Archive for the ‘Investment’ Category

ID-100109044There are two big question marks hovering over the UK economy. The answers  may determine whether the UK is seeing a temporary recovery or something a good deal more real.

First consider the surveys. Every month Markit and CIPS get together to produce Purchasing Managers Indices (PMIs) covering UK manufacturing, construction and services. Then they add them all together and produce a composite index. Over the last few months these indices have been really rather exceptional. A couple of months back the composite PMI hit an all time high. Okay data only goes back to 1998, even so it was impressive stuff.  Since then the PMIs have fallen back a tad, but they still remain way above historic averages.

Some economists reckon that the PMIs are consistent with quarter on quarter growth of around 1.5 per cent. To put that into perspective, there aren’t many emerging markets growing that fast.

But here is the thing, the hard data from the Office of National Statistics (ONS) is not so good. For the third quarter of last  year the ONS had quarter on quarter growth at 0.8 per cent. That growth rate is good, compared to what we have become used to it is marvellous, but it was less than the level the PMIs were indicating.

As for Q4 of last year, the PMIs suggested that was even better than Q3. Alas, not so the data from the ONS, it had the economy growing by 0.7 per cent. Okay, that growth rate may get revised upwards, but it is still way down on what the PMIs suggest.

Drilling down, construction may provide a partial answer. The ONS had this contracting 0.3 per cent in the last quarter of last year, the PMIs had it surging to its highest level in several years. Since then the PMIs tracking construction have got even better. This suggests that the ONS will either revise its estimate of construction’s contribution to UK growth in Q4 upwards, or we will show a marked improvement in Q1.

The latest PMIs also point to the largest backlogs in orders within the services sector since May 2007. That seems to suggest we are either set to see the sector’s output surge, or we may get rising prices instead. Or both.

Then there is business confidence, in the services sector this rose to its highest level since 2012.

These days, it’s popular to talk about that elephant in the living room. You hear the phrase so often, that is a wonder there are any elephants left in the wild, so busy are they filling up our livings rooms. Well apologies for adding to living room congestion, but as far as the UK economy is concerned there are two elephants in the living room

Elephant number one is household debt/house prices. Part of the UK’s recovery is coming on the back of rising house prices, making households feel richer, encouraging them to spend more. This is not new, the idea that the government is repeating the mistakes that led to the finance crisis in the first place is rehearsed most days in the media, and indeed by politicians.  Some deny it of course. But one piece of hard data needs to borne in mind. The fact is in Q3 of last year the savings ratio fell, this was the main contributor to growth. We haven’t got the data for Q4 yet. But given the imminent retirement of the baby boomers, is creating growth via less households savings really a good idea?

The other elephant in the living room is cash sitting on corporate balance sheets. If they could be persuaded to spend it, ideally invest it, the UK economy would boom like it hasn’t done for a very, very long time.

Just to remind you, according to the PMIs work backlogs are soaring, business confidence is rising, might that be enough to get companies spending again?

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It is kind of assumed that savings are good, debt is bad. If that is so, then there has been good news from the EU and bad news from the UK. In the EU savings ratios are rising, according to recent data, while in the UK they are falling. So that is EU good, UK bad. It is just that the real story is quite different, because there is something missing, and that missing ingredient is called investment.

Across the global economy savings equal investment. They have to; it is a matter of definition. GDP equals consumption plus exports, minus imports, government spending and investment. But across the global economy exports must equal imports. Drill down and look at government spending and actually it is one of two things: consumption or investment. So GDP really equals consumption plus investment.

But what are savings? By definition they are income that is earned but not spent on consumption. So by definition, savings equal investment.

But supposing we all decide we want to save more, and we all park more of our earnings in our savings account. Supposing there is no corresponding rise in investment. If this were to happen, given the equation that GDP equals consumption and investment, then either as we save more, other people borrow more, or the money we save is lost forever.

To put it another way, across the economy there is no point in saving unless this is matched by investment.

Now take the EU. According to data yesterday (30 July) in the EU27, the household saving rate was 11.0 per cent, compared with 10.7 per cent in the previous quarter. In contrast the household investment rate was 7.9 per cent in the first quarter of 2013, compared with 8.1 per cent in the fourth quarter of 2012.

Now take the euro area. In the first quarter of 2013, the household saving rate was 13.1 per cent, compared with 12.4 per cent in the fourth quarter of 2012. The household investment rate was 8.4 per cent, compared with 8.7 per cent in the previous quarter.

In short, savings ratios are rising, but investment ratios are not. This is not merely a negative development, it borders on being disastrous.

In contrast, the household savings ratio in the UK was 4.2 per cent in Q1 2013, the weakest since Q1 2009 when it was 3.4 per cent. The UK savings ratio is too low, but what really matters is not savings, it is investment.

In the UK investment remains way too low, but here is some rare good news. 2013 looks to be on course for seeing the highest levels of investment in the UK since before the crisis of 2008.

© Investment & Business News 2013

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The problem with banks lending to small businesses is that it is not often a good idea. Business loans are risky, of course they are. Mortgages are less risky because for one thing there is the property they are secured against, and for another thing there is the fact that to the people who own the homes keeping up mortgage payments is just about the number one priority. But there is a third far more important point. Businesses create wealth; mortgages don’t. And the creation of wealth is incredibly important, but also by its very nature risky. Banks have become the bogey men of the 21st century. The public hate them. The truth is, however, that small businesses, the type run by entrepreneurs and that create wealth don’t really need banks at all, not banks as they are these days anyway. They need something far more. And curiously enough the venture capital industry has just been spelling out what it is.

Barclays is on a fund raising spree. It needs to find £12 billion or so to ensure it can meet the 3 per cent capital ratio that the regulators have decided is essential. So it is raising money, selling shares, and trying to get existing shareholders on board. Of course, in an ideal world its better paid staff, the ones with big bonuses, would contribute to the fundraising by receiving their bonuses in shares rather than hard cash.

But just imagine if more than 3 per cent of its loans went bad. Imagine if the 3 per cent of the people it lent to went bust, and were unable to repay a single penny. The bank would be in rather a lot of trouble. That is why banks prefer providing mortgages, over loans to businesses. Think about that. Businesses fail; it happens all the time, so is a 3 per cent safety margin really enough?

We keep reading about how banks are providing mortgages again, but are not lending to businesses. But is that really a surprise? Banks are not geared to truly understand entrepreneurs; their business model doesn’t fit.

It wasn’t always that way and it doesn’t always have to be that way. But for as long as the principal way in which banks provide money is by charging a fixed rate of interest, which provides the same return regardless of the company being lent to (whether it turns out to be the next Google, a business growing at about 0.0001 per cent year, or a company that fails outright), the most a bank can make for backing such a business is always the same and is actually quite small. The most it can lose is… well it is everything it lent.

If banks were remunerated in the form of share of profits, so that they benefitted from the upside as well as losing out from the downside, it would be a different matter.

It was not always thus, of course. There was a time when local bank mangers understood local businesses, and even if they couldn’t provide funding they might have known someone who could.

Back in November 2008, Edmund Phelps, a former winner of the Nobel Memorial Prize in Economics, said in an interview with ‘Spiegel Online’: “A fundamental issue that regulatory discussions must confront… is what function society needs the banking industry to perform. Increasingly over the past two decades, the banks have tried to make money with mortgages, residential and commercial. As this has proved difficult, the banks will either have to shrink their supply of credit to the economy as a whole or else redirect some [of] their credit to the business sector.”

But now the venture capital industry has spoken up.

For some companies even getting an extension on an overdraft can feel like “pulling teeth”, or so said David Hughes, chief investment officer of Foresight Group, managers of Foresight VCTs. He added: “In our experience banks seem interested only in funding mature, profitable businesses with proven management and clear growth plans… We have heard numerous accounts of banks dragging their heels on seemingly straightforward requests, where for example the request for an extension to a facility took over eighteen months for the approval to come through. … From where we are sitting, the outlook for banks stepping up to the plate remains bleak.”

Alex Macpherson, head of the Ventures team at Octopus Investments, proffered a similar opinion saying: “The banks have rarely been interested in providing debt finance to high growth entrepreneurial businesses where an equity investment is typically more appropriate.”

So what does that mean? Businesses need to court the VC and business angel market and now peer to peer lending.
As for the government, well frankly so far its efforts don’t add up. The UK badly needs a more entrepreneurial minded psychology amongst the funding community in the UK. And the government needs to put its money where its mouth is. It is extraordinary that the last Labour government cut VAT in a scheme that cost the UK government tens of billions of pounds of revenue, while it provided a few million pounds here and there for SMEs mostly in the form of training, and quite often training was not what was required. The current government spends billions on trying to get house prices up, but Vince Cable’s business bank will have one million pounds of new money. The Bank of England creates £375 billion in new money via QE, but still entrepreneurs , the people who can create wealth and make the retirement of the baby boomers affordable, are left to fight over scraps.

© Investment & Business News 2013

If UK consumers open their wallets and purses and start spending in any significant way soon something is wrong. But there are reasons to think that exporters and investment may lead the UK forward. This is where we enter a danger period. A recovery built on correcting imbalances will be a good thing. But recovery built on consumer debt, as rising house prices encourage them to go out and buy, would be most worrisome and may even give credence to the prophets of doom.

The truth is that growth in UK wages has been lagging behind inflation since the beginning of 2010. Savings have been much higher too. In the second quarter of 2008, the UK was entering recession, but at that point economic forecasters had not woken up to this, and many were still forecasting a mild slow down. During this quarter the UK savings ratio was just 0.2 per cent.

This was surely evidence we had entered a time of madness. But a year later, the savings ratio had risen to 8.6 per cent. That was a staggering rise. UK households, scared by the prospect of falling house prices, had hit a big red button with the legend danger emblazoned on it. They saved more, and soon after, their wages fell.

So what do you get when consumers spend a lower proportion of their wages, while wages relative to inflation fall? Answer: a very severe dip in spending. No wonder the recession was so severe.

But the solution to this problem is surely not to encourage households to save less and borrow more. It is to try to get wages to rise, and for business and the government to use the money that households are saving to fund investment. At the same time, UK company profits are surging, and corporate cash sitting in deposit accounts at UK banks has hit 25 per cent of GDP, which is a 25 year high.

The UK can go one of two ways. The money that is not being spent, and is instead sloshing around the banking system, could be used to fund mortgages and in turn create a housing boom. Writing in the ‘Telegraph’ recently, Jeremy Warner said: “UK housing was not the cause of the financial crisis; in fact, UK mortgage lending has remained a haven of calm and safety for the banks throughout the storm.” See: Unbalanced and unsustainable – this is the wrong kind of growth

Maybe he is right, but isn’t that the problem. For too long, whatever money that is available has been used to fund mortgages, even buy-to-let mortgages because they are seen as safe, instead of funding entrepreneurs and wider investment because this is seen as risky. Even many would-be entrepreneurs have been seduced by the allure of easy and low risk money from buy-to-let, and have left the path of wealth creation and joined the path of re-shuffling wealth, which is all that buy-to-let achieves.

If the UK goes down the path of creating a housing boom, the causality may be true entrepreneurism and a boom based on debt rather than productivity. Alternatively, if savings were used instead to fund investment, the result would be truly exciting.

Despite George Osborne’s efforts to administer the first of the alternatives – the cheap and easy way to growth, election victory and an unsustainable economy in which falling government debt is paid for by rising household debt – there are signs that the second approach is occurring anyway.

The UK’s export recovery has been held back by the rather unfortunate fact that the Eurozone, our largest trading partner, is in the midst of an economic depression. But since 2002 exports to China have risen sevenfold. According to a report published by the ONS a few days ago: “In the latest three months the value of exports was 17 per cent higher than the average 2012 quarterly level. Import values from China were little changed, so the trade deficit with China, which had averaged £5.2 billion a quarter in 2012 shrank to £4.8 billion in the latest three months.”

Just as is the case in the US, there are also signs of manufacturing led recovery. UK car exports are beginning to outstrip imports. There is also anecdotal evidence of companies returning their manufacturing to the UK. As Capital Economics said: “The decline in offshoring has reflected a variety of factors. For a start, the trend towards more capital intensive production as technology improves means that the savings in labour costs that can be achieved by switching production to Asia have become a smaller component of total costs.

Western manufacturers are also increasingly specialising in high-tech sectors in which production cannot necessarily be replicated elsewhere. The strengthening of Asian currencies has also reduced the savings from offshoring. In addition, fast supply chains are increasingly valued, so that production can respond quickly to consumer tastes and inventory costs can be reduced. “

As for the UK, it said: “According to the manufacturers’ organisation EEF, the proportion of firms repatriating some output rose from 15 per cent in 2009 to 40 per cent last year.” It continued: “Low-value sectors such as textiles have been declining, while high-value markets such as pharmaceuticals and transport have been growing rapidly. The destination of UK manufacturing exports has also evolved. The share of goods exports going to the fast-growing BRIC economies increased from 5 per cent in 2007 to 8 per cent last year and has also persuaded some firms to produce domestically.”

There other reasons to be optimistic. Demographics are looking favourable. Population growth in the UK in this decade is likely to be at its fastest rate since the first decade of the 20th century. The shortage of homes to population is a problem, but there are signs this may be fixed as the government tries to reform planning laws. A house price bubble will do little for the UK in the long term, but a house building boom is different thing altogether, and this may happen.

North Sea oil output is on the rise again, and the shale gas revolution may or may not be a mixed blessing, but it should at least help to promote growth. And don’t forget that in a growing global economy the UK has certain innate advantages: its time zone being one. The UK working day overlaps with working days in both California and East Asia. The fact that English is spoken rather widely in the UK is another advantage. Add to that political stability and a strong legal system.

Yet, for all that optimism, something broken remains. The UK is not well disposed to encouraging risky investment. That may not sound like such a bad thing, but remember that risk is the key to innovation and growth in the long run.

The government can do more to help and it could start by using money created by the Bank of England via QE to directly fund investment into infrastructure and in entrepreneurs.

© Investment & Business News 2013

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Anthony Bolton was an investment star. When he turned to China, the investment community waited with bated breath. They are still waiting, and now Mr Bolton has announced his planned retirement.

If you had invested £100 into Anthony Bolton’s UK Special Situations fund, and left it there for 28 years, it would have been worth £15,220. Not a bad return.

No wonder Mr Bolton was heralded as the UK’s answer to Warren Buffett.

And when the great man turned his considerable ability to mastering China, investors flocked to his cause.

That was in April 2010. Alas, shares in The Fidelity China Special Situations Fund run by the investment star, have fallen 17 per cent or so since then. Not a good return.

In fairness to Bolton the CSI 300 – that’s the stock market index tracking Chinese shares that investors pay the most attention to – has fallen from 3,345 in April 2010 to 2,403 at the time of writing, so it is hard to make money at such times.

Maybe the investment approach adopted by Mr Bolton in the UK for all those years just does not work in China.

Maybe, it’s just a matter of timing. The Bolton investment strategy is quite risky, and high risk means high volatility. At certain times investors in his funds lost money, but if they stayed true, in time they did very well indeed. Maybe the same could have been said for Bolton’s China’s fund, it is just that right now is a not a good moment to make a judgement.

Maybe the problem was that Mr Bolton just doesn’t know China well enough.

The man set to take over at the Fidelity China Special Situations is Dale Nicholls. He has managed the Fidelity Funds Pacific Fund since September 2003 and over that period he has returned 154 per cent. So that’s not bad, either. Fidelity says: “Dale is a bottom-up stock picker with a growth bias and a significant tilt towards smaller and mid-cap companies.”

Maybe though the problem for Anthony Bolton – and this may apply to his successor too – is straightforward regression to the mean.

If an investment delivers a one-hundred-fold return, we can be fooled into thinking we had more influence than actually we did. Should we repeat our efforts many times, regression to the mean may mean that our average performance is more mediocre. A sportsman, or pop star, or serial entrepreneur may enjoy a run of success, but the more often they try to repeat their success, the more likely regression to the mean will occur.

Leonard Mlodinow of the California Institute of Technology used the metaphor “The Drunkard’s Walk” in his book of that name to explain the idea. He tells the story of Sherry Lansing, top brass at Paramount, who commissioned ‘Forrest Gump’, ‘Braveheart’ and ‘Titanic’. She was a “genius”, who then “lost her touch”. She was fired, following one flop after another.

In the year or so after her departure, the studio enjoyed a run of hits. So, its decision to fire Lansing was proven right, or so it appeared. However, films such as ‘War of the Worlds’ and ‘The Longest Yard’ had already begun under Lansing’s tenure. Mlodinow also quotes a Hollywood executive who reportedly said: “If I had said yes to all the projects I turned down, and no to all the other ones I took, it would have worked out about the same.”

© Investment & Business News 2013

“SEIS makes the tax breaks on ISAs look miserly,” or says Jeff Lynn, co-founder and CEO of Seedrs. “Yet,” he says, “few investors have even heard of it.”

Mr Lynn is not wrong. The Seed Enterprise Investment Scheme offers investors 50 per cent income tax rate, even if they are not paying income tax at that rate. There is also potential for a further 28 per cent tax relief via an exemption on capital gains tax. Click here for more . For encouraging entrepreneurism, it is a bold scheme.

Mr Lynn says: “No other major country offers such significant reliefs to investors in start-ups.”

He continues: “It is ironic that the UK has both the world’s most generous tax incentives to invest in start-ups, and we lead the world in equity crowd funding which opens the door for the small investor to participate, yet so few investors have even heard about SEIS which will at the very least see HMRC giving them back half of what they invest.”

Seedrs, by the way, claims to the UK’s leading online platform for investing in start-ups.

© Investment & Business News 2013

When it comes to dividends, Vodafone has ruled supreme. It has been the FTSE 100s top dividend payer for years. But, talk was afoot that the times they were a changing. Investors who had got used to their shares in Vodafone paying out more income every year, feared the party was over. But this morning things began to look different.

The ‘Sunday Times’ spooked investors. This week it ran a story with the headline: “Vodafone’s golden decade of dividends comes to end.” The CEO of Verizon Communications, which owns a 55 per cent stake in Verizon Wireless, with Vodafone owning the balance didn’t help. In a recent meeting with analysts from JP Morgan was reported to have said this will be a lean year for owners in Verizon Wireless.

For Vodafone that was a problem, because over the past couple of years its stake in the US company earned it no less than $18.5 billion in dividends. So if that was set to come to an end, it wouldn’t be good news for the company.

It turns out that 2013 looks like being a lean year with a feast in it, or to put it another way, the fattest lean year on record. It was announced this morning that Verizon Wireless is to pay its owners a $3 billion dividend, with $3 billion of that going to Vodafone.

Okay, problems are not over for Vodafone. Its core European market is stuck in recession, and moves are afoot to buy it out of Verizon, although if it can get a good price, this may not be such a bad thing.

Still, if this is a lean year, imagine what a fat year will be like.

© Investment & Business News 2013