“What did the Romans ever do for us?”
by Doug Brodie
/1. What happened in the markets to cause the sell off
This is what just happened.
People and hedge funds borrow money to buy stocks. Stockbrokers lend them that money so they can make interest on the loan, fess on selling more stocks, and charges on running a much bigger investment pool.
You put £100k in a brokerage account and buy £100k of Vodafone shares. If it goes up 10% you make £10k and the broker has a client account worth £110k (funds under management).
Or – you put in £100k and the broker agrees to lend you £50k (50%) with nothing but the shares as security – you take the loan and buy £150k of Vodafone shares. If it goes up you make £15k on your £100k investment (less the cost of interest). You’ve now made 15% on a stock that only rose 10%.
Now the broker has £165k under management (for fees) – still offering you gearing at 50% of your portfolio, you have £165k with a £50k loan so you can borrow a further £32.5k (£150 x 110% x 50% less £50k existing loan), and now you have £197.5k of Vodafone shares:
o [£100k + £50k on margin] x ↑10% gain on the price = £165k of stock
o £165k x 50% = £82.5k
You have put in £100k of your own capital, and borrowed £82.5k of margin finance, and you have £197.5k of Vodafone shares.
The shares fall by 20%, so the portfolio is now worth £158k – 50% of that is £79k. You have a margin loan of £82.5k so you’ll get a margin call of £3,500.
You can see why those of a gambling bent are attracted to margin trading – get it right and you make an exaggerated return out of ordinary gains, however it’s not a one way ticket. How to hedge fund traders get $1m dollar pay packets? They do exactly this but with $00’s of millions – and they are encouraged to do so because the banks get to run big loans, secured by the stocks bought and doubly underwritten by the borrower / investor.
Definition (Investopedia)
A margin call is a broker’s demand that an investor who has borrowed money to buy securities must deposit more money or securities into their account so it’s brought up a minimum value.
A margin call is a request for funds from a broker when money must be added to a margin account to meet minimum capital requirements. A margin call occurs when the percentage of an investor’s equity in a margin account falls below the broker’s required amount.
An investor’s margin account contains securities bought with a combination of the investor’s own money and money that was borrowed from the investor’s broker.
A margin call refers specifically to a broker’s demand that an investor deposit additional money or securities into the account so the value of the investor's equity and the account value rise to a minimum value indicated by the maintenance requirement.
A margin call is usually an indicator that the securities held in the margin account have decreased in value. The investor must choose to either deposit additional funds or marginable securities in the account, or sell some of the assets held in their account when a margin call occurs.
When the current President took office in the US he did so promising to cut taxes, spend on capital projects and throw money around; institutional investors piled in, thinking the rising market was pretty much a sure thing – the hedge funds borrowed, a lot. The tariffs were announced, way more destructive than any thought possible, markets fell, margins got called, to raise money to pay the margins the investors sold, pushing down prices, creating more margin calls …. you get the drift.
/2. What the man from Investors Chronicle did to an annualised 15% return
15% per annum since 2010 – an investment manager with worthwhile tips.
Fundsmith is run by Terry Smith – we’re not a particular fan of the man, not least because he was an ardent Brexit supporter who upped sticks and moved himself and his business to Mauritius to avoid paying UK taxes.
His equity fund was launched in November 2010 – he is a value, cashflow investor from the Warren Buffett mould, which means he won’t buy overvalued, overpriced stocks. This means his equity performance in the last couple of years has been way below the market, and his annualised returns of 15% since 2010 have now fallen to (just) 11.78%. Over the past 156 months (13 years) he has made profits in 90, losses in 66, so up 57% of the time, yet his gains in up months are higher than the losses in down months.
In the dotcom era Warren Buffett refused to play, so his stock performed materially below the index. As it turns out Warren is the world’s richest investor, so he was right. Terry Smith is the same, he prefers to hold cash generators such as Novo Nordisk, Visa, L’Oreal etc rather than overweight positions in Tesla and Nvidia.
Recent fund performance is no reason to ditch Fundsmith. In this week’s email I wrote about patience …”that’s why the stock market only really works for investors with patience and the right reserves: get either wrong and you’ll turn yourself into a forced seller, and blame the markets”. We were asked by Investors Chronicle this week to help out on a reader’s portfolio queries – a little bit of insecurity in a 58 year old who is looking to retire at the end of next year.
Whether or not you are ready to retire depends on several factors of which one is income: obviously, you need income to pay your bills, and that tends to be the first item everyone needs to put in order.
“We directly own 15 year old whisky casks …. With a combined current value of £40k.” Hmm, not a lot of income there. “At their current age and demand profile these will reliably grow at around 10% pa.” Problem solved then? “I’m not intending to use SIPP money much before state pension age in 2033 and let the pot continue to grow with an approximate minimum target of 5% p/a. “ Clearly there’s a comment to be made about running one investment based on 5%pa and another that will ‘reliably grow at around 10%pa’, but we’ll leave that aside.
Notably the investor sold his holding in Fundsmith ‘for poor performance reasons’ – however that does ignore what has been happening in the markets and just focuses on the recent years score card. When anyone comments of performance, the question the investor must always ask is below – if you don’t know what you are expecting, how do you now if the investment has been a success or not? And importantly, are your/my expectations rational and realistic? “Reading what the commentators say about today’s news is not the way to make an investment decision,” said Smith. True dat’…
“What do I expect to see from this investment in terms of return and time?
Our Investors Chronicle investor, expecting to retire within two years, sold his Fundsmith and bought RM Alternative Income, Lazard Japan and Polar Cap Insurance – I trust he has reconciled his research against his retirement objectives, these may be great investments, just need to be sure they are right for this portfolio (fitting in neatly with the Whisky Casks…)
“….. my SIPP provides me with my current headache. Where to invest this money?”
Sounds that he’s not quite convinced about the RM, Lazard and Polar Capital funds he’s just bought – investors need to back their decisions. Between the family’s ISAs and SIPP there is an available investment pot of £580k – in cash interest alone, today that can generate 4.2%-ish, being £24,360. He can also use an investment trust portfolio using trusts that have never failed to pay an income ever, that have raised their dividends by a material amount every year for the last 40 (covering the ’87 crash, dotcom, ’08, ’20, ’22 and now ’25 crashes), with consistent capital growth and a current yield of (say) 4.5% - 5%? Any higher income is pushing the edge of the envelope – with a couple of specialised exceptions.
“In a rising market, enough of your bad ideas will pay off so that you’ll never learn that you should have fewer ideas.”
Old rope?
I think the Investors Chronicle investor will remember the Prudential? The Man from the Pru? Well, the core of that business was the With Profits fund – it’s still here, its now worth £126 billion, it’s wholly owned by the Pru, with one difference – the Pru is now known as M&G plc in the UK. I raise this because M&G’s shares have fallen in tandem with the markets, and the dividend yield this morning is now 11.54%.
Don’t forget this chart of the S&P from last week; expecting the same as the 2020-25 curve is clearly wrong.
/3. Where the US is hiding $7.4 trillion.
/4. Robbing trains – yep, it’s still the Wild West in the US
That was then:
This is now:
