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Hamish Chamberlayne,Portfolio Manager with Janus Henderson’s Global Sustainable and Responsible Investment (SRI) Team, details the ten sustainability themes – five environmental and five social – that guide the generation of the team’s investment ideas.
The development of the world economy has reached a critical juncture. Over the last century it has depended on the availability of cheap resources to drive economic growth. However, the supply and use of many natural resources are approaching their limits.
Climate change is the most subtle, yet arguably the most important, constraining factor. We believe the defining investment issue of our time will be transitioning to a low carbon and sustainable economy while maintaining the levels of productivity required to deliver the goods and services that growing and ageing populations require.
We invest in companies that are rising to the challenges posed by global megatrends and those seeking to transform the industries in which they operate. In building our portfolios we are also aiming to balance environmental and social sustainability. The ten themes that guide the generation of our investment ideas are split into five environmental and five social themes, and the concept of ‘sustainability’ runs throughout our investment process. We believe that well-managed companies that have a competitive advantage will generate sustainable cash flows and returns on invested capital.
Five Environmental Themes
Currently transport contributes to 23% of global greenhouse gas emissions from fuel combustion (source: World Bank), making it a significant target for government curbs. This risk presents an opportunity for companies at the forefront of pioneering new energy technologies, vehicle efficiency, and public transport infrastructure. For example, advances in lithium-ion (Li-ion) battery technology mean that fully electric vehicles are becoming a more viable option for the average consumer in terms of cost, range (distance per charge), and driving experience (eg, low noise, zero emissions, greater internal space), such that they could challenge the dominance of combustion engines and traditional auto manufacturers within the next 10 years. Public transport, including rail and bus networks, is an important area of investment for reducing emissions, noise pollution, and congestion through shared journeys. Additionally, cycling is increasingly being promoted by governments for health and environmental reasons, which is supportive of companies with goods and services linked to it.
The World Health Organization estimates that 1 in 10 people globally lack access to safe water, while 1 in 3 lack access to proper sanitation. It is expected that half of the world’s population will be living under the threat of water scarcity by 2030. Water is under growing pressure both on the supply side (insufficient fresh water, uneven distribution, poor quality, climate change) and the demand side (increasing use in agriculture, industry, and municipal/residential areas). Governments cannot act alone to solve shortages – significant investment is required in infrastructure, alongside behavioural changes among all consumers to bridge the supply gap.
If the world economy is to limit the increase in global average temperatures to 2 degrees over pre-industrial levels, then investment in renewable energies is going to be crucial. The price of wind and solar power continues to decline, and is now on a par with, or cheaper than, grid electricity in many countries. Solar makes up less than 1% of the electricity market, but could become the world’s biggest single source of renewable energy by 2050, according to the International Energy Agency. One exciting development for the market is the falling costs of viable energy storage solutions: storage can help smooth the peaks and troughs associated with variable output from solar and wind farms
Roughly two thirds of primary energy contained in fossil fuels globally is wasted. Efficiency improvements are vital if we are to achieve economic growth while keeping carbon emissions within recommended levels. Changes will not just be needed within the industrial and transportation sectors: residential and commercial buildings are the largest and most inefficient users of energy globally. Incandescent light bulbs are an extreme example of energy loss; in contrast LED bulbs can be 90% more efficient and last 10 times longer.
As the global population continues to grow and urbanise, cities are facing a sharp rise in the volume and costs of their waste. The World Bank estimates that if no steps are taken, the amount of global solid waste produced is on course to exceed 11 million tonnes per day by 2100, three times as much as produced currently. Rather than being recycled, the vast majority of waste that is collected goes straight to landfills or is incinerated, releasing lethal toxins, greenhouse gases and leachate (liquids). Companies involved in waste management, recycling, and environmentally-focused engineering and infrastructure consultancy companies will be at the forefront of enabling this to change.
Five social themes
Sustainable Property and Finance
Financial institutions can be a force for good, lending to the real economy and allocating capital to where it is most productive. Consumer (retail) banks provide essential products and services for savers and borrowers, including current accounts and residential mortgages, and allow smaller and medium-sized businesses to manage cash flows, secure commercial property, and grow their enterprises. Also falling within this theme are social sector organisations that deliver affordable housing and supported living, and life insurance companies, which provide financial security and peace of mind for individuals and their loved ones.
There are several key aspects to this theme including workplace safety, road safety, consumer safety, and safety from cyber-attacks and financial crime. According to the World Health Organization injuries continue to kill more than 5 million people each year. Of this, about 2.3 million people die as the result of workplace accidents or occupational illnesses, and road traffic injuries claim around 1.25 million lives. Outside of these figures, many more people are seriously injured or left with permanent disabilities. In the area of consumer goods, complex global supply chains mean extra vigilance is required for assuring the safety of food and household goods/products. Lastly, cyber-attacks are growing in sophistication and frequency, resulting in an increased demand for cybersecurity.
Quality of Life
Gross domestic product (GDP) data continues to be used as the best measure for economic well-being, but an increasing number of national and local governments are using happiness data and research in their search for policies that could enable people to live more enriched lives; the less tangible aspects to our societies are arguably as important to health and wellbeing as material wealth. Companies that are well-governed, act as responsible employers, promote societal well-being, and consider their impact across all areas of their respective supply chains, are vitally important for creating a sustainable global economy.
Knowledge and Technology
Global productivity growth has been slowing. Productivity growth is essential if we are to achieve sustainable economic growth and therefore provide an adequate economic environment for a growing and ageing global population. Productivity improvements can come from many different sources: among these are mobile communication and networks, connectivity, intelligent use of data, improved access to knowledge and education materials, robotics, additive manufacturing or 3D printing, and advanced material science. Technical innovation is also catalysing ‘the sharing economy’, a socio-economic ecosystem built around the efficient sharing of human and physical resources.
Ageing populations are beginning to put systemic pressures on health provision and social care services in many developed economies, and this is likely to be a trend for developing economies too. According to the Organisation for Economic Co-operation and Development (OECD) more than 25% of the global population is projected to be over 65 years old by 2050 compared with just 15% today. A US study also indicates that around 50% of lifetime health expenditure is incurred during the senior years, so the challenge will be providing affordable care and services for this growing segment of society over a longer time horizon – as life expectancies are also rising.
At the Scottish, we take a contrarian approach to global stock markets.
We are high-conviction investors and focus on stocks that are out of favour with mainstream investors, as we believe these offer the greatest potential for long-term gains. This is because popular stocks tend to be overvalued – while out-of-favour stocks are often too cheap. We aim to exploit this inefficiency for our shareholders.
The investment environment is inherently cyclical. We see cycles in industry fundamentals, corporate behaviour, analyst views and investor sentiment. These cycles are closely linked: when an industry’s fundamentals have been strong for some time, management teams, analysts and investors tend to be overly optimistic about its future. This leads to irrational investment decisions. Some of our best opportunities arise at the opposite point in the cycle – when a downturn leads to excessive pessimism about a company’s prospects. When this happens, we can buy stocks precisely when the profit opportunity is greatest.
An innovative investment approach
We believe investment returns are driven by a change in a company’s prospects and an accompanying change in market perceptions. Often good companies are overly admired and consequently become overvalued. A company that has been badly run or is down on its luck may offer much more potential for improvement and, eventually, for outstanding returns. As contrarian investors, we see three distinct investment categories.
‘When ugly ducklings become fully fledged swans, we’re looking to sell. Until then, we keep portfolio turnover to a minimum’
We categorise the first as ugly ducklings – unloved companies that most investors shun. These firms face fundamental challenges, and the market has become extremely pessimistic about their prospects. But we see their out-of-favour status as an opportunity.
The second category is where change is afoot. These companies have made significant changes to their prospects, but the improvements are not yet recognised by the market. So, while other managers continue to steer clear, we see the potential for profit.
In the third category are companies that more to come. Unlike the first two categories, these companies are generally recognised as good businesses but we see an opportunity as the market does not appreciate the scope for further improvement.
A painstaking process
To identify the right opportunities, we use a qualitative and quantitative analytic framework to research companies’ fundamental prospects. We carefully assess any management change and restructuring actions, and consider the likely extent of any earnings recovery.
Companies in our portfolio can move along an axis from “ugly ducklings” to “change is afoot” and then “more to come”. When ugly ducklings become fully fledged swans, we’re looking to sell. Until then, we keep portfolio turnover to a minimum.
Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.
The Scottish Investment Trust PLC has a long-term policy of borrowing money to invest in equities in the expectation that this will improve returns for shareholders. However, should markets fall these borrowings would magnify any losses on these investments. This may mean you get back nothing at all.
Investment trusts are listed on the London Stock Exchange and are not authorised or regulated by the Financial Conduct Authority.
Please note that SIT Savings Ltd is not authorised to provide advice to individual investors and nothing in this promotion should be considered to be or relied upon as constituting investment advice. If you are unsure about the suitability of an investment, you should contact your financial advisor.
This promotion is issued and approved by SIT Savings Ltd, registered in Scotland No: SC91859, registered office: 6 Albyn Place, Edinburgh, EH2 4NL.
Authorised and regulated by the Financial Conduct Authority.
Why low cost, passive index investing could be the ideal solution for the time poor DIY investor
Those new to savings and investment could be excused for being more than a little daunted by the vast range of asset classes and investment vehicles that are available, and however carefully worded the marketing collateral is these days, issuers of financial products all want to convince you that theirs is worthy of a place in your investment portfolio.
DIY Investor aims to debunk the jargon that remains in the industry and equip its readers to objectively appraise the suitability of different investment types for their individual circumstances. By setting long term financial objectives it is possible for the self directed investor to construct a portfolio of passive investments with exposure to risk that is in line with their own risk tolerance.
There are indices that deliver exposure to most types of investment both home and abroad and each comes with differing volatility and risk profile.
Those looking for a readymade diversified range of investments but without the costs that accompany actively managed collective investments may find index investing an attractive option; and here are five reasons why:
1) Index Investing is Simple
Even for those with little investment experience, index investing is easy to understand.
The basic principle is that by buying a product that tracks a particular index – either via an index tracker fund or an Exchange Traded Fund (ETF) – you are automatically creating a portfolio of investments that are as diverse as the companies that make up the index.
Once you select the indices you wish to track, it is usually simple to set up regular contributions via your stockbroker and because the constituents of the index change over time there should be little need to rebalance your portfolio as it is effectively done for you.
Then, sit back and relax – markets will rise and markets will fall but you’re in for the long haul and you’re not looking to time markets or unearth the next ten bagger.
2) Index Investing Works
Studies have shown that after costs and taxes index investors can consistently beat the performance of the average active investor and that over time index funds routinely beat the performance of actively managed funds.
A key factor in this performance is their very low cost; with the total cost of ownership of actively managed funds very much to the fore post-RDR.
As an example, FTSE 100-tracking Legal and General UK 100 Index, charges just 0.10% and several brokers actually offer a discount to this.
To illustrate the effect that fees can have the following examples represent £10,000 invested, achieving 6% annual growth over ten years:
An actively managed fund charging 1.5% will grow to £16,929
A passive tracker charging 25 bps will return £19,185
Those that practice index investing are not looking for instant gratification, they are seeking long term returns with diversified risk – they’re betting on the tortoise and, at least according to Aesop, could just be backing a winner.
3) Index Investing can be Cheap
Low cost index trackers can be bought from your online broker and most offer ultra low commissions on regular investments. By pooling investments on a certain date many brokers will allow you to invest sums as little as £50 per month and build your portfolio slowly over time.
This is a good first step toward becoming a DIY investor – and by saving on commission and avoiding the cost of advice your portfolio will grow all the more quickly.
4) Index Investing for the Time Poor
With masses of information and fundamental financial data to paw over, stock picking can take up an enormous amount of time; those flourishing the hazelnut may argue that its discovery justifies the amount of squirrel ordure under their nails, but index investors are able to achieve solid long term investment performance without living and breathing their portfolio.
5) Index Investing for the DIY Investor
The government’s Retail Distribution Review (DIYs passim) changed the investment landscape for ever for many.
‘all things considered, here at the Fool we believe that an index tracker is the most suitable initial investment vehicle for the vast majority of people’
As they realized that the previously ‘free’ advice they received from their adviser was nothing of the sort some concluded that the performance of their portfolio did not justify paying for fee based advice and turned to DIY investing; their number was swelled by those deemed not to be sufficiently lucrative and therefore ‘orphaned’ by their adviser.
As an entry point to DIY investing, investment community The Motley Fool concluded, ‘all things considered, here at the Fool we believe that an index tracker is the most suitable initial investment vehicle for the vast majority of people’.
Those considering constructing an investment strategy around index trackers would do well to understand the risks they are exposed to and dilute this to a level they are comfortable with.
It is advisable to work out how much you will need to invest in order to achieve your financial goals and create a number of alternative scenarios by factoring in variables such as the effect of inflation.
Finally, keep a watching eye on costs – even small increases to dealing commissions or platform fees can make a big difference to the long term return on your investments – then be confident and Do it Yourself.
Investing in an ISA is like any other long term activity – it needs a clear destination or purpose (to make sure you can monitor your progress), you need to understand the risks that might be faced along the way (and what you might need to do to reduce or in response to those risks) and it needs some determination to stay the distance.
Start with the end in Mind
In these tough economic times trying to save or invest for the future is becoming increasing difficult for many. But the importance of providing for your old or infirm age is arguably higher than ever. On average we are living longer so will need more resources – at a time when the quality of pensions offered by employers are reducing.
A clear plan of what resources are needed for later life is growing in importance. Spending a little time to develop this plan is probably the most important stage in investing. Without a plan how will you know whether you are on track? This is an area where a good financial adviser can really help.
Any plan will of course need to understand the risks.
There are some obvious and less obvious risks that all investors face. Chief among them are inflation and volatility (the ups and downs). Another potential issue is cost – research shows that reducing the cost of your portfolios / funds is likely to lead to better returns.
Every investment has a different risk profile. Cash isn’t volatile but it is poor at beating inflation. Equities usually beat inflation in the long run but are more volatile in the short run.
Understanding your own risk profile is critical as it is the only way to build a portfolio that will meet your long term goals – you need to know:
Your attitude to risk (your appetite if you like)
Your need for risk (how much return (as risk and return are linked) do you need to meet your goals?)
Your risk tolerance (can you afford short term losses in pursuit of longer term goals?)
Too many investors underestimate the impact of inflation. Many people aged 60 today will live well into their 80s and beyond. Your investment plan needs to take account of this.
Eggs and baskets
Diversification, the idea that spreading your investment between different investments and asset classes can boost your returns has been around for many years, but is as valid today as it ever was. Often described as a ‘free lunch’, you can boost your returns and reduce your risk by diversifying.
Spreading your investment between assets classes (equities, bonds, property, and cash) leads to a lower risk for a given return (or, alternatively, more return for a given risk). The same goes for spreading investments within asset classes between, say, different geographies (e.g. UK and Overseas) or sectors (e.g. energy, financial and retail company shares). The important thing to remember that different assets will perform differently over time so to keep you portfolio well diversified you need to rebalance (sell the assets that have risen, and top up the ones that have fallen).
Index funds are an excellent way to achieve this diversification at very low cost – they hold a very broad mix of bonds or shares. And rebalance very efficiently. Though you still need to make sure that the asset mix is also rebalanced.
Cost is a Risk?
One of the biggest risks that long term investors face is cost. Every pound that is taken from your investment in costs or charges is lost forever. And so is the return on that pound …each and every year in future. It is one of the biggest unseen risks facing people drawing income from their pension funds too (but that is an article in its own right).
Unfortunately the investment industry is not always as good at showing the full costs as it might be.
Always look for the Total Expense Ratio (TER) of a fund, rather than just the Annual Management Charge (AMC).
Also check out the Portfolio Turnover Rate (PTR) to see how often the manager is trading the stocks and shares inside a fund – and thus how much extra cost drag from transaction costs the manager is generating by chopping and changing.
Another good reason for choosing index funds is that they trade far less often – so have lower running costs as well as lower expenses. It is just like cars – ones that are more efficient cost less to run!
Morningstar in the US conducted some analysis in 2010 to identify the best historic predictors of performance. The results are remarkably clear:
‘In every time period and every data point tested, low cost funds beat high costs funds.
Expense ratios are strong predictors of performance. In every asset class over every time period, the cheapest quintile (cheapest fifth) produced higher total returns than the most expensive quintile (most expensive fifth)’
Choosing low cost index funds gives you a head start when building your portfolio.
The same goes for the cost of any wrappers (ISA or pension) that you select. Make sure you know the initial costs, the running costs, the switch or trading cost and any other charges.
Long run Returns
Real assets (e.g. equities / property) usually outperform cash and bonds over the long run. The Barclays Equity Gilt study shows that in 9 of that of the last 11 ten year periods analysed 2004 – 2014, 1994 – 2004 etc. Equities beat bonds (but of course that means in 2 of them they didn’t!)
A key point is that asset allocation, how much you invest in bonds vs. equities for example, has been shown to be by far the biggest driver of long term returns and is far more important than which equity you are invested in. Using index funds to get access to a range of asset classes is a sound strategy.
Academic research into the performance track records of active funds bolsters the case for passive investing. An analysis of past performance figures concludes that, although some active fund managers appear to possess skill, the average active fund typically under performs the market. Even the most skillful investors struggle to produce consistent out performance. And the time, effort and therefore cost that would be required to select these managers (in advance of any hoped for out performance) is probably greater than the extra return anyway!
Investing is not an art – it is a Science
Investing needs a clear long term objective based on understanding the risk and returns you are seeking. Then you need to use the key rules of investing to help you achieve your goals:
Get the right mix of assets to meet your needs
Rebalance (keep your asset mix on track by checking it as the environment changes)
Mitigate the risks, where possible
Index or passive funds are an excellent low cost way to achieve broad diversification within an asset class at low cost. Combining index funds into a portfolio tailored to meet your needs – by using perhaps 10 or so index funds or simple ETFs – is a great way to invest for the long term. And stands more chance of making you, rather than the financial services industry rich!
The FTSE 100 has had a good week and is up over 100 points taking its lead from Wall Street.
The past week has been quiet from a reporting perspective.
The week ahead is very busy as the reporting season for 2017 final results gets fully underway and much held companies such as Lloyds Banking Group report on Wednesday; Other banking groups HSBC, Barclays, Royal Bank of Scotland and relative newcomer Metro Bank also report next week. There are numerous FTSE 100 companies reporting including Reckitt Benckiser, Intercontinental Hotels, Standard Life Aberdeen, RSA Group, Centrica, British American Tobacco, BAE Systems, Anglo American, Barratt Developments and Glencore.
Going ex-dividend next week we have two large dividends from Plus 500 who we have mentioned in the past. Beware the Israel withholding tax which is 25%. Nevertheless, in spite of this the yields are still very large with a gross yield of approximately 5% on the final dividend and approximately 3.9% on the special dividend. Other notable ex-dividends this Thursday include Shoe Zone (4%), Imperial Brands (2.3%) and HSBC (2.1%).
Daily Comments Roundup
The market is well up this morning. Plus 500 declared a big final dividend and a big special. Coca Cola HBG increased their annual dividend by 22.7%, whilst Galliford Try reduced their interim dividend by 13% on the back of Carillion fallout.
14 February, 2018 (2 days ago)
The markets continue to be volatile, especially in the U.S. Small dividend increases this morning from Pendragon and A&J Mucklow.
13 February, 2018 (3 days ago)
The Stock Markets have continued their big falls overnight on Wall Street and in London this morning. BP produced good results and a maintained dividend. Hargreaves Lansdown increased their 2018 interim dividend by 17%.
06 February, 2018 (10 days ago)
The FTSE 100 continues to fall as the US market falls on fears of rising interest rates. Little in the way of corporate news today.
05 February, 2018 (11 days ago)
The market is currently unchanged at the end of a bad week for the FTSE 100. Astra Zeneca maintained their 2017 Final dividend at $1.90 (133.6p)
02 February, 2018 (14 days ago)
The FTSE 100 is trading slightly up this morning. Royal Dutch Shell and Unilever both declared their final quarterly dividends for 2017. Rank declared its 2018 interim dividend.
01 February, 2018 (15 days ago)
THe FTSE 100 is flat this morning in early trading after a sharp fall on Tuesday. Centamin declared a USD 10c 2017 final dividend and Low & Bonar maintained their 2017 final dividend at last years level.
There are always money making investment opportunities waiting out in the market. It is only lack of imagination and idleness that stop us professional investment managers from taking them.
This is a fact I have needed to remind myself about in recent months. The UK can appear depressing with the Brexit debate ratcheting up to the point of angry disagreement in which everyone will be a loser and where real wages are falling.
The large consumer stocks, property companies and utilities are facing strong headwinds with a slowdown in economic activity predicted. There is also the structural challenge caused by yesterday’s strong franchises rapidly being reduced to today’s tired business models.
Think how Ladbrokes dominated the betting market only for its market share to be eaten away by the online platforms or the way an internet clothes retail business ASOS went from a start up to having a market capitalisation nearly the same as Marks and Spencer.
It is the rapid speed of change that is making some AIM listed companies such a good hunting ground for opportunities, despite the economic backdrop. ASOS had a value of a few million pounds in 2005 and it now has a market value of £5billion. It is still listed on AIM.
Many of the new, young companies on AIM will fail but this will primarily not be the fault of economy but rather their inadequacies as a business. In the same way the winners will succeed because of their own efforts and excellence of product. It is refreshing every time to meet and talk to a new young company on AIM.
For a start Brexit is unlikely to be mentioned. The successes come in many different areas of activity. A tonic water producer Fevertree and robotics company Blue Prism are two of the stars this year, while Scapa an industrial tape company and Johnson Services, a laundry business, have given very strong returns in recent years.
Success, like failure, comes in many different areas.
An interesting characteristic of Scapa and Johnson Group is that they were both once quoted on the main market. They had become problem riddled old companies. The move to AIM and new management teams meant they rediscovered their purpose and drive. This shows it is not only young companies that succeed on AIM but an old company can reinvent itself. It is the lighter regulations and lower costs that mean some companies leave the main market to join AIM and these can be important factors in their recovery plans.
What therefore is the process for finding a successful investment on AIM? Given there is no blue print for success there is no process for finding a successful investment other than doing the research. If you stay open to new ideas and then see a lot of companies already quoted on AIM or coming to AIM every so often through elements of luck and hard observation the successful investment will be found.
AIM has had a good year but this has not always been the case, in fact the AIM index was down from its launch in 1997 to May 2016 (See chart below).
The reasons for this were that investors had chased fashion. There were too many tech companies in the early days with absurd valuations that proved to be businesses of no value and then there was a mining boom when then hype did not match the reality resulting in heavy losses for investors. These two events dragged down the AIM returns. The returns since the nineteenth year anniversary have seen substantial growth driven by a diverse range of stocks (See chart below).
Source: Datastream, as at 21 November 2017. Rebased to 100, as at 12 May 2016
There will be many disappointments but the next generation of dynamic UK companies that will play their part in driving the UK economy forward, regardless of Brexit and politicians, can be found on the over one thousand companies that are on AIM. AIM can therefore play an important part in a well balanced portfolio.
Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
The Individual Savings Account, or ISA, has now been running for more than 18 years and over that time has established itself as one of the most popular products for individual investors. As at the end of the 2016/17 the total market value of Cash and Stocks & Shares ISAs stood at a whopping £585 billion, with 12.7 million accounts being subscribed to during the year.
Investors have been attracted to the government steadily increasing the annual allowance over the past few years and of course the tax free benefits which ISAs bring.
But despite the ISA’s tax free benefits, decent returns are becoming increasingly hard to come by.
On the Cash ISA side, interest rates on offer right now are near all time lows, with personal finance website Moneyfacts finding that the average easy access Cash ISA rate was just 0.62%. In Stocks & Shares, many major financial indices around the world are currently at or near all time highs, with a number of financial commentators suggesting that equities are over-valued and due for a downward correction.
Then we have to combine this with the creeping march of inflation. Over the past two years the CPI measure of inflation in the UK has risen from just 0.3% to 3% (for January 2018). This means that Cash ISA investors are seeing a negative real return on their savings, with equity investors having to look for increasingly risky investments in order to maintain their purchasing power.
But flexibility over ISA allocations, combined with a new ISA rules, mean that there are other ways of making a decent real rate of return
For the 2016/2017 tax year the government increased the annual ISA allowance to a generous £20,000. In addition, in 2016 a new product was added to the ISA stable – the Innovative Finance ISA (aka the IFISA). This allows investors to earn a tax-free return on loans issued by P2P lenders and so called “crowd bonds” issued by crowdfunding companies. Interest rates on these financial assets currently on the market, which are typically in the form of business loans, start at around the 4% level but can be as high as 12%, dependent on risk. That’s an attractive rate of return in the context of the Cash ISA and is within the range of historic expected returns on equities.
To give one example of a crowd bond, car finance business, The Asset Exchange, is currently looking for investors through Crowd for Angels. The company is seeking up to £300,000 by issuing a crowd bond and in return is offering interest of 12% p.a., paid monthly, fixed for 18 months. The minimum investment is £100.
Crucially, enabling investors to manage risk and return, the increased ISA allowance can be split in any proportion between the Cash, Stocks & Shares and IFISAs. For example, an investor with a higher risk tolerance might want to put £7,500 in a Stocks & Shares ISA, £7,500 in an IFISA and £5,000 in a Cash ISA. This means that, working with assumed rates of return for the different products, an investor can effectively set their own levels of risk and return.
Using the Cash and IFISAs only to simplify the calculations, here are a few examples.
Investor A – No tolerance for risk
Investor A is mainly concerned about preserving his capital so puts all of his ISA allowance Into a Cash ISA. This is effectively a risk free deposit so earns a low rate of interest – National Savings & Investments (NSI) is currently offering a 0.75%, no notice Cash ISA. While the investor has no risk of losing his capital he is earning a negative real rate of return given that inflation is at 3%.
Investor B – Low tolerance for risk
Investor B is prepared to take on a little more risk to boost his returns. He might do this by putting three-quarters of his annual ISA allowance into cash and the rest into a 12% IFISA eligible crowd bond. This boosts annual returns up to a more attractive 3.56%, a figure which is ahead of current levels of inflation.
Investor C – Medium tolerance for risk
Taking on more risk, Investor C splits their annual ISA allowance equally between cash and the IFISA bond. This takes annual returns up to 6.375%.
Investor D – High tolerance for risk
Finally, investor D has a high risk tolerance and puts three-quarters of his allowance in the IFISA eligible bond and the rest in the Cash ISA. The effective interest rate now rises to 9.19%, a level approaching that of expected returns from equities, with the 25% Cash ISA allocation providing a risk free buffer.
The chart below shows the rising levels of interest investors can obtain by increasing their exposure towards IFISA eligible bonds and away from cash.
Of course, like with any investment, the increased returns are possible because investors are taking on additional risk.
Lending money to businesses in the form of loans or bonds puts investors at risk of the company not paying back the capital or interest which it owes. So in other words, some or all of investors’ capital is at risk by investing in IFISA eligible bonds. And unlike with the Cash ISA, there is no Financial Services Compensation Scheme to fall back on should the product provider (P2P/crowdfunding platform) go into default. However, some crowd bonds, such as those issued by Crowd for Angels, are secured against assets of the lending company, thus reducing the risk of lending.
Andrew Adcock is Chief Marketing Officer at Crowd for Angels, an FCA regulated crowdfunding platform which is approved by HMRC to operate the Innovative Finance ISA and offers a range of crowd bonds to investors. For more information visit http://www.crowdforangels.com
Stocks & Shares ISA – top five questions to consider
How do you choose between a Cash ISA and a Stocks and Shares ISA?
An Individual Savings Account or ISA is a like a wrapper that protects your money from tax. This year the government is offering everyone over the age of 18 a tax free ISA allowance of £20,000.
You can choose to put your allowance into either a cash ISA or a stocks and shares ISA… but if you don’t use it before the 5th April, you lose it.
So how do you decide where to put your money? We’ve highlighted the key questions you should ask yourself:
1. Are cash ISAs still a good way to grow your money?
Cash ISA Interest
The best rate for an Easy Access Cash ISA is currently around 1.1%1 but the current rate of inflation is 3.1%2.
If the cash you hold in savings doesn’t grow at a rate at least equal to inflation then the real value of those savings is eroded as the cost of living increases.
2. Can investing beat inflation?
There are risks associated with investing but there is also the potential for your returns to be greater than the current rate of inflation. An average Stocks and Shares ISA grew 15.8% during the 2016/17 tax year3 ↑
3. What are the drawbacks associated with a stocks and shares ISA?
Market fluctuations – The value of your investment can go down as well as up
3 years or more – Investing is only suitable for the long-term
The fees – There are costs associated with investing
4. What are the benefits of a Stocks and Shares ISA?
Returns – The potential to make more over the long-term
Tax-free – you are sheltered from any tax on gains or regular income↑
Flexibility – You’re free to withdraw ISA money at any time
5. Why invest with a Click & Invest Stocks & Shares ISA?
Returns offered by Click & Invest Measured Investment Strategy between Jan and Dec 2016*
We have over 180 years’ experience of managing investments
We aim to beat the market, not just track it
We only charge a fee of 0.65% (plus underlying charges that average 0.60%)
We accept transfers of Cash ISAs or Stocks & Shares ISAs at any time of the year
1Money Supermarket, 2Office for National Statistics, November 2017; 3Moneyfacts;
*Past performance is not an indicator of future performance.
↑The tax advantages of ISAs may change in the future and will also depend on your individual circumstances.
All investment carries risk and it is important you fully understand these risks and are willing to accept them.
You may get back less than you invested.
Investments in the stock market may fall as well as rise and are not appropriate for investing for the short term. You may get back less than you invested. All investment carries risk and it is important you fully understand these risks and are willing to accept them. Past performance should not be seen as an indicator for future performance.
Investec Click & Invest Limited is an Appointed Representative of Investec Wealth & Investment Limited which is authorised and regulated by the Financial Conduct Authority. Investec Wealth & Investment Limited is entered on the FCA register under reference 124537. Investec Click & Invest Limited is registered in England, Company Number 03700427. Registered address 2 Gresham Street, London, EC2V 7QP
The way shares in ETFs are created and destroyed is an important financial innovation that gives them an edge over mutual funds.
Creation and redemption is the act of bringing new ETF shares into being when demand is high and winking them out of existence when demand falls away. It’s a mechanism that’s common to both ETFs and mutual funds but, like flight in modern birds, the ETF version has evolved into a more efficient dynamic than that used by its older mutual fund relative.
Unlike in a mutual fund, ETF investors do not have to bear the costs of buying and selling the securities within the fund needed to track an index. Instead the ETF issuer contracts Authorised Participants (APs) to gather the underlying securities required. APs are usually large financial institutions (think the trading desk of a global investment bank) and market makers that can operate cost effectively in the capital markets.
Shares in an ETF are created when an AP hands over a basket of securities to the issuer that matches the assets tracked by the ETF. The issuer lodges these securities with an independent custodian and gives the AP a ‘creation unit’ in exchange.
The creation unit is a block of shares in the ETF that represents the equivalent Net Asset Value (NAV) of the underlying securities. In other words, each ETF share gives you exposure to a sliver of the securities tracked by the ETF and stored with the custodian.
ETF creation/redemption in action
Consider the case of a physical FTSE 100 ETF:
The AP delivers a basket of FTSE 100 shares in line with the index weightings published by the issuer in its daily portfolio composition file (PCF). The FTSE 100 shares are held by the ETF’s custodian.
The AP receives an ETF creation unit in exchange. This amounts to a large batch of shares in the FTSE 100 ETF. 50,000 shares is standard but it can be as high as 100,000 or as low as 10,000.
The AP is now free to sell those ETF shares on the stock exchange where they can be traded by institutional players (e.g. brokers and hedge funds) and retail investors (i.e. you and me) who want exposure to the FTSE 100.
The AP makes a profit on the ETF shares by charging spreads, smart management of its securities inventory, and arbitrage (see below).
The exchange between the AP and the ETF issuer is known as the Primary Market whereas ETF trades on the stock exchange are referred to as the Secondary Market.
The redemption process works just the same but in reverse. An AP buys up ETF shares on the stock exchange until it has a creation unit’s worth (e.g. 50,000). The ETF shares are then given back to the ETF issuer who redeems them for the equivalent value in the underlying securities.
ETF creation/redemption advantages
The ETF investor is shielded from market costs such as spreads and commissions because these transactions are typically handled by the AP. That stands in contrast to mutual fund managers who must trade securities directly in the market when investor demand outstrips supply, or investors clamour for their money back and the managers are forced to make net redemptions.
These underlying trading costs aren’t included in a fund’s OCF but instead bubble up through tracking difference.
Long-term investors are also spared the hidden costs of trading by speculative investors who quickly flip their funds. This perennial problem for mutual funds is solved by the ETF’s spread which pushes the expense onto investors as they enter and exit.
Even then, the spreads on large, high-volume ETFs are generally narrow because AP’s can often manage demand for the underlying securities from their large inventories as opposed to incurring trading costs in the market. In addition, the creation cost incur only once and the higher the turnover of ETF shares, the lower the marginal cost per share.
The creation / redemption process also controls supply and demand pressures through arbitrage so that investors don’t have to worry about their ETF’s NAV veering away from the underlying value of its securities.
ETF creation/redemption arbitrage
If an ETF becomes cheaper than its underlying securities then the AP will buy ETF shares in the Secondary Market and redeem them with the issuer. The issuer must hand over the underlying securities and the AP can now sell them for a profit in the stock market because they are worth more than the value of the ETF.
The AP will keep buying undervalued ETF shares and then selling the higher valued securities until prices are equalised again and there’s no more profit to be made.
The same happens in reverse if an ETF is overvalued in comparison to its underlying securities. The AP buys the cheap securities and exchanges them for ETF shares with the issuer. The more valuable ETF shares are then sold, netting arbitrage profits, until supply and demand pushes their prices back in step.
Because ETFs typically have several APs, there is intense competition to scoop the arbitrage profits quickly. That prevents a single AP allowing a large premium or discount to open up and ensures that most ETFs trade at or close to fair value.
Variations in creation and redemption
The creation / redemption process is a little different for synthetic ETFs. APs assigned to synthetics typically pay for a creation unit with cash. In that instance, the ETF issuer buys any required securities or adjusts the swap agreement that delivers the ETF’s return.
Whereas most physical ETFs use the ‘in-kind’ process described earlier, APs can hand over a sample of the ETF’s securities plus some cash.
This may well happen for exotic ETFs when the underlying securities are less liquid and therefore more expensive to trade. Note, it’s the liquidity of the underlying securities that is your best guide to the liquidity of the actual ETF. The daily trading volume of a relatively small ETF is unlikely to be a problem when the underlying securities can be easily traded and therefore quickly created and redeemed as supply and demand for the product fluctuates