As systematic investors, we seek to continually challenge the process in order to maintain a solution which we feel gives us the best ability to meet our lifestyle and financial goals.  We understand that trying to predict the time and direction of market movements over shorter time periods is a fool’s pursuit. Any change in portfolio structure or investment approach, therefore, must be guided by a change in the evidence or our investment goals.

The interest rates set by central banks have been rising around much of the world in recent times. One will have done well to avoid such headlines in the news. 
In the UK, the base rate set by the Bank of England was just 0.1% three years ago and now sits at 5.25%, at time of writing. 
This considerable increase, much of which happened in 2022, led to historically low returns on bonds, as bonds fell in price in order to align with rising market yields. 
Despite rates not having been at such levels for some time, it is not uncharted territory. 
In fact, since 1975 rates have been above current levels more than half of the time.
For investors with medium to longer term liabilities, i.e. 5 to 10 years and beyond), these rate rises, and corresponding price falls, have significant benefits. 

Given the structure of portfolios, the - now higher yielding – bonds should get through the price falls experienced and thereafter be enjoying a higher return. It also opens up other options for savers – annuity rates and fixed term instruments now become more viable, in some circumstances. However, when it comes to the expected returns on portfolios, the evidence remains the same. We can look at historical figures to give an insight into whether there is a relationship between current rates on cash and subsequent portfolio returns.

Historical data reveals at a given level of starting interest rate, the proportion of times in the subsequent year, that the investment portfolio outperformed this starting cash rate. In essence, this is seeking to answer the question: ‘if I lock up my cash today for the next twelve months I am guaranteed x%, so why take on the additional risk of investing in a portfolio?’. 

Well, our research reveals that between January 1970 and June 2023, the proportion of periods that a 60% equity portfolio outperformed cash in the subsequent year were higher than 50%.  There is no clear relationship between the level of cash rates and subsequent outcome of portfolio returns relative to cash. Over all 1-year periods in our sample, the 60% equity portfolio outperformed locked up cash in 2/3rds of observations. The average excess return of the portfolio over cash in the 1-year periods was 4%. As we extend the holding period of our portfolio to 5- and 10-years the proportion of outperforming periods rises to over 80%. Other practical implications are worth considering. 

Locking up cash reduces liquidity, and may only be withdrawable outside of the agreed period with a significant penalty. 

Also, savers with larger sums of cash need to be wise and spread cash across banking groups to remain under FSCS protection limits. Bank failures in the US this year offer a cautious reminder to savers not to naively ignore protection limits.
In closing, risk and return remain inextricably linked.  The baseline has increased for all asset classes so please stick with the program. 

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Readers of the Sunday papers’ financial pages will be familiar with the dividend chasing stories that pundits and some fund managers love to peddle.
These generally focus on high dividend paying shares or ‘income’ funds that focus on these shares.
The thought that one can take an income from a portfolio without the need to sell shares can feel appealing to some. But dig a little deeper and it quickly becomes evident that a portfolio constructed from a bottom up dividend-driven approach is unlikely to be the most optimal approach and contain risks that may not be fully appreciated.

The first point to note is that you cannot have your cake and eat it!
If a company pays out a high dividend, that money cannot be reinvested by the firm to deliver higher future earnings which in turn drives share prices - in other words, the present value of future cashflows of a company.
So, with higher dividends today, you forgo tomorrow’s price growth.
In theory, the dividend policy of a firm should make little difference to its total return (by total return we mean, dividends plus share price appreciation) .

The second point to note is that different sectors of the economy tend to have different average dividend payout strategies.
For example, tech companies tend to reinvest most of their cash flows into product development and attaining greater market share, whilst energy companies – operating in a more mature industry - may not be able to find projects in excess of their cost of capital and may return money to shareholders via dividends.
Chasing dividends tends to end up in large sector ‘bets’ away from the market.

The third point to note is that because each equity market reflects the companies listed on it, large sector differences do exist between markets.
For example, the UK has materially less exposure to technology companies compared to the US but higher weightings to energy companies.
As a consequence, the UK market has a higher dividend yield than the US market.
A dividend-driven approach will likely overweight the UK (and other higher yielding markets) relative to other lower-yielding markets.
If we look at the average dividend yield of the 10 largest global markets by size between 2015 and 2023, we can see that Switzerland leads the way, followed by Australia and then the UK.

The final points worth noting are: within each market, dividend payments are often concentrated in just a few shares resulting in share concentration risks; and higher dividends tend to describe value companies which are less healthy companies with higher expected returns, potentially inadvertently skewing a portfolio towards higher expected risks.
If you have bonds in your portfolio, chasing higher yields from lower quality bonds or lower quality borrowers), this simply adds equity-like risk to your portfolio.
The higher the yield, the riskier the borrower. But that story is for another day!
An eminently sensible alternative approach to taking income from a portfolio is to think on a ‘total return’ basis where an investor is agnostic to taking dividends or selling shares to deliver the capital required.
This is the way that pension plans and endowments tend to draw income.
It allows you as an investor to maintain the structural integrity of their portfolio and to avoid company, sector and market bets in the pursuit of higher dividend yields on portfolios.
My advice is, don’t cha

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For many investors a propensity to place too much weight on recent events in terms of what the future may look like is quite common. This is known a ‘recency bias’ and it is this, we regards as the scourge of investors.

Charles Schwab, a major US broker, sponsored some research on its own client base to identify which behavioural biases predominate in their clients and recency bias was the one most commonly exhibited.

Around 50% to 60% of all investors appear to suffer from recency bias, and the number is even higher for younger investors.

Some investors may include global commercial property such as shopping malls, offices, industrial buildings, logistics hubs and data centres, in the growth assets portion of their portfolios to provide a bit of diversification to their pure equity exposures.
It is not guaranteed to work all the time but can be beneficial at times. The logic and empirical data certainly supports a reasonable case for including global commercial property.
Yet, of late, global commercial property has been under pressure on account of lifestyle and work-pattern changes.

Add in rapidly rising interest rates and the ‘story’ sounds quite bleak - in 2022, global commerical property, as an asset class was down by around -14%, whilst the UK equity market was up by about +7%.
And, global commercial property is down again in 2023.
Many investors might be tempted to consider abandoning it as an asset class, because they believe the future ‘obviously’ looks bleak, and its recent run of poor performance is thus likely to persist.
Yet, doing this would ignore a central tenet of systematic investing that all this doom and gloom is already reflected in market prices for global commercial property - in other words, it might go higher or lower from here, not because of what has recently happened but what new information the market receives.

Every asset class has its bad and good periods yet global commerical property has been the most consistent when compared to Developed and Emerging Market equities over the past 20 years or so!
Abandoning or adding to a portfolio simply by extrapolating what has recently done well or badly is not a great strategy.

In 2022, commodity futures were the star asset class, returning around +30% in a year when bonds and equities were down in value. In 2023 they are down in value by around -15%.
And, when gold rises in price, investors’ are always curious.
As investors, we should never fall into the trap of thinking that the recent past points us to future outcomes.
Furthermore, we should never fall into the trap of thinking that a winning investment strategy is to pick what has just done well and avoid what has just done badly - follow this path is highly likely to result in great disappointment.

In closing, let's reflect on these wise words written by Charles D. Ellis in his excellent 2002 book Winning the Loser’s Game (Ellis, 2002):
‘The hardest work in investing is not intellectual, it’s emotional. Being rational in an emotional environment is not easy. The hardest work is not figuring out the optimal investment policy; it’s sustaining a long-term focus at market highs or market lows and staying committed to a sound investment policy. Holding on to sound investment policy at market highs and market lows in notoriously hard and important work, particularly when Mr. Market always tries to trick you into making change

Find all our useful links on our LinkTree - https://linktr.ee/jonathangibson

And why not visit us at: https://www.wellsgibson.uk/

And get a copy of the book, Purposeful Wealth here: https://www.amazon.co.uk/Purposeful-Wealth-Contentment-Certainty-Financial/dp/B08T42FNGM