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LC Newsletter - January 2015
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Happy New Year!
 
A warm welcome to January's issue of Longbon & Company's newsletter. The temptation in January (now that the New Year's resolutions are long consigned to the dustbin) is to reflect on the year past and make predictions for the year to come. Reflecting upon 2014 will throw up some surprises - more about this later - but stating the position of world markets at the end of the year ahead is an exercise in futility. I am always amazed at those who ought to know better predict, with some sincerity, where, for example, the FTSE 100 index shall be at the year end. Needless to say, I have no such wish to embarrass myself. The investment policy of this firm is to maintain a broad asset allocation across markets and sectors and to consider the 'bigger picture' that will drive those markets. It is not, and shall never be, about following alchemic predictions!


Investment Themes in 2015
So what shall be the drivers in 2015? The following few themes are, I think, the major factors that shall have influence over investment markets in 2015. The paragraphs provide some insight into my thinking as we embark on 2015. I see no need to deviate from the well-trodden asset allocation model. It has served us well for the past few years as the graphs shown later in this letter prove.

Deflation in Europe
What of 2015? I think that one of the biggest themes in 2015 shall be the issue of deflation. This is a very real threat in Europe - Germany and France have just reported negative inflation figures. Investors do not need long memories to learn about the damage wrought by deflation - Japan, from 1989, was caught in a deflationary spiral which led to the Nikkei 225 index losing 82% of its value over a 20 year period. Mercifully, though, policy makers have learnt lessons from Japan's mistakes and that is why I believe the European Central Bank have little option (sorry, Mrs Merkel) but to embark on full quantitative easing (QE), very soon. Such action will pump much needed euros into the system thereby boosting equity valuations and helping keep interest rates as low as possible. This is an excellent environment for both equity and fixed-interest (bond) investors. On the downside the euro shall continue to weaken and I would expect dollar/euro parity before long. Indeed, the weakness of the euro is partly due to the market's expectation of reflation by QE. Again, markets (investors) are the organ-grinders and politicians are the ...!

Oil
Another factor in 2015 is the collapse in the oil price. It would not surprise me at all were the price to fall further still - $30 a barrel is my bottom. Certainly, reduced energy costs should help the cashflow of Developed World PLC. It is tantamount to a tax break for the citizens and companies of oil-consuming countries which will be reflected in increased economic activity thus underpinning equity valuations. Some commentators have (incorrectly) argued that the collapse in the old price is a reflection of weakening demand from China. This is not the case. The oil market is being manipulated (it is no coincidence that the countries which suffer most from low oil prices are those who are most antagonistic to the US - Venezuela, Russia and Iran). Another important factor is the inelastic supply and demand for oil. Simple economics dictates that an upset to the equilibrium has a profound effect on the price. Overall, this is good for most equities, excepting the oil and related companies. A side note, smaller oil extraction companies, particularly those involved in fracking, could suffer extremely badly if the oil price falls lower. The oil majors make up nearly 20% by value of the FTSE 100 index and can explain, to some extent, the increase in volatility of this index over the past few months.

Interest rates
I hope that I am correct in that there is little to say here except that rates shall remain unchanged throughout 2015. It is implausible that the UK will see any interest rate rises this side of the election and equally implausible the other side, too. In more normal circumstances the strength of the US economy would suggest that a rate rise is likely (as suggested by Mrs Yellen). However, I don't think the the policy makers are likely to take such a step. The currency markets have stepped in where politicians fear to tread, hence the strength of the US dollar. Such an environment is anathema to the bond bears - those who have predicted interest rate rises, and hence a collapse in the value of bonds, for the past two years. I am retaining my exposure to bonds, for now. 

What Happened in 2014?
2014 was far from a vintage year for equity  investors.  Indeed, I suggested in a missive issued at the start of 2014 that equity returns were likely to be much lower than witnessed in the recent past - indeed, they were.  However, as is so often the case with equities they have overshot - the largesse of both up and down sides is synonymous with equity investing - on the downside returning a meagre 0.7% as measured by the performance of the FTSE 100 index.  (The FTSE 100 is a useful index because it is the major index that is most closely aligned to an international equity portfolio).  Interestingly, and very worryingly for some investors, if one ignores the impact of dividends then the FTSE 100 return is negative at -2.7%.  These figures underline the importance of equity dividends  - over the course of 2014 it is the dividend income which has produced the investment return.  Price (growth) alone was a loosing strategy.  The quest for dividend and income generating investments is one of the cornerstone investment philosophies of this firm.

Conversely, parts of the fixed-interest (bond) market performed exceptionally well in 2014. Put simply, bond prices will rise when interest rates fall and vice-versa.  Many commentators expected interest-rate rises in 2014 and thus bond exposure was reduced in many portfolios.  I am pleased to report that this firm ignored such predictions (see above) and maintained a full bond exposure.  Of course, interest rates continued unchanged throughout 2014 which caused longer-term rates to decline; the best bond performance was seen at the long (+15 year end of the market).  I am not going to predict when interest rates do rise but do not be surprised if nothing happens until 2016.

I increased exposure to commercial property in 2014 based on the attractive yield coupled with the improved economic environment.  This appears to have been a sound strategy with commercial property funds, as measured by the Investment Associations (IA) Property index returning in excess of 13% over the year. 

Short Term-ism
As I sit down to write these few words reflecting upon the year past and the prospects for the year ahead it occurs to me that, to some extent, I am guilty of the modern disease of short term-ism and the desire for instant gratification.  It does seem that in most walks of life society expects immediate returns.  Indeed, I cannot help but think that career politicians (isn’t that something of an oxymoron since a politician’s ‘career’ is often short and usually ends in failure) carry some of the blame - their vision is constricted by the five-year horizon so that brave long term plans are consigned to the waste bin.  What, though, has this to do with investing?  Investing is a long-term process (speculating is short term investing); many commentators, though, focus on short-term returns.  This is of particular relevance when the investment world moves into a period of higher volatility - more frequent and more severe falls and rises in stockmarkets.  Sadly, the same commentators focus, so often, on the headline-grabbing falls but rarely the rises: such behaviour leading to investor anxiety.  However, if one were to allow oneself to sit back and reflect on the longer term returns it would become obvious that the patient investor is often richly rewarded.  Indeed, I would suggest that if people walking down Haslemere High Street (my apologies to the residents if it is referred to as a 'Boulevard') were asked to guess the total return achieved by the stockmarket in the UK over the past three years (from the start of 2012 to the end of 2014) very few would pick an answer of 'returns in excess of 30%' (the correct answer is 31.5%).  Indeed, if one were to focus on the returns earned in 2014 the equity market would have very few willing participants.  Investing is a long-term business (the oft mentioned 'five years or more' holds true) and it is long-term performance that matters.  

The danger with short-term reporting is that it cannot display one of the most powerful forces in investing.  That is compound interest and, to the patient investor, a most welcome phenomenon.  Take the FTSE 100 index.  Over ten years the price has risen by 38%.  However, if one adds in income (which is assumed to be re-invested and hence compounded) the returns grow to 98%.  In simple terms one makes more money from equity dividends than one does from the share price.  This is a golden rule of investing and one that is key to the investment management of this firm.  I like income and I like to hold assets that pay an income to the investor.


Longbon & Company Investment Performance
For the past three years I have reported to you using annual and quarterly performance figures (so I could be accused of short term-ism).  This, though, is merely a function of the length of my engagement with you - now that Longbon & Company has been trading for almost four years I shall begin to include three-year figures, where appropriate, in your reports.  

With this born in mind I am very happy to report to you on the performance of this firm’s model portfolios (income, growth and balanced over the past three years (from the start of 2012 to the end of 2014).

Income Portfolio, 3 years total return from 01 Jan 2012 to 31 Dec 2014 
 
The figures refer to the past, and past performance is not a reliable indicator of future results.  The figures do not take into account charges or tax.  The actual returns to investors would be lower because of the effect of charges and tax. The performance figures are simulated - they reflect the model portfolios and cannot reflect accurately client portfolios due to timing of trades, charges, cashflow, investment objectives and risk profiles.

'Elsie Models' is the name given to the portfolios of Longbon & Company.
 
Source: Financial Express
Growth Portfolio, 3 years total return from 01 Jan 2012 to 31 Dec 2014 
 
The figures refer to the past, and past performance is not a reliable indicator of future results.  The figures do not take into account charges or tax.  The actual returns to investors would be lower because of the effect of charges and tax. The performance figures are simulated - they reflect the model portfolios and cannot reflect accurately client portfolios due to timing of trades, charges, cashflow, investment objectives and risk profiles.

'Elsie Models' is the name given to the portfolios of Longbon & Company.
 
Source: Financial Express
Balanced Portfolio, 3 years total return from 01 Jan 2012 to 31 Dec 2014 
 
The figures refer to the past, and past performance is not a reliable indicator of future results.  The figures do not take into account charges or tax.  The actual returns to investors would be lower because of the effect of charges and tax. The performance figures are simulated - they reflect the model portfolios and cannot reflect accurately client portfolios due to timing of trades, charges, cashflow, investment objectives and risk profiles.

'Elsie Models' is the name given to the portfolios of Longbon & Company.
 
Source: Financial Express

Naturally, I am delighted to be able to report such figures.  It is particularly pleasing that all three portfolios have exceeded the performance of both the Wealth Management Association's benchmark portfolio in each sector and the FTSE 100 index.  I believe that the performance results have been achieved by having clear and robust investment policy which ignores 'noise' and focuses on the important themes that are likely to affect investment markets. 


Savings Pension and Tax in 2015
In the world of savings and tax the dear Chancellor has been most generous.  2015 shall witness radical changes to pensions allowing utter freedom and the much-maligned pension as being, 
once again, the cornerstone of one’s saving regime for both the present, and most importantly, future generations.  Also, later this month, a new National Savings product is to be launched.  Beware, though, the boffins at the treasury are concerned for their cashflow: the three-year product demands that investors pay tax every year on the interest which is not receivable until maturity.  In effect, investors shall be loaning money to the treasury; sounds like one from Sir Humphrey Appleby’s pen!

I expect an announcement from the Chancellor that, were he re-elected, inheritance tax (IHT) thresholds to be increased dramatically - say £2m before tax is payable.  I do not wish to engage in a war of words but IHT, as it stands,  is a disincentive for saving.  The amount of tax raised is almost an irrelevance and cannot, for a moment, do much to re-distribute wealth.

It promises to be a busy year for this firm with interesting investment markets, an election and the accompanied budgets of which there might be several.  I shall keep you informed 
in a manner that, I hope, is both interesting and informative.  I would be delighted to receive feedback and, in particular, if the topics discussed are of interest or whether there are those that you would like to see covered.



A Happy New Year to all my readers.  

 
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Longbon & Co Ltd trading as Longbon & Company
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