A round-up of some of the key views on 2015 sent to IFA Magazine.
Buy-to-Let as Annuity Alternative
New research from Direct Line for Business reveals that pension regulation changes would lead to a third of retirement savers considering investment in buy-to-let property as an alternative to a traditional pension income funded by an annuity.
“New analysis by Direct Line for Business (DL4B), the small business insurer, reveals that a third (32 per cent) of people aged 45 – 64 with a pension would consider using some or all of their pension pot to fund the purchase of a buy-to-let property as an alternative to a traditional pension income funded by an annuity.
DL4B’s research has highlighted that the number of ‘silver landlords’ could increase significantly given the changes in pension regulation which mean that from April 2015, people approaching retirement and pensioners will be able to access as much or as little as they want from their pension pots.
Property Lettings Expert, Kate Faulkner said: ‘Buy-to-let is becoming an attractive option for people, especially while property and rents rise. It can deliver some great returns over 15-20 years. Given the recent pension liberation announcement, for some it could be good to diversify their investments when approaching retirement, but landlords need to seek financial/expert advice and ensure they understand the returns that property can deliver and especially the tax implications.’
As property and rental prices continue to rise, buy-to-let can provide a regular income flow while also offering the opportunity for capital appreciation. The research shows that the main reasons for considering this investment given by potential ‘silver landlords’ was that it produces regular income (cited by 43 per cent of people), the perceived security of the investments (23 per cent), and expected capital appreciation (17 per cent). One in ten (9 per cent) potential buy-to-let investors favour the investment because they would like to invest in something that will allow them to leave an inheritance to their children.
The research highlighted the perceived high returns available for landlords as those approaching retirement anticipate an average (median) yield of between 10 per cent and 14 per cent on their investment.
Jazz Gakhal, Head of Direct Line for Business explained: ‘Buy-to-let can be a flexible investment, providing an immediate source of income as well as being a long term asset. As such, it is understandable that people approaching retirement age are considering investing their pension pots in property. However, prospective landlords should understand that buy-to-let does not come without financial risk.
‘Legal expenses for repossessions and potential damage to property are but just a few of the costs that can take significant chunks out of landlords’ annual yield. Taking the necessary precautions such as carrying out full reference checks on prospective tenants, inspecting your rental property regularly, and taking out landlord insurance can help to minimise some of the risks faced by landlords.’”
Positive on Russia
James Butterfill, Global Equity Strategist, is still positive on Russia:
“The sharp decline in both the rouble and crude oil prices has put the Russian equity market under significant pressure. But in rouble terms Russian equities have only fallen by 1.3% in the second half of 2014 to date (though volatile), highlighting that currency selling has had the greatest impact.
What has rattled international investors are Western sanctions, the weaker economy and the damage to rouble-denominated dividends. While the economic situation is serious, Russian equities look oversold – the MSCI Russia index is now trading at 0.4 times its book value – a 70% discount to emerging markets as a whole and a more bearish position than even the low of 0.6 times during the credit crisis. To find anything cheaper, you would have to go back to the 1998 crisis triggered by the collapse of hedge fund LTCM, when Russia’s equity market traded at 0.2 times book value.
We believe that it is unreasonable to say that Russia’s current plight is worse than the credit crisis, but not quite as bad as the LTCM crisis. In the 2008-09 credit crisis, when oil prices sank to $35 a barrel, Russia had a higher ratio of external debt, its banks had much greater dependence on short-term funding, and its 10-year government bond yield spiked to 10%. Current government bond yields are at 13% and recent economic data has been beating expectations, which leads us to conclude that Russian equities are oversold.
Since the crisis precipitated in February, Russian equities have fallen 45% – in line with some of the worst geopolitical crises of the past, such as the Yom Kippur war or the Iraq/Kuwait war. But in both of those instances, as with 90% of geopolitical crises, three years after the event markets had recovered by an average of 32% (see the related article on page 14 of our Investment Outlook 2015: on and off the beaten track). We therefore continue to believe the current geopolitical crisis and current low valuations represent a potential buying opportunity, and have maintained our portfolio positions in spite of the volatility.
From a sector perspective the banks are most at risk. Capital flight brings to light potential capital adequacy issues and – although confidence has been partially restored by comments from the Central Bank of Russia, which is already taking steps to stabilise the banking system – we would avoid the sector for now. We see opportunities in companies with clear strategies for dividend payments, strength in cashflows and a greater ratio of dollar assets relative to liabilities. These characteristics favour the oil & gas sector, where pain from lower oil prices has been offset by great flexibility in capital expenditure and lower operating costs. Basic materials and exporters also fall into this category, which generally offers better dividend yields and currency protection.
Heartwood Investment Management
Elevated Political Risks
Martin Perry, Investment Director, says that political risks are clearly elevated heading into 2015, highlighted most notably by developments in Russia:
“Confidence remains fragile in Russia and, we believe, efforts on the part of the central bank and the Ministry of Finance to stem currency volatility are likely to be a sticking plaster over what is likely to be an extended and protracted political and economic problem.
Limited access to the US dollar funding market, resulting from the West’s sanctions policy, and the decline in the oil price has driven local foreign exchange agents, corporates and households to hoard US dollars – the “dollarisation” effect. The Ministry of Finance intervened in the foreign exchange markets to sell nearly $7 billion of surplus US dollar reserves and stated that it would closely monitor exporters’ foreign exchange operations. In addition, the Bank of Russia announced that it would recapitalise the banks in 2015 (details yet to be announced) and ease capital requirements, following its unsuccessful attempt to stem currency volatility when it raised interest rates by 6.5%.
In the near term, the Russian sovereign and the corporate sector should remain resilient. Cash (the majority held in foreign exchange) to short-term debt ratios are generally high in Russia’s corporate sector, banks have a reasonable amount of net foreign assets, and the Russian sovereign’s foreign reserves are just over $400 billion. Furthermore, the contraction in imports expected next year should maintain a current account surplus, assuming that the oil price stays around current levels.
However, under the current sanctions regime, falling growth, high inflation and high interest rates will lead to longer-term economic underperformance, which will not entice inward foreign investment and result in a further contraction in market liquidity. The political stakes are high. Putin has described the West’s actions as attempting to “chain the Russian bear” and make it moribund, and he shows no signs of wavering from the current policy on Ukraine. The West will need to tread carefully to restore long-term economic stability not only to this region, but the broader global economy.
As well as rising political and economic risks in Eastern Europe, last week the Greek parliament voted in a first ballot to elect a new president. The government candidate, former European Union Commissioner Stavros Dimas, did not secure the required number of votes, increasing the risk of an early general election. There are another two rounds of ballots (23rd December and 29th December). The Greek government is looking for an early exit from its debt relief Troika (IMF, ECB and European Commission) programme, but the rise in the cost of financing (Greek ten-year bonds are yielding nearly 9%) makes an early exit unlikely. Developments in Greece serve as a reminder that euro sovereign debt sustainability issues have not gone away.”
Investec Wealth & Investment
“2015 is set to be a year of ‘tempered optimism’, according to Vision 2015, a new report on key trends and market developments for the year ahead from Investec Wealth & Investment.
IW&I believes that significant progress has been made to repair the global economy in 2014 and this will help drive a more positive investment environment in 2015. In particular, the US is the one region of the world that has achieved a self-sustaining recovery, driven by cheap energy and technological innovation. In Europe, the European Central Bank has become more aggressive with its monetary weapons, even if full-on Quantitative Easing (QE) is currently still locked in the armoury, while China has enough economic resilience and flexibility to not become the catalyst for a further downgrade in global growth. Finally, middle class consumers in emerging economies remain a growing constituency and will be for several years.
After a challenging end to 2014, with markets having previously been tested by events such as Russia’s annexation of Crimea and the Ebola crisis and more recently by a very weak oil price and a collapsing Russian ruble, the next 12 months will continue to be affected by volatility, warns IW&I – though for investors with a longer investment horizon, volatility should present little to fear.
John Wyn-Evans, Head of Investment Strategy at Investec Wealth & Investment, said: ‘Looking forward to 2015, we remain constructive about the prospects for future returns. Central banks continue to ‘have our backs’ and will not risk any incipient recovery by raising rates too far or too fast. Equities can generate a return equivalent to their earnings growth plus the dividend – we just need that earnings growth to materialise. The US market has demonstrated what is achievable, delivering around 9% in 2014 so far2.
‘The promise of better returns is beckoning, but there are several potential risks to keep us watchful, and expectations have been dulled by a difficult 2014. Any further threat to growth could easily tip Europe into deflation, for instance, which would throw into question the ability of consumers and even some governments to repay their debts.’
Deflation remains a challenge across a number of markets, adds IW&I, though is by no means the highest probability outcome, just one of many that needs to be considered. Indeed, IW&I notes that central banks are focused on creating more inflation. Unemployment rates in the US and UK are at levels where investors might expect wages to start rising, and there are tentative signs of this happening. A return to higher inflation in 2015 would change the investment landscape, creating a stampede out of conventional bonds and into index-linked ones.
John Wyn-Evans added: ‘Volatility is often portrayed as a malign force, and while it’s true that nobody likes to see their portfolio fall in value, the ability to ride through the market troughs frames one’s attitude towards them. For an investor with no leverage and a longer investment horizon, volatility should present little to fear, particularly if dividends and bond coupons keep flowing – these are historically the least volatile, and largest, component of investment returns.
‘We believe that a traditional balanced portfolio of gilts and equities is pretty much condemned to unexciting – but still positive – returns from current valuations. One option in this environment is to take more risk not only by investing in more equities, but also by considering higher-yielding corporate bonds, real estate and infrastructure funds. The price to be paid for the higher return will be higher volatility, a factor that we shall have to get used to after several years of low volatility and limited market setbacks.’”
Ten investment ideas for 2015 from the investment strategy for private banking team:
1. In a low rate environment, prefer U.S. to EUR sovereign bonds.
2. Favour equities over fixed income on a valuation basis.
3. Hold some alternative assets to withstand higher equity-bond correlation during potential corrective phases.
4. Maintain a cautious stance on commodities.
5. Overweight Asia relative to Latin America and Emerging Europe.
6. Gain exposure to the U.S. consumer – but be selective in U.S. high yield.
7. Keep exposure to selected (Asian) emerging credit and local currency debt.
8. As the U.S. Federal Reserve tightens, be long the US dollar and anticipate further yield curve flattening.
9. Prefer European to U.S. credit and overweight European equities, particularly high-quality cyclicals and financials.
10. Seek international equity diversification in USD-based portfolios, hedging currency risk.