ThesisMarket Commentary - Thesis Asset Management...70% of the time in order to beat the market...

Chart 1

Invested annually with 5% growth per year

700,000

600,000

500,000

400,000

300,000

200,000

100,000

0

n Starting at age 25

n Starting at age 35

£639,199

£353,803

25 30 35 40 45 50 55 60 65

Age

January 2019 1

ThesisMarketCommentary

Why investing for the long

term is important

It is important to remind ourselves of two corner stones to successful long-term investment. Exposing one’s investment portfolios to the power of long-term compounding and as such it is the time in the market not timing the market.

The power of compounding

Albert Einstein is said to have called

compound interest the eighth

wonder of the world

Compounding can be defined as “Interest on Interest” over a defined period of time.

A short story to illustrate the power of extreme compounding. There is a legend that involves the Indian inventor of the board game known as Chess. On demonstrating the game to the King, he was offered a reward for the game’s invention. Legend has it that he asked for a grain of rice on the first square of a Chess board and that it is doubled for every subsequent square. One grain on the first square, two on the second, four on the third and so on. The King, feeling this is a very small price to pay, agreed immediately. This was in fact a very ambitious

request, the number of grains of rice required to fill the chess board is 18,446,744,073,709,551,615; that is the equivalent to 600 years of global rice supply.

Compounding within one’s portfolio is achieved thanks to reinvesting two sources of cash flow. Reinvesting the cash generated by companies paid out to investors in the form of dividends and through investing in companies that are reinvesting their retained earnings (cash flow) at a higher rate than their cost of capital (cost at which a company can finance its assets). Compounding is often known as the snowball effect. To work, it requires two things: the reinvestment of earnings and/or dividends and time. To demonstrate the power of time in the market, Chart 1 shows the difference 10 years can make should an individual start

This was in fact a very

ambitious request, the

number of grains of rice

required to fill the chess

board is 18,446,744,073,

709,551,615; that is the

equivalent to 600 years

of global rice supply.

Source: J.P. Morgan Asset Management. For illustrative purposes only, assumes all income reinvested, actual investments may incur higher or lower growth rates and charges.

CONTINUED ➤

n With dividends reinvested

n Without dividends reinvested

£90,503

£26,906

Fully invested Missed 10 best days

Initial Investment

Missed 30 best days Missed 50 best days

30,000

25,000

20,000

15,000

10,000

5,000

0

January 2019 2

Chart 2

Chart 3

£5,000 investment with/without income re-investedGBP, FTSE All-Share returns

Returns of FTSE All ShareGBP, Value of a £10,000 investment from 1999 to 2018 with annualised total return (%)

Thesis Market Commentary

CONTINUED

CONTINUED ➤

Source: Bloomberg, FTSE, J.P. Morgan Asset Management. Based on FTSE All-Share index and assumes no charges. Past performance is not a reliable indicator of current and future results. Guide to the Markets - UK. Data as of 31 December 2018.

Time in the market not

timing the market

Not only does time in the market allow investments to benefit from the effects of compounding as discussed but it also exposes investors to the best days in the market when often a material amount of total return is generated. Chart 3 illustrates the impact of being fully invested between 1999 and 2018 vs missing the best 10, 30 and 50 days of return over that 19-year period.

Timing the market is ‘like playing

poker against the world’s best

financial minds’ Ray Dalio (Founder

of Bridgewater Associates)

to invest £5,000 per year at 25 and at 35 until they are 65.

Individual investors have a choice as to whether to reinvest or pay out dividends but as investment managers it is our job to attempt to identify investments that have the ability to compound value over time. It is a key element of our investment philosophy. Our direct UK portfolios utilise our TESS process whereby a combination of profitability metrics and the expertise of our in-house research and investment teams scour the market for companies that we feel are well positioned to grow profitably over time and have attractive valuations at the point of purchase to achieve this goal. This of course over-simplifies a process with so many variables. Chart 2 is an illustration of the power of reinvesting dividends. If an individual invested £5,000 in the FTSE All-share index in 1986 and reinvested all dividends by 31st December 2018 it would be worth over £90,000. If dividends were paid out the investor would have £26,000 (this is an illustration and does not assume any charges).

Source: Bloomberg, FTSE, J.P. Morgan Asset Management. Investment outcomes based on total return. For illustrative purposes only. Returns calculated daily over the time period assuming no return on each of the specified number of best days. Past performance is not a reliable indicator of current and future results.

Guide to the Markets - UK. Data as of 31 December 2018.

120,000

100,000

80,000

60,000

40,000

20,000

0

5.1%

1.7

-2.1

-5.1%

'86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08 '10 '12 '14 '16 '18

n Negative

n Positive

n Negative

n Positive

n Negative

n Positive

60%50%40%30%20%10%0%

-10%-20%-30%-40%

60%50%40%30%20%10%0%

-10%-20%-30%-40%

60%50%40%30%20%10%0%

-10%-20%-30%-40%

193

619

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50

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98

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06

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82

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20

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20

162

018

1-year annualised returns


Each bar represents the average return for the preceding 5-year time period

24%

76%

90%

100%

10%

Each bar represents the average return for the preceding 15-year time period


January 2019 3

Chart 4

Risk of Stock Market loss over timeS&P 500 Index 1936 – 2018


CONTINUED

Timing the market is a notoriously difficult feat to achieve. There have been numerous academic studies analysing market timing, the most famous being written by William Sharpe, the Nobel Prize winner. In his 1975 paper entitled “Likely Gains from Market Timing” Sharpe concluded it is necessary for a

market timer to be correct at least 70% of the time in order to beat the market (This was based on an investor being either 100% equities or 100% cash). A 70% hit rate is indeed a difficult feat, bordering on prophetic. As we do not claim to be prophets we also do not claim to be able to time the market.

Another way of looking at market timing is to analyse the probability of suffering a loss over different time periods. As chart 4 illustrates, using the history of the US stock market (S&P 500) as a guide, the likelihood of suffering a loss should go down the longer one is invested.

Source: Thesis Asset Management, Morningstar

CONTINUED ➤

2018 saw a return

to more normal

levels of volatility

which became

more pronounced

in the final quarter

of the year

UK

Co

rpo

rate

bo

nd

s

n Local currency n SterlingJ

apan

Gilt

s

US

UK

pro

per

ty

Go

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MS

CI W

orl

d

UK

hig

h y

ield

bo

nd

s

Em

erg

ing

Mar

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Asi

a ex

-Jap

an

FTS

E A

ll-S

har

e

Oil

Eu

rop

e ex

-UK

CONTINUED

CONTINUED ➤

Review of 2018

After many years of relative calm (measured by volatility in financial markets) and broadly rising asset values; 2018 saw a return to more normal levels of volatility which became more pronounced in the final quarter of the year and was accompanied by falling asset values globally.

Chart 5 shows a summary of how different asset classes performed during 2018, where the picture was very different as recently as September.

Such periods test resolve and raise the question as to why one should remain invested. Although no one likes to experience negative portfolio

Source: Thesis Asset Management, Morningstar

returns, economic and market cycles are a fact of life. We have learnt that statements such as that made by Gordon Brown in 2006 as Chancellor of the Exchequer: “No more boom and bust”, was misguided and ended up as looking ill-timed by 2008.

It is during these periods that portfolio diversification, active stock picking and asset allocation come to the fore as we will look to protect your capital and take advantage of attractive buying opportunities as they arise.

So what are we doing? We are not starting from an outright bullish positioning among risk assets. Our equity positioning is largely neutral vis-à-vis our benchmarks or even underweight the median

-11.2% -10.0%-10.8%

-5.2%-4.1% -4.1% -3.0%

-2.5% -2.5% -2.2%

0.5% 0.5% 1.6%

3.9% 3.9% 4.7%

-1.4%

-4.4%

-8.7% -10.3%-9.5% -9.2%-10.2% -9.5%

-15.3%

10.0%

5.0%

0.0%

–5.0%

–10.0%

–15.0%

–20.0%

Chart 5

positioning of peers (from our external knowledge). From a fixed interest perspective, we have been underweight and negative on bonds for a while. Our current allocations relative to our strategic weighting are shown in Chart 6.

Europe ex-UK refers to iShares Europe ex-UK Idx (IE) Instl Acc€, Oil refers to Brent Oil, FTSE All-Share refers to FTSE AllSh TR GBP, Asia ex-Japan refers to Mgr Benchmark Pacific/Asia ex-Japan AW, Emerging Markets refers to RAFI Emerging Markets TR USD, UK high yield bonds refers to Aviva Investors High Yield Bd 3 GBP Acc, MSCI World refers to MSCI World NR USD, UK Corporate bonds refers to iShares Corporate Bond Index (UK) A Acc, Japan refers to Nikkei 225 Average TR JPY, Gilts refers to S&P U.K. Gilt Bd TR GBP, US refers to S&P 500 TR USD, UK property refers to Aviva Investors UK Property 1 GBP Acc and Gold refers to ETFS Physical Gold.


January 2019 4

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

1 of 7 2 of 7 3 of 7 4 of 7 5 of 7 6 of 7 7 of 7

CONTINUED

CONTINUED ➤

To increase uncorrelated assets in portfolios we introduced exposure to gold in early 2018, an asset class we last held in 2013. We have historically held hedge funds to reduce correlation in clients’ returns, but after two funds failed to perform as designed, and following recent interest rate hikes, money market funds offered a more attractive risk adjusted return; we sold the hedge funds to increase our cash holdings.

We are still maintaining our positions in private equity and smaller companies, although these are perceived as higher risk. Our strategy for such holdings however has been clear from the outset; we believe in these areas / asset classes for long-term outperformance and accept there will be odd weak periods of performance. Our position sizing in these areas and others such as Emerging Markets has reflected their inherent risk and they are not large weightings within portfolios, although we could

increase these in future, depending upon market conditions.

Risk in the equity space can equally be managed through the style of funds in which we invest, where our UK allocations (either through our direct stock picking process or the fund choices) is viewed as having a slight ‘value-bias’ (buying undervalued shares with the expectation they will increase in value) and strong dividend yield credentials. We continue to believe the UK equity market remains at a significant discount to other developed markets, which makes it attractive for investors prepared to wait for the political dust to settle – which it will do eventually. From a dividend yield perspective, on aggregate our UK portfolio of direct stocks is yielding c.5%, one has to go back to the lows of 2008-09 to see a similar level of distortion in UK share prices.

Earlier in the year, we did not chase North America or US technology shares, which were the primary

driver of global equity market returns until the end of September. Relatively speaking this strategy had hurt performance for much of 2018 but turned into a tail wind in Q4 as the US, and in particular the Nasdaq Index (a bellwether for listed technology companies), underperformed global markets.

We manage global multi asset portfolios aimed at generating risk adjusted returns through economic cycles over the long term. Timing the market is notoriously difficult but by adjusting weightings geographically and between asset classes we are attempting to positon the portfolio to balance risk and return. Different asset classes have varying risk and return characteristics which may change over time; our asset allocation process accommodates this by having a range for each asset class within which the allocation can be flexible. Holding uncorrelated asset classes helps to moderate portfolio risk. We may reduce the weighting to an

Chart 6 – Weighting ranges and current positioning for each mandate

n Current n Equity n Alternatives n Fixed interest n CashSource: Thesis Asset Management


January 2019 5


January 2019 6

CONTINUED

asset class whose prospects we do not like, but are likely to maintain some exposure in order to preserve diversification. Chart 7 illustrates the performance of the Thesis securities model (risk mandate 4) vs a selection of asset classes over the last 12 years. The most recent data in the right hand column illustrates the year-to-December 2018 month-end.

Source: Morningstar Direct

Global REITs 22.1%

Emerging Market Equities 37.4%

Aggregate Global Bonds 45.1%


Gold Miners 34.0%


Global REITs 17.6%

US Equities 29.9%

Global REITs 30.5%

Japanese Equities 17.6%

Gold Miners 91.7%



Cont Europe Equities 18.8%

Gold Miners 19.9%

Gold Miners 11.8%

UK Equities 30.1%

Global REITs 26.7%

Sterling Corporate Bonds 5.4%



US Equities 20.8%

Thesis Securities 4 of 7 8.3%



US Equities 1.6%



2 Month GBP LIBOR 6.2%

Global Equities 21.2%


Global REITs 3.0%




US Equities 7.3%

US Equities 33.5%


Global REITs 1.0%

UK Equities 16.8%


Japanese Equities -1.1%



US Equities 2.9%




Global REITs 6.4%






Sterling Corporate Bonds -9.9%

Global REITs 18.1%

US Equities 18.7%



UK Equities 20.8%



Global REITs 27.0%

UK Equities 13.1%

Sterling Corporate Bonds -2.2%



US Equities -12.8%



Thesis Securities 4 of 7 -3.3%

UK Equities 12.3%





US Equities 11.3%

Global Equities -3.4%




Gold Miners 16.2%

UK Equities 14.5%

UK Equities -3.5%








US Equities 1.6%

UK Equities 5.3%





US Equities 10.9%



UK Equities 1.0%



Gold Miners -4.5%


US Equities 3.7%

Global REITs -23.1%

US Equities 12.6%




Global REITs 0.4%

UK Equities 1.2%


UK Equities 16.8%

Gold Miners 0.7%


Gold Miners -0.6%


Cont Europe Equities -24.6%



Gold Miners -14.4%


Aggregate Global Bonds -4.4%





Emerging Market Equities -7.6%



UK Equities -29.9%









Global REITs -1.4%

UK Equities -9.5%


Global REITs -12.3%





Gold Miners -17.8%

Gold Miners -53.1%

Gold Miners -8.8%

Gold Miners -15.9%




2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Indicies used have been sourced from Morningstar Direct. All returns have been converted to those attained if investing in Pound Sterling. US Equities relates to the total return of the S&P 500 index. Sterling Corporate Bonds relates to the total return of the Markit iBoxx GBP Corporate index. Cont Europe Equities relates to the total return of the MSCI Europe Ex UK index. UK Equities relates to the total return of the FTSE All Share index. Aggregate Global Bonds relates to the total return of the BBgBarc Global Aggregate Bond index. Japanese Equities relates to the total return of the FTSE Japan index. Emerging Market Equities relates to the total return of the FTSE Emerging index. Global REITs relates to the total return of the FTSE EPRA/NAREIT global index. Global Equities relates to the total return of the FTSE All World index. 2 Month GBP LIBOR relates to the total return of the ICE LIBOR 2 Month GBP index. Gold Miners relates to the total return of the FTSE Gold Mines index.

n US equities n Thesis Securities 4 of 7 n Japanese Equities n Global Equities

n Sterling Corporate Bonds n UK equities n Emerging Market Equities n 2 Month GBP LIBOR

n Cont Europe Equities n Aggregate Global Bonds n Global REITs n FTSE Gold Mines TR USD

Wo

rst

Bes

t

Chart 7

Important Information This update is for information only and is not an invitation to engage in investment activity. Issued by Thesis Asset Management Limited, Exchange Building, St John’s Street, Chichester PO19 1UP. Authorised and regulated by the Financial Conduct Authority (registration number 114354). Investors should be aware that the value of their investments and the income from them can fall as well as rise and they may not receive back the full amount they invest. Tax treatment depends on the individual circumstances of each client and may be subject to change in future. Past performance is not a guide to future performance. Investments denominated in foreign currencies are subject to fluctuations in exchange rates which can be favourable or unfavourable. TAM1901_05


Tim Harman

Investment Manager, Guildford Office Email: [email protected]

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