Opportunity in uncertainty
Set your goals and stick to your plan
Important - The value of investments can fall as well as rise, so you could get back less than you invest, especially over the short term. The information shown is not personal advice, if you are unsure of the suitability of an investment for your circumstances please contact us for personal advice. Once held in a SIPP money is not usually accessible until age 55 (rising to 57 in 2028).
The only two questions that matter for investors right now
Clue: they aren’t the ones you think
What will Brexit look like? What economic impact will the ongoing ‘Chimerica’ trade war have? What’s the outlook for interest rates?
Markets are forever obsessing over questions like these.
There’s always something to worry about, and negative headlines sell more papers. If you think back over the market’s rise since 2009, there have been plenty of big worries along the way – the euro zone debt crisis, US government shutdowns, the Scottish IndyRef, the Brexit referendum and Donald Trump’s election to name but a few.
But what if markets are asking the wrong questions?As investors, the questions we really should be asking are these:
- What are the long-term prospects for companies?
- Am I paying a fair price for their shares?
UK plc looks in good health
Despite the doom and gloom in the media, UK plc is in pretty good shape in our view, Brexit or no Brexit.
A look at the forecast earnings per share for the companies which make up the FTSE All-Share confirms this. Analysts expect earnings per share to rise by 37% over the next twelve months, and a remarkable 88% by the end of 2021. Does this look like an economy in crisis?
So what about value?
There are a number of ways of measuring whether individual shares or stock markets are good value. None of them are failsafe, and they shouldn’t be taken in isolation.
Nevertheless, most of our value indicators are flashing green at the moment. The UK stockmarket is under-owned and unloved, and we think this means there’s an opportunity for long-term investors.
The CAPE of good hope
Our preferred measure of value is the cyclically adjusted price to earnings ratio (CAPE). This is less complicated than it sounds – it’s a measure of company earnings relative to share prices, adjusted to take the economic cycle into account.
In December this ratio stands at around 16, compared to a long-term average of 19. This means share prices are low relative to companies’ earnings. History has shown investments made when valuations are low stand a better chance of long-term success.
Yield of dreams
UK companies are known for paying generous dividends to investors. Currently the UK market yields around 4.5%, comfortably the highest it’s been since the financial crisis back in 2008/9.
Yield isn’t just important to income investors. Dividends form a vital part of the overall return from owning shares. If you’re investing for growth, you can simply reinvest them to increase the value of your investment and boost its future potential. Yields will vary though, and aren't a reliable guide to the income you'll receive in future.
A higher yield means better value
The market’s yield also tells us something about value. A high yield means share prices are low relative to the income being paid out to investors – in effect it means the market looks good value.
To illustrate this we looked at data going back to 1985, and worked out the returns you’d have received over the next ten years when investing at different starting yields. We found a significant correlation – broadly speaking, the higher the yield when you invested, the better your returns tended to be over the next ten years.
Those investing when the yield was similar to today’s 4.5% were able to achieve annualised returns of around 12%* over the next ten years. The worst outcome was just over 5% a year.
Though as ever you need to remember past performance isn’t a guide to the future. There’s no guarantee the historical relationship will hold in the years to come. You could still get back less than you invest.
10 year total returns at different starting yields
Past performance isn’t a guide to the future. Source*: Datastream, Lipper IM, HL to 31/12/18
But what about Brexit?
It’s fair to say we’re not living in normal times at the moment.
But we think it’s likely that politicians will find some kind of route through the chaos – even if that means kicking the can down the road a few times first, by delaying Article 50. You can read our latest thoughts on Brexit on our dedicated hub.
Over the longer term, share prices are driven by the prospects for companies – not politics. We think today’s low valuations in the UK mean it’s a good time to invest for the long term, provided you can stomach the prospect of sharp market movements over the coming months.
A final thought
Fund manager Nick Train (regular readers will know we respect his views enormously) signed off a recent note to investors with the following.
A thought about investment, albeit slightly convoluted, from George Gilder, futurologist:
The investor who never acts until “the financials” affirm his choice is doomed by trust in spurious rationality.
Gilder means that what is known no longer has any value in investment markets. You have to act before the news is known. In other words you have to have faith.
We think investors should keep the faith in the UK market, although it could be a bumpy ride. On the pages that follow you’ll find some of our latest investment ideas, along with tax-saving tips and a new way to make more of your cash savings.
Stick to your plan
Head of Investment Analysis
There’s no crystal ball – but the good news is you don’t need one
I’m sure you’ve heard terms like ‘diversification’ and ‘asset allocation’ thrown around a lot. And with good reason. Dividing your money between different types of investment, like shares, bonds and cash (asset allocation), and having a good spread of investments in each area (diversification), is important.
But only if you get it right.
I don’t mean trying to predict which areas will do best this year. Even the best economists and strategists fail to get this right consistently. There’s no crystal ball after all. But in fact getting it right is much simpler than that.
What’s your goal?
The key to successful investing is to stick to your long-term plan, even when markets feel rough.
Asset allocation and diversification will help you work towards your goals. When you look at investing like this the whole process becomes simpler, and your asset allocation shouldn’t change that much.
Most people’s goals can probably be split into four broad areas: maximise growth, earn an income, strike a balance, or preserve wealth.
Once you know where you sit you can start to think about where to invest.
Going for growth
Shares are great for investors who want to grow their wealth. Over the long-term companies aim to grow their profits. They’ll often plough a lot of this back into the business to expand and improve.
If the companies do a good job it can boosts profits even more. The best management teams repeat the process and create a virtuous circle. Profit growth doesn’t even need to be huge – the effect of compounding means even modest annual growth adds up to a significant improvement over time. But of course not all companies will succeed, which is part of the risk of investing.
Ultimately, if profits go up the share price should too, so shares are a great choice to help grow your wealth over the long term.
Options for income
Companies often pay out a chunk of their profits as dividends too. Just as rising earnings help the share price grow, they can help dividends grow too. This makes shares an excellent option if you want to earn an income from your investments, especially if you want that income to grow over time. Remember that dividends aren't guaranteed though, and they aren't a reliable guide to the income you might get in future.
We think the UK’s being overlooked as an investment destination at the moment. There are lots of great companies here with superb growth potential and excellent track records of paying dividends. Some overseas exposure is usually sensible as well.
Bonds can be great for income too, and often become more popular when stock markets have a wobble. They usually rise and fall in value to a lesser extent than shares, though they do still fluctuate. For this reason lots of people add bonds to their portfolio to help reduce risk.
When you invest in bonds you essentially lend money to companies and governments. You get a fixed amount of interest and your money back when the bond matures. You don’t need a company to do better and better, you just need it to have enough money to service its debts.
That said, after several years of quantitative easing – governments printing money to buy back bonds from banks to try to stimulate the economy – most developed market government bonds offer very low yields. We don’t think they offer a lot of value right now.
Don’t forget cash
Cash is one of the most important, and often forgotten, assets. Everyone should have a bit set aside. A rainy day pot is essential, but it’s also useful to keep a bit of cash ready to take advantage of stock market falls or new opportunities.
Cash might play a bigger role in a portfolio focused on capital preservation. Our new Active Savings service makes it easier than ever to manage your cash and get better interest rates.
A word on risk
Risk is a very personal thing. At its most basic it’s the chance to permanently lose money, either because an investment does poorly and never recovers, or you don’t give it enough time to recover.
Lots of things can cause your investments to move up and down in the short term. Interest rates, inflation, economic growth, politics, and currencies are just some of them. But we tend to think a good spread of investments and a long time horizon should help see you through most environments, even Brexit and ‘Chimerica’. Unlike cash, investments will fall as well as rise in value, so you could get back less than you put in.
Remember, not taking enough risk can itself be risky. You’ll need your investment to generate sufficient growth or income to achieve your objectives. An approach that’s too cautious has the potential to leave a shortfall.
Be tax efficient
Take your helping hand
Not everything that affects your wealth is so hard to predict.
We’re confident to suggest that taxes will chip away no matter what’s going on in the world. And the government has said that taxes are definitely on the rise.
While taxes might rise in the short term, the government offers generous incentives that encourage us to save for our future. Where it’s right for your circumstances, make sure you take advantage of any help you can get.
There are no guarantees with investing, but you can improve your chances of success by not paying more tax than you need to and regularly reviewing your investments. The more money you can shelter away from tax, the harder it can work for you. By compounding more of your money for longer you could hugely improve your returns.
As a reminder of just how powerful the effects of compounding can be, Watch our short video to see how compounding works.
Unlike cash, all investments can fall as well as rise in value so you could get back less than you invest. Tax rules can change and benefits depend on personal circumstances.
By making your savings as tax efficient as possible, you’re actually improving your returns before you even start investing. One of the easiest ways to start doing this is to invest using your pension. The key advantage is that you could get tax relief on what you put in.
For example, if you’re a basic rate tax payer the government will top up your personal pension contributions by 20%. So to have £100 in your pension, you’d only need to contribute £80. Those who pay tax at a higher rate might be able to claim back even more.
It’s worth pointing out that on average, over the very long term with dividends reinvested, the UK stock market has grown by 9.3% a year to 21 January 2019. By investing in a pension and getting at least 20% back in tax-relief, you’re effectively giving yourself about a two year compounding head start.
You can’t normally take money out before you’re 55 (57 in 2028), so starting when you’re young makes sure you’re giving your money more time to grow. Combining a 20% head start with being invested for a really long time can make for fantastic compounding results.
The chart shows how much you’d have made when the FTSE All-Share index began, just over 33 years ago, if you’d have invested £8,000 or £10,000 in a pension (£8,000 plus the current basic rate tax relief). Remember tax rules can, and will, change.
The chart is just an illustration, excluding charges, and past performance doesn’t mean you’ll get the same results in the future. In this case, the difference between receiving basic-rate tax relief and not is more than £36,000. And for those who pay more than basic-rate tax the difference could be thousands more.
FTSE All-Share - £8,000 vs £10,000 invested
Past performance isn’t a guide to the future. Source: Lipper IM to 31/12/18.
Pensions like the HL SIPP can give you even more investment flexibility than usual pensions – you can choose when, where and how you invest. It means you have the option to invest in higher-growth areas like emerging markets or smaller companies. Investing in these areas can be a great strategy for those investing for a long time, but remember they can be more volatile and are higher risk.
Unlike a lot of things, pensions typically get better with age – the earlier you start, hopefully the bigger the pot.
If you think you might need access to your investments sooner, you could think about a Stocks and Shares ISA. All investments in an ISA are free from UK tax, so you’ll pay no income or capital gains tax. And although investing is best for the long term, you can normally withdraw your money whenever you need to.
|Rates of tax||Basic rate tax payer||Higher rate tax payer||Additional rate tax payer||ISA investor|
|Capital gains (in excess of the £11,700 annual allowance)||10%||20%||20%||0%|
|Dividend income over £2,000*(i.e. income from shares)||7.5%||32.5%||38.1%||0%|
|Interest income (i.e. from cash, corporate bonds and other fixed interest invesments)*||20%
Refers to tax year 2019/2010. Tax rules can change and benefits depend on individual circumstances. *This example assumes an individual has fully used their personal allowance and none of the interest falls within the starting range for savings.
Each tax year (6 April to 5 April) there’s a limited amount of money you can put in ISAs. This tax year the ISA allowance is £20,000. You might not be able to use your full allowance each year. But as with SIPPs, the sooner you get started, the more time your investments will have to compound.
Remember tax rules can change and tax benefits depend on your circumstances. This article isn’t personal advice, so if you’re not sure what’s best for your circumstances please ask us for advice.
Finding the best in business
Unicorn Outstanding British Companies
When the future’s unclear, it makes sense to invest in companies that could do well whatever happens. There’s plenty of them in the UK. And Chris Hutchinson, manager of the Unicorn Outstanding British Companies Fund, tries to find the very best ones.
He’s managed the fund since launch in December 2006. Plus he’s supported by an experienced team including assistant fund manager Max Ormiston.
So what do they look for in a company?
Hutchinson and his team invest in companies that do something unique. The harder it is for competitors to replicate, the better. So a strong brand, intellectual property and market leading position are all positives.
They look how the company’s managed too. A strong, experienced senior management team is a must. And they should own a significant amount of the business themselves – that way their interests will be aligned with those of investors.
Keystone Law is a great example. It offers legal services to small and medium-sized businesses. What makes it unique is that its lawyers are self-employed. They have no fixed salary but get to keep 75% of their billings. It's disrupting the entire legal profession and its share price has risen strongly in recent years, though there are no guarantees this will continue. The company's directors own a significant number of its shares.
There are only a handful of companies that meet the teams high standards, so they invest in a small selection of around 30-40 companies. Each one has the potential to make a big contribution to returns. But the reverse is also true so it’s a more risky approach.
They’ll consider companies of any size but tend to find more opportunities at the smaller end of the market. Small and medium-sized companies have the potential to grow into FTSE 100 giants, but there’s a greater chance of failure. That makes them higher risk.
The fund’s still quite small in size. This is good because it means the fund's more nimble than others. A small portion of the fund is held in cash to help the team take advantage of new opportunities quickly.
The fund’s grown 197%* since launch and beaten the broader UK stock market by 117%. Past performance isn’t a guide to the future though.
We put this down to the manager's ability to invest in companies with better prospects than those of a similar size and in the same sectors . This fund could be a great addition to a portfolio designed to grow investors' money over the long term. We recently added it to the Wealth 50 list of our favourite funds.
Unicorn Outstanding British Companies - performance since launch
Past performance isn’t a guide to the future. Source: Lipper IM to *31/12/18.
|Annual percentage growth|
Dec 2013 -
Dec 2014 -
Dec 2015 -
Dec 2016 -
Dec 2017 -
|Unicorn Outstanding British Companies||-3.1%||19.0%||4.2%||10.2%||-5.3%|
Past performance is not a guide to the future Source: Lipper IM to 31/12/2018.
Senior Investment Analyst
It pays to be boring
Aviva Inv UK Equity Income – yield 4.6% (variable and not a reliable guide to future income)
In today's tech-savvy and fast-paced world, it's easy to get caught up in the excitement of the latest trends.
It applies to investing too. It's tempting to focus on the flavour of the week in the hope of making a quick buck.
But it doesn't always work out that way.
As investors we shouldn't lose our long-term focus. Sometimes it actually pays to be boring.
It's one of the reasons we like Chris Murphy's investment approach, manager of Aviva Inv Investors UK Equity Income. He likes to keep things simple. His main focus is cash – how much does a company generate? But most importantly, how likely is it that it'll grow this cash steadily over the long term?
It sounds like an obvious thing to look at, but steadily growing businesses often look relatively dull. Sometimes they're overlooked.
Take Ibstock – the largest clay brick maker in the UK.
It's unlikely to get most pulses racing, but the longer-term potential gets Murphy excited. The need for more housing could increase the demand for its products. And the high costs involved in setting up a business like this means few are likely to try to compete. This should help it maintain a higher share of the market.
The company already makes plenty of cash. But this has the potential to grow. Ultimately it’s cash and earnings that help support a company's share price, and the dividends it pays to shareholders.
Murphy doesn't just invest in companies that pay high dividends though. He also invests in companies with lower yields if they’re reinvesting cash back into the business for future growth, or they have the potential to grow their dividends as they get stronger over time. Some of these are smaller companies, and the fund invests in a relatively small number of businesses, both of which can increase potential but add risk.
More often than not Murphy's made the right calls about the companies he invests in . Since taking over this fund in 2009 it's grown 171%* compared with 139% for the average fund in the UK Equity Income sector . And he's done a great job of growing the income paid to investors . The fund yields a healthy 4.6% at the moment, though this isn't guaranteed and the income paid in future will change.
We like that the manager keeps things simple. We think he has the ability to identify companies that will continue to generate earnings through the good times and the bad. In our view the fund's a great choice for income, growth or a combination of the two.
Aviva Inv UK Equity Income - annual income from a £10,000 investment
Past performance isn’t a guide to the future. Source: Lipper IM to *31/12/18.
|Annual percentage growth|
Dec 2013 -
Dec 2014 -
Dec 2015 -
Dec 2016 -
Dec 2017 -
|Aviva Inv UK Equity Income||2.9%||6.6%||10.5%||12.2%||-10.8%|
|IA UK Equity Income||2.8%||5.7%||8.8%||11.4%||-10.5%|
Past performance is not a guide to the future. Source: Lipper IM to 31/12/2018
This fund takes it charges from capital which can increase the yield but reduces the potential for capital growth.
Yields from further afield
Artemis Global Income
Most income investors focus on the UK stock market. And with good cause. It’s full of companies that have paid strong, steady dividends.
While the UK is a great place to invest for income, there’s a whole world of opportunities out there ripe for an equity income portfolio. So where do you start?
Enter Jacob de Tusch-Lec, manager of Artemis Global Income.
He scours the globe for companies he thinks will deliver decent levels of both income and growth. Some are mature businesses that have paid high, stable dividends. Others pay lower yields but with more potential to grow over time.
He also invests in some unloved companies that pay attractive dividends while he waits for them to recover. He mainly invests in large and medium-sized companies, but there are a few higher-risk smaller companies held for their growth potential.
Around a third of the fund’s currently invested in the US. But there’s a broad range of other countries including Israel, Italy, Norway and Japan. Some companies are based in higher-risk emerging markets. There’s little invested in the UK, which could make the fund a good addition to a portfolio with a bias to our home market. The manager also has the flexibility to invest in higher-risk high-yield bonds.
De Tusch-Lec’s done a good job running the fund since it launched in 2010. Over this time it's grown 143%* compared with 142% for the FTSE All World index and 110% for the IA Global Equity Income sector. But past performance isn't a guide to future returns.
The fund currently yields a healthy 3.3%, higher than lots of other global funds, but this isn’t a guarantee of what you’ll get in the future.
The manager invests differently to others which gives him good opportunity to do better than the benchmark over the long run. But his style won’t always outperform, like we saw at the end of 2018.
We think de Tusch-Lec’s a talented manager and expect him to do well for investors over the long run, although there are no guarantees. That’s why we recently added Artemis Global Income to the Wealth 50 list of our favourite funds.
Artemis Global Income - investments by area
Source: Artemis, December 2018
|Annual percentage growth|
Dec 2013 -
Dec 2014 -
Dec 2015 -
Dec 2016 -
Dec 2017 -
|Artemis Global Income||12.1%||5.7%||21.6%||10.8%||-13.2%|
|FTSE All World||11.3%||4.0%||29.6%||13.8%||-3.5%|
|IA Global Equity Income||6.3%||2.2%||25.0%||10.5%||-5.9%|
Past performance is not a guide to the future Source: *Lipper IM to 31/12/2018.
The fund takes its charges from capital which can increase the yield, but reduces the potential for capital growth.
See the full list of our favourite funds with 30% off the average annual fund charge.