Quarterly Investment Comment

Quarterly Investment Comment: Q3 2014

Review

The first half year of 2014 was benign but unbalanced, from an investment point of view.  Despite increased risk from Ukraine and Iraq, volatility remained at a seven year low.  Despite the creation of jobs, there was little inflation.  Despite investor interest, volumes have been thin.  There is a risk in the “normalisation” process arriving too late or too gradually, but until the Fed has fully tapered, we do not see a major driver for equity markets to experience corrections.

Brent crude oil was up from $94 to $112, US natural gas was flat at $4.461 (Nymex August).  Gold was up 7% to $1,325 and silver was up slightly at $2,087.  Sterling strengthened around 4% against both the Euro (to €1.25) and the Dollar (above $1.70).

Investment risk and return may be explained by a variety of factors such as interest rates, company size, and relative valuation. Markets responded in 2014 as follows:

Interest rates and the ‘Taper’

The Federal Reserve has continued to reduce quantitative easing by ‘tapering’ asset purchases by $10bn, from $85bn in 2013 to the current $35bn per month.  Quantitative easing could therefore be finished in the US by autumn.  After this, the Fed will move to raise interest rates, though it is still unclear when such a move can be expected.  Rates are likely to remain at 0.25% for the foreseeable future.  This is in contrast to the Bank of England, with Mark Carney recently saying that he expects interest rates in the UK to rise ‘sooner than expected’ from 0.5%, with rates stabilizing at a ‘new normal’ of 2.5% to 3% by 2017 rather than the pre-2008 level of 5%.  In Europe, the Central Bank has loosened monetary policy with interest rates lowered to -0.1% to encourage banks to lend.  Markets have demonstrated positive movement whenever quantitative easing has been announced, but have not always given up gains after monetary tightening announcements.  With the ECB loosening, we expect European equities to do well.

Company Size

In general, larger companies do better in the later stages of the economic cycle and smaller companies do better in recoveries.  While the Top UK 100 Companies grew 1.90% YTD, the UK Small Cap grew +2.80% YTD.  This could be another indication that the UK economy is at a more mature point in the economic cycle than the US.  We believe now is the time to increase larger company exposure and reduce somewhat smaller company exposure in portfolios.

Value vs. Growth

Value investing can be defined as investing in companies with strong fundamentals and low price-to-earnings ratios.  Investors pay less per pound of profit than with growth companies.  Shares that we favour from a value perspective trade at under 15x Price/Earnings.  By contrast, the  TechMARK 100 Index trades at 27.8x Price/Earnings.  We believe that the ‘value’ approach to investing is likely to outperform in the current investment climate.

Outlook

In summary, we believe that larger, ‘value’ companies should do better as the economic cycle matures.  Looking forward, the UK leads the recovery in terms of developed economies, but this also increases the likelihood of earlier interest rate increases.  The market currently expects a 0.25% increase by March 2015.  UK GDP growth was 3.1% (annualised) in Q1 2014 and is forecast to stay steady through 2014.  The US, by contrast, reduced GDP growth expectations from 2.8% to 2.1% for 2014, partly due to Q1 estimates which were revised down from +0.1% to -2.9%, ascribed to the appalling winter weather.  Corporate earnings are still strong in the UK and US and we consider markets will respond to reflect this, albeit with potential volatility over the summer months.

Risk warnings
This document has been prepared based on our understanding of current UK law and HM Revenue and Customs practice, both of which may be the subject of change in the future. The opinions expressed herein are those of Cantab Asset Management Ltd and should not be construed as investment advice. Cantab Asset Management Ltd is authorised and regulated by the Financial Conduct Authority. As with all equity-based and bond-based investments, the value and the income therefrom can fall as well as rise and you may not get back all the money that you invested. The value of overseas securities will be influenced by the exchange rate used to convert these to sterling. Investments in stocks and shares should therefore be viewed as a medium to long-term investment. Past performance is not a guide to the future. It is important to note that in selecting ESG investments, a screening out process has taken place which eliminates many investments potentially providing good financial returns. By reducing the universe of possible investments, the investment performance of ESG portfolios might be less than that potentially produced by selecting from the larger unscreened universe.