As good as gold
by Doug Brodie
/1. The US market is broken: 20% of the entire S&P 500 gain in 2024 was from only one company. Why index trackers have created a huge problem.
I often say that we’re not the clever people, our job is to know who the clever people are: David Einhorn is a $2.5 billionaire investor, Bill Ackman is a $9.3 billionaire fund manager and Michael Burry qualified as a doctor before launching his hedge fund and is famous for being $800 million better off for calling the US subprime catastrophe correctly in 2007 and 2008. (He was one of the key characters in The Big Short).
All three of those learned, experienced and proven investors have raised this red flag. We know that the embedded value of our home is sometimes out of kilter with how the local market prices it – sometimes too high, sometimes too low. The real market price of your home is that price that it will trade at, meaning a price both you and the buyer agree on.
What’s happening with index (passive) investing is the same as the housing boom of the mid-90s – this was created in part by the demutualisation of the building societies and the removal of mortgage lending restrictions. When I bought my first flat in 1984, the only place I was allowed to get a mortgage was my bank – to get a mortgage from another bank or building society, you first had to qualify by holding a savings account with them for a year or more, to prove your creditworthiness. (Note Scrabble players – a 16-letter word!).
The chart below shows us what happened back in those days. You can also see the crash from 2006 onwards – banks got caught, they stopped lending, house prices crashed.
Simply, that shows us two things – when you pour money into a market the price of those assets is pushed up by the wall of money for no other reason, and the market value is supported only by the inflow of money, not because of the intrinsic value, or utility, of that asset.
This is what has happened to actively managed investment funds globally, with c$500bn being pulled.
The flip side was another record year for passive funds, specifically ETFs which dominate the US markets. People stopped talking about the basic tenet of investing in the stock market, known as the efficient market theory, which means the market value is always based on all the relevant knowledge of all stocks being available to all the market.
That may be, but that is not what is driving the market now – it is the wall of money that is simply ‘buying the index’ because it is there with no regard at all for assessing which individual stocks are under- or (more usually) over-priced. The index tracker is a dumb animal and it is simply an order from investors to ‘buy everything’. The index is capital weighted, which means the companies at the top are the ones with the biggest market value. This in turn means they attract more dumb money, buying the shares only because they are top of the pile, so driving the price up further. Which in turn means more dumb money… you get the picture, and this is what the big guys are warning about.
The S&P 500 has (you guessed it) 500 companies that make up the index. However, just 26 companies make up over half that entire market value – it is very, very top-heavy. Index funds are buying everything based on what it was previously worth (yesterday’s price), and the big hedge funds are doing this with a very short-term opinion about price – not the price/value in six months from now, but the price of their options expiring next Friday. Note, US markets trade 80% of their entire capital value each day. (That tells you these are traders, not investors).
St Louis Fed.
These investors don’t care what the value is, they only care about what the price is.
Back in the day, the big money that drove the market was guided by a committee of people sitting round a table in institutions discussing what value they saw in stocks relative to the current market value. In the 1990s Coca-Cola was often the leading stock, and the positions (investments) they took sometimes took 10 years to be right. Nowadays, those people don’t exist; that type of investing is a tiny portion of the actual trading volume.
This is not capital efficiency in the way markets were designed. But, the US giants Fidelity and Capital together manage around $10 trillion and they only exist because they deliver. For Chancery Lane, the above consideration is not for us to ‘take a position’, or ‘tilt our portfolios’, it is being knowledgeable about expectations, so that we – you – can be prepared. To defend against that volatility, we use cash reserves so that client income is not affected by market volatility. It works.
/2. Client case study – how much income does £256k get you?
Back in 2012, a client introduced us to his daughter; he was on a downward trajectory, he and his daughter were the only members of the family and he needed her financial affairs looked after. Specifically her income.
There’s no magic button or secret wheeze to doing this, it’s more about being methodical, being consistent, and repeating, repeating…
The Wonderful Ms M started with £256,000 in a GIA, which was then fed each year into her ISA. Her GIA is now c£30k, her ISA is now c£210k, plus to date, she has received £175,000 in income. The ‘net of everything’ return to her pocket has been 4.4% per year, her income from here was £12,600 last year, it has never fallen in any month since the start.
Sometimes boringly reliable is the most exciting thing you want from your money.
/3. Investment trusts – the trend is your friend until it’s not.
The table below is from the AIC.
If your money isn’t in a Chancery Lane portfolio, what did you or your manager decide as the correct asset allocation for this coming year?
JP Morgan publish their own global version of this using macro sectors, however, the message it is telling you and me is the same – there is no consistency at the top of the market on an annual basis. The message to be heard is clear and consistent.
/4. Doug in the FT.
Tom Treanor is a man we like to know; he is head of research at AVI, Asset Value Investors, the fund manager who runs three investment trusts including AVI Global – previously known as British Empire, first listed back in 1889.
AVI are active and they are disruptors in the investment trust sector – we choose to be the same, hence the article above in last week’s FT; however, Tom does disruption on a deep level. For example, they were heavily involved in the resolution of the Hipgnosis trust, the one that bought the embedded rights to songs from all the great and good, from 10CC to Mr Manilow to Blondie, and even Carole Bayer Sager. When the trust started going awry, AVI were instrumental in bringing a new team on board and the eventual successful sale to the private equity giant that is Blackstone.
We are huge fans of the status quo, however, we are quite happy to raise an issue on behalf of our clients when we see one. The boards of many trusts (many is not all) have been long overdue a shake-up – there are 416-ish investment trusts caretaking over £267 billion in investor money: this is a serious job with real responsibility and we want to see these trusts run by competent boards, not appointees from the Old Boys Network or as a ‘thank you’ for past favours. It’s a real job and must be treated as such. We will not be quiet.
/5. Treating pensions as assets rather than income threatens their true purpose.
The debate about the Government’s plans to charge inheritance tax on pensions has highlighted how some people see a pension as an asset rather than a way to provide for their gold years.
Simon Grover, The Quiet Room.
Simon writes about pensions and the pension industry, focusing on communication to the end user – the pensioner. In his recent article, he draws a line connecting the askew view of the pension in much the same way that some people see their houses as investments rather than their homes. If you think about it, generally the value of our homes is irrelevant as we can never realise that value (not a cue for an equity release debate, please); it is there to provide us with shelter and security. In the meantime, pensions are there to provide us with a replacement income once we render ourselves unemployed and give up the working paycheck that has been delivered to us every month for the past 40 or so years.
The problem is partly embedded through something we have seen for decades and which Simon has now discussed, and that is that the pension statement you and I receive every year is a statement of assets, not a statement of our pension. This is a problem – it is the provider absolving itself from any responsibility of the real pension value that the person wants – a monthly pension income.
When we reduce pensions to their raw, unclothed state, we create uncertainty with retirees. They feel ill at ease because they don’t know if their £3,250 monthly salary is going to be matched by a similar sum from their pension; or worse, if it is matched, will the money run out or be sustainable? Size of capital often serves to deliver inaccurate expectations: what would you rather have, £1m in a pension pot or £3,400 per month for life, growing with inflation?