Fund Management Diary Meeting held on 19 July 2016 EU Bailout Rarely have we been through such a period when events have moved so fast that markets have inevitably been left in the wake. Critically, the accession of Theresa May as Prime Minister of the United Kingdom, is undoubtedly the most significant and, she highlighted themes that in themselves are dominating global economics. At the forefront is the rise in populism over the political classes and she pledged that she would work for everyone and not the privileged few ; she would look to maintain the Union and deliver Brexit ; moving away from austerity with purposeful stimuli and opening the United Kingdom up for business with the world. All of this was achieved within days and while there has been some criticism of Boris Johnson as the Foreign Secretary, overall, she has been acclaimed for the selection of her cabinet, together with her objectives for future governance as set out. Meanwhile, the Labour Party is falling apart with the parliamentary party completely at odds with Jeremy Corbyn, who puts his own political dogma above agreed party policies. Also, the contrast to the overall state of the world following the tragedy in Nice, where it appears there were no security forces on duty and the police who were present initially thought they were dealing with an accident, leaving the pantechnicon to drive one and a half miles through the crowds. This was followed closely by the coup attempt in Turkey and following the clampdown by President Erdogan, moving the politics to a strictly Islamist state is now causing great concern all the more so because political refugees could be arriving on the EU s shores, claiming asylum, which will have to be supported by the EU judiciary. Meanwhile, the world is awash with liquidity due to excessive QE over the last eight years, which has damaged the operation of the world s financial system. The traditional workings of the system was that retail banks utilised deposits provided by savers and insurance companies etc, which represented the bank s liabilities and this money was then lent at higher rates, to provide margins of 2% and higher. However, as interest rates reduced, the ability of the banks to make money became harder and harder. As these entered negative territory, not unnaturally, resistance from depositors was encountered, particularly if they attempted to charge for the privilege, making it virtually impossible for the banks to reduce the cost of their liabilities. As central banks have now started to impose negative interest rates, it has become almost untenable for banks to pass the cost to depositors and therefore effectively this is imposing a tax on bank profits. In the days of normalised monetary policy, retail banks owned portfolios of government bonds, which were also part of their reserve ratios as required by regulators and the interest paid was an important source of income. However, as older bonds matured, they are now being replaced by greatly reduced yield, which has resulted in banks either having to cut their costs, or increase charges to borrowers, which has been estimated as now costing bank profits over 20% per annum.
This has had a knock-on effect, particularly for insurance companies, which match liabilities by investing wisely and looking to take a decent income, but the significant reduction has resulted in them either having to raise premiums or increase risk! Also, savings products which were sold when investors were looking to obtain 1-2% over risk-free returns at guaranteed rates, are currently causing problems in the banking systems, particularly in Germany, France, Italy, Portugal and Spain, with these investments now creating bad debts to the relevant retail banks. The pigeons are now coming home to roost, with Italy at the forefront, teetering on the brink of a banking crisis. Its economy is suffering stagnation and deflation, with Italian banks burdened by some 360bn of non-performing loans, equivalent to around 20% of GDP. The biggest worry at the moment is the solvency of the Bank of Monte dei Paschi di Siena, where the shares are now worth a tenth of its book value. Tensions between rules made in Brussels and the requirements of national politics are in conflict and great care will be required by the political classes. The problem in a nutshell is that in Italy, some 200bn of bank bonds are held by retail investors, who under the current EU rules could be subject to a bail-in (haircut), thereby creating losses for ordinary investors, creating another Lehman-type situation. The Italian Prime Minister, Matteo Renzi, is looking for leniency and wishes to apply flexibility and would go for a referendum in the autumn, to support a government bail-out for the banks, similar to TARP, as applied by the US government at the height of the 2008 financial crisis. Meanwhile, Angela Merkel has responded by saying that we wrote rules for the credit system, which cannot be changed every two years. However, given the situation, the consensus view is that a fudge will be the outcome! Adding to the EU s woes, the EU Commission has ruled that Spain and Portugal violated a 3% budget deficit limit last year and could face possible fines of 0.2% of GDP. France s position, which is not dissimilar, has warned Brussels against punishing them, as it would send a bad signal, on the basis that this would be unjustified and counter-productive. The Eurozone finance ministers have indicated that the two countries would face censure and escape with zero fines, depending on what proposals they came up with to solve the problems! It is somewhat cynical that the EU has been swamped with liquidity by their central bank, while individual governments seem incapable of reacting in the face of bureaucracy. While has its own central bank, the President, Mario Draghi, continually meets opposition and has had to use his considerable influence to force through solutions. While the Eurozone is currently comprised of 28 nations, but has no central body to apply fiscal policy and the fair movement of money, then it must expect to go from crisis to crisis. Germany should undoubtedly take the lead, but for too long it has seemed reluctant to acknowledge that balance of payments, surpluses and deficits need to be adjusted between the states. Therefore, any realistic solution seems to be as far away as ever and inevitably, bail-outs will be required. Germany must be prepared to provide leniency, especially as a crisis may only be months away. Strategy We have expressed our concerns regarding in many of our diaries and we believe that the situation needs to be carefully monitored over the coming months. We have been happy with our fund selection, which has been within our themes, with our emphasis on holdings equities with earnings growth and income potential, while maintaining special situations holdings in bonds.
Providence The bond allocation (which is short duration focussed) has been weak in relative terms, but has remained positive in absolute terms over recent weeks. The relative underperformance has been driven by the continued strength of longer duration bonds (particularly gilts) which we do not believe to be sustainable. The Premier Income fund has shown signs of recovery in the short term but we continue to watch the fund closely as themes change within the macroeconomic space. Equity Income 38% Bonds 31% Other 1 Select Two out of a selection of six funds are being monitored closely by the team following the referendum. We feel that overall, the selection is well diversified and the committee are not looking to switch funds in the short term; however we have provided further details below. The SVM Growth fund has continued to be weak relative to the sector. The fund manager has stated that the fund was positioned for a Remain vote and was heavily weighted towards consumer cyclical/domestically focussed stocks. This area has been particularly volatile since the referendum, negatively impacting the performance of the strategy. We will monitor the fund closely going forward and do not expect to make changes in the short term as new macro themes are yet to fall into place. The Majedie Income fund which has been hit by volatility within the financials sector has shown signs of improvement in the very short term. As stated above, we are not looking to make any changes in the short term and will continue to monitor performance as new themes develop. 12% 11% Equity Income Bonds 14% 10% 9%
International The Schroder Tokyo fund has been a positive addition to the portfolio and has outperformed the sector during recent months. The L&G Asian Income fund has been particularly strong against the sector and we suspect that current market conditions are favouring the value/income style. The Baillie Gifford Pacific fund has been weak in recent periods. The fund is fairly concentrated and can demonstrate a cyclical performance characteristic which is a style that has not been favoured during the recent market volatility. The team are following the fund closely for further relative performance deterioration but have no plans to switch the holding in the short term. 3 12% 10% 14% Japan Venture The Asian fund selection has been particularly strong relative to the sector since the referendum. The fall in sterling has favoured the Venture strategy which is a globally focussed fund (particularly Asian and ) and we are mindful that currency movements are a big theme in present market conditions and this is likely to continue to have a strong influence going forward. Specialist Other 32% 9% 29%
Important Information Please note that the contents are based on the author s opinion and are not intended as investment advice. This information is aimed at professional advisers and should not be relied upon by any other persons. Any research is for information only, does not constitute financial advice or necessarily reflect the views of the author and is subject to change. It remains the responsibility of the financial adviser to verify the accuracy of the information and assess whether the fund is suitable and appropriate for their customer. Past performance is not a reliable indicator of future performance. The value of investments and the income derived from them can fall as well as rise and investors may get back less than they invested. Important information about the funds can be found in the Supplementary Information Document and NURS-KII Document which are available on our website or on request. Issued by Margetts Fund Management Ltd Margetts Fund Management Limited is authorised and regulated by the Financial Conduct Authority For any information about the company or for a copy of the company's Terms of Business, please contact the company on 0121 236 2380 or at 1 Sovereign Court, Graham Street, Birmingham B1 3JR You can e-mail us at admin@margetts.com