Sunday, 29 July 2018

Stocks & Shares: What's The Best Way To Invest For Your Future?


Debate has raged on amongst academics, professional investors, and the general public as to the most profitable method of wealth creation. Karl Ahlstedt, Founder of The Horizon Institute and Guest Lecturer at the University of Wales, explores the various options.


From bonds and real estate, to stocks and exotics, the options are both numerous and daunting for the uninitiated investor looking to profit in the long term.

Timeframes matter; there is no specific optimal type of asset for every time horizon, with the significant departure occurring between short-term (typically less than 5 years) and long-term (typically more than 5 years) investment.

Investors that need to access their investment capital in under 5 years tend to be locked into investments that are low risk and highly secure – at the cost of abysmal returns. In the UK today (July 2018), the typical return on cash savings accounts across the high-street remain at near record lows of 0.3% per year. With inflation likely to be above 2% according to the ONS, the purchasing power (or more simply, the worth) of the invested capital falls by as much as 1.7% per year- essentially a 1.7% annual loss, hardly an inspiring incentive for those looking to secure a stable financial future.

Prior to the 2008/09 financial crisis, the savings rate of easy access bank savings was as much as 5%, and consequently interest rates fell- making borrowing cheaper, and saving less rewarding. This led to investors taking greater risks to fight off inflation and protect capital growth. This is where the financial markets entered the scene for even the most ordinary of people.

The stock market since inception has returned an average of 7% per year in capital growth, and even the worlds worst investor would, on average, only have to wait 13 years to recover any losses, based on investing lump sums prior to each financial crisis.

There’s more to consider. Actively managed funds, such as those from hedge-funds, bring with them substantial management fees. This is often a 1-5% management fee, and a 20% performance fee. Given returns of 7% averaged out, the real returns to investors would generally be between 2% and 5% per year. Generally enough to stave off the effects of inflation, but again it is hardly inspiring for those planning long term financial security.

Yet, the world is changing – the cost of transaction fees continues to decrease, and we are seeing the first zero-fee brokerages opening across North America (Robinhood) and Europe (Freetrade). While this allows individuals to trade at minimal costs, the financial markets are hardly a place for the inexperienced. The majority of uninformed investors would be advised to avoid building a “positive selection portfolio”, to use the jargon of the industry

This is where an individual investor identifies, analyses and executes trades to build a portfolio of stocks. The investor is responsible for exposure, risk, financial analysis, and technical analysis to execute trades at the right time. Traditionally, professionals who perform these duties have a quantitative background with degrees in mathematics, physics, economics and finance.

These professionals construct and use complex financial models, back-testing and analysis which is often beyond the scope of individual investors. This is part of the problem: many of the worlds brightest minds are involved in buying and selling equity securities, and competing with that expertise and resources it often a futile approach.

Instead, for most ordinary investors a more passive approach is often best. Index funds track the list of companies that make up the index, e.g. the FTSE100 contains the top 100 British companies by market capitalisation (how much the company is worth).

Therefore, investing in a FTSE100 mutual fund provides exposure to the index as a whole. Remember the 7% annual returns we mentioned earlier? This is where that number came from, it is the average amount per year the collection of stocks (the index) has increased since inception across the developed world. There are a few caveats here, but generally it holds up well enough to be considered an accurate assessment.

To conclude, a word of caution – since the last financial crisis (and the drop in central bank lending rates), stock markets have become one of the only bastions left for investors seeking 5%+ returns. This has led to substantial demand for stocks and shares which has pushed many financial markets across the globe to record highs. Very simply, higher demand = higher prices.

I would specifically point out that the S&P now has a CAPE (cyclically adjusted price earnings) ratio similar to that of the great depression, and while its unlikely another great depression is around the corner, the S&P is almost universally accepted as being expensive now when compared to historic levels.

Decided the passive approach isn’t for you? Want to learn how to build a stock portfolio the same way as they do on Wall Street? Learn more about active investing at The Horizon Institutes blog.

Disclaimers:
The author is in no way affiliated with the brokerages mentioned above.

This article was written by Karl Ahlstedt, Guest Lecturer in Finance at the University of Wales and Founder of The Horizon Institute.
Mohammad Lone Editor

Friday, 20 July 2018

Why Burberry Destroyed £30m of its Products - An Introduction to Artificial Scarcity


How companies artificially rig markets to work in their favour- and how it gets a lot darker than just burning handbags...

Burberry has recently caused quite a stir after a controversial business practice was recently revealed. News broke that the British high-end luxury fashion brand has incinerated as much as £28m of its own cosmetics and fashion products over the past year, to protect the brand and eradicate counterfeiting.

While these latest revelations have drawn attention to Burberry, this practice of destroying one's own stock is not by any means new in the fashion industry. H&M has a deal in Sweden to burn its own unwanted stock to produce energy. Slashed shoes were found disposed outside a Nike store in NYC. And Richemont, the group whose portfolio includes luxury watchmaker Cartier, has reportedly destroyed more than £400m of luxury watches over the past 2 years.

The most significant threat of these surplus products to a company like Burberry is not the aiding of counterfeiting, rather the potential effect the sale of such items on the grey market could have on the brand. The grey market, unlike the black market, is not necessarily illegal- rather it is a market which sells goods obtained unofficially. Some argue that popular retailers such as TK Maxx are examples of the grey market- obtaining genuine branded items, some of which are from unofficial channels, and selling them for less than the brand itself.

Burberry's concern is this: if their goods found their way to a shop like TK Maxx, and were sold for a fraction of their actual price, what would be the perceived value of the bags which it sells for full price? The appeal of a luxury brand is exclusivity; the grey market offers anything but this. What's more, it is highly unlikely that the original brand gets any of the grey market revenue at all.

Considering all this, Burberry's incineration of its own goods is an investment in the company's brand, protecting its goods from reaching the grey market and helping to maintain high prices. This is artificial scarcity.

Why is this scarcity artificial?

Well, the fact that the surplus goods existed shows that Burberry can produce than it is putting onto the market. Through artificially reducing supply (burning it), Burberry can keep demand, and thus prices, high.

To provide contrast, an example of genuine scarcity could be the recent CO2 shortage confronting many beverage manufacturers. The shortage of carbon dioxide has restricted the production of fizzy beverages, which, if prolonged, may force producers to raise prices.

The spread of Burberry's brash act in the news has brought practices that ensure artificial scarcity to light, but in reality, pretty much every business enforces some type of artificial scarcity. Few companies (perhaps, except Tesla) genuinely produce at their maximum capacity, whether to protect their brand as Burberry does, or to protect costs.

Disregarding the contemptible waste of material involved in some methods of creating it (think of how much leather Burberry burned), one could argue artificial scarcity is too substantial an issue. When it comes to luxury brands, for example, few people suffer from not being able to afford a £1000 handbag.

Where artificial scarcity does come into issue is in industries whose products we depend heavily upon. The pharmaceutical sector is an example; producers with monopoly power over certain drugs can in effect hold its users at ransom by restricting production and sending prices rocketing. Investigations have found this to be happening with medical products as widely used as stents, where some US firms were found to be exporting an increasing number of stents to India, but distributing fewer, despite demand increasing.

The Organisation of Petroleum Exporting Countries (known as OPEC) also leverage artificial scarcity to their benefit. Its members, which include Saudi Arabia, Venezuela and the UAE, are able to control global oil prices through co-ordinating their output. If it is decided that a rise in oil prices would benefit members, all members reduce their output of oil, and if an oil price cut is desired, they increase output. Such organisations are known as 'cartels'- illegal in most instances due to their lack of competition, but uncontrollable in the case of an organisation as influential as OPEC.

Artificial scarcity is always working in favour of businesses, rarely (if ever) working in favour of consumers. In the consumer world, it can cause massive waste, but little other genuine threat to consumers themselves.

However, when artificial scarcity is a tactic leveraged in potentially life-changing industries, such as pharmaceuticals and natural resources, it exposes capitalism at its most vicious- wealthy producers holding consumers depending on their product at ransom, and benefiting from their desperation.

Mohammad Lone Editor

Friday, 6 July 2018

Pros & Cons #6: Buying A House


House ownership is traditionally seen as a sign of steadfast finances and, well, a settled life. So why did 2017 see house ownership in the UK fall to a 30-year low- and is this really a problem?



House ownership among the British population has been in decline over the past decades, culminating in the home ownership rate of 62.9% in 2017, according to the English Housing Survey. This is the lowest ownership rate since 1985, the midst of the turbulent Thatcher premiership. This decline comes despite efforts of successive recent Conservative governments to push home ownership through various incentives (for example, the Help To Buy policy designed to help first time buyers get on the property ladder).

So, why is home ownership at such a low level? The Institute for Fiscal Studies (IFS) asserts that the youngest adults in society are those at the greatest disadvantage compared to those of their age in previous decades. The purchasing power of the young has been disproportionately hurt by the failure of incomes to keep up with the rising costs of living. According to the IFS, "almost 90% of 25-34 year-olds faced average regional house prices of at least four times their income, compared with less than 50% twenty years earlier".

fig.1 - source: Resolution Foundation
Research from the Resolution foundation (fig.1) suggests home ownership among 25-34 year olds is currently at its lowest rate since the 1960s.

Other factors also contribute to the decline in home ownership- for example the decline of construction of new homes, foreign investment in large city centres (both of which have contributed to high prices), and also a changing attitude among the younger generation towards home ownership. Even among those who have the financial capacity to purchase a home, the decision to go ahead with the purchase is becoming less clear cut.

Germany is known for its renting culture- a 2013 study found just 43% of Germans were homeowners- and it could be possible that in the long term, the UK is heading in a similar direction. So what should you weigh up when deciding whether or not to purchase a house?


PRO: Your (Relatively) Stable Asset

The belief that home ownership represents stability is not an old wives' tale- indeed, owning a home means that you own an asset that, in usual circumstances, should be reliable and in fact increase in value over time.

What's more, when you own your home you have full autonomy over what you want to do with it. Renting leaves you dependent on your landlord- if they don't want you to put a nail in the wall to hang up a family photo, you can't. Although there are laws to protect those who rent (tenants), the landlord can also make you leave the property, even against your will. No one can do this to you if you live in a property you own (except the bank, if you don't keep up with your mortgage, that is).

Owning a house leaves you with a fall-back in case of financial catastrophe- it is a valuable asset that you can sell to downsize and shore up emergency funds, or sell to have a helpful hand further up the property ladder. A common practice among people approaching retirement age is to sell their home and downsize- leaving them with a tidy financial benefit to enjoy retirement with.


CON: Responsibility

As the saying goes, "with great power comes great responsibility"- and a house is no exception. Owning a house means you are responsible for it completely- you've got to deal with any issues that arise, whether that means a broken window or a fault in the structural integrity of the whole building. If you don't invest where necessary in the maintenance of your home, the value could tank.

On the other hand, tenants enjoy the freedom to pass over (most) issues of maintenance to the landlord, who has the responsibility to sort these things out. Furthermore, while the tenant doesn't take a share of any increase in the value of the property they are renting, the tenant is also protected from any fall in value- it is the landlord who has to absorb this cost.


PRO: Favourable Finances

Depending on when you purchase your home, you can benefit financially from favourable economic conditions.

The most common advantage taken by homebuyers is low interest rates- these are influenced largely by the base interest rate set the Bank of England, which essentially uses it as a tool to either stimulate or reduce demand in the economy. Low rates mean borrowing is cheap, encouraging people to take out loans to purchase houses, generating more activity in the economy.

Furthermore, taking up a fixed interest rate enables a clear idea of payments that are to be made over the time of your mortgage- as opposed to renting under a landlord, where the rent can change upon their whim. Home buyers need to decide, however, whether a fixed or variable (changing) interest rate suits them best- a variable rate helps when the Bank of England lowers its rate during the period of the mortgage, but increases costs should the Bank of England do the opposite.


CON: Lack of flexibility

Purchasing a home is not suited particularly well to a young generation that is more mobile than ever. A 'job for life' was a reality for previous generations that has become increasingly rare for today's youth. This is due not just to increasing job insecurity, but a young workforce that is more willing than ever to relocate regularly- in part thanks to phenomena such as social media tying people down less to 'home'.

Purchasing a home is neither a short nor flexible process- the average mortgage repayment period is 25 years. On the other hand, most renting agreements are 12 months long. Thus, renting offers a more appealing and feasible option to young people who may be changing careers every 2-5 years, or those hoping to upsize their home relatively soon.


PRO: Satisfaction

Studies indicate that home ownership brings a greater sense of security and happiness- a YouGov poll from 2017 found 73% of home owners to be satisfied with their standard of living, as opposed to just 53% of renters. 
Mohammad Lone Editor