BP – WHAT NEXT?
I bet your first reaction to the headline is this is about British Petroleum and their current problems. It's not but I'll come back to that later. The BP I had in mind is, B standing for BIG and P standing for PICTURE. It's the BIG PICTURE many of us have lost sight of over the last four weeks.
When I did my piece to you in April, you may remember I was critical of experts who claim the only way to invest in equities is to track an index. The most commonly known one here of course is the FOOTSIE, or as it's sometimes known, the FT 100 Index. Four weeks ago it was 5,800 and it's fallen 12% since. A similar fall happened in the US, and heavier falls happened elsewhere in the World.
For at least the last fifteen years we've been critical of the way in which equity portfolios try to match an Index. But it's the case many private investors and, even worse, Pension Scheme Trustees think Index tracking still makes sense.
It doesn't work. A decade ago the biggest share in the UK stockmarket was Vodafone. Index trackers were forced to buy more of it as it grew during the Dot Com boom, but in the last ten years its shares have fallen 64%.
Until a couple of years ago the big star was the banking sector and as the share prices of HBOS and RBS rocketed, trackers had to buy more of them. Then, following the last subprime crisis, bank shares fell up to 95% and dividends disappeared completely. And now it's British Petroleum's turn, as Steve Forbes explains in "Informing You".
The Big Picture tells us to remember the First rule of investment is to BUY LOW, SELL HIGH. Trackers on the other hand do the opposite so are fundamentally flawed. What's worse is they track an Index also flawed.
The Capital Weighted Index system means the performance of the biggest companies like BP skews Index movements significantly. World renowned analyst Rob Arnott, a long term critic of the current system, has shown any other index method would increase equity portfolio returns by 2% to 4% per annum, over the long term and as a consequence would have removed Pension deficits completely.
Value investment guru Professor Jeremy Siegel, in the US, warned investors back in the mid 1990s that once a public company starts to dominate a Capital Weighted Index, as Vodafone and Microsoft did in the late 90s in the UK and US respectively, they should expect significant investment underperformance for at least the next 10 years. You will note BP share price has fallen a third since 2000.
That's the reason we endeavour to find fund managers who manage in an unconstrained way. We like those who ignore capital weightings, who are contrarian and buy low and sell high and that's why we prefer managers like Neil Woodford, who has dramatically outperformed the FOOTSIE over the long term. A few years ago he ignored most of the UK banks, and had the courage more recently not to invest in BP or Shell despite the fact they constituted around 17% of the index.
So, our BP - the Big Picture - is to remind you that despite the shock horror headlines, contrarian funds we selected for our clients have done well over the last 12 months despite the recent falls. JPM Natural Resources is still up 40%, Technology funds up 45%, US funds up over 35% with Emerging Markets and Asian funds up 30% - 33%.
BP also stands for BE PREPARED. The King of Emerging Markets is Mark Mobius. Yesterday he reminded us Emerging Nations account for over 30% of Global Income. That's a 44% increase in the last five years. But research shows Institutional and Private investors are hugely underweight with an average of 5% exposure.
Headline worries about a China property bubble are, he claims, grossly overstated. He admits pockets of excess apply in an area representing only 9% of the overall Chinese property market, and reminds us that a 30% down payment is usually required. Now there's a sensible thing for the West to consider.
Instead of getting our knickers in a twist over headlines about Dubai collapsing (remember that?), or Greece’s debt triggering a global depression (it constitutes 0.6% of the World’s income), we should pay more attention to the fact the Baltic Dry Index, a function of rising World trade, is up 32% in 6 weeks.
And there are 3.5 billion consumers in Emerging Markets desperate to be better off. That’s a heady combination of high demand, low debt and fast growth.
So our message is still the same. We expected the Summer to be bumpy and that's why we introduced caution to your portfolios. But by late September, we would expect to be fully invested again in growth assets with the main focus overseas.
Alan Steel
Chairman
This letter is the personal opinion of Alan Steel, please check the appropriateness to your individual position with your adviser before taking or refraining from any action.
