So far this has not started the liquidity tightening so much feared in advance, but then the increase was so small, and rates remain so low, that nothing much seems to have changed in the world of finance.
Looking for income
Indeed, whatever the original intentions of quantitative easing – the concept of trickle down value – this changed as central bankers realised it was not stimulating economic growth. Now it is much more about reducing relative currency values in the hope that this will encourage exporters and domestic manufacturers.
Either way, this will not help long-term pension savers or those desperate for a safe – but livable – return on their money. Fortunately for the politicians, stock markets remain high so the rich, at least, remain content.
Indeed, US markets have only ever sold at these valuations twice before – once in 1929 and a second time during 2000 and the tech boom.
This leaves most investors in a quandary. The alternatives for those with long-term savings to invest have traditionally been debt – especially that of developed countries such as the US and the UK – or equities with their promise of rising dividends. But the former is dangerous with such low yields, and the latter are at risk with current valuations.
The danger in outdated theories
The one thing that most investors should not do is to buy ‘structured products’, which few understand except for the higher yields promised. Mostly these are based on the Black-Scholes valuation of derivatives, a theory blown out of the water first by the bankruptcy of Long-Term Capital Management and then the 2008 mortgage derivative disaster.
Naturally, the investment bankers are reluctant to admit that ‘corporate finance’, to which they have devoted their university years and then their working lives, is professional nonsense. Black-Scholes assumed that there was ‘independent value’ in stock market indices, the interest rate, or assets. In the last case, the only objective reality is liquidity – a business either has it, or is bankrupt, regardless of the theory of ‘value’. This was the case with Michael Milken, Bernie Madoff, Jeff Skilling of Enron and, of course, the banks in 2008.
Corporate finance was born in the late 1940s. Until then it was accepted that investment management was a craft business with, like all other human activities, some who were good, some terrible and the majority just average. This was not good enough for hard-faced CEOs, asked to commit the enormous investment funds they were establishing to finance their employee pensions.
As always there were academics willing to create the necessary theories, especially with the help of the newly developed computer. Sufficient examination of past price movements, an imaginative explanation of why they took place, and all sorts of theories appeared that showed markets could be understood and so controlled. These became known as the ‘Efficient Market Hypothesis’ and pension fund management became an enormously profitable business; sadly for the pensioners, only the fees remained after the end of the Cold War and the return to normality in financial markets.
Seeking Mr Right
Investors who read Terry Smith’s denunciation of market analysts (Investment Spotlight, January) may despair of investing well in these markets, and at these levels. But good value, as defined by the market itself, can always be found, as can good craftsmen – Smith is one such, and so was Anthony Bolton.
Both are needed since only clever equity investment can keep savers safe. Developed world governments are hopelessly over-borrowed, central bankers have lost the plot, economic growth has stalled, and either inflation or deflation threaten, but no one has any idea which it will be.
And if professional investors seem entirely devoted to dealing, well it was ever thus. Modern stock markets were born around 1600 in Amsterdam, where the principal business was betting on which [if any] of the Dutch East India Company’s ships would make safe harbour in Europe from their Asian trading stations, and what their cargo might be. And very soon those brokers were trading actively in futures and derivatives.
Without knowledge of corporate finance, of course, these contracts were simply called ‘windhandel’ or trades in the air. In that Calvinist society, to go bankrupt as a ship-owner or merchant was seen as bad luck, but to do the same thing as a broker was recognised as moral depravity. This condemnation of financial dealing prevailed throughout Europe until the beginning of the 20th century.
But within a century of the opening of the Amsterdam stock market, the growing number of rich families ensured the opening of markets throughout Europe, the rise of quoted securities, and the development of wealth managers. Of course, this did not eliminate the idea of investment as the quick and easy way to instant wealth as 1715 and the South Sea Bubble were to prove.
Good long-term managers
The needs of Europe’s growing rich stimulated the development of sensible managers, able to give their customers the excitement they wanted, as well as the stability they craved. The more intelligent appreciated the need for security diversification, either through international investment or those with specific income or geographical aims, and developed the investment trust as a pooled investment vehicle, first in Holland and then later in Britain during the 19th century.
The continued existence of some of these 19th century foundations testifies to the correctness of that reasoning, as well as the willingness of some of Britain’s richest families to use such vehicles for their family wealth. Those investors excited by the opportunities of private equity and IPOs, but worried about the lack of transparency in both these markets, might consider such investment trusts as a safer way into these asset classes.
The Cayzer family controls Caledonian Investments, with a fortune originally based on shipping, and a strategy concentrated on UK equity interests, both quoted and unquoted. RIT Capital Partners, separate from the international Rothschild banking business, is a multi-asset global investment business, although with a large stake in UK financial advisory business.
Hansa Trust, significantly smaller than the other two, is the vehicle of the Salomon banking family [Rea Brothers]. Its investment strategy is towards the UK and eclectic in its tactics, but with one third of its value invested in a Bermuda company [Ocean Wilsons] that controls ports in Brazil.
These investment trusts are all controlled by the founding families, and do not bother with any form of discount mechanism – the families are in it for the long-term and so do not much care about fluctuating share values compared with their NAVs. Until recently, none showed much interest in outside investors, but that has changed recently. All three have appointed new investment directors, giving them authority to appeal to the general public, with tighter tactical control of the portfolio and a greater emphasis on generating income.
Currently all three yield about 2 per cent, sell on reasonable discounts to Nav, but have good five and 10-year records of Nav growth. Investors need to ensure that their own objectives and time horizons fit in with that of the controlling families. These three trusts are typically well diversified, since as family vehicles they are very concerned with avoiding downside risk, and have a long-term and patient view – just what is needed in the years to come.
