Money Movement Report

On page 8 of the April 2017 newsletter, there’s a piece about some work we’ve started on looking at the movement of money into and out of funds.

Here’s a copy of the article, some further commentary, and links to a couple of other reports.

For some time, we’ve been trying to get a feel for the amount of money flowing into and out of the various Investment Association sectors.

One of the problems with doing any Unit Trust and OEIC analysis is getting hold of the raw data. The funds are not traded on an exchange, in the way that stocks and shares are, and the only way to find out fund details is to ask the fund managers. There are a couple of companies that collate this information, but they are still reliant on the fund managers to update them. Some are better at this than others.

When we started looking at fund flows we thought we could just add up the portfolio values of all the funds in each sector. We soon found out that a lot of data was missing, and so we have tried to concentrate on a ‘representative’ sample.

We have taken the funds that we usually include in our weekly analysis, removed the ones without reliable portfolio size data, sorted them by fund size, and then used the top half.

We have then used the same funds each week and monitored how the values have varied.

There are various factors that affect the overall fund value. These are the change in value of the assets held within the fund, and the amount of money being added to, or taken out of, the fund. The next step is to see how we can split the overall movement into these two different components.

In the newsletter we have shown a summary of the last three months. Here are links to a couple more reports showing the movements over recent weeks.

Money Movement by value

Money Movement by percentage

M&G Property Portfolio Update

During the last few weeks we have seen the M&G Property Portfolio fall by over 6% and then recover.

The sudden drop took place on the 12th May 2016, when M&G announced that they had moved the pricing basis of the fund from an offer basis to a bid basis. There was a notice put on their website explaining that the decision was taken due to a trend of sustained outflows from the fund, expected to continue in the foreseeable future.

M&G June 2016

I, like many of our members, contacted M&G to ask for further clarification. Most of us got little more than a polite reply encouraging us to look at the announcement on their website. One of our members did get a much more comprehensive response, which he has kindly allowed me to share with you …

“As an asset class, property recovered strongly in the period following the 2008/2009 banking crisis. Indeed, the asset class has produced above-average returns in the last three or so years. The combination of slowing growth in property asset values and the impending referendum on EU membership later this month is the most likely reason why some investors have chosen to reduce exposure to property, resulting in the Fund’s move to a net outflow situation. The M&G Property Portfolio experienced a price swing in March 2013 and also May 2013, with these price swings lasting only a matter of days. Further back in the history of the M&G Property Portfolio, the Fund experienced a more prolonged period of net outflows in the period leading up to, and during, the banking crisis. At that time, the price was calculated on a bid basis between November 2007 and June 2009. Both the Property Portfolio and its Feeder Fund are currently being priced on a bid basis and I hope you will appreciate that it is not possible to say when the price basis for the two Funds will revert to an offer basis.

Looking to the future, Fiona Rowley, the Manager, holds the opinion that in the next three years, returns from the asset class will result from rental income rather than coming from further increases in commercial property values. I must emphasise that this is the Fund Manager’s opinion and should not be taken as advice or a recommendation. It is not possible to make any guarantees about future performance or the way in which commercial property prices will move in the future.

You can find an explanation concerning the move of price basis on our website as follows:

http://www.mandg.co.uk/investor/funds/prices/property-fund-prices/

To provide some more detailed information on the subject, as of 12 May 2016, the Fund’s price basis changed to reflect the fact that the Fund is currently experiencing a net outflow of cash. Being invested directly into buildings, the Fund needs to carry a large cash position, so there is no liquidity issue as such and the underlying value of the Fund’s assets remains unchanged. The price swing mechanism aims to ensure that the value of the Fund is not diluted for remaining investors when the Fund is cancelling shares, rather than creating new shares.

Perhaps I can expand further on the subject. Prior to the change in price basis, the Fund was receiving net inflows of cash. The amount of money going into the Fund, in terms of investor purchases, was much higher than the amount coming out as a result of investor redemptions. As the Fund is open-ended, further shares could be created to meet the demand.

In the scenario I mentioned, the Fund’s price was determined by the cost of creating new shares, which would involve buying more buildings. Property transactions are much more expensive, in percentage terms, than, say, share purchases. A figure of around 6%, representative of land taxes and legal fees, was therefore included in the price when the Fund was creating further shares to meet investor demand. Investors buying shares paid this cost, investors selling their holdings effectively benefited from a bid price which included the high costs of buying property. Since the shares being redeemed by the Manager could be re-used when the Fund was receiving net inflows of cash, withdrawals were priced to reflect the fact that the Fund needed to buy more underlying assets. In this manner, the value of Fund’s underlying assets is not diluted; an ‘offer/creation’ basis for pricing was used, because further shares were being ‘created’.

In the current scenario, the Manager has needed to move the price basis, as the Fund is experiencing a continual net outflow of cash. At present, the price is based on the value of the Fund’s assets, after deducting the cost of selling property (around 1.15%), as the Manager needs to cancel shares. This reflects the situation if the Fund were to actually need to sell some of the buildings it holds. I should like to reassure you that the Fund has sufficient liquidity to meet redemptions from cash. I hope you will appreciate that it would be unfair to offer a price based on creating shares to investors leaving the Fund, when shares are actually being cancelled. This could ultimately have the effect of diluting the value of remaining investors’ holdings.

With the Fund having a net outflow of cash on a daily basis, investors who sell receive the price as if the Fund is selling its assets. As the costs involved in buying and selling property are high, there is a difference of more than 6% when the price basis changes. We believe this to be a fair and equitable way of mitigating the risk that the value of remaining investors’ holdings is diluted by the net outflow of cash from the Fund. With the price being based on what the Fund would receive if it cancels shares and sells its assets, rather than the cost to the Fund of buying further underlying assets, investors who buy further shares will pay a more favourable price. Those investors selling their shares will receive a price based on the value of the Fund’s assets, less the cost of selling those assets.”

On the 3rd June 2016 M&G announced that the price had swung from cancellation pricing back to creation pricing.

Although we have covered the topic of bid / offer pricing in our newsletters and regular weekly emails, I thought that this response was particularly thorough, and I hope that it has given a useful insight into this aspect of investing in funds.

Euro Survival

I have always been inheritantly wary of large entities such as business conglomerates and in particular the European Currency Union. How can it be possible, even with the best management available, to drive and manoeuvre these unwieldy entities towards a common goal? Especially as in the case of the E.U. this task is being attempted by politicians. So surely the Euro must be doomed to failure. Who in their right mind would contemplate trying to orchestrate the people from the Mediterranean regions to walk in step with the people and their work ethics from the Northern climes?

I mean, have currency unions ever been attempted before and if so were any successful? Well the answer to that is yes and yes. The Latin Monetary Union in the late nineteenth century failed as did the Scandinavian Monetary Union attempted at around the same time. Both struggled on for about sixty years before throwing in the towel and admitting defeat. The German Zollverein was launched in 1834 and although it had its ups and downs until the Weimer Republic was established in 1919 it must be considered a success. Of course the obvious success was that of the United States and the American dollar which even survived the Civil War during its seventy years of becoming established.

So history says that it is possible to achieve a Currency Union, but it is likely to take a long time and it’s not guaranteed to be successful. In today’s world where information passes instantaneously and politicians are subject to tribal self- interest abuse from opposition parties can the Euro succeed? As the Union is formulated today the answer is probably no. However loosening the strings by letting some countries leave and give more financial help to those struggling countries that wish to stay, may help it to succeed. After all there is a huge political will to make the Euro work and the majority of Europeans are still in favour of it so perhaps it will fudge its way to a lasting solution.

If one assumes that the Euro remains in existence then along the way there will be more pyrotechnics with accompanying Bank collapses and country crises. These events will provide great opportunities for investors to buy as the markets rise and fall whilst the Euro struggles to become a stable currency. Certainly watching the stronger German stock market may reveal Fund Managers capable of taking advantage of these fluctuations as German stocks become artificially cheap. This should show in the Saltydog numbers. We will have to wait and see.

A Perfect Storm (revisited)

At the end of April 2012 I wrote an article entitled “The Perfect Storm”. In this article I envisaged the catastrophe lying in wait for the Investment World that would be created by the following three events. Firstly, the slowing down of the Chinese manufacturing miracle would create internal unrest and bloodshed sufficient to unseat many Asean countries` economies. Secondly, the Euro as a currency and Euroland as a market would cease to exist. Finally, that the safety and security of American government Gilts and Bonds would be eroded. Well, a year down the road very little if any of this has taken place. During this period we have seen the world stock markets rise to approach, and in some cases breach, their all time highs and then fall back close to where they started.” Volatility” is still the by-word.

China has seen its rate of manufacturing growth almost halve to an enviable (for the rest of the world) seven percent. During this time the Chinese government has contained any unrest by allowing wage rates to rise and by investing internally into the country`s infrastructure. The Chinese middle classes are fast forming the largest population of tourists as they catch up with travelling the world. Provided that the Chinese government is able to continue in this approach and let internal consumption continue to rise and create the majority of the demand for their manufacturing base, then China could very well not be a problem for the investing world, but in fact a great opportunity.

Today the Euro and Euroland still exist in their original form, but what the next few years will bring is still very much a case of watch this space. There are still huge differences in the strength and viability of the various member state economies. The questions of austerity for some and not for others and high unemployment for some and not for others are open wounds that continue to fester. The politicians for all their bluster continue to kick this can further down the road for somebody else to eventually resolve. The UK politicians are facing demands from the population to hold a referendum as to whether the UK should leave the E.U. Should this referendum take place and the vote be carried then many other E.U. countries may follow suit. That would spell the end of the E.U. as a future world force.

The safety and security of American government gilts and bonds is still a meaningful question, but one that no longer would seem to be an imminent danger. In fact quite the reverse may be the situation. The American economy would now seem to be on a rising curve. Increasing manufacturing at home, falling unemployment, increasing new house starts and the godsend of Shale oil and gas is revolutionising the economy for the better. It has now reached the point that Q.E. will be curtailed in the near future. There is still however the matter of enormous existing debts to be serviced but inflation and the removal of overseas purchases of oil and gas will all contribute to the reduction of these debts. This being the case, then the American dollar strengthens and the country`s bonds and gilts are secure. Now that is quite a turnaround from a year ago.

What will the next year bring for the investing world to consider and act upon? Perhaps the developing world`s emerging middle classes will create such a demand for gold jewellery that the price of mining stocks will rise due to demand without gold having to be considered as a safety valve against the dollar.

Maybe the U.K. will become a rising market if it continues to increase employment in the Private sector whilst reducing the amount of people employed by the State. Perhaps the UK Austerity measures can be made to stick and attention would be focused on the vast amounts of wealth that is wasted on unmonitored projects and institutions. This may in turn revive the desire to be self reliant and less dependent on State handouts. All of this could lead to a rise in the UK stock market and a place for your investments. Now wouldn’t that be nice!

The Whipsaw Effect

In the last few days I’ve done a good deal of soul searching as I have reviewed our speedboat portfolio for the latest newsletter. Go back a couple of months and we were fully invested with stock markets at a long-time high. The portfolio had only been going for 6 months and was showing a return of nearly 25%.

You may well of heard the butterfly effect – a principle of `chaos theory‘, in which one small change could create a massive difference to other events at a later time. The central tenet is often summarised using a famous saying. Its origins and the quoted geographical regions vary, but for the sake of this piece we will say ‘a butterfly flapping its wings in Washington could cause a storm in Tokyo’. Well, on the 22nd May the US Federal Reserve butterfly (common name: Ben Bernanke) fluttered his wings by indicating that its programme of quantitative easing might be reduced. Within a few hours the Nikkei 225 had dropped by over 7%, and the value of our funds fell with it.

Markets continued to fall and within a couple of weeks the FTSE100 had dropped by nearly 12%. We followed our principle of selling when markets fall and were soon 100% in cash. The markets almost immediately recovered over half of the losses, and although we’ve reinvested we missed out on the initial gains.

It’s hard to think of a better example for our critics to use to demonstrate of one of the problems with momentum trading. They talk about the whipsaw effect where markets head in one direction, but then do a quick about turn followed by a movement in the opposite direction. These are the most difficult conditions for the momentum trader who is looking for trends that last for longer than a couple of weeks!

So does this mean our theory is inherently flawed – definitely not. By reverting to cash we protected ourselves from further falls. Although on this occasion they didn’t materialise they could have done. We may operate short term, but we’re playing the long game. If markets drop significantly, and then almost instantly recover, we have to accept that we always won’t time our selling and reinvesting perfectly and will either make a small gain, break even, or make a small loss – on this occasion we lost a few weeks profit. What really matters is the one time when markets start falling and then keep falling – not going safe in 2007 could have cost you 40% of your investment and don’t forget that even when the FTSE100 peaked in March this year it was still lower than it was in December 1999. In the last few years we have seen two other markets corrections, August 2011 and May 2012. On both occasions our ‘Tugboat’ portfolio headed for the safe haven, we minimised our losses and when we reinvested we had made a net gain.

Think of being active as an insurance policy – you may not appreciate paying your premium every year, but at least you can sleep at night, and when it really matters you’re safe.