Investment managers talk much of asset classes and the
importance of not having all one’s eggs in one basket. In the investment world, here we talk of equities (shares), bonds or
fixed interest securities, cash or cash equivalents, property, commodities and perhaps
hedge funds. By spreading one’s
investment capital around, hopefully because not all of these assets are
completely correlated (all move in the same direction at the same time), the investor achieves capital protection,
reduced volatility and potential growth.
Discretionary fund managers construct portfolios with asset allocation
driving investment strategy; percentage
allocations will vary over time depending on the investment manager’s
assessment of the changing macroeconomic landscape.
Equities, whilst considered the riskiest asset class is
the investment arena where I spend most of my time. Whilst considered to be the risk capital of a
listed company, with this comes
significant investment return potential.
In simple terms, these returns
can come by way of share price appreciation and / or dividend income in
addition. Companies come in different
sizes from FTSE 100 Blue Chips,
household names such as BP, Marks & Spencer and Vodafone to mid caps
such as Halfords and Stagecoach down to much smaller companies. While not always the case, the larger the company is, the lower the risk or volatility in the
expected return. A company’s size (or
market capitalisation) equates to its number of shares in issue multiplied by
its share price at any one moment in time.
Investing into companies brings the potential to gain
international exposure as most do business overseas, for example in faster growing markets such as
China and South America. This brings the
ability to benefit (or lose) as a result of foreign exchange movements. But the main reason is to benefit from a
company’s ability to grow profits over time as the stockmarket will reprice its
shares (higher) accordingly. Growing
annual dividend payments also serve as a key draw to equities (dividends are paid out of profits) and
certainly in a low interest rate environment as now, this has attracted many new investors to the
market. Above 5% annual dividend returns
are commonplace and achievable today.
Shares themselves can be classified in different ways
with different shares appealing to different types of investor. A ‘yielder’ is a share (of a company) that pays
a high level of dividend to its investors.
Often popular with older investors looking to boost their annual income
levels, these might include utility
companies (such as gas, electric, water and telecoms). However economically defensive sectors like Pharmaceuticals
and Tobacco also tend to pay generous
dividends. While income is important
here, there is clearly also the
potential for the share prices to rise which would give “total returns” in
excess of just the income payments over time.
A cursory glance at the performance of Imperial Brands over the past 15
years shows a very handsome appreciation in share price value.
A capital growth share tends to pay little (if any) of
its profits out as dividends, deliberately by the way, as certain companies
prefer to re-invest all or a high proportion of their profits into the business
for ultimately increased levels of organic (capital) growth. In this case,
an investor would be targeting a rise in the company’s share price as
the prime investment objective, with
income not being as important. Many
smaller companies tend to be capital growth opportunities where cash
preservation is often key, but there are
also large cap companies such as Ashtead,
the FTSE 100 equipment rental company whose share price performance over
time has been hugely impressive. Some
might say who actually needs dividends ?! It is typical to see high income tax
paying investors targeting this group of companies as dividend income is low
(upon which high levels of tax would become due).
A ‘value’ share is one which is arguably mispriced
normally as sentiment toward it (or its sector) is negative. Some may called this group ‘the unloved’ and it
tends to be the hunting ground of the contrarian investor : someone who likes
to invest against the herd in search of returns. The contrarian approach, whilst a risky one
can produce significant upside with patience;
as an out of favour stock comes back into favour. Antony Bolton of Fidelity Special Situations
fund fame (now retired) was a legendary contrarian value investor. A thorough understanding of a company’s
financial statements would be an integral part of making this investment
strategy work. A share may be overly
depressed in view of its underlying financial health and a value investor would
look to take advantage in such a case.
With hindsight, when Rio Tinto
was trading on a 5 year low at 1500p 15 months ago, a value investor may have taken a
position, albeit it in a higher risk situation
and made significant returns as the company recovered. The current share price is nearer 3000p so
Investors both new and existing need to know and fully understand
the risk of investing in shares. When BP’s price halved in 2010 further to the
Gulf oil spill, we were all given a
crude (no pun intended) reminder of
this; one of the largest companies in
the world. The share price is still 25%
below the pre-spill level. An investor new to shares needs to know that
the bank account is safe (apart from inflation risk) and that shares, even if they pay a 5% income yield can go down
as well as up. Careful research and
stockpicking is needed to isolate opportunities with manageable levels of risk.
A lower volatility method to gain equity exposure might
be through a managed fund (say an Investment Trust) which will hold many
different company shares. This spreads
company specific risk and certain funds may even hold different asset classes
within them : shares and bonds for example which would reduce risk
further. Ultimately each investor needs
to understand what their objectives and attitude to risk really are with
guidance from the adviser; in my case,
Over the long term, it is well documented that equities
have significantly outperformed alternative asset classes which vindicates the
“buy and hold” strategy. Shorter term
strategies aim to take advantage of market volatility. Shares bring inflation protection unlike the
lower risk alternatives and this is very important. In addition, there are also tax advantages to
holding some types of share (AIM listed for instance), where Inheritance tax will not be payable at
the time of death.
This report was written by Philip Scott, Director at SI Capital Stockbrokers on 8/5/17
when the FTSE 100 was trading at 7300.