Question the Committee, Edition 1, December 2015…

Committee’s Note

A note from the Investment Committee (“IC”) Chairman

Firstly, I’d like to thank you all for your questions and engagement with Question the Committee 2015. The success of this pilot has made it clear that further such initiatives will be well received and we have consequently included biannual Question the Committee into our proposed communications for 2016. The Committee have enjoyed the variety of questions received, varying from comments on global financial markets, recent political events and short term volatility levels, to specific questions surrounding the individual Committee members and the culture of our meetings. Special thanks to the winner, who’s question demonstrated a strong understanding of the current economic climate in the UK. Once again, I would like to take the opportunity to thank you for your ongoing support and look forward to working with you in the New Year. Merry Christmas!

Ashley Brooks, IC Chairman

Winning Question

“In the UK we have very low and very stable inflation, we have a historically low and stable base rate, we have the highest GDP growth amongst the G7 nations, we have falling unemployment. Major companies are reporting strong results generally and maintaining dividends, they have strong balance sheets, are cash rich and buying back their own shares. Why are the FTSE 250, FTSE350 and the FTSE all-share performing so poorly in 2015, when bearing in mind the back drop of (what appears to be) a strong financial climate?”

Great question. Global exposure has been a big theme in the UK market this year; those exposed to the more global headwinds have suffered, and where earnings are more domestically driven, returns have been stronger. As you say, the UK looks in a good place, but 70% of the earnings of the top 100 companies come from overseas. Currency wars, the Chinese slowdown, deflationary fears and a still fragile European recovery have all unfolded, and uncertainty has depleted investor confidence. As we approach an interest rate tightening cycle, and an EU referendum in 2016, there are still factors that will keep investors out of equity markets. This leads us on to the composition of the indices you quoted above. The FTSE 250 and the Small Cap exclude the FTSE 100, whereas it makes up 81% of the FTSE 350 and 73% of the FTSE All-share index. At the time of writing, the former have returned 8.37% and 5.68% respectively, whereas the latter have been dragged down by FTSE 100’s –4.92%. We have had a preference for mid-caps, which in the main are more domestically focussed, for nearly 18 months, and have benefited from their relative strength. I would also like to pose something for consideration regarding your correct analysis of corporate cash levels and share buy-backs. Could the main reason that share buy-back levels are so high be because companies cannot see good enough growth opportunities to invest their cash? Yes, existing shareholders can benefit from an increasing share price, but this has to be offset by its future potential for growth and the sentiment of management.

Investment Committee

Contenders

With a good private pension pot and with current low interest rates, would it be better to take the tax-free lump sum and invest that in a new main residence to live in or leave it where it is, assuming you have enough pension to live on if cash is taken?

More of a financial planning than an investment based question, from which the answer would depend highly on your objectives. The low interest rate environment would only be beneficial to this proposal if you were borrowing to fund the purchase, in which case, you would need to consider how the debt repayments will be covered by your pension income. There are good fixed rates on the market at the current time, but we would also suggest that any interest rate increases from here (such as last week in the US) would be a sign that economies are performing strongly, which should benefit risk assets such as equities. You also need to consider the tax consequences for the future of taking all your tax-free lump sum now, so this is an important financial planning decision. In the absence of further information our stock response to this question would be that we would not (without good reason) recommend that a client swapped a highly liquid and tax efficient asset for an illiquid one.

Investment Committee

Do you invest our money directly in specific assets, like shares (e.g. shares in Tesco or M&S) or property (e.g. a shopping centre or business park), or do you invest in funds which have wider-ranging and actively managed holdings in retail or commercial property?

Our Portfolios are fully invested in collective investments (funds). We do not invest in direct shares, bonds or property, due to the extra risks associated, and the additional costs such as dealing and commission charges. It is important to note that this does not restrict out investment universe, as we asset allocate across all asset classes and geographies. We would also point out that as well as the investment risk/return relationship, we also have a consideration for ensuring the gains made within our portfolios are not subject to unnecessary taxation. In general, tax management is much more effective through using collectives than direct holdings.

Investment Committee

With the referendum on a possible Brexit scheduled for the end of 2017 and current opinion polls suggesting a 50%/50% split, what action is the Committee taking / considering to position funds to benefit, whatever the outcome?

We like the way you phrased the question here, as we always try to manage the portfolios to be well positioned in a diverse range of scenarios. Even if the opinion polls suggested a certain outcome, it would be foolish to make changes based on this speculation. Instead, we are focusing on what either result could mean for asset classes, volatility levels, and future trends. The tabloids would have you believe that this is the biggest threat to investments in 2016, but we would argue otherwise. Without sounding complacent, bond market valuations, monetary policy, and global growth trends are, in our view, more important to asset class returns. Of course, these are all interconnected, and the EU referendum will certainly bring about spikes in volatility. Overall though, we will continue to focus on capital preservation and efficient diversification, taking advantage of any long term value that appears, whilst staying cautious in the short term.

Investment Committee

What is going to happen to my investments when the Referendum votes to exit the European Union?

In short, we would suggest that headlines such as “Britain to lose its AAA credit rating if Brexit” will be overplayed, and the effects on investment markets will be less than anticipated. Nonetheless, it will bring about short term volatility, but it’s important to remember that we are global investors and the UK makes up under 10% of the global economy. As you are invested in a portfolio that holds a diverse blend of assets, it is designed to reduce risk and take advantage of short term volatility in particular to protect the downside, whilst also picking up value where appropriate to move forward over the years ahead.

Investment Committee

How do you ensure that all Investment Committee members speak out in meetings and share opinions? Do you work by consensus, majority vote or is there a risk that the most senior members could overly influence policy?

Another great question since this is often overlooked when considering the success of an investment team. In terms of structure, we have five members who each have an equal vote, and work by majority. This is secondary though, as having a vote does not necessarily mean it won’t be influenced by others. Instead, we strive to offer a culture that is open to challenge, and that is free from hierarchy. We also ensure each member has direct responsibilities. An example of this is delegating market sectors between members. We are each be responsible for conducting in-depth research, and after following our strict investment process, we individually present our findings at each meeting, which will form the basis of continued discussion and analysis. Sectors are rotated each quarter to reduce continuity bias. This is just one example of our rigorous process, which is regularly reviewed by both the Committee and external auditors.

Investment Committee

What are DB Woods plans for 2016 to protect their customers’ assets from the very volatile financial markets?

Your question here is regarding 2016, however, we would like to first touch on the challenge we have faced in 2015: Investment markets have had a tough year, with most asset classes offering a negative return since the start of the year. All of our six portfolios are well into positive territory year to date, despite most of the world stock markets being down significantly, since April. We are also delighted that all of our portfolios have outperformed their respective industry benchmark average. Our plans are to continue with our rigorous processes, and to maintain diversification across a broad range of assets. We remain cautious for 2016, and are therefore positioned to take advantage of market falls over the medium to long term. We definitely see highly volatile markets as an opportunity and not a threat, providing you retain perspective that the benefit of our strategy will need time to play out. As with this year, if we can continue to outperform by excellent margins when markets fall, we have an excellent opportunity to buy into more value and improve returns. We are constantly challenging the way we work, to ensure the portfolios work hardest for you in the tough times.

Investment Committee

Will the current instability in oil prices continue to affect the global markets? If so, should individual investors with a relatively small portfolio consider moving their investments elsewhere?

Commodity prices are one of the many drivers of global markets. They are huge demand and supply balances which are constantly altered by everything from the weather, to political battles. The recent oil price collapse has been well covered, but there is less of an understanding of its effects. People often see a collapse and think it is purely negative, however, in many cases there are also positive effects, and more importantly, opportunities are often created on the back of it. Let’s consider oil in isolation, although the same sentiment can be adapted to other commodities which have dropped heavily in value. On one hand, the political football being played by the Americans and the Saudis has caused the price of oil to fall below a level in which most oil producing companies (and countries) can make a profit from producing it. This has caused revenues and profits to fall, which in turn affects share prices negatively. Given that the UK equity market comprises of a large number of commodity based mega corporations, it has weighed harder on us here. Conversely, the fall in the oil price has made the price of fuel cheaper, reducing people’s household bills and giving them more disposable income (it is estimated that this will have increased, on average, by more than 10% in comparison to 2014). Given the returns on offer in savings accounts, people are urged either to invest this extra cash in the stock market, or spend it on other goods and services, both of which can boost the economy and share prices. To answer your question, current instability makes for more market volatility. As investors in our portfolios take a medium term view we would argue that opportunities are created by volatility, though sometimes this may take some time to play out. Ultimately, it is the price you buy an investment for, and the price you sell it at, that determines your returns, so when assets are falling in value based on external factors that will wash away, more value is often created over the longer term. We would therefore recommend to ‘stick’ and not ‘twist.’

Investment Committee

Are the risk profiles i.e. low, medium, high etc. fully represented by the individuals who comprise the committee and if so, in what ratios?

Firstly, we would confirm that Investment Committee (IC) and the wider DB Wood team, (as well as a number of industry specialists), buy our portfolios to support their own investments. We hope this demonstrates conviction for all our risk adjusted portfolios. The six portfolios we run are assessed by the IC as a whole, and are also subject to periodic external evaluation and audit. The IC is based on a rotating asset research mandate to ensure objectivity, as well as a rigid filter system using a market leading provider of financial data. We also operate a one member one vote system. Our culture promotes independent thinking, transparency and objectivity. In direct answer to your question, the portfolios are fully represented by all committee members based on an equal ratio.

Investment Committee

It would be helpful to have more regular updates about plans to protect our assets. The blog does not really give much useful information.

Thank you for your feedback. Improving the visibility of the Investment Committee is a key business aim for 2016. Alongside the Quarterly Investment Updates, our Investment Committee will be posting monthly blogs, and will running a “Question the Committee” biannually. These are just a small part of an aim to improve communications across the business, and other developments in this area will be released in the new year. Please also consider liking our Facebook page and following us on Twitter, as we send out regular posts regarding the performance of the portfolios and more, via these mediums.

Investment Committee

Given global fluctuations in markets and economies due to uncertainty over political unrest and costs of basic raw materials (oil etc.), how can investors and savers be sure that the decisions made by the Investment Committee and their own “risk profiles” are positioned correctly?

Perception of risk is highly subjective. As a Committee our view of risk is very heavily steered towards capital preservation on the one hand, and outperforming the risk free return (the amount of return that can be achieved in the market without taking risk), by a set and increasing amount over a prescribed period, on the other. We expose each portfolio to a greater level of risk to help achieve this as we move up the risk levels. In turn, we ensure our clients are willing (and able) to accept the potential losses that we think might be possible over the short term for the risks taken. We position our different risk portfolios to achieve more return per unit of risk taken. Our software enables us to look retrospectively as to how well we have achieved this, as there should be what is known as an ‘efficient frontier’ between each portfolio and the its risk and return profile. We assess our performance over the short, medium and longer term, and stress test all our ‘ideas’ against the same principles prior to making any changes.

Investment Committee

Thanks for reading! Please look out for the IC’s ongoing correspondence, including our first Quarterly Investment Blog of 2016, to be released in January. In the meantime, should you have any further queries, please do not hesitate to contact the office or send an email to iinvest@dbwood.co.uk.