Where should you invest in 2013?
Last year started with a crisis in Europe, followed by sluggish growth in the UK and the prospect of a daunting "fiscal cliff" in the US.
At the beginning of 2013, not much has changed. The European situation is stable but far from resolved, UK growth is lacklustre and President Obama faces a battle with the House of Representatives over tax rises and spending. Yet investors had a bumper 2012.
By and large, it was a year that rewarded the brave. Investors may not have felt like investing in a riskier area such as UK Smaller Companies in the midst of apparent economic meltdown in January, but those with the courage to do so saw an average return of nearly 20% on their investment.
Top funds of 2012
All the top funds for the year included some exposure to mid or smaller companies - Neptune UK Mid Cap, Fidelity UK Smaller Companies, Standard Life UK Equity Unconstrained.
Equally, European funds - in spite of the eurozone's ongoing problems - were the best-performing regional funds. European Smaller Companies funds recorded an average rise of more than 14%, while the Europe ex UK sector saw double-digit returns.
Surprisingly, given the slowdown in China, another strong area was Asia, and particularly Asian property.
At the other end of the reward spectrum were government bonds. Those risk-averse investors who stuck with index-linked government bonds saw their caution punished with a 2.5% drop in the value of their investment. UK gilt investors didn't do as badly, but a 2.6% rise looks pretty meagre compared with performances in other parts of the bond market, notably in the High Yield or junk bond sector, where investors saw more exciting returns.
In the end, the moves of eurozone policymakers in the form of the Long Term Refinancing Operation (LTRO) at the end of 2011 and the European Stability Mechanism formed in September 2012, proved crucial. So did the steady improvement in economic statistics seen at the end of the year, with US GDP numbers beating expectations. The turn in the Chinese economy, in particular, eased a headache for investors.
Many of the problems still remain. The US presents the most immediate issues. Mark Robinson, chief investment officer at Berry Asset Management, says: "The US election only removed the uncertainty of who was going to be in power. How policymakers will cope with reduced public spending is still to be decided. This is why markets are behaving as erratically as they are now."
Tim Cockerill, head of research at Rowan Dartington, believes that decisions made over the fiscal cliff will have a major impact globally in 2013. "If they can't come to an agreement then tax increases and spending cuts will come into force automatically on 1 January 2013 and knock around 5% off US GDP. Clearly, that won't be allowed to happen." He believes markets could bounce when it is finally resolved, but could dip in the interim on the back of the uncertainty.
Europe's problems may have been temporarily addressed but they are far from resolved. The European Central Bank may have committed to doing "whatever it takes" but real questions remain as to how much that will be.
Cockerill says: "Spain is likely to seek a bailout and Greece will continue to run out of money. At best, the eurozone will have a mild recession in 2013 led by Spain and Italy. However, a real and growing danger is social unrest because of the high levels of unemployment - currently 25% in Spain.
"The long road to economic health favoured by the politicians will be far too slow for most of the population. This year could therefore be crunch time in Europe. If so, this will cause disruption in markets."
China and the emerging markets are looking stronger and this could be the swing factor. China's latest industrial output figures showed a remarkable bounce in growth, which could reverberate across the globe, and retail sales growth is also strong and rising.
Mind the divident trap
There are a number of conclusions that can be drawn: first, that defensive assets are very expensive. Tony Yousefian, chief investment officer at OPM Fund Management, says: "Defensive areas have done very well. Anything with the slightest hint of income has risen and valuations now looked stretched."
Ian Brady, chief investment officer at Oaktree Wealth Management, highlights equity income in particular.
He says: "Equity income investing has attracted a cult-like following in the past 18 months, and while it is based on sound reasoning, we think 2013 could see certain 'dividend traps' appear.
"By that I mean companies whose valuations have simply become too expensive for the growth they are likely to deliver - where the current dividend will not provide enough support to offset the likely fall in the share price. There is also the 'dividend trap' of current high dividends not likely to be supported by moribund future cash flows, for example, in utilities and telecoms."
This means looking to the racier parts of the market. This may feel unnerving but these areas saw some momentum in the latter part of 2012. For Brady, China, Japan and European small caps could provide the punchiest returns for those willing to accept volatility.
"For Yousefian, it is China. He says: "Emerging markets have been hit because they are more export-focused. China, in particular, should be the beneficiary of a pick-up in global growth."
Gavin Haynes, managing director at Whitechurch Securities, is also backing emerging markets, and Asia in particular. He explains: "There is a high number of uncertainties but investors have to take a long-term view. Emerging markets and Asia have suffered because of the high level of risk-aversion but there is a structural shift of economic power from West to East.
"There are some markets now on very attractive valuations. There does seem to be an end to the slowdown witnessed in China, yet markets are still pricing in a very gloomy scenario."
Haynes also believes that when the market turns it could turn quickly, and those sitting on the sidelines waiting for things to get better before they invest will miss out. He points out that in June 2011, equity markets ticked up 10% in a matter of days.
Berry's Robinson also likes Asia but is adding some exposure to the US, believing US companies may be key beneficiaries of Asia's strength. Lowman at Investment Quorum shares this sentiment but is looking to specialist funds such as the Morgan Stanley Global Brands fund instead.
Rise of the unloved markets
Two other markets, much unloved in recent times, that would benefit from an uptick in global economic activity are Europe and Japan. On the surface, Japan looks horrible - its latest GDP figures show its economy contracting by 3.5% and it has an intractable demographic problem - but Darius McDermott, managing director of Chelsea Financial Services, believes it could be worth a contrarian bet.
"It was one of the weakest markets in 2012 and is looking attractive on valuations. Japan's low-growth economy and unfavourable longer-term demographics are forcing some listed companies to look overseas for more attractive sources of revenue growth. This is manifesting itself in a wide range of corporate activity.
"This is creating opportunities for those investors who understand which Japanese companies can meet the challenges of expanding their businesses overseas."
Fund selectors are increasingly dabbling in Europe, albeit through "safe" funds of, say, BlackRock's Alister Hibbert or Jupiter's Alex Darwall. A racier bet, says Stephen Peters of Charles Stanley, would be the European Investment Trust, managed by Edinburgh Partners. After a poor run of performance it is sitting on an 18% discount to net asset value, but is run by capable managers and will benefit from a higher-growth environment.
For a truly contrarian investment, Peters is looking at private equity investment trusts. He says: "The discounts are wide, the market is seeing greater activity and funds are starting to pay out dividends." He likes some of the higher-quality trusts such as HG Capital and Electra.
Low bond exposure
Fixed-income investment is a trickier conundrum. Almost no one believes there is value in government bonds and many expect weakness in the market to spill over into corporate bonds. Andrew Wilson, chief investment officer at Towry Law, says: "We have our lowest ever bond exposure. There is no cushion in the price of bonds anymore. Yields are so low that they offer no protection if interest rates rise, and the capital losses could be hideous."
Lowman agrees: "Putting money into the safest asset classes is unlikely to be profitable. Core government bonds - of the UK, Germany and US - are already giving a negative return if you adjust for inflation."
McDermott goes one step further: "Gilts will be OK until the government's quantitative easing programme ends or interest rates rise, and then there will be a dash for the exit. With average durations on gilts at nine years, even a 1% rise in the yield will result in a 9% capital loss. And if yields return to normal levels quickly, the potential capital losses are quite frightening. I still think strategic bond funds are investors' best bet because of the flexibility."
He also likes high yield and even emerging market debt. Top funds in both areas have been those from Pimco and Invesco Perpetual. Wilson also likes emerging market debt, but has moved to short-dated high-yield bond funds and flexible bond funds with the freedom to use derivatives to protect investor returns. He also likes global index-linked bonds, but admits real value is becoming harder to find in bond markets.
It will be another uncertain year and stockmarkets still face a number of headwinds, but investors should not be tempted to conclude that this means they should plump for the safest investments - in these markets, the safest investment may well bring the lowest returns.
Investment trusts are companies that invest money in other companies and whose shares are listed on the London Stock Exchange. As with unit trusts, private investors buying shares in an investment trust are buying into a diversified portfolio of assets (to reduce risk), which is managed by a professional fund manager. Investment trusts differ from unit trusts in two important ways: they are listed on the stockmarket and so are owned by their shareholders and are closed-ended funds with a finite number of shares in issue. This means the share price of investment trusts might not reflect the true value of the assets in the company (known as the net asset value, or NAV) and if the NAV value of a share is £1 and the share price in the market is 90p, the trust is said to be running a discount of 10% to NAV. But this means the investor is paying 90p to gain exposure to £1 of assets. Investment trusts can also borrow money and use this money to buy investments. This is known as gearing and a geared trust is thought to be more of an investment risk than an ungeared one.
Net asset value
A company’s net asset value (NAV) is the total value of its assets minus the total value of its liabilities. NAV is most closely associated with investment trusts and is useful for valuing shares in investment trust companies where the value of the company comes from the assets it holds rather than the profit stream generated by the business. Frequently, the NAV is divided by the number of shares in issue to give the net asset value per share.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
Lower interest rates encourage people to spend, not save. But when interest rates can go no lower and there is a sharp drop in consumer and business spending, a central bank’s only option to stimulate demand is to pump money into the economy directly. This is quantitative easing. The Bank of England purchases assets (usually government bonds, or gilts) from private sector businesses such as insurance companies, banks and pension funds financed by new money the Bank creates electronically (it doesn’t physically print the banknotes). The sellers use the money to switch into other assets, such as shares or corporate bonds or else use it to lend to consumers and businesses, which pushes up demand and stimulates the economy.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
The familiar name given to securities issued by the British government and issued to raise money to bridge the gap between what the government spends and what it earns in tax revenue. Back in 1997, the entire stock of outstanding gilts was £275bn; by October 2010 it had surpassed £1,000bn. Gilts are issued throughout the year by the Debt Management Office and are essentially investment bonds backed by HM Treasury & Customs and considered a very safe investment because the British government has never defaulted on its debts and this security is reflected in the UK’s AAA-rating for its debt. Gilts work in a similar way to bonds and are another variant on fixed-income securities.
The total money value of all the finished goods and services produced in an economy in one year. It includes all consumer and government consumption, government spending and borrowing, investments and exports (minus imports) and is taken as a guide to a nation’s economic health and financial well being. However, some economists feel GDP is inaccurate because it fails to measure the changes in a nation's standard of living, unpaid labour, savings and inflationary price changes (such as housing booms and stockmarket increases).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.