By Dorian Raimond, Head of Fixed Income Strategy and Trading, Hilbert Investment Solutions
As we have entered a new regime of higher inflation and higher yields, decades-old templates of portfolio construction might be worth reconsidering. Bonds yields have become more attractive again, while the product seems to have lost some of its diversification appeal. Could structured solutions well come out as the welcomed saviour?
Typical pension allocation follows portfolio theories like Markowitz’s (backed by a few decades of historical evidence), with the aim to balance volatility (‘risk’) and returns by attributing a risk-weighted exposure between equities (higher and more volatile returns), and bonds (less volatile and yielding less, with a defined capped upside).
The lower rates / lower inflation regime experienced since the ‘80s has proven to be a great soil for risk parity and 60/40 portfolio constructions. As many professionals of the sector have reported, the negative correlation of rates and equities during that time was a function of several factors – from the introduction of inflation targeting by central banks which had gained their independence, to deflationary pressure from globalisation, to quantitative easing by central banks after the 2008 financial crisis, and a self-fulfilling market mechanism.
The ‘Everything Rally’ brought on by the years of quantitative easing (QE) began to challenge the theory; correlation between equities and bonds started to turn positive as each shock brought ever faster quantitative easing, leading to longer periods of positively corelated (positive) returns. But returns were positive, and we looked elsewhere. Then, in 2022, came the “Everything Sell-off”. While 2023 was good overall, intra-year sell-off’s saw once again bonds and equities go down in tandem.
What fuelled the success of these strategies is just not there anymore. Those portfolio constructs do not achieve their aim in a regime of higher inflation, since bonds and equities are likely to remain positively correlated.
But inflation is going down, so surely, it’ll go back to normal?
It’s hard to dismiss the case against it. Globalisation is not in vogue anymore and 40% of the world population voting this year is likely to confirm this trend. At the same time, between the exponential growth of public debt on the back of fiscal stimulus, and the quantitative tightening of central banks (reversing their monetary stimulus), bond yields might easily be floored.
Geopolitical tensions remain on the rise and will keep being the tailwind for inflation (and deglobalisation). As long as central banks keep their independence (a debate gaining traction in fact), we should not expect rates to go aggressively lower. Should inflation make a comeback, rates might in fact rise further.
While bonds might not work as a risk offset to equity exposure, the investment itself is still very much an attractive proposition. Especially if corporate earnings start to deteriorate and weigh on stock prices. Bonds just need to be considered for what it says on the tin; fixed income. The great reset in yield has made for more attractive nominal returns for bonds – but also for structured products.
Under a low-rate regime, structured products were mostly for yield enhancement as investors looked for ways to add leverage. But as rates rose, the issuance of structured products rose as well. The higher yield regime created new opportunities for structured products; total or high capital protection.
Structured products are now offering close to 10% return with high capital protection. An attractive proposition versus typical 60/40 portfolios, especially as you get closer to retirement age in a high inflation environment. Such coupons offer a higher chance of a positive real yield on your life-long investment, while the capital protection is key to protect against a 2022 redux.
This has always been the crux of the matter; participating in equity upside, clipping high fixed income coupons, while not risking life-long invested capital, and even more so as one gets closer to retirement age. As portfolio construction itself is not trusted to provide this protection anymore, pension solutions like Hilbert Protect 90 offer 90% capital protection. This capital is invested in equity and fixed income ETFs, and every quarter, returns making for a new high-water mark of investment values are also protected at 90%.
For more information about Hilbert Investment Solutions’ retirement products with capital protection, click here to visit our website.
The value of investments can fall. Investors may not get back the amount invested.
For Financial Advisors only. This is not investment advice.
Dynamic Planner, the UK’s leading risk based financial planning system, has analysed the data* of almost 17,500 advised investors views on the importance of sustainability.
As COP 28 gets underway, Dynamic Planner has found that while investing sustainably remains an important factor, as willingness to take risk increases the importance of sustainability reduces. The analysis showed that of those investors in risk profile 10, Dynamic Planner’s highest risk level, 6 out of 10 viewed sustainability as of low importance **
Chart showing the relationship between an investors risk (1-10) and sustainability (low to very high profiles)
Dynamic Planner also found that a larger proportion of men (39%) than women (26%) view sustainability as something of low importance, while (32%) of women view sustainability as of medium to very high importance compared to men (21%).
The stereotype that younger clients have a greater preference for sustainable investments due to supposedly being more values-driven and having a greater desire to seek investments that align with their views were not borne out in the analysis, with no apparent differences across any of the age groups.
In terms of which aspect of sustainability is held in highest regard, more investors said the ‘G’ of ESG is a priority as it means investments help companies treat all stakeholders fairly. Even a proportion of around 70% of investors who consider sustainability to be of low or some importance, agree with this statement, 17% and 51% respectively. Surprisingly fewer placed as much importance on ‘E’ – that investments help to improve the environment. The ‘S’ – that their investments should help improve people’s living conditions was the lowest priority of the three ESG factors. However, of those who view sustainability as of high and very high importance, a higher percentage strongly agreed that it is priority to help improve the environment, compared to improving living conditions and treating stakeholders fairly.
Chart showing importance placed on ESG statements
Louis Williams, Head of Psychology and Behavioural Insights at Dynamic Planner, said: “Our analysis paints a nuanced picture of attitudes towards investing sustainably and ESG factors. Events like COP28 which bring the world together to focus on issues such as climate action have ensured that many people understand the importance of acting in a sustainable way. However, using the power of their investments to shape the world for the better is perhaps limited for some due to the greater focus on trying to achieve a better return.
“We have found those investors who are more comfortable with increased financial risk are prepared to invest in market opportunities that go beyond the realms of companies that act in a sustainable or ESG risk managed way. This may be because climate change and risks of stranded assets have not yet been properly understood or their appetite for not missing out on certain market sector returns is still the overriding motivation. There also may well be some investors who want their fund managers to engage (by remaining invested) to bring about change.”
* Research has been undertaken using data from Dynamic Planner’s sustainability questionnaire, an industry first when it was launched in 2021 and created by the team behind the UK’s leading risk profiling process. A client’s sustainability preference is profiled on a scale, like their attitude to risk, providing you with a foundation for a conversation and enabling you to match it with solutions with ESG ratings available to research in Dynamic Planner.
Dynamic Planner also offers clients access to independent and whole of market ESG research of more than 32,000 funds. Guard against greenwashing and trust that the research is objective and is rigorously completed by a 200-strong team of analysts at MSCI, a world leader in the field which has been doing it longer than anyone else.
** Risk Profile 10 – Likely to contain very-high-risk investments such as emerging market shares and a small amount in high-risk investments such as shares in UK and overseas developed markets.
The Dynamic Planner Investment Committee met on 23 October and reflected on the implications of the global stagflation environment, with negative earnings growth, persistently high inflation and Central Banks unlikely to pivot to significantly cutting interest rates anytime soon, for fear of inflation spiralling out of control again. Many developed economies, particularly in the case of the UK and US, are teetering on recession and may have already experienced periods of intermittent recession, without necessarily realising it.
The continued flatlining of the UK economy for such a long period was also a subject of discussion. Inflationary pressures (particularly from semi- and low-skilled wage growth) remains stubbornly high with interest rates, after 14 hikes so far, likely to remain high for longer. Rising fuel prices, as a result of the rising tensions in the Middle East, could also delay the more recent falling headline inflation numbers.
Quantitative tightening by Central Banks, to reduce their balance sheets and higher interest rates, means major concerns persist for the overvalued Global Government Bonds. Bond yields, having risen steeply at the shorter end, saw the curve flatten, but it remains inverted, which traditionally is a recessionary signal. Whilst interest rate normalization continues, negative real bond returns are to be expected for the foreseeable future, as high inflation persists and the US / global yield curves steepen.
With the prospect of further periods of volatility associated with the ongoing geo-political crises, and the inevitable run in to next year’s elections in the US and UK, the IC focused on the diversification benefits of the benchmark allocations and the stress testing of the Value at Risk metrics.
Read the full analysis and update from the Dynamic Planner Investment Committee.
Nearly three months after the 31 July deadline, the Consumer Duty continues to make headlines. Industry commentators talk of ongoing ambiguity, and subsequent inconsistent implementation of the far-reaching regulation.
As that dust continues to settle all around financial services, Chris Jones, Dynamic Planner’s Proposition Director, joined a first Consumer Duty Champions Forum webinar to answer concerns.
What are common misconceptions clouding the Duty? What is the regulation’s essence? Post-July, what now for the Duty? How will it influence upcoming regulatory activity, like the review of retirement income advice?
Chris was joined by Michael Lawrence, Chair of the Consumer Duty Champions Forum. Over a dedicated 60 minutes, the duo poured their experience into unpicking the above, and more. The webinar was hosted by the Consumer Duty Alliance, formed this year in March, an independent body helping firms implement the Consumer Duty.
‘TCF by another name?’
Michael Lawrence: Chris, how would you respond if I said, ‘The Consumer Duty is just TCF [Treating Customers Fairly] by another name. I don’t need to do anything new’.
Chris Jones: Yes, go through the TCF outcomes and some of those are covered in the Consumer Duty, but they are things which fundamentally any business would want to do, whether it’s in financial services or another walk of life. Why wouldn’t you do those things? But when you say simply, ‘Consumer Duty is TCF by another name’ you’re disparaging both.
The regulator might have expected TCF to have been better implemented across financial services and perhaps if it had been implemented with more energy, then maybe the Consumer Duty might not have been required.
But, for me, the Consumer Duty was the FCA listening to what it was hearing and becoming properly client-focused, and indeed more adviser-focused and more closely linked to the real world. What’s really going on? And adding more help, rather than simply setting out outcomes, which firms had to work out how to implement. The Duty provides a lot more guidance about how you go about that.
‘Real desire to drive change’
Michael Lawrence: I think you’re right Chris. There have been a number of significant strategic interventions by the FCA in the retail investment market. Things like TCF, RDR and Product Governance under MiFID. I think all of that has been aiming to reach a point where firms are thinking carefully about their business model. Who is it right for? Who is it wrong for? Then undertake activity in a way which is consistent with client outcomes.
Boiling down the Duty to its essence: is your service right for your target market of customers? Are you charging a fair price? Help your customers make good investment decisions. And support them with ongoing advice. There’s not a lot to argue there, but that’s not to say that in complying with the Duty there isn’t complexity and challenges for firms.
I know, because I was working at the regulator until earlier in 2023, that there is a real desire through the Duty to drive positive change throughout financial services, but specifically within the consumer sector. I think what we will find is the regulator moving from looking at the Duty, in and of itself, to looking at other topics through the Duty’s lens. Like retirement income advice, which is a good example and ongoing.
‘A change in mindset’
Michael Lawrence: Moving on. Some firms think that now the July 2023 implementation deadline has passed, the job is done.
I’d personally be nervous of taking that view. And that is not to disparage the significant work firms have done, in the run-up to July, but we’re very much at the end of the beginning, in one sense, with the Duty. Now it’s about embedding changes which have been made into BAU.
Hopefully, people working in financial services, whatever their role, now know or are learning to know what the Duty means for their firm’s BAU. ‘Am I acting to deliver good consumer outcomes? Am I acting in good faith?’ I think that thinking will continue to evolve.
Chris Jones: The Consumer Duty is, if it was required, a change in mindset for your business – of being entirely consumer focused in every thing you do and every decision you make. That change in mindset is full of positives, for your business and for your working life. So I think if firms saw it as simply something they had to do by July 2023, they’re missing a huge opportunity.
Hear more. Watch the full 60-minute discussion with Chris Jones and Michael Lawrence, ‘Cutting through the Consumer Duty noise – What really matters?’
With 46% of team members at Dynamic Planner being women, we are truly embracing equity. For International Women’s Day 2023, we asked four women what embracing equity means to them. This is what they said.
Steph Willcox, Head of Actuarial Implementation
With three in four mothers with dependent children in work, the highest level over the last 20 years, it seems only reasonable that we should be embracing equity in the workplace. Working mothers are in a much better position post-pandemic, with the rise and expectation of flexible working, but we are starting to see a shift back to demands of being in the office placing pressure on primary caregivers.
Childcare costs in the UK are among the highest in the world, with 62% of parents saying they work fewer hours as a result. I would like to see workplaces acknowledge the balancing act that working parents, and in particular women, try to achieve, and look to their flexible working policies, to ensure they are supporting their employees for the relatively small period of time for which this is a major issue. I am grateful to work for a company which fully embraces hybrid working and supports me to be able to maintain a full-time career and a hectic family life.
Yasmina Siadatan, Sales & Marketing Director
Equity, diversity and inclusion should be looked at through every lens. Both within the business and externally, I believe we should be forging change. Businesses should hire individuals who share their values and strive to ensure there is a representation of all people. Where there are gaps, steps should be taken to correct this.
Our commitment to diversity and equity is not only limited to what we do internally, but we also care about it deeply when it comes to our product. We try to ensure a continuous impact to bring more women into our industry, as well as ensuring what we do and how we communicate appeals to more female advisers and end clients to also address the bias that exists when it comes to investing.
This is how we do things at Dynamic Planner and our success and culture demonstrate the value of operating a diverse and inclusive business. The promotion of equity, diversity and inclusion has to come from the very top table. The CEO and their immediate leadership team must take an active role in driving the agenda forward. They set the tone for the company and help to create a culture that values everyone.
Elly Gallagher, Head of People & Values
What it means to me is having a company culture where everyone can be their true selves. Where each person has a voice and is respected, and listened to, and their views are valued. This requires us to have deep connections to team members and building of trust so everyone feels safe and that sense of belonging.
I’m proud of the diversity at Dynamic Planner and of our focus on people and inclusivity within our culture. On International Women’s Day, we celebrate the achievements of our talented and strong women, recognise that women are increasingly represented within our technology teams, management and leadership, as well as more broadly the financial services industry. We are making progress, but there is always more to do and we really do have the power to make a difference!
Melinda Lovell, Enterprise Development Director
#EmbraceEquity springboards into Gloria Steinem’s definition of feminism as, ‘Anyone who recognizes the equality and full humanity of women and men’. To emphasise the word ‘humanity’, that, to me, is the essence of equity. Understanding and embracing our humanity allows us all to find the shoe that fits, find the firm that supports and the team that emboldens us to become our best selves.
#EmbraceEquity is also the fastest way to overcome the common corporate pitfall of ‘strategic shrink’, by bringing diversity of experience, thought, and approach to an organisation, and indeed to an industry.
The news from the Office of National Statistics (ONS) that inflation has eased slightly from its 41 year high at 11.1% to 10.7%, will provide a little hope but not quite enough to eradicate the worry that people feel for the immediate future and their financial position.
For those already struggling to cope with the rising cost of living, this will only compound the situation. For people fortunate enough to have investments, some may need to make decisions about how to plan to support the increasing cost of living. For many, a better understanding of cognitive and emotional biases could help.
Unfortunately, as humans, we have limitations on our abilities to process all the necessary information when making a decision in order to make the most rational choice, particularly as we are often bombarded with a wealth of information and have time constraints in which to make decisions. So, when it becomes challenging to keep track of the ever-changing prices of goods, interest rates, and trends in inflation, then we can often make shortcuts in our thinking to simplify the decision-making process, but this can lead us to make errors.
Dynamic Planner outlines below well-known biases that are particularly fuelled by the news of high inflation, along with ways to reduce or avoid them:
- Framing effect– this refers to how information is presented. People rely too much on the way a message is framed which can affect how they interpret information and therefore act on it.
How to avoid: Try to reframe a problem or message and find alternative perspectives. Research also shows that those who are more knowledgeable and up-to-date on an issue are less susceptible to the framing bias and the way a message is portrayed. It is therefore important to discuss inflation and its impact with an expert or read the financial sections in newspapers and online to help understanding.
- Anchoring bias– During uncertain times decisions can be influenced by fixating on a reference point or information you have received. People may make comparisons, estimates and decisions in relation to this reference, which is known as anchoring, ignoring other relevant information.
How to avoid: Research shows that just the way in which information is presented can cause people to look at a reference point and ignore all other relevant information. Even though a reference point, whether one you have determined or have observed in the media, may seem important, don’t be fixated on a figure, they are often arbitrary and irrelevant, and can cause greater worry.
- Regret aversion– Anticipating regret and envisioning the emotional discomfort of making a poor decision can result in inertia, where people may fail to act or stick with a default option for fear of making an active choice which later turns out to be sub-optimal.
How to avoid: Not making or avoiding a decision still involves making a choice. Research found that automatic pension enrolment increased pension participant rates from 49% to 86% in 2001, and this is why such behavioural nudges (an opt-out rather than an opt-in system) have been applied today, helping us to save more for the future. Spend time thinking about your priorities and viewing the future with optimism, finding ways to better regulate your emotions can also help reduce fear and succumbing to feelings of regret when facing a difficult decision.
- Present bias– Individuals can have the tendency to pursue instant gratification by overvaluing present rewards at the expense of future returns. We often engage in impulsive behaviour in return for immediate pleasure, whether opting for unhealthy fast food or spending money today rather than saving for tomorrow.
How to avoid: It is important to delay gratification particularly when we consider saving for retirement, immediate rewards can often lead to regret. When saving, set realistic goals as setting yourself up for failure can reinforce the desire to accept instant rewards and discourage you from persevering and saving for the future.
- Availability bias – refers to our tendency to use readily available information, information that comes to mind quickly and easily when making decisions. We also often evaluate the likelihood of future events on recent memories without putting them in perspective of the longer-term past which can lead us to make poor financial choices.
How to avoid: Perceptions of inflation can be heavily influenced by your personal purchasing experiences. Research shows that price changes of items that were recently purchased, bought frequently, resulted in an increase in price, and particularly a large increase, influenced people’s perceptions of inflation. Gain a more accurate and objective picture of inflation and discuss with an expert or research the current situation, as recent events and personal experiences can cloud your judgement and lead to greater worries.
Louis Williams, Dynamic Planner’s Head of Psychology & Behavioural Insights said: “The current situation is worrying for everyone, some of us will not have experienced inflation anywhere near as high in our lifetime.
“For those who are fortunate to still have a degree of choice in how to manage their money, understanding the biases that may influence their attitudes and behaviour could help them achieve better longer-term outcomes as well as counter some of the impact of inflation.
“Having a much deeper understanding of our susceptibilities to behavioural biases can be a great help in overcoming rash or ill-thought-out decision making, especially when faced with all the uncertainty we have right now combined with the soaring cost of living.”
By Jim Henning,
Head of Sustainable Investment
When it comes to doing our washing, we all know it’s important to read the clothing labels to avoid any unfortunate mishaps (as well as trying to reduce the water consumption and temperature levels). Similarly, when it comes to sustainable investing, the risk of ‘greenwashing’ has been a persistent issue.
The ever-widening range of sustainable investment objectives, definitions and related solutions has led to misunderstandings, confusion and sometimes claims are being made that simply wouldn’t stand up to scrutiny. This can lead to the unintended consequences of eroding trust in the financial services industry and lowering levels of capital flows into sustainable enterprises than would have otherwise been the case.
Global regulatory bodies have been busy trying to fix this problem by defining what exactly a sustainable investment means, thereby bringing more clarity, standardisation and raising standards. Greater transparency is vitally important but is an incredibly complex and technical task and remains very much work-in-progress.
It’s also interesting to note that the EU, US and UK regulators have chosen three definition categories, but predictably each have important differences in approach. Based on the recent FCA consultation paper ‘CP22/20 Sustainability Disclosure Requirements (SDR) and Investment Labels’, the UK proposals look more aligned to the US than the EU scheme. In the latter case the EU’s SFDR was intended to be a disclosure regime only, while the FCA’s proposals introduce a labelling regime with three sustainable categories and new consumer‑facing summary disclosures.
Sustainability Disclosure Requirements – Proposed fund labels
*At least 70% of a ‘sustainable focus’ product’s assets must meet a credible standard of environmental and / or social sustainability, or align with a specified environmental and / or social sustainability theme. These products will typically be highly active and selective.
**These products will typically be highly selective, emphasising investment in assets that offer solutions to environmental or social problems and that align with a clearly specified theory of positive change.
Importantly, the new labels will also apply to discretionary managed portfolio services (MPS). For an MPS to qualify to use one of these labels, 90% of the total value of the underlying products in which it invests must meet the qualifying criteria for the same label. The DFM provider must then make the disclosures for each of the underlying products available to retail investors.
Choosing the right name for a product has always been important and often the subject of much internal debate within marketing departments. As it’s likely the first thing a retail investor is made aware of, the FCA intends to prohibit the use of sustainability related terms in either product names or marketing material for those products that do not qualify for a sustainable label. Examples of these terms would include ‘ESG’, ‘climate’, ‘impact’, ‘sustainable’ or ‘responsible’.
Following the consultation period, the final rules are due to be published by end of June 2023 and new labelling, naming and marketing restrictions will follow on 12 months later. The disclosure proposals in CP22/20 are far-reaching, covering all regulated funds to varying degrees, not just the labelled ones. They will require much more granular transparency and ongoing disclosures particularly surrounding investment objectives and policy, alongside progress reporting against published KPI’s.
There is no doubt that qualifying for a sustainable label will be a high bar to meet for many asset managers. In fact, based on the FCA’s own initial estimates, of those products that currently have sustainability-related terms in their names and marketing, two-thirds could decide to remove them accordingly.
Based on the 139 risk profiled multi-asset solutions currently in Dynamic Planner that have such terms in their names, it is interesting to see the differences across both funds and MPS’s. ‘Sustainable’ is by far the most favoured naming option across both wrapper types, but there is notably a greater proportion of more specialist ‘Impact’ and ‘Ethical’ offerings in the MPS space. For ethical screened funds, I suspect many are likely to elect one of the new labels, as sustainability has always been an important underpin to their philosophy and the preference of their traditional dark green investor base.
Over coming months, we can expect a raft of objective and fund name changes in light of the proposed regulations. At Dynamic Planner, we will ensure that relevant and objective sustainability research is available in the system, covering both products adopting the new labels and those which don’t. In the latter category, many will continue to actively apply ESG screens in their stock selection process and engage with investee companies (and also more widely across the asset management firm) from a fiduciary risk management perspective.
Thereby, users will be fully equipped to connect the recommended solutions to both risk and sustainability preferences via our Client Profiling process and meet the forthcoming Consumer Duty requirements.
Not a Dynamic Planner user? Schedule a free no-obligation demo with a business consultant and experience the full functionality of Dynamic Planner.
By Dynamic Planner Investment Committee [Aug 2022]
Dynamic Planner’s Investment Services team and the independent members of the Investment Committee [IC] have been identifying the risks of rising inflation and interest rates for a considerable time, being actively discussed at the quarterly meetings and reflected in decisions taken. This quarter is no different.
As the IC met on 23 July 2022, it was prepared for the subsequent UK interest rate rise and remains confident that its capital market assumptions are valid in these market conditions. Following the rapid economic bounce back from Covid lockdowns, the IC had become increasingly concerned about the impact of rising inflation expectations taking hold. With UK inflation currently running at 9.4%, the highest level experienced for more than 40 years, it is understandably grabbing the headlines.
The corrosive impact of inflation on living standards and reduction in spending power of accumulated wealth should not be underestimated, even when at modest levels. So, what can be done when the Bank of England is warning of inflation reaching 13% and staying at ‘very elevated levels’ throughout much of next year, before eventually returning to its long term 2% target in 2024?
Interest rates are already on the rise, with the biggest UK increase in 27 years announced last month (the Bank of England base rate now stands at 1.75%). Similar measures to put up borrowing costs are happening elsewhere around the world, with the US Federal Reserve having hawkishly raised rates to a range of 2.25% to 2.5%, and the European Central Bank delivering its first interest rate hike in over a decade, taking the eurozone out of negative rates.
A tightrope for central banks
The current combination of stagnating economic growth and rising inflation, referred to as ‘stagflation’, is particularly troublesome for asset allocators. Tightening monetary policy to tackle stubbornly high inflation, at a time when the economy is already slowing, can be a very difficult tightrope for central banks to walk, if recession is to be avoided. This unwelcome scenario had been a risk of growing concern for the IC, even back when market consensus expected inflationary pressures to be temporary in nature.
Oversight of ex-ante and ex-post forecasts and scenario analysis are essential functions of the IC. Results from detailed stress-testing conducted last year showed that a drawn-out stagflationary environment would create the most serious challenge for the multi-asset portfolio benchmarks. This was mainly due to the potential impact of sharply rising interest rates on bond values and their increasing correlation with equities. The latter has been magnified as yields have been driven to rock-bottom levels, due to unprecedented monetary stimulus post the 2008/09 Financial Crisis.
So, what has the IC been doing?
Using long-term trend analysis and research sources, the strategic direction of travel of the asset allocation decisions taken by the IC over a number of years can be summarised below:
- Managed reduction in bond exposures
- Continuing global diversification trend
- Prudent increases in cash positions
The multi-asset benchmarks, which have been running since 2005, have experienced periods of considerable market stress, but these decisions have helped prove them to be extremely resilient and perform in line with our long-term expectations.
As we navigate these prevailing cross currents of acute economic and geo-political uncertainties, the IC will continue its laser focus on ensuring the benchmarks remain best positioned for long-term investors looking for protection of their wealth against both inflation and volatility. You will be hearing more from us again in early September, when we announce changes to the 2022/23 benchmarks following the annual review process.
- On 20 October 2022, join our Chief Investment Strategist, Abhi Chatterjee for a quarterly webinar, updating you on the performance of the Dynamic Planner asset allocation benchmarks and wider market outlook
By Chris Jones, Proposition Director
If I were governing an island nation and wanted to connect to the mainland, I would have a number of choices. Would I go bridge, or would I go tunnel? More importantly, would I pay for it from the public purse, or would I outsource for it to be built privately? I would have a lot to consider.
The costs, the benefits, does my state have the money, could I raise it with taxes, could I borrow it with sovereign debt, do I have the expertise to build it, what toll would people pay and how often? Would I want to carry the iron triangle of scope, cost and time? It’s a lot to take on.
For example, I could look to the Channel Tunnel and to the Queen Elizabeth/ Dartford Bridge. There is a plaque at the bridge that says it: ‘Marks the first time this century that the Government has contracted to the private sector the financing, design, construction and management of a major road’. This Private Finance Initiative concession was enabled by the Dartford-Thurrock Crossing Act 1988 and it was opened on the 30th October 1991. Three years isn’t bad.
When it comes to the Tunnel, Article 1 of the Anglo-French Treaty of Canterbury signed on 12 February 1986 says that: ‘The Channel fixed link shall be financed without recourse to government funds or to government guarantees of a financial or commercial nature’. It opened on 6th May 1994. All which is quiet compelling.
Then I look at the fact that the Dartford Crossing is now raking in £100m annual profit and that in 2019, post-Brexit pre-Covid, the GetLink group (formerly Eurotunnel) had a net profit of 159m euros and my head is turned. Maybe I want that revenue for the state, but would I get it? Would my sovereign debt-funded public sector project have the lean, cold-blooded efficiency of the business world, where the imperatives of the market would, by default, reduce waste and inefficiency?
The big problem is what happens between the investment of capital over 30 years ago and these returns. For both projects it was a very bumpy ride, and it was only 10 years ago that meaningful profits began.
Whilst the Tunnel is often portrayed as a financial failure, in fact, finance did its job to raise funds and absorb risks amazingly well. Risks were transferred to private investors and the private investors bore them. If the project had been delivered on time and budget and if demand had materialised as forecast, the banks expected an 18.8 per cent return on investors’ capital. No-one should be surprised if there are risks associated with such returns.
With perfect hindsight on demand risks and cost overruns, a public sector investment subsidy of another 50% of the capital costs would have been required to make the project financially attractive to private investors. Importantly, however, the government didn’t have to make this commitment. Overall, it generated an economic rate of return over the life of the concession estimated between 3 and 6%. Not so bad when you consider how gilt yields have fallen over the same period.
Outsourcing and infrastructure
Overall, you can see why outsourcing these things would be attractive to me as the government of an island nation. Of course, in reality we are unlikely to be on the government’s side of the table and would be looking at this question from the other side, on behalf of investors. The free market must demand a premium for the risk and the long-term nature of investments such as these.
With gilt and other yields low, infrastructure can be tempting for fund managers. However, whilst they serve the government in a similar way, they carry quiet different risk and return characteristics for the investor:
|Little credit risk
|Little default risk
|Generally longer term
|5 to 45 years
|Can be inflation proofed
|No inflation proofing
|Can be variable income stream
Beyond these generic differences, at Dynamic Planner we analyse the risk of infrastructure investments within the funds that we profile on an individual basis in whatever format they take: equity, debt, physical property, structured product etc.
We therefore consider it more like an instrument to be considered for its own idiosyncratic risk characteristics rather than an asset class, with an index that captures its systematic risk characteristics. As you can see from the bridge and tunnel examples above, one infrastructure initiative is quite different from another, and the various investment structures are different again.
In his last budget, Sunak committed to fixing the UK’s infrastructure as part of a levelling-up push, a central tenet of the government’s plans to kickstart the economy after the coronavirus pandemic. The Treasury’s pitchbook for Investing in Infrastructure UK says this generates new investment into priority areas (including energy, transport and water) by matching the UK’s needs to investor interest. The majority of the £383bn national infrastructure pipeline will be funded through private sources. It also sets out its own Risk UK Infrastructure risk and return profiles.
On the other side of the Atlantic in the US (to whom we are connected by cables that were built by a more recent popular infrastructure investment), Biden has announced a $2.25 trillion infrastructure package.
Well before Sunak and Biden’s interventions, there was a lot of capital in infrastructure investment:
- The top 5 infrastructure debt managers: Blackrock, EIG, AMP, AXA and Macquarie, raised $52bn in the last 5 years.
- The top 5 global infrastructure fund managers: Mcquarie; Global Infrastructure Partners, Brookfield, Stonepeak and KKR manage $232.1bn. The top 50 raised $78.5bn last year alone of infrastructure assets (Nov 2020).
Such a large amount of local and global capital investment cannot be ignored.
Whether or not you invest in infrastructure within your retirement solution, with whom and how, all requires careful consideration and analysis of the risk factors, which you would outsource to a fund manager.
But if I were governing an island looking to build a bridge or a tunnel, I would definitely outsource it to the private sector rather than raise sovereign debt. Whilst I would certainly benefit from their resources, technology and expertise, the simple idea of making the whole thing somebody else’s problem clinches it for me. I suspect that also plays a significant part in real government decisions.
So, if outsourcing to offload the problem onto somebody else is a good idea for Governments, it must be even better for advisers and their clients. It’s not the cold utility of whether you look back at the end of 30 years and quantify the financial benefits; it’s the outsourcing of not only the work and time but the worry that makes it so compelling.
I am very sceptical that a client could self-direct and self-manage and get a better investment outcome than if they paid for advice, but the more important thing is what else they could have been doing with their time and mental capacity. Focusing on work and getting a promotion, studying for an exam, doing overtime, helping their kids study to get a scholarship etc. Outsourcing the work frees up time and it frees up mental capacity.
A number of US studies show that for many people, just the simple act of passing the responsibility and liability to their adviser is worth the advice fee.
According to Dynamic Planner’s own Head of Psychology and Behavioural Insights, Louis Williams:
“People miss out by not shifting this responsibility.
“Many struggle to accumulate their savings for retirement because they lack financial knowledge, resources, and are susceptible to various cognitive and emotional biases. The two most appropriate solutions for this are either significantly improving your financial literacy or increasing your uptake of financial advice.”
With all else being equal, outsourcing is worth it just to make it somebody else’s problem. In most cases you also get time expertise, resources and technology that you don’t have. It’s more efficient, particularly where a task can be done once and its result is used by many.
Advisers thinking about infrastructure within their clients’ solutions are going to need to rely on a multi-asset fund manager to handle all the variables and complexities described above.
Asset managers can rely on Dynamic Planner to consistently assess the risks of infrastructure within their funds.
And advisers can outsource to Dynamic Planner and build our system into their own infrastructure, so that our technology and expertise is yours, freeing up your time and capacity to add value for your clients.
Not yet a Dynamic Planner user? Schedule a free no-obligation demo with a business consultant and experience the full functionality of Dynamic Planner.
By Chris Jones, first published in April 2021
If you lived and worked on an isolated island community, and you were able to source everything you needed from your fellow islanders, retirement would be a relatively simple thing to plan.
You would earn a wage or make a profit doing your thing. You would not only spend your income on your fellow islanders’ goods and services, but you could also invest whatever you had left over in their businesses. When you retired, your share of the profits in those business would be directly correlated to the cost of the goods and services, and everyone is happy.
You could, of course, lend money to these businesses instead but there would be no certainty that the fixed capital repayment or interest would be correlated to the cost of goods in the future. This inflation risk is why asset-backed and equity in particular are so good for retirement planning. We may not have felt it recently, but inflation does creep up on you over time.
In either case there are other risks: the business might go bust, the owner may not honour the agreement and so forth. These are things that apply to both the loan and the equity.
I am imagining my theoretical example set in the 18th or 19th century: a blacksmith, baker, farmer, publican, tailor, doctor etc. Since then, advancements in transportation, industrialisation, and communications have led to globalisation which brings improvements and challenges to this premise.
Reducing risk through diversification
Over the last generation, people have been able to invest in Mitsubishi, Nestle, Total, Tesco, BP, Diageo, M&S, GSK etc. Clearly being able to do this reduces risk through diversification and a fair and efficient market. It does introduce additional market and currency risks, but nonetheless people can easily invest in the companies that supply them and this is sensible and encouraging. I understand that the reason funds tend to show top 10 holdings is mainly because investors feel reassured by this.
If globalisation impinges on our remote island scenario, had you invested in your local small business supplier, would it have been acquired and integrated into a global company, or would it have just gone? Whilst investing in equities for long term future retirement needs is compelling, the question of which share is important.
At Dynamic Planner when we use phrases like U.K. Large Cap Equity or Short-term Bonds it has a very specific meaning. For these examples, it is the MSCI UK Equity Large Cap Total Return Index and ICE BofA 1-5 Year Sterling Corporate Index. Individual funds or stocks and shares vary from that both in performance and in risk characteristics, as we can all easily observe. We of course calculate and measure this variance and use it when we risk profile funds at a holdings level.
Expected real returns
Whilst indices are great for consistency of term and qualitative analysis, their components are very fluid and they are totally ex-post (or after the event) in nature. When a share grows, it enters or forms a larger part of that index; that doesn’t mean that it will stay there or remain at that proportion of the index.
Our service provides ex-ante, expected real returns; volatility, correlations and covariances as well as a Monte-Carlo stochastic forecaster. What we cannot do is tell you what stock will make up an index in 30 years’ time. If we could, I would be living on my own private island right now. When you think about asset manager charges, caps and their value, it’s worth reflecting on how difficult yet worthwhile it is for them to try to do this on your behalf.
Whose labour, goods and services will be needed when you retire?
The companies that make up local indices and the countries that represent a global index change quite dramatically. At the end of the 19th century commodities and the UK were dominant.
By 1967 the largest companies in the US were GM, Exon, Ford, GE, Mobil, Chrysler, US Steel and Texaco -almost all car related. At the same time, the UK was busy devaluing its currency and voting not to allow women into the London Stock Exchange. Back then half of UK shares were directly owned by individuals, so in many ways the market was closer to my imagined island scenario than the globalised fund-led market of the 21st century.
Change in relative stock market size from 1899 to 2021.
Things change. Would anybody like to be living off Kodak, Blockbuster or even Tie Rack shares today?
Whilst the basic principle of exchanging your labour for capital whilst you work, and then exchanging your stored capital for labour when you can’t, has been consistent and remains valid today, when it comes to choosing where to store your capital the fundamental question remains: whose labour, goods and services will be needed when you retire?
There has been a lot written about ESG and sustainability. Everyone has an opinion and many people have suddenly become experts. I am certainly not an expert and I won’t add my opinions to the pile.
It does, however, appear sensible to invest in companies that will still be around in the future, and it might be that use of the word ‘sustainability’ is all you need to prompt you to consider ESG information and your client’s preferences. A psychometric sustainability questionnaire and objective MSCI ESG data is available in our system.
Not yet a Dynamic Planner user? Schedule a free no-obligation demo with a business consultant and experience the full functionality of Dynamic Planner.