Archives for December 2014

Beware of Greeks bearing unwelcome gifts this Christmas

2015 could begin with bad news from Greece. The governing coalition has put forward a candidate for the Greek presidency, and has said that if he is not approved by the end of 2014 then they will call a general election. For the last few months the Greek opinion polls show the Syriza party as likely to win any general election. Syriza’s major policy proposal is to call on the rest of Europe to “restructure” or forgive a large part of the money that Europe has lent to Greece. They are threatening that should this not be forthcoming, then they will unilaterally default on their debt, threatening another financial crisis in the Eurozone.

The process for selecting a president is that a candidate must win two-thirds of MPs support – this is 200 out of the 300 Greek MPs, on either a first or a second vote. On a third vote, only 60% support or 180 MPs is sufficient. On Tuesday, on the second vote, the governing coalition achieved 168 votes, essentially just the votes of the parties in the coalition and little support from other parties. The third vote is on December 29. It is not at all clear that 12 more votes can be found for the government’s candidate.

So a New Year election is a distinct possibility. A Syriza victory is also a distinct possibility although it is expected that EC leaders will make speeches making it very clear to the Greek people that a Syriza vote is a vote for chaos. There is little support, particularly from Northern European countries, for the idea of writing off loans to Greece, though Portugal and Ireland will be watching with keen interest, having also borrowed heavily in the wake of the Eurozone crisis.  Syriza would though like to remain in the euro – in effect retaining the asset of the euro membership but losing all the liabilities from their debts. Cakes and eating come to mind!

From a Greek perspective, now would actually be a very good time to default on past debt. After years of savage austerity, the Greek budget is now just in surplus before accounting for debt interest or the repayment of debt. This means that Greece no longer needs to borrow money from anyone to fund itself, and so its level of debt is near a peak. Defaulting now has lots of upside and limited downside from this perspective.

The German word for debt is has very close links with the word for guilt, and Germans would regard a Eurozone country defaulting on its debt as profoundly wrong, threatening the very sanctity of the single currency. There would be a strong move to have Greece ejected from the euro, though there is no legal process for any country to leave the euro.

While the world enjoys its Christmas and New Year holidays, Greek MPs will be determining whether we return to our desks to find a new crisis threatening the Euro.

The German dilemma

Within the Eurozone, Germany is coming under increasing pressure to approve and adopt policies designed to stimulate the Eurozone economy. This is because (i) Germany is the largest economy in the Eurozone, (ii) since the global financial crisis, Germany has enjoyed the strongest performance within the Eurozone based mainly on exports, which has led to a very substantial trade surplus, (iii) German public finances are in a very healthy state compared with most in the Eurozone and (iv) they are rich and have the policy flexibility to act.

Many in the rest of Europe are calling on the German government to launch a large debt-financed fiscal boost through public investment spending, creating, it is hoped, jobs and demand throughout the Eurozone. The Germans are resisting this strongly because they have worked very hard in recent years to get their government finances back onto a solid footing, and are expected to get close to a balanced budget in 2014. German politicians are stoutly resisting European calls for them to spend more and move back into deficit.

It is though in monetary policy where the greater controversy is being generated. Through his public utterances over the last six months, Mario Draghi has sought, to maintain market confidence by positioning the ECB as about to introduce a US- or UK-style QE programme in its efforts to boost demand and inflation. However the actual policy steps agreed at ECB meetings have not lived up his words – QE is always just a few months away. It is clear that, behind the scenes, the Bundesbank and several ECB members are fiercely opposed to such a policy, with many in Germany believing it to be illegal. They are angry at the way that Draghi has sought to bounce them into such a policy by his public statements.

To many in Europe (and indeed the world), the Germans are the bad guys, doggedly blocking any moves to boost the moribund Eurozone economy due to their particular economic ideological fixations around sound government finances, conservative monetary policy and a strong currency. Being so out of step with their Western allies is not a position in which post-war German governments have wished to find themselves, and in any other field than economic policy, they would have made adjustments to their position and found a compromise.

It should however be recalled that Germany never asked for the single currency, and when it became inevitable, did their best to restrict membership only to those economies that were happy to embrace German economic orthodoxies, for precisely the reasons that are now being played out within the Eurozone.

In 1990, Mitterand’s price for accepting the re-unification of Germany was monetary union. In permitting Germany to become a much larger, and thus more powerful nation, he sought to maintain France’s significance by sharing the all-powerful Deutschemark. Kohl accepted this provided that all those involved in monetary union were prepared to manage their economies according to German orthodoxy. Thus the ECB’s mandate was constructed along very similar lines to that of the Bundesbank – very independent of politicians, with a mandate of low inflation delivered through conservative monetary policy. Similarly, the Maastricht Treaty constrained the size of government deficits and public debt that individual countries would be permitted. With these in place, the only economic solution for countries finding themselves in economic difficulties is for export-led growth, with the private sector becoming more competitive in global markets through cost control, innovation and structural reform. There would be no room for short-tem fixes generated by lower interest rates, weaker currencies and debt-financed government spending.

The criteria for membership of the euro were deliberately designed to exclude what are now known as the peripheral economies. Only the “core” European economies were expected to qualify, who understood and were prepared to accept German economic thinking. However everyone wanted to qualify and through a combination of the long economic boom of the 1990s and some very creative accounting, the euro began life both with many more members than Germany had ever intended, and with much weaker (though disguised) public finances than Germany would have countenanced.

Since 2008, the Germans have continued to espouse the policies that they believe were written into the monetary union. Thus they expect countries to embrace public sector austerity to reduce budget deficits and bring their giddy debt levels back under control, they expect their Central Bank to adhere to policies of sound money by control of money supply growth and they have a particular fear of Central Banks who buy government debt with newly-printed money. This is the economic and monetary union Germany insisted on, signed up to and has always believed that others had agreed to.

To date they have not relented on these principles, but it is leading to great pain and bad will across Europe, where the peripheral economies which previously resorted to policies of devaluation and government spending to boost their economies in times of trouble, cannot understand why these should not be adopted now. Germany now faces its greatest dilemma – whether to abandon the economic principles which have been the foundation of its economic success since 1945 and remain on good terms with the rest of Europe, or, remain true to its economic ideals and be the cause of the break-up of the monetary union as weaker economies are forced to leave.

In 2012, Angela Merkel opted to bail out Greece rather than risk the break-up of the euro, though by all accounts the decision was close and arrived at only after months of consideration. When the ECB finally votes to adopt QE (almost certainly sometime in early 2015), there will be vigorous opposition within Germany including legal challenges. Once again Mrs Merkel’s leadership will be key in determining the future for Germany and for Europe.

2014 – A year of change for investment trusts

The ripples from the implementation of RDR at the beginning of 2013 brought investment trusts under the scrutiny of a broader audience of advisers and investors this year. As a result, investment trust boards have begun to understand there is an opportunity to make their funds more attractive for both existing and potential new shareholders.

Lower fees
The simplification and reduction in fee structures across the sector has been a marked trend in 2014, as the competitive pressures from ‘clean’ share classes meant investment trusts have shifted from being cheaper than open-ended funds to being more expensive, as advisers’ trail commissions are a diminishing feature of the marketplace.

Examples of investment trusts reducing fees in 2014 included: Perpetual Income and Growth, Schroder Income Growth, and Montanaro European Smaller Companies.

Greater attention to managing the discount to reduce share price volatility was also evident. It is the volatility of the discount which has historically been one of the factors holding back adviser interest in investment trusts. Both Martin Currie Global Portfolio and Jupiter Green have adopted a zero-discount policy. There is a psychological effect that operates here, as the very existence of such a policy acts to keep the discount lower and less volatile.

Income-focused trusts have been proactive with their dividend policies, with some moving to quarterly dividends to provide a more regular stream of income to their shareholders. Brunner has a 40-year record of consecutive dividend increases, and now delivers that through more frequent cash flow, which has great appeal for income-conscious, retail investors.

Perhaps the most dramatic example of an investment trust board seeking to become more relevant to the changing UK marketplace has been at British Assets. The board has jettisoned a traditional equity mandate and investment manager in order to pursue a multi-asset income strategy targeting capital preservation and income growth – this is subject to a shareholder vote in January.

A closed-end structure lends itself well for this, given there is no need to deal with inflows/outflows, and the ability to save some income in revenue reserves and use it to smooth dividend pay-outs in leaner years.

Pension changes
This move is in response to the change in pension rules on annuities from April 2016, as an asset with low volatility providing income that grows over time is likely to prove a very appealing substitute to an annuity.

New capital raising in investment trusts was concentrated in two areas (see table, below). In general, new issues came in less liquid asset classes, better suited to the closed-end structure. Areas such as infrastructure, distressed debt, environmental, solar, and property led the way.

Many of these fitted the second theme of income – sustainable yield is in increasingly short supply in financial markets, and new sources of investment income are in strong demand.

Box showing new capital raising in investment trusts

Corporate activity
Across the industry, discounts have been fairly stable though they have been a little spooked in recent weeks by signs of weaker economic growth in Europe and China. They remain, however, at historically low levels and, unnervingly, at levels last seen in 2007, just before the financial crisis.

The low level of discounts has meant relatively muted corporate activity – Edward Bramson’s assault on Electra was, and remains, somewhat surprising, given its superior long-term track record and small discount relative to the sector.

Meanwhile, 2014 saw the sector say goodbye to Jupiter Second Split, Prosperity Voskhod, CQS Rig Finance, Dexion Trading, and BlackRock New Energy, among others.

Board scrutiny
In 2015, we are likely to see a continuation of more scrutiny from boards to make their propositions relevant for today’s investors, a greater focus on fees and simplicity of fee structures, and better transparency and communication with investors. The change to annuity rules will see more investors seeking diversified sources of yield.

The Financial Conduct Authority’s focus on the wealth management industry is also likely to lead to greater consistency of holdings across clients within the same firm. This is producing more heavily policed approved holding lists, which in turn demands greater liquidity for any individual trust to make it onto such lists.

The pressures on smaller trusts (below £100m and arguably below £200m) from this change of emphasis amongst the wealth management industry is beginning to exercise the minds of boards, and a greater appreciation of the benefits of economies of scale is occurring, which may lead to merger activity.

On the regulatory front, attention should be paid to the success or otherwise of the AIC’s campaign to get ESMA to change its proposal that would currently make every investment trust a complex product for MiFID II purposes.

Were this to go through it would mean advisers would have to consider investment trusts as more risky investments than individual equities, and likely lead to far less investor interest.