AUGUST 2010                                                                                                                               Download PDF Version

A Letter from Gary Brass                                             


Chris Andrew Esq.
Director
Clarmond Advisors
25 Grosvenor Street
London W1K 4QN

By email: ca@clarmond.co.uk

FOR PUBLICATION TO INTERESTED PARTIES

August 2010


Dear Chris,

From a Scottish golf course: helping investors perfect their ‘swing’

I recall that during the summer holidays, the Financial Times would encourage its journalists to explore stories that might not otherwise be published. I particularly remember a series of articles many years ago on ‘Great Historic Financial Frauds’, written by then-editor Richard Lambert (now Sir Richard), culminating in the scandal of the Lloyd’s insurance market (which he regarded, incidentally, as possibly the greatest fraud of all). Furthermore, the summer doldrums provides an opportunity for junior professionals to make their reputation as their married-with-children seniors toil with bucket and spade and no Blackberry to provide distractions.

So it was with such thoughts that I accepted your kind invitation to join the Advisory Board of Clarmond Advisors, your new wealth advisory business, and offer this letter for publication if you see fit.

Between the golf, tennis and walking, and besides my FT, I have been reading two books: Get Smarter by Canadian billionaire philanthropist Seymour Schulich, founder of Franco-Nevada Corporation; and Niall Ferguson’s biography of Sir Siegmund Warburg, High Financier. Get Smarter provides mentoring and wisdom for those wishing to succeed in business, while the Warburg biography offers fascinating insight into the growth of the London merchant banks in the post-war period and the principal role played in this development by Sir Siegmund (SGW).

I mention these books because each in its own way touches on themes I wish to consider here. SGW considered the stock market no better than a casino, and he had little time for the asset management activities of his firm. (How ironic that he should have died in 1982 on the eve of the great bull market which made his shareholders wealthy through the growth of Mercury Asset Management and its subsequent sale to Merrill Lynch).

Schulich takes a different view of the markets, but is highly cautious to avoid the herd instinct. To invest wisely, the ‘odds’ must be considered to be in favour of the investor. He cites as an example the year 1998, when crude oil fell to $11 a barrel and oil stocks were unloved. Nobody conceived that oil would reach today’s level of $80 per barrel − never mind the $150 struck two years ago, though a few analysts thought it might drop to $5. As Schulich writes, “this was a classic illustration of how going against the crowd can give an investor lopsided odds”.

I believe that such thoughts and requirements should never be far away when investing. To generate excess returns, patience is required and one must await the ‘asymmetric opportunity’ where there is conviction that the upside/downside relationship justifies putting chips down on SGW’s green baized roulette table. When these opportunities do appear it is for the investment professional to decide how to best exploit them. This may be through the purchase of a more generic ETF product, it may be through investing in a specialist fund, or it may be through a more complex option strategy. Incidentally, the zero and double zero of the Roulette wheel might be equated to the commissions payable to intermediaries in the stock market but it need not and should not be regarded as a casino: full and sensible consideration of the options can significantly reduce the element of chance in any investment decision.

Before indulging in some current asymmetric views we hold at Clarmond, it is worth first setting out the justification for our thinking:

  1. 1.US equities, based on the risk premium relative to corporate bonds, are historically cheap. Indeed the yield on shares, as calculated by expected dividend returns by J.P. Morgan, is at its highest level versus investment grade corporate bond yields since at least 1982.

  2. 2.Banks’ loan portfolios have declined sharply since the onset of the financial crisis and are unlikely to recover soon. While some signs have emerged that lending has risen off the bottom at smaller banks, the overall trend remains down. At the very least, according to Jonathan Golub of UBS, “these fears could keep an already skittish stock market from trading higher”.

  3. 3.Banks and others are taking advantage of improving earnings and growing investor demand to raise billions of dollars in debt at historically low levels of interest rates.

  4. 4.The European bank stress tests were somewhat benign, although the consequent increased transparency has helped restore some degree of confidence.

  5. 5.US housing demand continues to be extremely depressed. Even though US householders can borrow for 30 years at a fixed rate of 4.59% – an all time record low – the number of mortgage applications for home purchases continues to head downwards. Stubbornly high unemployment and subdued consumer confidence (in the West) implies that rates are unlikely to rise soon. But if the markets are struggling now, it is hard to picture them thriving when interest rates return to the mean.

  6. 6.We should note of the cautious outlook expressed by leading industrialists like Lakshmi Mittal, compared with the reported stronger-than-expected earnings from a number of leading European companies.

  7. 7.Western Government and consumers remain heavily indebted, although US personal saving rates are moving substantially higher.

  8. 8.Successive European government ‘amnesties’ regarding secret Swiss bank accounts has released substantial investible funds (i.e. hundreds of billions of dollars), which now seek new opportunities.

  9. 9.Emerging market growth rates remain strong; in China urbanisation and the emergence of the Chinese consumer continues to fuel economic growth. Demographic movements in the West are a medium-to-long term drag on economic activity and saving patterns.

On the basis of these beliefs and assumptions, and taking a one year view (perhaps I will write another letter in 12 months’ time), I would today advocate the following ‘asymmetric’ investments:

  1. Long international dividend-paying quality equities and short bonds;

  2. Long indexed linked sovereign debt;

  3. Favour emerging market equities;

  4. Anticipate rising prices for ‘Triple A’ residential and commercial property in principal global cities;

  5. Long gold and soft commodities; and

  6. Long cash.

Finally, I think there is more than a 50/50 chance that equity markets in general will be unrewarding for the next few years and that immense patience and shrewd stock picking will be required to achieve satisfactory relative returns.

See you in London on my return.

Yours, as ever

GMB
Gleneagles, August 2010

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