Complacency kills returns

No one can predict the future accurately - no matter how good an investment manager they are - but we can look back to see what lessons can be learned and consider what risks and opportunities the future might hold.

Five years ago, we were at the epicentre of the credit crunch and portfolios had been decimated. The blue-chip FTSE 100 index was down over 40 per cent, reducing a £1m portfolio that was invested in the stock market to less than £600,000. Even a more diversified, typical "balanced" fund was down almost 30 per cent as the 'crunch' took no prisoners and all asset classes were affected.

It felt as though the financial world would never be the same again and investors would have been forgiven for throwing up their arms in surrender and seeking the security of cash. In fact, if you believed the headlines in the press at the time, you may well have done just that.

However, five long years later and the FTSE 100 is up an incredible 125 per cent. How can this be, when we have not yet reached the previous pre-crunch market high from which the subsequent drop was 40 per cent?

This is because of two factors that most investors fail to fully appreciate:

• That it takes a 100 per cent return to replace a 50 per cent loss.
• The compounding effect of dividends on total returns.

Clearly, anyone brave enough to invest in the market in the middle of the turmoil (as we encouraged clients to do) has been handsomely rewarded.

Looking good?

So, can we all breathe a sigh of relief now? Can we celebrate that we are now finally out of recession? That Europe defied the odds and survived?

Unemployment is falling, interest rates are ridiculously low and house prices are on the up. Surely now is the time to invest in the stock market - after all, where else can you make money?

Focusing on companies, we can see that profits are rising, cash on deposit is still at record high levels and mergers and acquisitions activity is picking up steam again. So what can possibly go wrong? The answer, in short, is "a lot".

The stock market moves in cycles and has been shown to rise strongly during recessions and fall sharply during economic booms. It is my opinion that after five years of a bumpy, uncomfortable and yet steep journey upwards, the market is likely to pause for breath or even fall sharply over the next two years.

My predictions (always a dangerous statement to make but I did say that no one can accurately predict the future…) for two years hence i.e. January 2016, are for the FTSE 100 to be:

Outlook	Return	Probability
Positive	+20%	20%
Neutral	Level (give or take a few % either way)	50%
Negative	-20%	30%

What to do

We are always looking for underperforming, unloved assets that are just about to turn a corner and our current theme is commercial property.

Yes, I do know there are lots of empty buildings and, of course, I know rents are under pressure and banks own lots of suspect property they need to offload. Yet, I also know rents are averaging 6.2 per cent per annum yields even taking into account all those empty premises. I know prices stabilised in June and have subsequently risen steadily for the last three months.

I know money is starting to slowly move into this sector on a consistent basis and when the inflows pick up then fund managers need to buy buildings and prices will rise. I know that with the economy expanding, companies will need more space and empty properties will be filled quickly.

My recommendation

I think it is time to say thank you for the 125 per cent stock-market increase, bank some of the gain by reducing equity holdings and allocating the profits to property funds, which only invest in bricks and mortar (no shares) and don't have any borrowings. In short, funds that own good quality buildings, in excellent locations with quality tenants.

My forecasts for commercial property over the next two years are completely different to the stock market:

Outlook	Return	Probability
Positive	+20%	30%
Neutral	+14%	30%
Negative	+8%	20%

The downside of banking gains in the stock market and reinvesting in property is that you run the risk of making less money if the stock market continues its meteoric rise. However, in the current climate, that's a risk I am confident of taking on behalf of my clients.

 

Colin Lawson is founder and managing partner of Equilibrium Asset Management that manages private client portfolios totalling in excess of £300m

He writes a regular blog about wealth management for Private Client Adviser