise that the weak Dollar, a crumbling Euro and further tensions in the Middle East will all contribute to physical gold rising in value as the natural safe haven asset. But there’s also an unexpected source of fuel to this brightly burning fire. Our old friend – the banks.
Harsh bank collateral requirements
You see, while the banks have been blamed as the cause for your equities and bonds crashing in value, the very same institutions could be set to provide a huge catalyst to your gold holdings. The credit crunch and subsequent global crash have rocked the very foundation of the global economy and how money is leant and borrowed. It’s universally agreed that changes have to be made to ensure this doesn’t ever happen again. The obvious revision is to the way banks themselves lend and just as importantly the prudence they take with bank collateral for bad debts.
When a bank lends out money, it has to put a percentage away as bank collateral, a type of reserve to cover any losses from bad debts. This in theory protects the bank and other lenders/borrowers from suffering losses should a debtor fail to repay debt. The Basel accord is a set of laws set by influential central bankers to determine how much capital banks should hold and in which form this capital can be.
The types of assets financial institutions need to hold are split into three
classifications or ranks. Tier 1 assets are cash and Government bonds. Mortgages qualify as Tier 2 assets, while the bottom rung is made up of assets such as gold. The higher proportion of the ‘safer’ Tier 1 capital a bank holds, the more it can leverage its balance sheet. So over the past 5 years as the spotlight has fallen on the banks and they’ve desperately tried to shore up their balance sheets – we’ve seen them selling assets like gold and increasing holdings in Government bonds or cash.
Gold will be used for bank collateral
However, the financial world we live in has changed beyond all recognition, and the powers who set the capital ratios for banks realise this. So the latest version of these rules, known imaginatively as Basel III, looks set to address this. These rules for 2013 address two areas. Firstly, it increases the overall ratio that banks will need to hold in capital. Secondly it’s set to change some of the asset classifications with the most significant change coming to gold! Gold is set to become a Tier 1 asset alongside cash.
This is the first step towards a gold standard with institutions such as the Bank for International Settlements (BIS) recognising gold’s value alongside cash itself.
As BIS notes in its progress report on Basel III implementation:
“At national discretion, gold bullion held in own vaults or on an allocated basis to the extent backed by bullion liabilities can be treated as cash and therefore risk-weighted at 0%.”
Now, we’ve witnessed a steady shift in the holdings of Central banks from holding reserves in Dollars towards a heavier gold holding. They realise that a fast depreciating Dollar does nothing for their reserve levels and only gold can provide a reliable store of wealth. I’m sure banks have also been tempted to shift their reliance on holding paper currency as capital but the traditional tiering ratio has prevented this. Now they have a compelling reason to re-address this balance. With gold set to become the same as cash we will no doubt experience aggressive bullion buying from all the commercial banks in a bid to diversify their capital.
So rather than dwelling on how the banks have destroyed the value of your paper portfolios, recognise the opportunity the banking crisis now offers you.
Buy gold today and watch its value rise, not only from the obvious economic and political instability we’re experiencing, but also from the helping hand the banks are about to offer.
Obama is re-elected for yet another term as President and the US are now stuck with a descending economy for at least the next four years! I’m at a loss for words! Has this really happened? Are we heading for the “fiscal cliff” of higher taxes and spending cuts with a President that thinks that health care is more of a priority than our contaminated economy? The answer is yes! It’s Groundhog Day and central banks better turn on their printing machines because Obama has already indicated another round of monetary easing.
Obama: What it means
1) As Obama closed in on a “victory”, the Dollar lost significant value and prompted investors and countries alike to trigger a mass sell of the greenback.
2) Given the markets’ understanding that Obama’s plans for the US is catastrophic for the global economy, analysts are expecting inflation to escalate.
3) Since Obama’s win – the value of Gold has jumped 3% with a host of predictions pointing towards further imminent and long term price increases.
4) Further gold price drivers are international crises such as the Israeli/Iran situation, the recent Syria/Turkey border incident and the longer term threat that the Muslim Brotherhood, which now controls Egypt, will seek to extend its influence in the oil-rich countries in the Middle East tinderbox.
5) On the supply side, gold miners are running out of high grade ore, there are problems with labour in South Africa, and both working and capital costs have risen substantially
6) Central banks have now stopped selling their gold and become big buyers.
It’s finally obvious why more and more of the world’s rich are moving their wealth and other valuables away from the economic turmoil in the US and into gold as a safe haven and a hedge against escalating inflation.
Mounting debt
Debt is on the rise. The economy seems to be quickly and quietly spiralling out of control. The feelings of Nostalgia overwhelm us as the prospect of European states falling into default catch us off guard once again. The Federal Reserve has committed to injecting more than $40bn into the economy every month with no upper limit on this printing frenzy. Japan and China are now going through the motions in order to follow suit. Confidence in financial markets is diminishing owing to weak growth prospects, high inflation and ineffective controls.
This shouldn’t be a zero sum game and fortunately for our clients it’s not. As all of the above escalates, gold has been steadily rising. Gold has extended the biggest quarterly gain in more than two years on speculation central banks’ stimulus will spur investor demand. The questions from investors constantly change but at the moment it’s not a question of “when” it’s, “how high?”.
As more currency is printed in the global Quantitative Easing programs, the value of traditional (or Fiat) currency is diminished. Along with reduced value, is falling perceived value as both individuals and institutional funds managers realise more money doesn’t equate to more value.
As a safe haven asset, gold benefits in times of falling currencies, especially the US Dollar. Investors flock to buy gold during these periods and it’s easy to see why. As a precious metal, gold cannot simply be printed like paper currencies. So while their value is undermined, gold simply cannot follow suit. It has to be discovered and mined. The fact that all the gold discovered in the entire history of the earth would fit into a cube the size of the Eiffel Tower, demonstrates how lack of supply acts as a support mechanism for its value. Sadly for paper currencies, the central banks can simply continue to print more, further undermining the value.
QE3 – where will it stop?
Over the last 30 days the value of gold has increased by over 10% with many analysts pointing out that we have only seen the tip of the iceberg. Whilst the fed has announced its intention to inject another $40bn every month – the real worry is that this particular prescription is an unlimited one. Some refer to this stimulus topping more than $1.5 trillion and with no end in sight the dollar could lose significant value.
“Even when the unemployment rate begins to come down decisively, we’re not going to rush to remove policy,” Bernanke said at a press conference
Japan has now joined the United States and Europe in mounting more stimulus measures to boost its economy.
As the world continues to print more and more money, currencies will depreciate and inflation will trickle upwards. The two effects together will mean that people’s cash held in bank accounts or otherwise will need to yield more and more interest to break even with the cost of living. Do you see banks increasing interest rates any time soon?
The relevance this has with gold investment is that the dollar has an inverse relationship with gold; as the dollar loses value – it takes more of it to buy the same ounce of gold thereby making gold more valuable. Furthermore as inflation pushes up the cost of goods and services it also pushes up the value of gold and people rely on this trend in order to keep up with the rising costs of living.
As other central banks follow the lead set by QE3, gold’s appeal will strengthen and people will exchange their depreciating cash for gold that’s increasing in value.