Sunday, 22 October 2017

Mean Reversion and Market Timing

For some time I have been a little concerned about the high valuation of equities, particularly in the US. It is just over 12 months since I decided to sell 25% of my Lifestrategy 60 fund. 


In addition I have continued with the selling down of individual shares as well as top-slicing a few of my equity income trusts.  Added to this has been the fall in the value of sterling post the Brexit referendum result in June 2016. This factor alone boosted the value of my Lifestrategy holding by ~12% over the year (and other funds) as they are denominated in US dollars.

Unfortunately, the timing of these sales was probably a little premature - the equity markets have continued to rise and there has not yet been much sign of any sustained recovery in sterling, maybe we will need to await the outcome of the prolonged Brexit negotiations. 

The value of my Lifestrategy 60 fund has increased by a further 7% since last October. In the meantime the sale proceeds remain in cash waiting for a suitable opportunity to reinvest.

VLS 60 past 12 months (click to enlarge)

Reversion to Mean

This is the well-known principle which suggests the price of any particular asset class, however volatile over the shorter periods, will eventually return to its long term average. Here's my post from2014 which describes it in more detail.

The US equity markets have been trading well above their long term average for some time and sterling has been well below its average compared to the US dollar since June 2016. It would therefore be logical to conclude that there will be a correction - the US markets will fall and sterling will rise. The only part of the equation creating a problem is when this will take place. Markets can move against the tide for lengthy periods.

Market Timing

Markets rise and fall so it should be easy to buy low and sell high. When the markets fall back, repeat the process. It sound like a reasonable strategy but in practice, it is very difficult to achieve...in fact, many new to investing do the exact opposite. Therefore the traditional wisdom is to avoid trying to time the purchase/sale of investments but merely buy and hold long term. This is the strategy I try to stick to but I am human and my weakness is a temptation to tinker around the edges.

However, surely if the concept of mean reversion is valid, it should be possible to take advantage of market timing over the same period that an asset class is reverting to its long term average. This is the conclusion of Peter Spiller in his most recent quarterly report (pdf) to shareholders (always a good read).

Spiller has managed the Capital Gearing Trust for 35 years and has a very good track record. I actually added it to my portfolio earlier this year - not for income but as an option to preserve some of the gains made from equity holdings in recent years.
He articulates the case for market timing in a way that intuitively makes sense to my way of thinking and concludes that when the outlook is poor, it is better to hold a reduced weighting to the riskiest assets and wait for better opportunities down the line.

Rebalancing

Of course, the most common way to counter the additional risk to my portfolio from the rising equity element is to rebalance  - sell off the equity gain and redistribute to bonds/cash. This has the effect of ensuring the portfolio remains at a level with which I am comfortable. Indeed one of the great features of the Lifestrategy range is that this aspect is automatically built-in to the fund selected.


Indeed, some of the proceeds from my equity income fund sales and share sales has been reinvested into more cautious funds - the likes of AJ Bell Passive (Moderately Cautious) and CGT.

So the obvious question would be...why did I feel the need to sell a proportion of my VLS fund last October? I think the main driver was the dramatic 20% fall in sterling which artificially boosted the value of my VLS fund. Combined with the fact it was (and still is) the largest single fund by value in my portfolio made me a little unsettled with the prospect of sterling reverting back at some point. Also, the fund holds a large proportion of the US equity market which was trading and continues to trade at all-time highs.

Seeing how things have unfolded over the year, it was probably the wrong thing to do but maybe if I remain patient a little longer it will become a good call.

So maybe my intuitive move to reduce some exposure to equities as the markets have risen over many years combined with a further boost from the fall in sterling can become part of a strategy which offers some flexibility. I am still in the process of thinking this through a little more to try and clarify my own thoughts but feel sure that it should be possible to come up with a formula to compliment a rigid rebalance between equities/bonds/cash - a sort of Rebalance++ option.

As I posted earlier in the year, I'm not suggesting current levels represent the top of the market bull run as I know it is impossible for anyone to predict the top (...or bottom). However, at this point in the cycle, my preference is to hang on to the some of the capital gains accumulated since 2009 rather than stay fully invested in the hope of squeezing out even further gains.

It seems I may have a longer wait than first anticipated before the opportunities present themselves but, unlike the fund managers, I have no responsibilities to other people and I am happy to sit on the cash for as long as needed.


Feel free to comment on the current state of the markets and whether you are concerned about a correction. Are you worried about the lack of progress on Brexit and the real possibility of a no deal?

Wednesday, 18 October 2017

Inflation is on the Increase


The recent inflation figures released this week show consumer prices rose faster in September, at 3%, than at anytime in the last five years. This is now well above the long term average of 2.5% from 1989 to 2017.
 Prices are rising in part because of the rising costs of imported goods due to the pound's fall in value since we voted to leave the EU last June.
September inflation rates are used by the Department for Work and Pensions to set how much pensioners receive from the start of the new tax year in April 2018.
In 2018 I will become eligible for my state pension at the grand old age of 65. The net effect means I will now receive an additional £5 per week next year and a starting pension of £164 per week (£710 per month).
Public sector pensions, such as those paid to teachers, police and NHS staff, will also rise in line with CPI. In addition, the 'lifetime allowance' on private pensions will increase, by £30,000, from April 2018. 

(click image to enlarge)


That will mean an individual can have £1,030,000 across their private pensions without facing a tax charge.
According to the OECD, our state pension equates to ~23% of average earnings. This should increase to nearer 30% as more people retire on the new flat rate pensions which started in April 2016. Currently, most pensioners will be stuck on the 'old' system which is much less generous apart from those who are topped up with the means tested pension credits.

Benefits

Most welfare benefits such as Jobseeker's allowance are frozen until 2020 so they will not see any increase next year. However PIP (disability) and maternity benefits will increase by the 3% from next April.

Interest Rates

The continuing rise in inflation is now putting pressure on Mr Carney and the MPC to increase the Bank of England base rate which has remained at a 300 year low since 2009. It currently stands at just 0.25%. I am expecting a rise back to 0.5% maybe as early as next month.

In the US, the Fed have increased their base rate 3 times over the past year from 0.5% to currently 1.25%.

The other financial event will be the Chancellor's budget on 22nd November and speculation of yet more tinkering with pensions and help for the younger generation. No doubt the usual short-term political manoeuvers in response to the poor election result.


Leave a comment below if you are affected by rising inflation.

Sunday, 8 October 2017

Workplace Pensions

In 2008 the government introduced new pensions laws designed to get people saving. The idea is to help people to save by giving them access to a workplace pension scheme so they don’t have to rely on just the State Pension.

Workplace pensions were launched back in October 2012 to address the problem of people living longer but failing to save enough money for retirement. It is aimed at the private sector where less than 25% of the workforce were saving for retirement compared to over 90% enrolled in their employers pension scheme in the public sector.

Under the new rules, every employer has to give their workers the opportunity to join a workplace pension scheme that meets certain standards. Depending on how old they are and how much they earn, many workers will be automatically enrolled into the scheme. Other workers will be entitled to join the scheme if they want to.

Workers earning over a certain amount will also be entitled to a minimum contribution into their retirement pot. It’s usually made up of money taken from the workers’ pay, money paid in by their employer and money from the government, although employers can pay the entire minimum contribution themselves if they want to.

The minimum contribution has been introduced at 2% of a worker's pay. This will rise to 5% from April 2018 and then to 8% from April 2019. Everyone aged 22 yrs and over and earning at least £10,000 per year must be enrolled. So far, around 8 million have been signed up and when the scheme is fully rolled out it is estimated that some 10 million workers will be enrolled in a workplace pension.

Some Providers

In addition to the more established pension providers such as L&G, Standard Life and Aviva, there are some newer providers for employers to consider. Some of the more popular new providers include NEST, NOW:Pensions and The People's Pension.

The National Employment Savings Trust (NEST) is the auto-enrolment programme set up by the Government to support the launch of the auto-enrolment initiative.
NEST is effectively a public body that’s accountable to the Department for Work and Pensions

Most NEST savers are expected to invest their pensions in retirement date funds – also known as target date funds. These are funds that are managed on the basis that you’re most likely to retire in a particular year.

So if your most likely retirement date is 2025, your pension will be invested in the 2025 retirement date fund. If your most likely retirement date is 2055, you’ll be invested in the 2055 fund.

If you’re joining NEST in your 20s, your early contributions will mainly be invested in low-risk assets. Only about 30-40% of your cash will be invested in the stock market. This provision is to protect newly enrolled workers from the shock of a dramatic market fall. 

For example, imagine that NEST invested 90% of all Foundation phase investments into equities. Let’s then imagine that the stock market had a bad year and fell by a quarter. If that happened, there’s a big danger that young savers would be very upset and opt out from auto-enrolment for many years to come.

But if twentysomethings have a lower risk portfolio, they’re more likely to carry on paying into their pension for the rest of their working lives.

NEST is low cost with an annual charge of 0.3% on all your assets plus 1.8% when you first invest the money. So if you invested £1,000 this year, you’d pay a 'contribution charge' of £18, and if your total pot was worth £10,000, you’d pay a £30 annual charge. If you invested a further £1000 next year, you'd be charged a further £18 contribution charge on that fresh investment.

NOW:Pensions  is backed by Danish retirement specialists ATP, which has run the Danish National Pension for more than 45 years. NOW:Pensions has used its experience in Denmark to put together an interesting investment approach. Indeed, there’s just one default investment plan.

Your money is split across five different risk classes including Government bonds, index-linked Government and other bonds, equities and commodities.

During the savings phase, the cash will be invested in the classes listed above through the Now: Diversified Growth Fund. On reaching the pre-retirement phase (ten years before your planned retirement date, though you can change this to five or 15 years before that date) the money will start being moved into less risky investments contained in the NOW: Retirement Countdown Fund.

There’s a 0.3% annual management charge, coupled with a monthly administration fee of £1.50 (which falls to 30p for those earning less than £18,000 a year, at least initially).

The firm behind The People’s Pension is B&CE, a company which has managed workplace pensions – particularly in the construction sector – for more than 30 years. There are three profiles to choose from which will determine how your money is invested: Cautious, Balanced and Adventurous. If you’ve stuck to one of the three main profile funds, your money will automatically be moved into more secure investments on a gradual basis from 15 years before the planned retirement date.

One of the big attractions of The People’s Pension is that it is a not-for-profit organisation, which means that the charges are relatively low – there’s just a simple, flat 0.5% annual management charge to pay. That’s much easier to get your head around than the NEST fee structure of 0.3% per year plus a 1.8% contribution charge.

Some Concerns

Millions are now signed up to a workplace pension but the first area of concern would be that contributions are taken after the first £5,876 of pay is ignored. So, from 2019, someone earning £15,000 will only pay in a total of 4.8% not 8%.

Secondly, the maximum level of income eligible for the scheme is currently £45,000 - no deductions are made on earnings above this figure.

Thirdly, there may be a further 10 million self employed as well as those who work part time and earn under £10,000 or who have several jobs each paying less than £10K and who do not qualify for auto enrolment. The government are currently reviewing the system to find a way to include such workers. It is estimated that as few as 1 in 7 self-employed are saving via a private pension.

I firmly believe the government should take a look at increasing the 8% minimum (4% employee, 3% employer and 1% tax credit) as this is not likely to provide much of a pension for many workers.

Someone earning £15,000 who joins the scheme at age 37 and pays in for 30 years would amass a pension pot of around £75,000. This would be sufficient to give a drawdown pension of just £3,000 p.a.


This much needed addition to help workers save for their retirement is definitely a good start but this appears to be a 'one size fits all' approach where someone in their early 20s will contribute the same proportion of income as a worker in their 40s or 50s. There is a rule of thumb which suggests people should contribute half their age as a percentage into a pension. Someone aged 30 would pay in 15% of their wage and a worker aged 50 would pay in 25% for example.

There needs to be some review process or dashboard which can show every individual what level of payment they can expect based upon the percentage they contribute and the length of time before they expect to take pension benefits from their plan.

In the absence of significant developments to the current system, I suspect many workers will be disappointed with the levels of income in retirement.


If you are paying in to a workplace pension or have any general thoughts please feel free to leave a comment below.