General Background of Investments in the UK - Essay Example

Introduction Dysg Capital Advisors is a UK fund which provides an investment vehicle for educational purposes. The fund was initiated in July 2004 with the aim of providing an avenue for saving towards educational purposes. Members of the fund make regular contributions to the fund, their aim being to achieve significant growth in value in the long run, in order to finance an educational objective, mainly children's school fees or university fees. The fund gives the option to the contributors to withdraw from their funds after a minimum period of 5 years. 'Saving is a very fine thing. Especially when your parents have done it for you,' said Winston Churchill. The fund being a savings avenue for children's future, enjoys the status of being a charitable fund. As of February 1, 2009, the fund holds 15.5million of assets. The mode of holding is as given below: From July 2009, it forecasts that fund withdrawals (by members which have invested for at least five years) will exceed fund inflows (from new and existing contributors) by 3% per annum on average for the subsequent five years. The fund also faces direct competition from MFs and other depository institutions in attracting investors. General background of investments in UK Industrial production in the UK dropped below industry expectations, sparking fears that the contraction in growth for the last quarter would be as sharp as 1.5%. "Jonathan Loynes, economist at Capital Economics, noted that for the month of January alone, production fell by 2.6 per cent against consensus forecasts that the drop would be less than half that". The manufacturing sector, declining by 6.4%, is one of the biggest losers among the industrial groups that make up the index. Among the market sectors, consumer durable goods registered a sharp fall of 8.9% while non-durables fell by 2.5%. (Cohen, Norma, 10th March 2009, "Industrial output falls worse than feared", Financial Times) UK average house prices, as measured by the Halifax House Price Index, are currently close to the price levels seen in 2004. Wiping out the 2% gain it saw in January, the index has recorded a further 2.3 percent decline in February, contrary to popular expectations. Impending actions on further financial support from banks and caution on the part of lenders by forcing higher down-payments from buyers could push the house prices down a further 10 to 20 percent. (Cohen, Norma, 5th March 2009, "House prices resume downward trajectory", Financial Times) The UK economy shrank a further 1.5 percent in the last quarter and forecasts point towards an annual 4 percent contraction by the end of this quarter. With UK preparing for its so-called quantitative easing to stimulate its economy, large scale borrowing is on the cards. Talks of nationalizing banks have kept banking stocks depressed and while this is good for government bonds, concerns for the banking sector are not eased. The Bank of England has announced plans of spending 75 billion pounds to buy corporate bonds and government assets that have between 5 and 25 years to mature. Analysis of the existing asset classes UK equities: According to economic forecasts, the GDP growth is expected to contract by 3% this year. Even though expectations are high as far as long term growth is concerned, with inflation likely to close in on zero and the environment being tough for corporate earnings, the short-term story direction is hard to take a call on. The valuations of equities, having absorbed most of the bad news shed by the economy, represent good value at current levels. But with the government currently occupied with bail-outs and support packages and the pessimistic outlook held by majority of the investors, 2009 is not likely to see much come back as far as equities are concerned. (easier.com, Finance, 16th February 2009, "Threadneedle: Outlook for UK equity market). The outlook could still get worse with the expected increase in unemployment figures and companies shedding their excess capacities built up during the past years. Overseas equities: With the UK economy showcased as one of the weakest economies in the world today, and with interest rates approaching zero, the currency is likely to remain weak. This is good news for companies that have invested overseas. About 50% of the UK's earnings are from overseas and for those invested in such companies with high global exposure are likely to gain from such investments. UK corporate bonds: Turbulence in the stock market leads to greater interest in bonds, thereby making them more interesting investment vehicles. When the markets are volatile and the economy is in turmoil, interest rates in the economy are expected to come down. When interest rates fall, bond prices go up. Latest statistics show that investors are plumping for corporate bonds as they can get 7% returns without taking the risk of investing in the share market. With the Bank of England looking to slash interest rates further, more than half of the 1.5 billion invested in funds in December last year went into corporate funds. (Salmon, James, 11th February 2009, "Corporate bonds delivering a 7% return") UK government bonds: UK government bonds have seen momentous movements in the recent past, with investors rushing to buy after Bank of England's plans to buy billions of pounds of assets to kick start the economy. Rising bond prices push yields lower, which in turn will help in lowering borrowing costs for both businesses and individuals. (Kollewe,Julia, The Guradian, 6th March 2009, "Rush to buy government bonds") With the banking stocks taking a bad hit, demand for government bonds are high in the market today. With the 10-year gilt yields going down and the bank shares tumbling, government bonds are the safest remedy to inject cash into the system. The Bank of England is expected to spend about 65 billion pounds on government securities and 10 billion pounds on corporate bonds in the coming months. (Brown, Matthew, Bloomberg, 9th March 2009, "U.K 10-Year Yield Drops to Lowest since 1989 on Bank Concern") Bond markets are dependent on inflation and government bonds maturing in more than 10 years have been struggling (Miller, Andrew, 20th February 2009, "Right Now, UK Government bond market is favored"). Performance over a longer term has become increasingly difficult to predict, especially with the markets in topsy-turvy and the economy heading steadily downward. Commercial property: UK's commercial property prices, having already fallen by 25 percent in the recent past, are still struggling under pressures from falling rents. With the economy in turmoil and office and retail occupiers finding it difficult to retain the rentals paid, the prices are on a downward trend. "The IPD property index shows that the fall in property total returns accelerated in the third quarter of 2008 over the previous quarter, to -3.8 per cent, the worst month so far this downturn, with capital values down 4.3 per cent". Statistics show that some parts of the country are worse affected than others, with local businesses struggling to survive. "The knock-on effect, inevitably, will be falling rental values, lower investment prices and rising vacancies, which will mean difficulties for the property companies and investors active in these areas" (O'Murchu, Cynthia & Thomas, Dan, Financial Times, 22nd December 2008, "Falling UK commercial property prices"). Plan of Action Assuming that the investments in the above mentioned assets have been made and revised over the last 5 years of the fund, it would be difficult to arrive at a purchasing cost or the loss that the fund would have made in the recent past. The economy has hit a huge slowdown in the last one and a half to two years, leaving the country and the global economy is a state of turmoil. It should also be highlighted that the recommendations made in this note are under the assumption that exiting the existing asset classes would not lead to huge losses to the fund's overall performance over the years. In times like these, with the global economy in turmoil and markets highly volatile, it would be advisable to diversify one's portfolio within reasonable realms of choices available. Spreading cash around various investment vehicles can reduce the risk of over-exposure. Exposure to international markets is highly recommended at times like these. If direct exposure is too much risk, indirect exposure by investing in UK companies that have major global earnings would be ideal. With a major chunk of investments concentrating on higher education for children, Dysg Capital's capacity to take risks cannot be high. In such a scenario, it would be best to spread risks over various companies with international exposure, thereby ensuring that the company is a part of the global tide. As world-famous investor Warren Buffett said: 'It is better to be certain of a good result than hopeful of a great one.' While investing in corporate bonds, it is imperative to remember that these are not cash or bank deposit substitutes, but rather instruments tied to market movements. While they have upsides in a volatile market as it is today, they also have downsides which are linked to the long term interest rates of the economy. It is also important to know the risks that the companies that issue the bonds carry. While bondholders are given higher preferential rights than shareholders, it is still dependent on the company's affairs to produce the amount to be paid back. With the Bank of England looking to induce money into the economy through purchase of government and corporate bonds and the global economy moving deeper and deeper into depression, the demand for safer avenues such as bonds are expected to increase. Medium term bonds, ranging between 5 and 10 years will be more preferable considering the volatility in the markets today. With the effects of the impact of US slowdown on the UK economy being understated, diversifying internationally on a short term tactical basis is an attractive option. This has in turn led to the UK government bond market being the favored one for the time-being. (Miller, Andrew, 20th February 2009, "Right Now, UK Government bond market is favored") With commercial property prices steadily showing downward trends, it would be advisable to have lesser exposure to the same. The international market scenario is highly linked to property prices and an upward trend could possibly take a while to come by. Keeping in view that withdrawal from the fund could well exceed the inflows over the next 5 years; it would be advisable to leave a sizable chunk of investments in liquid assets. Medium term bonds, both government and high rated corporate, are a good investment avenue for short term as well as safe investments. An increase in the bond allocation along with a reduction in UK equity exposure would be well warranted. With the equity market as it is today, it could take considerable time for the markets to recover and be back on track. In such a scenario, especially with the withdrawals closing in, it would be advisable to minimize the UK equity exposure and increase exposure to bonds. Even though commercial property investments are also not likely to show high returns in the immediate future, investing wisely in companies with exposure to real estate would be advisable. Such exposure could be combined with equities. Another solid investment avenue for medium term investment would be exposure to gold and gold related funds. Even with the recent surge in gold, demand for the same has remained untainted. The reason for the same being the fact that gold has always been considered a solid medium of exchange and the hedge or safe haven it provides against all economic and political crises. With a 5% exposure to gold and a more tactical approach towards the same, considerable profits could be made out of the same in the short to medium term. Finally, exposure to global equities, as mentioned above, should be well diversified and continued. With the emerging markets rising in terms of economic stability, it would do good to have some exposure either directly or through companies that have exposure to the same. References Brown, Matthew. 2009. "U.K 10-Year Yield Drops to Lowest since 1989 on Bank Concern". Bloomberg. [accessed on 10th March 2009]. From http://www.bloomberg.com/apps/newspid=20601102&sid=aictpUda.CnE&refer=uk Cohen, Norma. 2009. "Industrial output falls worse than feared". Financial Times. [accessed on 10th March 2009]. From http://www.ft.com/cms/s/0/035ab8c8-0d5c-11de-8914-0000779fd2ac.htmlnclick_check=1 Cohen, Norma. 2009. "House prices resume downward trajectory". Financial Times. [accessed on 10th March 2009]. From http://www.ft.com/cms/s/0/e414bb38-096b-11de-add8-0000779fd2ac.html Easier.com, Finance. 2009. "Threadneedle: Outlook for UK equity market". [accessed on 10th March 2009]. From http://www.easier.com/view/Finance/Investments/Funds/article-234413.html Kollewe,Julia. 2009. "Rush to buy government bonds". The Guradian. [accessed on 10th March 2009]. From http://www.guardian.co.uk/business/2009/mar/06/bankofenglandgovernor-interest-rates Miller, Andrew. 2009. "Right Now, UK Government bond market is favored". The Journal. [accessed on 10th March 2009]. From http://www.nebusiness.co.uk/business-news/business-comment/2008/02/20/right-now-uk-government-bond-market-is-favoured-51140-20496825/ O'Murchu, Cynthia & Thomas, Dan. 2008. "Falling UK commercial property prices". Financial Times. [accessed on 10th March 2009]. From http://www.ft.com/cms/s/0/33d70816-cfff-11dd-ae00-000077b07658.html Salmon, James. 2009. "Corporate bonds delivering a 7% return". Thisismoney.co.uk. [accessed on 10th March 2009]. From http://www.thisismoney.co.uk/investing/article.htmlin_article_id=474592&in_page_id=166 Read More