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Tiller investor update: October 2018

 

October has been one of the most volatile months this year. The US stock market (the S&P 500) started October at a level of 2,925 and finished at 2,711 having briefly tipped into correction territory by dropping 10%.

This level of volatility is not unusual for stock market investors. Arguably one of the main reasons why stocks and shares outperform cash over the long term is to compensate investors for bearing this volatility.

We constantly monitor the performance of the portfolios to ensure the level of volatility they experience is within an acceptable limit. This limit is linked to the risk profile you discovered via our risk profile questionnaire.

Even in October, when many stocks markets moved into correction territory (defined as a fall of 10% or more) Tiller portfolios remained within their risk limits.

This means the cautious positioning prevented them from falling as much as one would have expected.

The October sell-off had started, perhaps counter-intuitively, with positive economic news from the US. This had investors fearing higher than expected inflation. As bond investors demand a higher yield as compensation for higher inflation, bond yields rose and the cost of borrowing for companies rose with it. Global stock markets moved lower in response.

However, by the end of October the situation had changed. Bond yields have fallen back below the levels at the start of October, and yet stock markets have continued to fall.

We believe this is reflective of the US economy being in what is described by economists as ‘late-cycle’. In this phase unemployment tends to be low, and the economy is operating at its full capacity. As a result, the central bank will raise interest rates to prevent inflation from going too high. When this happens, some investors will worry that the bank is raising rates too quickly and cutting off economic growth. This results in stock market volatility as investors struggle to decide whether rates are being raised too quickly or not.

Because of this, we are happy to remain cautiously positioned in client portfolios. This means holding a smaller percentage in equities, and a larger amount in high quality, short-dated bonds than usual.

 

Equities

 

Overall we are holding less equities (i.e. stocks and shares) than usual. This reflects our cautious view of the world.

Globally, the US market has performed best year to date but looks increasingly expensive versus the rest of the world. Valuation metrics that compare share prices to company earnings are reflective of this.

In Europe and the Emerging Markets stock market valuations are more reasonable. For this reason, our algorithm would normally be allocated a bigger percentage. However we are concerned that in the short term investors are not focusing on the fundamental picture and valuations. Instead, they are focused on geopolitical news and the impact of US rate rises. Our conclusion is that there will be a better time to buy more equities in these regions.

In the UK equity market we believe the more domestic-focused mid-cap part of the market could benefit if any form of Brexit deal is struck, so we increased our positions in holdings such as the Vanguard FTSE 250 ETF and the Merian UK Mid Cap fund (formerly known as the Old Mutual UK Mid Cap fund).

To fund a new position in UK property companies we reduced other geographical equity markets, such as emerging markets and the US. This again increased our UK domestic focus.

We also converted our Europe ex UK equity exposure into sterling hedged exposure. In other words, if sterling does rally against the Euro we do not lose money due to the currency move.

 

Bonds

 

We continue to maintain a mixture of high-quality corporate bonds and government bonds. Because the expected returns on bonds are low by historical standards our algorithm does not allocate a big percentage of a portfolio to bonds.

Within Smart and Select portfolios the percentage allocated to diversifiers is mainly funded by holding less bonds.

 

Property

 

In October we added a new position to all portfolios. The iShares UK Property ETF is invested in property equities trading on the London Stock Exchange.

Top holdings include Segro, Land Securities and British Land.

Unlike the more international FTSE 100, this is more of a pure-play on the UK economy.

If we once again look back to the day of the referendum in 2016, this ETF fell by up to 20% intraday as investors panic sold. Since then the price has recovered, but not back to the level it was before the vote.

When we dig into the fundamentals of the underlying holdings we find that stocks such as British Land and Land Securities are trading at significant discounts to their underlying value.

Should the UK exit the EU without a trade deal in place, we would hope that the cheap valuation would provide a margin of safety.

In the event of a Brexit deal the commercial property market could see renewed interest and this holding should perform well.

 

Commodities

 

We’ve been holding a commodities ETF in portfolios since we launched. As the price of oil has continued to trend up, the overall commodities index has moved with it, despite the weaker performance of precious and industrial metals this year.

As the price of oil is a factor in inflation, this position has not only provided higher capital growth than many equity markets – it also helps hedge portfolios against the risk of higher than expected inflation.

 

Alternatives

 

This section only really applies to Smart and Select portfolios. The funds used within this asset class are often grouped within the ‘Absolute Return’ classification. This classification should not be taken too literally. The name is a reflection of the expectation that these funds are not as dependent on equity or bond markets performing well.

It is, in our opinion, the sector where investors need to be the most discriminating. There are lots of under-whelming funds within this classification that struggle to overcome their fees.

That said – when you can find a good diversifying fund it really improves the risk/return profile of a portfolio.

The funds that we use within portfolios continue to perform in a manner that is a) uncorrelated with other assets and b) has low volatility of returns.

 

Disclaimer:

The views contained herein are not to be taken as a recommendation or advice.  Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. A mandatory sell of a theme may result in a taxable capital gain or loss.  All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted.  It is very important to do your own analysis before making any investment based on your own personal circumstances.  You should take independent financial advice from a professional in connection with, or independently research and verify, any information that you find on Tiller’s website and wish to rely upon, whether for the purpose of making an investment decision or otherwise.  It should be noted that investment involves risks, the value of investments may fluctuate in accordance with market conditions and investors may not get back the full amount invested.


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