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- 1. 9771472206092 >41 moneyweek.com £3.95 14 October 2016 Issue 815 Britain’s best-selling financial magazine Why death is getting more expensive P20 Signing Coldplay didn’t make me rich P31 The pit bull backing Donald Trump P34 HOW TO MAKE IT, HOW TO KEEP IT, HOW TO SPEND IT Don’t panicSterling’s slide is good for the UK, says John Stepek Page 24 14 October 2016 Issue 815 Britain’s best-selling financial magazineBritain’s best-selling financial magazine Don’t panic Britain’s best-selling financial magazineBritain’s best-selling financial magazineBritain’s best-selling financial magazineBritain’s best-selling financial magazine Why death is getting
- 3. moneyweek.com 14 October 2016 MONEYWEEK “If we want a more balanced economy, the sterling crash could be what we need” Editor-in-chief: Merryn Somerset Webb Executive editor: John Stepek Managing editor: Cris Sholto Heaton Markets editor: Andrew Van Sickle Senior writer: Matthew Partridge Contributors: Chris Carter, Emily Hohler, Jane Lewis, Sarah Moore, David Prosser, Alex Rankine, Natalie Stanton Group art director: Kevin Cook-Fielding Picture editor: Natasha Langan Designer: Sam McMurchie Production editor: Stuart Watkins Chief sub-editor: Joanna Gibbs Website editor: Ben Judge Advertising sales director: Simon Cuff (020-7633 3720) Commercial director: Vinod Gorasia (020-7633 3664) Publisher: Dan Denning Managing director: Helen Hunsperger Founder and editorial director: Jolyon Connell Group publisher: Bill Bonner Editorial queries: Our staff are unable to respond to personal investment queries as MoneyWeek is not authorised to provide individual investment advice. Email: editor@moneyweek. com Phone: 020-7633 3651 Subscriptions & Customer Services: 020-7633 3780 Mon-Fri, 9am – 5.30pm Web: contactus.moneyweek.com Subscription costs: £69 a year (credit card/cheque), or £19.95 every 13 issues (direct debit). MONEYWEEK is published by: MoneyWeek Ltd, 8th Floor, Friars Bridge Court, 41-45 Blackfriars Road, London SE1 8NZ. MONEYWEEK and MONEY MORNING are registered trade marks owned by MoneyWeek Limited. ©MoneyWeek 2016 ISSN: 1472-2062 • ABC, Jan – Jun 2016: 45,239 MoneyWeek magazine is an unregulated product. Information in the magazine is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Appropriate independent advice should be obtained before making any such decision. MoneyWeek Ltd and its staff do not accept liability for any loss suffered by readers as a result of any investment decision. Loser of the week Footballer Wayne Rooney could be facing a £3.5m tax bill, says The Times. HMRC has challenged a suspected tax avoidance film scheme called Invicta 43, that involved investors borrowing money to buy the rights to the films Fred Claus and 10,000BC. Investors could pay in, for example, £200,000, borrow a further £800,000 and get £400,000 of tax relief on the total £1m that could be used to shelter other income, with tax paid later on the income generated from leasing the films back to the studios. Rooney reportedly paid £2.5m into the scheme in cash and borrowed £10m. could be facing a £3.5m tax bill, says The Times. HMRC has challenged a suspected tax avoidance film scheme called Invicta 43, that involved investors borrowing money to buy the rights to the films Fred Claus and Investors could pay in, for example, £200,000, borrow a further £800,000 and get £400,000 of tax relief on the total £1m that could be used to shelter other income, with tax paid later on the income generated from leasing the films back to the studios. Rooney reportedly paid £2.5m into the scheme in cash and borrowed £10m. MONEYWEEK Coverillustration:AdamStower.Photos:Alamy;iStockphotos;RexFeatures In the middle of this week, the UK pound fell to the lowest in 168 years (or possibly more – the data’s a bit dodgy before that) as measured against a basket of the currencies of its major trading partners (Germany, France, the US, Japan and Italy). It is weaker than it was when we left the Gold Standard in the 1930s, weaker than it was when we left the European Exchange Rate Mechanism in 1992 and, of course, weaker than at the bottom of the financial crisis of 2008. This can’t be dismissed lightly: it’s a big deal. But the question is – a big deal in which direction? Is it a nightmare for Britain, or a scary bout of volatility with a very silver lining. In our cover story on page 24, John Stepek has the answer. Sterling has been overvalued for years (we have been writing about this very thing in MoneyWeek since at least 2008) and it is generally accepted that our economy is horribly unbalanced: too much finance, too little of everything else. If we really want a more balanced economy the sterling crash could be “exactly the medicine we need”. It could bring us lower house prices, higher interest rates, better productivity, a genuine manufacturing resurgence, a reduced dependence on finance and perhaps even less of a north-south divide. Who could be against any of those things? They are, of course, the very things that almost all commentators on all sides have been claiming they want the state to deliver for years. The other thing the 20%-odd fall in sterling does, of course, is render irrelevant all mutterings about post- Brexit tariffs. The top tariff rate is unlikely to be more than 10%, something that, as a letter to the FT points out, would bring “the price of British exports back to a little less than they were year ago”. Net effect: nothing at all. The problem with this happy interpretion of the sterling slide is that this isn’t going to feel good going into Christmas. The UK imports 40% of its food, 90% of its clothes and around the same percentage of its toys. That means that dealing with all this currency volatility doesn’t just mean focusing on the long-term benefits to us all. It means acting to avoid short- term disadvantages. You might want to buy your Christmas claret and your made-in-China presents earlier than you usually do (price rises take a while to filter through). You should also turn to page 21. There we look at the attempts by some MPs to water down the inflation protection on defined benefit pensions. Right now – with inflation super low – that might not seem like a particularly big deal. When inflation is 6% it will. Finally, note that the best way to outrun inflation is to invest in stocks that can outrun it. With that in mind Max King looks at three excellent income trusts, on page 28, and our interview this week is with Charles Heenan of Kennox. His aim, he tells us, is to make sure that the long-term value of the capital held in his fund is always protected. So far so very good (see page 22). From the editor-in-chief... Merryn SomersetWebb email: editor@moneyweek.com Good week for: Leah Bracknell: The former Emmerdale actress said she felt “extremely blessed” after fans donated over £55,000 online to fund her pioneering medical treatment in Germany. Bracknell was diagnosed with stage four lung cancer five weeks ago. DIY roadmenders: A council in Devon has turned to volunteers to fix pot holes in roads it says it can’t afford to repair in response to a £21m shortfall in its budget. Volunteer road wardens get two days training, equipment and materials. Bad week for: Gloria Hunniford: The veteran television presenter said that she had “lost all faith in banks” after fraudsters stole £120,000 from her savings account with Santander. Muhammadu Buhari: The president of Nigeria advertised two of his 11 presidential jets for sale in a local newspaper after the country went into recession. No price was quoted, but a Hawker 4000 reportedly cost $51m when it was bought six years ago by his predecessor Goodluck Jonathan. Wasted money: Axing plans to build the controversial Garden Bridge over the river Thames in London will still cost taxpayers £22.5m, even if the project is scrapped tomorrow, according to a report by the National Audit Office. 14 October 2016 Issue 815 Britain’s best-selling financial magazine
- 4. MONEYWEEK 14 October 2016 moneyweek.com The way we live now IndiGo, an Indian budget carrier, has become the world’s first major airline to introduce child-free zones on its planes, said Andrew Ellson in The Times. The group, which operates 818 flights a day to over 40 destinations, says it will set aside rows 1 to 4 and 11 to 14 as Quiet Zones to ensure that business travellers can get on with their work. IndiGo is following in the footsteps of some smaller Asian airlines, one of which allows passengers to pay up in order to escape screaming children. So far, however, no Western airline has signalled that it will follow suit, even though it would be a popular idea: a 2014 poll found that 70% of passengers backed it. The way we live now 4 news Washington DC Republicans flee Trump: Paul Ryan, Speaker of the House of Representatives, has become the latest high-profile Republican to distance himself from his party’s presidential candidate, Donald Trump. He said he would stop defending Trump, while many Congressional candidates in tight races rescinded their support after a video of Trump boasting about groping women emerged last week. A poll taken after the video’s release showed Hillary Clinton leading 46-35 among likely voters. Trump also caused uproar in the second presidential debate last Sunday by saying he would jail Clinton if he wins. Given that a Trump victory would severely unsettle global markets, an increasingly likely win for Clinton implies a 75% chance of an interest-rate rise before the year is out, according to Goldman Sachs. Mexico City Peso shrugs off Trump: The Mexican peso jumped to a four-week high this week. It is now over 5% up from last month’s record low of almost 20 to the US dollar. The peso has become a barometer of Donald Trump’s progress throughout his campaign given his threats to slap high tariffs on Mexican exports, build a wall on the border, and ditch the North American Free Trade Agreement. Since July, notes Michelle Davis on Bloomberg.com, several Mexican companies intending to sell shares or bonds have singled out Trump as a risk factor in their prospectuses. “I don’t recall ever having risk factors that called out individual US major party figures”, said Jorge Juantorena of Cleary, Gottlieb, Steen and Hamilton. ©GettyImages Pretoria Finance minister charged with fraud: The South African rand slid by over 3% on the news that South Africa’s Finance Minister Pravin Gordhan had been issued a summons to appear in court next month to answer fraud charges. He is accused of misconduct when he was in charge of SARS, the tax collection service, ten years ago. He has said the allegations are completely unfounded and politically motivated. He’s probably right: President Jacob Zuma and his allies appear to have it in for Gordhan, who has tried to rein in overspending and attempted to combat cronyism in state- owned enterprises. The worry is that if he is he is forced to go, the prudently managed treasury could be at risk of being continually pilfered by the president’s circle, and South Africa may be downgraded to junk status. Brasilia Government pushes through spending cap: Brazil’s President Michel Temer has persuaded Brazil’s lower house of parliament to back a constitutional amendment freezing public spending in real terms for at least ten years. Temer’s comfortable victory in the vote “is the most significant sign yet that Temer’s government may have the political support needed to live up to investor expectations”, says Bloomberg. com. Investors have propelled the local stockmarket to two-year highs despite a deep recession because they think Temer can implement some long overdue spending discipline – the budget deficit has hit 10%of GDP – and structural reforms. The spending freeze faces another vote in congress and then two in the Senate. The next test is a bill to alter the pension system.
- 5. moneyweek.com 14 October 2016 MONEYWEEK news 5 London FTSE 100 at record high: Britain’s blue- chip index, the FTSE 100, reached a new all-time peak around 7,130 early this week. Its previous record was achieved last year, before which the index spent 15 years trying to eclipse its 1999 level. The jump was due to a fall in the pound, which is back around $1.22 and at an eight-year low in trade-weighted terms (against a basket of major trading partners’ currencies). It has lost almost a fifth this year by this measure. The blue chips make 70% of their sales abroad, so they benefit from a cheaper currency. Jitters over the possible consequences of a “hard Brexit”, implying being outside the single market, have caused the latest sterling slide. (See page 24.) Paris Opec output hits record: The oil exporters’ cartel Opec produced a record 33.64 million barrels per day (mbpd) in September, according to the Paris- based International Energy Agency. The 14-member group is trying to hammer out a deal, to be finalised next month, to curb output to 32.5mbpd-33mbpd. As oil revenues have slid in the past two years, Opec states have had to rein in spending. This has proved painful and so they have “effectively abandoned” its policy of trying to put US shale producers out of business by flooding the market, notes the IEA. However, boosting prices will be hard work. At $60, increasingly cost- effective shale firms could return; Opec members often cheat on their quotas; and non-Opec production has risen of late. Athens Greece ticks reform boxes: Eurozone ministers have approved the disbursement of a €2.8bn tranche of bailout money to Greece. The sum is a part of Greece’s third international rescue package. Ministers were impressed that the government had implemented structural reforms ranging from liberalising the energy sector to setting up a new privatisation agency. But these measures, however worthwhile, “are unlikely to make a material difference to growth in the short to medium term”, notes the FT. The International Monetary Fund thinks the current fiscal targets are too strict, while it also recommends debt relief to fuel confidence, a course of action that Berlin is keen to avoid lest it infuriate taxpayers and help populist parties. Stockholm Ericsson in trouble: Shares in telecoms equipment maker Ericsson slumped by almost a fifth to a seven-year low this week. The group said sales in the third quarter had fallen by 14% year-on-year, while its operating profit crashed from SKR5.1bn a year ago to SKR300m. Demand for mobile broadband had fallen as European operators cut back spending, while there will be a multi-year lull until mobile groups elsewhere roll out 5G networks. The group also confirmed it would cut a fifth of its Swedish workforce amid intensifying competition from Finland’s Nokia and China’s Huawei. Ericsson has struggled since it sold its mobile phone business in 2012, with forays into IT services and media failing to convince. Beijing China tackles corporate debt: China’s State Council has approved a debt-for-equity swap programme as part of a package to lower corporate indebtedness. It says it also wants to encourage mergers, bankruptcies and debt securitisation to cut company debt worth $18trn, or 170% of GDP. Debt-for- equity swaps have been under consideration for some time, but critics suggested that Chinese banks would merely end up swapping bad loans for shares in dodgy companies, thus keeping them alive and crowding out productive investment and future growth. The government has tried to allay these fears by applying the programme for companies with a promising future. It will also soon announce further measures to restrict credit growth, reversing recent monetary loosening that has bolstered growth this year.
- 6. MoneyWeek 14 October 2016 moneyweek.com by Andrew Van Sickle Thailand: a right royal mess The deteriorating health of an 88-year- old man wouldn’t normally wipe 3.6% off a country’s stockmarket. But the world’s longest-reigning monarch, King Bhumibol Adulyadej of Thailand, is a crucially unifying figure in a divided country. And with the succession uncertain, tension could flare up again. Thailand has “gone from one crisis to another” recently, says Capital Economics. There have been two coups in ten years, the most recent in 2014. The context is a bitter divide between a poor rural population and an urban elite. The country is currently under military rule, a new constitution has just passed through parliament and a general election has been promised for 2017. Given that the king’s presence may well have helped avert civil war on several occasions, his death could deepen the political divide and knock a post-coup recovery off course. Tourism, which comprises 10% of GDP, would be damaged, while there is little prospect of other sectors picking up the slack. The relatively subdued global environment precludes a boost for exports, which tend to be concentrated in slow-growing industries anyway. High consumer debt – 80% of GDP – militates against a rise in household spending. Business spending is subdued in any case, owing to chronic instability: investment growth has averaged a measly 3% over the past decade. Now it could fall further. To cap it all, stocks have looked expensive of late. Don’t expect a major bull run anytime soon. It’s been a peculiar few days in the markets, says Ian King in The Times. There was the “flash crash” in the pound (see page 24), for one thing. Even odder, however, was Italy’s sale of its first 50-year bond. And “more astonishing” was the demand for it. It attracted €18.5bn of orders, far more than the government had expected. It was priced to yield 2.85% – in other words, investors are happy to get that much per year for a bond that expires in 2067. Five years ago, at the peak of the euro crisis, Italy couldn’t even persuade investors to accept that return on three-month paper. This is nuts for so many reasons it’s hard to know where to start. But “the Wikipedia list of Italian prime ministers” is probably as good a place as any, as DollarCollapse.com notes. “Spoiler alert: they’ve had a million of them.” Well, not quite, but 63 governments since 1945 is not the sort of statistic that would seem to justify entrusting your money to a country for half a century at a piddling rate of return. It’s always been a shaky polity; a collection of disparate and fractious states cobbled together in 1861. Since the war, poor macroeconomic management by successive governments has racked up debt and increased inflation. The latter tended to be higher than the European average, and certainly higher than 2.85%, which hardly bodes well for real returns from this bond. Years of overspending have produced a public-debt pile worth 130% of GDP. Nor is there much reason to suppose things are about to take a miraculous turn for the better. The Italian economy has lagged the eurozone for years, and in recent months has slowed to a crawl again. One key problem is the banking system, suffering from bad debts worth around €360bn. Continual political stalemates in the two upper houses of parliament have thwarted structural reforms to galvanise growth in the over- regulated economy. An attempt to rectify this in December, through a referendum on measures to reduce the upper house’s authority, could go badly wrong. Prime Minister Matteo Renzi has staked his personal authority on it, and has said he will quit if he fails. That could lead to chaos, given the economic stagnation and pervasive anti-EU populism on the political scene. The polls suggest Renzi will lose. In a worst-case scenario, says King, the EU could tear itself apart in the next few years, and Italy could do the same. Italy’s bond, then, is a bet that all will be well, which is not a viewpoint that history would justify. It’s just another example of “the desperation for anything that offers yield”, says the FT’s Miles Johnson. Steer clear. Italy’s 50- year bond madness 6 markets Prime Minister Matteo Renzi: he’ll quit if a referendum to reform the upper house fails King Bhumibol Adulyadej’s illness is causing instability ©Alamy ©PressAssociation
- 7. moneyweek.com 14 October 2016 MoneyWeek Chart of the week: Global IPO sales at post-crisis low It’s been a poor year for initial public offerings (IPOs). The value of flotations in the first three quarters of 2016 totalled $82.5bn worldwide, compared with $190bn at this stage in 2014 and $123bn in 2015. In Britain, the value of new listings is down 60%, compared with 45% in the US and Europe, says the FT’s Gavin Jackson. It’s been an unusually volatile and uncertain year, kicking off with January’s jitters over Chinese growth, but the main theme has been geopolitical uncertainty. Brexit and the US election have discouraged new listings. Still, nerves may be settling: IPOs rose in September. 200 150 100 50 0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Global IPO sales (first three quarters) $bn People have got so used to ultra-low interest rates amid talk of stagnation and deflation that they can barely imagine anything else. But an interesting talk last week by Charles Dumas of Lombard Street Research suggests that the West is in solid shape, rate rises may be closer than we think, and the 35-year bond bull market is over. The speech concentrated on the eurozone economy, which Dumas says is in better shape than most analysts realise. The German economy is 7% above its pre-crisis peak; Spain is growing at more than 3%. The euro’s inflation-adjusted exchange rate is over 10% lower than during the eurozone crisis, making European products very competitive on world markets. The collapse in the oil price in 2014 was an “extraordinary stroke of luck” that fuelled “impressive” household spending and also lowered inflation, prompting the European Central Bank to keep printing money. Solid trade and consumption has underpinned strong capital spending. The three “main engines of economic advance”, then, are in “pretty good form”. Meanwhile, the financial and eurozone crisis reduced the economy’s productive capacity, Beware emerging- market bonds The global hunt for yield has turned to increasingly risky asset classes. With the yields on emerging- market government bonds also at historic lows, investors have piled into debt issued by firms in developing countries. The emerging-market corporate bond index has risen by over 13% in 2016. But investors “need to be careful”, says Buttonwood in The Economist. The fundamentals are starting to deteriorate. Twenty- six issuers defaulted last year, up from five in 2014. This year’s tally is already 18. The default rate on junk debt has hit 3.1%, the highest since the global crisis. “More defaults are probably on the way.” Trade is a crucial component of emerging- market growth, and it’s spluttering. Citigroup estimates that it hasn’t been this weak compared to global GDP growth since the 1930s. Protectionism clouds the outlook further. Note too, says Buttonwood, that “when things do go wrong for emerging-market borrowers, it seems to happen faster”: the interval between a bond issue and its default averages 3.6 years in emerging markets, compared with 5.8 in developed ones. markets 7 Eurozone money printing is set to ease next summer ©iStockphotos Get set for rising bond yields and hence the potential, or trend, growth rate. So the rate at which the eurozone can expand without stimulating inflation – economy-wide demand exceeding supply, essentially – is lower. Dumas thinks the eurozone is already growing at trend. As the oil slide falls out of the annual inflation calculation, the headline rate will head back to 1% in the next few months. That will gradually prompt the realisation that money printing needs to stop: deflation, after all, has been averted and the economy will be strengthening beyond trend soon. Dumas thinks we can expect quantitative easing to start tapering off next summer. With America also growing at above trend, we will see bond yields, which may already have seen the low post-Brexit, climbing in anticipation of dearer money, thus definitively turning their back on a 35-year fall. Viewpoint It’s election season... time for partisans to pose as economists and strategists in order to explain how much the markets support their favourite candidate… [but] Mr. Market… isn’t especially concerned with politics… I don’t want to suggest that presidents are irrelevant to markets and the economy; their actions can and do affect interest rates, and commodity and equity prices. A well-designed stimulus can help blunt the harm of a recession, while policy blunders such as waging unnecessary wars… will affect markets. But during the ordinary course of business, a president isn’t usually an especially important market- moving agent. Barry Ritholtz, Bloomberg Views 2016’s top metal has further to go Industrial metals have generally moved “in lockstep” with Chinese demand in recent years, says Bloomberg.com’s Agnieszka de Sousa. But they have started to diverge this year, suggesting that the supply outlook is now the main influence on prices. Plentiful supplies have held copper back, while zinc, this year’s best-performing metal, has jumped by 50% because the market is so tight. Above-ground stocks are at a seven-year low, while an environmental crackdown in China has curtailed mine production. Glencore, also a major producer of the metal used to coat steel, has reduced output. Goldman Sachs predicts a deficit of 360,000 tonnes this year. Prices look set to rise from around $2,320 a tonne to $2,500 by the end of the year, reckons Goldman, but that should be high enough to trigger “a major supply response” – so the market will then cool.
- 8. MONEYWEEK 14 October 2016 moneyweek.com I wish I knew what a carry trade was, but I’m too embarrassed to ask An asset’s “carry” is the amount of interest it produces. In the case of a currency, the carry is what you can make by depositing the currency at the central bank (ie, the country’s interest rate). In the foreign-exchange market, a carry trade involves borrowing in a currency with a low interest rate and using the money to buy one that pays a higher interest rate. If the exchange rate remains constant, you’ll receive more interest than you pay. Since US interest rates are higher than those in the UK (0.5% compared with 0.25% ), buying dollars and selling sterling would technically be considered a carry trade. Buying a lower-yielding currency to invest in a higher-yielding one can seem attractive – the currencies of countries with higher interest rates tend to attract more capital, drawn by the more attractive yields, and so carry traders can enjoy a double- whammy – a higher interest rate, plus capital appreciation. However, carry trades involve a huge amount of risk – if the trade reverses and everyone tries to get out at once, gains can turn into losses extremely rapidly. For example, in the years leading up to the 2008 financial crisis, one popular trade was to borrow money in pounds or dollars and then invest in a high-yielding currency, such as the Icelandic krona. This worked very well – until the krona collapsed at the start of the financial crisis and everyone ran for the exit at once. As a result, the strategy has been described as “picking up pennies in front of a steamroller”. Guru watch Forget the doom and gloom mongers – Professor Jeremy Siegel of Wharton School of Business reckons that now is not a bad time to be an investor. US shares are going through a period of “high valuations” in historic terms, he admits, but they still look “pretty good”, given expected growth and low interest rates. Indeed, “for the first time in maybe 50 years” investors are looking at robust dividend payouts and “beginning to think about stocks as the income-producing asset they will need in the future”. As far as Siegel is concerned, that makes perfect sense – solid dividend-paying stocks offer “3% or 4% with good growth possibility”. Siegel isn’t worried about the wider US economy either. Earnings are growing at a reasonable rate, and consumer confidence is “just finally getting back to near pre-crisis levels”. He’s not even worried about the upcoming presidential election. Sure, the market “would be a little more comfortable with a [Hillary] Clinton victory”, but in fact, “a lot of [Donald] Trump’s economic policies, like his tax plan and plan for less regulation, are far more capital-friendly”. As for Brexit, from an American perspective, Britain leaving the European Union is “a non-event”. However, there is one asset class that he’s not so sanguine about – Siegel admits that he does have “a pessimistic view of bonds”. There are two reasons for this. Firstly, he says, valuations are “super high” and yields “aren’t very good”. Secondly, “the Federal Reserve is definitely going to raise interest rates”. He expects the Fed’s next rate rise to come in December. The US central bank is then likely to “wait to see what happens before tightening again”, but the fact is that “any increase is going to harm the capital position of long-term bond holders”. The Big Mac index: tempting, but flawed 8 investment strategy Ever since the UK voted to leave the European Union, the pound has been skating on thin ice. This week, it fell through. In less than four months, sterling has plunged from a high of just over $1.50 to the US dollar to a low of below $1.20 (it has rallied a little since). It is by far the worst-performing major currency this year, with even the Mexican peso – which traders are using to bet on the likelihood of a Donald Trump presidency – outperforming it. We look at the impact of the plunge in sterling on the wider economy on page 24. But has the rout in the pound been overdone? One way to check is by using The Economist’s “Big Mac index”. The Big Mac index is derived from an economics theory called “the law of one price”. Simply put, this claims that in a modern global economy, the cost of any given goods should be the same around the world, once you take the exchange rate into account. So if a product costs £5 in London and $10 in New York, the exchange rate should be £1 to $2. The argument is that any serious price differential would result in people buying a product where it is cheap and selling where it is expensive (arbitrage). As the name suggests, the Big Mac index uses the price of the famous McDonald’s hamburger – a simple, standardised product that is sold in 119 countries around the world – to calculate whether a currency is cheap or overpriced. According to The Economist, as of July, a Big Mac sells for an average of $5.06 in the US, compared with £2.99 for the UK. This implies that the exchange rate should be £1 to $1.69, which would make the pound relatively cheap. Of course, the Big Mac index is a very rough, somewhat light-hearted guide to currency valuation. Using other goods produces entirely different results. For instance, the latest iPhone costs £599 in the UK and $649 in the US, implying an exchange rate of £1 to $1.08, suggesting that you should be buying dollars. However, you can take a wider measure – purchasing power parity (PPP) data, which looks at the price of all goods and services in an economy. This suggests that £1 should be worth around $1.45. And several studies suggest that over the long run, currencies do tend to revert to the exchange rates predicted by the PPP and even the Big Mac index. However, they don’t work terribly well to make short-term predictions. Indeed, Ahmad Raza of the University of Otago found that currency trading strategies based around these measures underperformed. The main reason for this is that in the real world there are often barriers to trade, such as tariffs and simple physical distance, which prevent the theoretical arbitrage described above. Indeed, some services are almost completely non-tradable. Global brands also have sufficient market power to vary their prices by region. So while PPP and Big Mac prices can provide useful pointers to a currency’s fundamental value, they are only part of the picture. And as Brexit has shown, in the short term there are plenty of surprises that can derail even the most considered currency forecast. How to value currencies by Matthew Partridge investment strategy XX The Big Mac index: tempting, but flawed page 24. But has the rout in the pound been overdone? One way to check is by using The Economist’s services in an economy. This suggests that £1 should be worth around $1.45. And several studies suggest that over the long run, currencies do the exchange rates predicted by the PPP and even the Big Mac index. don’t work terribly well to make short-term
- 9. moneyweek.com 14 October 2016 MONEYWEEK Who’s getting what ■ Arsenal Chief Executive Ivan Gazidis enjoyed a £440,000 pay rise last season, despite his club failing to win a trophy. The increase bumps Gazidis’ salary up by 20% to £2.64m for the year, making him the second-highest paid executive in the Premier League behind Manchester United’s Ed Woodward on £3m a year. ■ Former Friends star Jennifer Aniston has been paid $5m (£4m) to feature in a new advertising campaign by Dubai-based airline Emirates. The advertisement was seen three million times within 14 hours of appearing online. It follows a similar one for Emirates last year, for which Aniston was also reported to have been paid $5m. ■ The CEO of Scottish Development International, Anne MacColl, is to receive a £200,000 pay-off after quitting her role. The government-funded organisation, which promotes Scotland’s interests on the world stage, has lost more than £31m of public funds in the last two years amid a series of failed investments in renewable energy. ■ The so-called king of the London insurance market, John Charman, has banked $311m from the sale of his 5% stake in Endurance Specialty, the Bermuda-based underwriter with a large presence on the Lloyd’s of London insurance exchange, bought by Japanese insurer Sompo Holdings for $6.3bn. Sharman is to stay on as CEO and stands to pocket a further £13m from share options. Nice work if you can get it The fat cat bosses of Britain’s “Big Six” energy companies earned a staggering £29m between them last year, The Sun reveals. British Gas owner Centrica alone paid its top staff £13.1m, with Chief Executive Iain Conn taking home £3m. Directors at SSE received £3.7m, and E.On, EDF, Scottish Power and nPower paid theirs £12.5m between them. Other notable outsized salaries include E.On boss Tony Cocker, who is on an estimated £1.1m, EDF head Vincent de Rivaz on £1.3m, and SSE’s Alistair Phillips-Davies, who pocketed £1.7m last year. Paul Coffey, boss of nPower, was paid a “relatively” modest £320,000. “Meanwhile, families are paying £6bn a year more than they should due to excess tariffs,” says the paper. In the UK, some 14 million people work outside a nine-to-five set-up XX city view Whether it is selling a few things on eBay, renting out a room on Airbnb, or working as a full-time freelancer, more and more of us are now working in the gig economy. If you include people who do a bit of trading on the side and the traditional self-employed, around 14 million people in the UK have some kind of work outside the traditional nine-to- five, according to consultants McKinsey. That’s close to half the total 31.5 million people in work in the UK. The good news is that the government is starting to take notice of this shift. Theresa May has appointed Tony Blair’s former aide Matthew Taylor to report on how to help the self-employed. However, the government must resist attempts to get gig workers into insurance schemes, or to unionise them, as many on the left would like. Instead, here are four key reforms that would help. First, allow the self-employed to hire one extra person free of National Insurance charges, or any kind of employment law beyond minimum health and safety standards. The barrier between having zero staff and one person is huge – take on just one person and you suddenly have a hurricane of regulations to obey and taxes to pay. Hence many self-employed people end up working too hard because they don’t want to turn away clients, but they also don’t want the hassle of becoming an employer. Allowing them one assistant would help a lot – and if just 10% of them took it up, it would create almost half a million new jobs. Next, raise the VAT threshold from £83,000 to £142,000. No business turning over less than the prime minister’s salary should have to register for VAT, with all the paperwork that involves. There are lots of self-employed people who decide to limit the amount they earn to stop themselves breaking through that barrier – and that stops them from growing their businesses. Third, cut them in on tax breaks, without all the work involved in becoming a company. The UK has done a lot to make itself an attractive place to set up a company. Corporation tax will fall to 17% by 2020, the lowest of any major economy. The 10% rate of capital- gains tax for entrepreneurs is lower than anywhere, apart from a few tax havens. But none of that is available to the self-employed – even if many of them are just as entrepreneurial. So how about creating a new category of a “single person company”, with no reporting requirements to Companies House, and no requirement for a formal audit, but still benefiting from lower corporate taxes? That would help a great deal. Finally, we should simplify working from home. For example, there is no reason why only a percentage of home office expenses should be tax deductible – allow anyone working from home to claim the majority of their costs, just like any other business can. Sure, there will be some expensive claims – a lot of pricey furniture might suddenly be a requirement for the home office. But so what? They are contributing a lot of tax revenue, and there is no reason they shouldn’t get a few breaks as well. The gig economy is one of the great growth stories of the decade. It is creating jobs in a way that no other sector can right now. But the self- employed are escaping the restrictions and rules of corporate life. The last thing we need to do is wrap them up in new structures. Health and pension schemes, maternity cover, and all the rest of the paraphernalia of big company life are largely irrelevant. Give them the freedom to develop their own careers – and the economy will rapidly reap the rewards. Set the gig economy free to grow ©iStockphotos city view 9 Set the gig economy free to grow Matthew Lynn
- 10. MONEYWEEK 14 October 2016 moneyweek.com Samsung’s hopes go up in flames Samsung is the world’s biggest seller of mobile- phone handsets, boasting a market share of over 22% in the second quarter of 2016, according to research firm Gartner – more than twice Apple’s market share. It has carved out a position as a high-quality brand whose products sell for a premium price. Now that brand is under threat. Its top-end phone, the Galaxy Note 7, which retails in the UK at over £700, developed a worrying tendency to burst into flames. The firm recalled 2.5 million handsets in September, but phones shipped to replace the faulty units also burst into flames. So on Tuesday, Samsung took the drastic step of halting production and taking the device off the market. The saga has been a disaster for Samsung – $21bn was wiped off its share price earlier this week, and the company says pulling the Note 7 could hit profits by $2.3bn. Its ambitions to rival Apple in the smartphone market “suffered a deep blow”, says Jung-a Song in the Financial Times. And the fact that the firm replaced defective handsets with ones that were still unsafe “could trigger a large loss of faith in Samsung products”, says Richard Windsor from Edison Investment Research, quoted on BBC.co.uk. “Expect others to capitalise on the opportunity,” says Dan Gallagher in The Wall Street Journal. Chinese firms such as Huawei were already set to take Samsung on. Another winner could be Google, which has just launched its own top-end handset, the Pixel. “Google’s record in hardware has never been stellar,” but this time it may have got lucky. 10 shares These are the “best of times for European air passengers”, says Chris Bryant on Bloomberg Gadfly. But “for airline investors, it’s hard to imagine how things could possibly be worse”. Shareholders in easyJet have had a remarkably successful run over the last few years. In a notoriously cut-throat business, the company has managed to deliver an increase in profits every year since 2009. But last week it said that it expects pre-tax profits for the 12 months to 30 September to fall by some 28% compared with last year. Shares slumped to their lowest in over three years on the news, and are down by almost 50% in the last year. Carolyn McCall, the airline’s chief executive, blamed “extraordinary events”. Terrorist attacks in Nice, Brussels and Paris and air-traffic control strikes in France have all disrupted schedules. The tumbling pound is expected to wipe £90m off the airline’s profits this year. “Every 1% of the pound weakening versus the US dollar pushes the fuel bill up roughly £10m”, said analysts at Societe Generale. And while it’s true that the airline is carrying 6.6% more passengers, they’re paying 8.7% less for their seats. McCall is betting on expansion to see easyJet through the tough times – “history shows that at times like this the strongest airlines become stronger”, she says. “The airline grew capacity by 5.8% during April-September,” says Royston Wild on Forbes.com, “and plans a further 8% hike in the current year.” That should leave it “in good stead to enjoy splendid revenues growth once its current troubles subside”. But others aren’t so optimistic. Adding capacity is the wrong way to go about things, says Bryant. If the airline industry wants to preserve shareholder value, it needs to consolidate. If it keeps “seeking salvation through expansion, fares will fall further, and so will earnings and airline stocks”. “Europe’s airlines are their own worst enemies,” he adds. By contrast, US airlines, which have been through a period of consolidation, are “far more profitable than European rivals”. Quite, says Nils Pratley in The Guardian. Europe’s short-haul market “has too much capacity”, with “cheap oil” fuelling too much expansion. One comfort for shareholders is the “chunky” dividend, which yields 5.7% “at the reduced share price”. But that might not be enough to tempt investors. “Prospects for earnings themselves are the real worry. One tough year could be viewed as exceptional, but the City is expecting at least three before the clouds clear.” Not all investors may be willing to wait that long, says Bryce Elder on FT Alphaville. “If I were a shareholder,” he says, “I’d be asking questions.” William Hill, Britain’s biggest bookmaker, is in talks with Canada’s Amaya, owner of PokerStars – the world’s largest online poker business – about a £5bn “merger of equals”. The new company would be headquartered in London, with Amaya’s CEO, Rafi Ashkenazi, taking the top job. The deal adds to “the feeding frenzy among bookies”, say Peter Evans and Daniel Dunkley in The Times, driven by “rising taxes and a crackdown on fixed-odds betting terminals”. Mergers include Paddy Power and Betfair, Ladbrokes and Gala Coral, and GVC and Bwin.party. “The new company would have 60% of its revenues from online betting, and 40% in ‘land-based’ business,” says Murad Ahmed in the FT, making it “well diversified across different betting areas”, and bringing cost savings of more than £100m. Still, the deal is risky, says Nils Pratley in The Guardian. PokerStars faces a lawsuit in the US state of Kentucky that comes with a potentially huge fine. And the combined firm would be too exposed to markets where gambling is either “banned or the rules are so unclear that your local operation can be legislated out of existence”. Overall,”both these companies have bad hands, says James Moore in The Independent. “The best bet for their shareholders? Fold.” easyJet hits turbulence Bids and deals: William Hill goes all in on PokerStars The low-cost airline was a rare success in a cut-throat business, but headwinds are building fast Canada’s Amaya, owner of PokerStars – the world’s largest online poker business – about a £5bn “merger of equals”. The new company would be headquartered in London, with Amaya’s CEO, Rafi Ashkenazi, taking the top job. The deal adds to “the feeding by Ben Judge
- 11. moneyweek.com 14 October 2016 MONEYWEEK Vital numbers Price at 11 Oct % change since 4 Oct FTSE 100 7,115 0.58% S&P 500 2,163 0.84% Nasdaq 5,329 0.91% Dax 10,661 0.39% Topix 1,356 1.19% Hang Seng 23,549 -0.59% $ per £ 1.23 -3.15% € per £ 1.11 -2.63% ¥ per £ 127.28 -2.77% Gold ($ per oz) 1,254 -1.26% Oil ($ per barrel) 53 3.92% Directors’ dealings John Dawson, founder and Chief Executive of Alliance Pharma, “now has somewhere to stay when he visits the City”, says Investors Chronicle. Dawson sold three million shares at 45.25p – a total of £1.36m – using the proceeds to buy a flat in London. He and his wife still own 12% of the pharmaceutical licensing and marketing firm. Investors were rattled by rising net debt and squeezed margins in the latest half-year update, but growth remains strong. “The shares trade on 12-times forward earnings, which still looks undervalued to us. Buy.” A French view The news that Chinese film group Fundamental Films is to invest €60m in EuropaCorp has had little impact on the French film studio’s shares, says Investir.fr. Investors are nervous about the risks of big-budget science fiction film Valerian and the City of a Thousand Planets, which will be released in July 2017. But Fundamental Films is funding €50m of the estimated €200m budget, and with presales for cinemas and TV channels included, 92% of the funding is covered. EuropaCorp needs to show it can succeed with a US-style blockbuster of this type, but its current market capitalisation values its future productions (which include the next instalments in the popular Lucy and Taken franchises) at just €166m. Buy, with a price target of €5.5. Three to buy Daily Mail & General Trust Shares The Daily Mail & General Trust (DMGT) owns the Daily Mail, the Mail on Sunday and Metro, and a large B2B publishing operation, as well as a 31% stake in online property portal Zoopla. DMGT has invested heavily in MailOnline and other digital ventures and new chief executive Paul Zwillenberg – who has a background in digital media – is well placed to turn those investments into extra revenue and profit. 750p Provident Financial The Sunday Times Provident Financial dropped sharply after the referendum, but has since roared back, helped by the outlook for its Vanquis arm, which specialises in lending to people with difficult credit histories. Provident is wholly UK-focused, which looks like a disadvantage, but if the economy weakens and the big high-street banks pull in their horns there will be more space for Vanquis to expand. 3,190p Jimmy Choo The Mail on Sunday The luxury footwear maker has performed disappointingly in the US in the past year, but business in the Far East is booming. It will benefit from recent currency movements because the weak pound means its earnings abroad convert back into higher sterling profits at home. 139.75p Three to sell JPR Group The Times Investors are more confident in this financial services group – which was created by the merger of Just Retirement Group and Partnership Assurance – after encouraging half-year figures and assurances that the group will achieve promised cost savings. But the share-price recovery looks complete and the shares are no longer good value. Avoid. 142p Greggs The Times The latest trading update contains nothing to worry investors in this baker. The firm has moved into the fast-growing food-to- go market and is opening new stores at a rate of about 70 a year. However, inflationary pressures are now building up for raw materials, which could bring problems down the line. With shares trading at 18-times earnings, there is little upside. 1,051p ITE Group The Times The exhibition and conference organiser is exposed to the trouble spots of Russia and Turkey. A recent trading statement reported that revenues were stable, but the weakening pound disguised an 8% like-for- like fall in the underlying figures. This may be the nadir for ITE, but on a price/earnings ratio of 15 times, the shares are not worth buying. 156.75p Buys A.G. Barr The soft-drinks maker has a strong balance sheet and valuable brands. (Shares) 508.5p AstraZeneca Dividends are paid in dollars so will gain from sterling’s weakness (Times) 5,025p BAE Fears over delays to defence orders from Saudi Arabia are overdone (Times) 537p Burford Capital Management at the litigation-finance group has a solid record (Investors Chronicle) 415p CRH The materials group is reaping the rewards of recent acquisitions (IC) 2,578p DFS The furniture retailer is cheap on a price/earnings ratio of 12 (Times) 273.25p Hastings Group The firm’s motor-insurance operation is well placed to add customers (Times) 223p National Grid Low rates make this utility’s secure income stream attractive (Daily Telegraph) 1,058p Paragon Group There is undeniable growth potential at the challenger bank (Times) 318.5p Regional Reit This Reit owns property outside London, which offers higher yields (Telegraph) 103p Secure Income The property company’s dividend should continue to grow (Times) 310p Swallowfield The cosmetics manufacturer is now developing its own range of brands (IC) 270p Topps Tiles Investors are nervous, but recent share-price falls now look overdone (Times) 101.75p Zotefoams The specialist foam maker has good prospects despite a weak first half (IC) 258p And the rest horns there will be more space for Vanquis to expand. Jimmy Choo The Mail on Sunday The luxury footwear maker has performed disappointingly in the US in the past year, but business in the Far East is booming. It will benefit from recent shares 11 MoneyWeek’s comprehensive guide to this week’s share tips
- 12. MoneyWeek 14 October 2016 moneyweek.com A debate about success Trump claims that he took a $1m loan from his father and turned it into a $10bn empire. In fact, that’s an example of semi-truthful hyperbole. He joined the business in 1968, inherited control of it in 1971, and then inherited $40m in cash from his dad in 1974. In 1978, Business Week put his net worth at $100m. Had he invested that in an index fund tracking the S&P 500 – the kind many Americans use to save for retirement – he would today be worth $6bn. That’s quite an underperformance – and at the same time, says Robert Reich, the economist who served under Ford, Carter and Clinton, Trump has benefited from about $850m in tax subsidies in New York alone. This is “not a businessman”, says Reich. This is “a con man”. A curious mix of skilful and utterly reckless 12 briefing Is Donald Trump really a billionaire? Probably, although it’s hard to be sure. The Republican candidate for the US presidency has defied convention and refused to release his tax returns. He may well have paid no income tax for the past 18 years after registering a near-billion dollar loss in the mid- 1990s. However, Trump did have to file a “personal financial disclosure” with America’s Federal Election Commission in July 2015, when he decided to run for the nomination. The press release with this 92-page document states that “as of this date Mr Trump’s net worth is in excess of TEN BILLION DOLLARS [his capitals]”. He also revealed that his 2014 income was $362m, “which does not include dividends, capital gains, rents and royalties”. So he’s worth around ten billion? Not according to numerous journalists who have examined the claim. According to Fortune, which has repeatedly challenged Trump’s claims about his own wealth over many years, the $362m figure is in fact Trump’s overall revenues (ie, before deducting any costs), not his income. After making extremely generous assumptions about everything from rental yields to stockmarket dividends to the value of Trump’s personal brand, Fortune estimates a pre-tax income for Trump’s businesses (which are in real estate and leisure) of $166m. Assuming his businesses are worth 20-times earnings, that puts Trump’s overall worth at around $3.3bn. Bloomberg estimates it at $2.9bn. Still pretty wealthy then? Absolutely. But the bizarre thing (or one of them) about Trump is his desperation to over-egg his own status. “He lives to see his name praised in the press”, a former business associate told Fortune this year. “When it comes to choosing between getting more publicity and making good deals, I’d say it’s a tie.” On top of genuine success in New York real estate (and plenty of flops in other areas), Trump has dedicated his life to building what The Washington Post once called “an architecture of self- aggrandisement”. To be fair to Trump, he appears to recognise this. “I play to people’s fantasies,” he wrote in his 1987 book The Art of the Deal. “I call it truthful hyperbole. It’s an innocent form of exaggeration – and a very effective form of promotion”. Is he a good businessman? He’s a curious mixture of skilful and utterly reckless. Trump has made much in the election campaign of his status as a billionaire who will get things done. But his business record is decidedly mixed. His main claim to fame (other than his role playing himself on The Apprentice) is as a Manhattan real estate developer – a profession he inherited from his father, Fred. His flagship projects include Trump Tower on Fifth Avenue, Trump Tower in Chicago, and his Trump Organization owns buildings, hotels and golf courses around the world. Yet despite his talent for self-promotion, Trump has always been a “relatively minor player”, according to The New York Times. He has never been ranked among the top-ten developers in the city, and of the dozen buildings in New York that bear his name, nearly all are branding relationships; he doesn’t actually own them. Still, most analysts agree he’s a canny property developer – and an effective manager of others’ developments – who has benefited from a booming market over several decades. What about other businesses? Here’s where it gets much messier. Trump’s dealings in hotels and golf courses appear successful (his companies are privately held, so details are scarce). But forays into other areas – including casinos, airlines, and professional football – have ended badly. In the 1990s, Trump’s entanglements in casino development and ownership led to four separate bankruptcies, which to this day (according to The New York Times) mean that Wall Street banks are hesitant to lend him money. “I think he’s very good at real estate, I don’t think he’s very good at other things,” according to his biographer Michael d’Antonio. “He tried to run casinos and failed four times. That’s not evidence of brilliance when it comes to operating a complex business.” What about Trump University? The so-called Trump University – in fact a series of property development seminars that separated students from their cash with savage cynicism – is the most prominent of the Trump brands to have attracted negative attention during the campaign. But Trump has also put his name on everything from steaks and ties to bottled water and perfume. Opinions divide on whether all this makes him a canny operator or not. On the one hand, why is a billionaire getting mixed up in a seminar scam that could only end up trashing his brand? On the other, since his low point in the 1990s, he does appear to have sworn off taking on large amounts of debt, and instead used his brand to collect licensing fees on multiple projects in addition to real estate. If his brand does not now take him all the way to the White House, some speculate that his real plan is to leverage his political brand into some form of new, right-wing media empire. Trump TV? It may be just weeks away. Playing to people’s fantasies ©Alamy The GOP candidate for US president is a publicity seeker of note who admits to using “truthful hyperbole”. This run might be a really effective way of boosting his brand, says Simon Wilson briefing XX
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- 14. MoneyWeek 14 October 2016 moneyweek.com Money talkThe Federal Reserve’s policy of low interest rates is “dangerous”, says Martin Feldstein. “Notwithstanding talk of a ‘non-recovery’, rising asset prices have lifted household wealth to an all-time high,” fuelling consumer spending, faster GDP growth and lower unemployment. Meanwhile, investors have turned to equities, long-term bonds, commercial real estate and other riskier assets in search of yields, pushing prices to “unsustainable levels”. Fed Chair Janet Yellen is concerned that normalising rates would cause these prices to fall, dragging the economy down, but the longer the Fed waits, the more damaging the eventual decline. Unusually low rates are also causing lenders to loosen lending criteria. If an asset-price correction causes an economic decline, “these high risk loans will suffer and… lenders will be in trouble”. The current low bond rate has removed the pressure to deal with budget deficits, but as debt grows, so will the cost of servicing it, and the tax burden will rise. The Fed must raise rates now. “Women are often forced to be held in the ideal of what a male audience wants. They have to be pretty, likeable. I hate the word ‘likeable’. I hear it all the time in Hollywood, and I don’t care if I’m likeable or not.” Actor Emily Blunt (pictured), quoted in The Sunday Times “Hillary is probably the most overqualified person ever to run for the presidency. Women have to get up an hour earlier and have many more degrees after their name just to be considered.” Former Vanity Fair editor Tina Brown, quoted in the Evening Standard “A big part of not having money as a kid isn’t that you haven’t the stuff you want… [you worry about your parents’ anxiety]… but I’m grateful...it gave me a... good work ethic.” Actor Sarah Jessica Parker, quoted in The Observer “Where else but in America can you turn your life around in one generation, going from nothing to worrying about your kids being too spoiled? But they see where I’ve come from and they’re pretty grounded.” Actor Mark Wahlberg on refusing to indulge his children too often, quoted in the Evening Standard “The inherent vice of capitalism is the unequal sharing of blessings. The inherent virtue of socialism is the equal sharing of miseries.” Winston Churchill, quoted on Forbes.com Why the Fed must raise rates now Martin Feldstein The Wall Street Journal 14 best of the financial columnists ©RexFeatures Some falsehoods are “so near the truth that they convince and are widely believed”, says Jake Van Der Kamp. In the run-up to the Brexit referendum, Martin Schulz, the president of the European Parliament, reportedly said that “it is not the EU philosophy that the crowd can decide its fate”. He never said those words – yet he might as well have done, as they neatly encapsulate European ideas of “relations between the governing and the governed”. People believed it because it is true. Brexit is “not an expression of arrogance, ignorance and nostalgia but of fundamental differences from the EU on the nature of the rule of law, democracy and personal liberty”. The EU is “distinctly non-democratic”. Worse, those in charge are inept, as shown by their failure to stimulate growth. The British may be seen as rats for leaving, “but let’s have it straight that the ship is indeed sinking and the crew will do no more than sing ‘Nearer my God to Thee’ as they lead the passengers under the waves.” Better to be the rat than drown. Britain is right to flee the EU Jake Van Der Kamp South China Morning Post Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble promised that taxpayers would “no longer have to rescue banks”, says Jan Hildebrand. Shareholders and creditors would be called upon to make sacrifices before the state stepped in to help. This was controversial, with people concerned that creditors would withdraw from financing European banks. So it’s no wonder that attempts have been made to bend the rules, notably in the current crisis at Deutsche Bank (DB). But, for markets, DB’s problems are “a test of whether the federal government will keep to the rules it insisted on” or whether in an emergency it “will issue state aid without creditor participation in order to calm the situation”. The stakes are high. If Germany sets a bad example, that would send “a devastating signal” to citizens who remember the promise that they would not be the first to pay. It would also deal a blow to the long-term stability of the financial system, since it would be an invitation for the industry to “keep on gambling”. Germany must not bail out DB Jan Hildebrand Handelsblatt Global The UN’s Green Climate Fund (GCF) was set up in 2010 as part of a pledge to mobilise $100bn a year by 2020 to help developing countries cut climate emissions and cope with climate change, says The Economist. Last year, after “coaxing” $10.3bn from governments, the GCF started operations; its first investment – a solar electricity scheme in Rwanda – is finally up and running. Few of the 17 projects it has approved, however, “are transformational”. Part of the problem is that, “with one eye on future fund-raising”, the board has set an ambitious target of approving $2.5bn of investment this year, and so is “waving through” every proposal. Another issue is who run projects. The GCF channels money through “accredited entities” including big banks. This is controversial, but small institutions can’t cope. The GCF has potential, but it must sort out its processes and “if it is to have any point, it must go where the World Bank or private money dare not”. A slow start for the UN’s climate fund Editorial The Economist best of the financial columnists XX
- 16. MoneyWeek 14 October 2016 moneyweek.com How much could Brexit cost? Draft cabinet papers leaked to The Times this week warned that a “hard Brexit” could cause the economy to shrink by 9.5%, writes Emily Hohler. Hard Brexit implies Britain leaving the single market and having to rely on World Trade Organisation rules for trading with the continent. The document says that after 15 years, trade and foreign direct investment would be “around a fifth lower” and public sector receipts would be up to £66bn a year lower. What rot, says Tim Worstall in Forbes. These figures belong to “Project Fear”. The Treasury assumes that if we leave the EU we could “put up our import tariffs”, which of course we wouldn’t, because doing so would be “entirely insane”. Patrick Minford, Vidya Mahambare and Eric Nowell, on the other hand, worked out a decade ago what would happen if we left the EU and followed a “sensible trade policy”, and found that we would get a 3% or so boost to GDP. The prospect of hard Brexit is still alarming, says Andrew Rawnsley in The Observer. Look at sterling. Investors are waking up to the prospect of Britain “lurching out of the EU without reliable access to her most important markets”. May has announced that Article 50 will be triggered by April 2017. Once she triggers Article 50, she has two years to negotiate a new deal. The danger, says Gideon Rachman in the FT, is that before one is ready, Britain will be out of the EU and “face tariffs on manufactured goods and the loss of ‘passporting’ rights that allow financial services firms in the City to do business across the bloc”. Betting on politics by Matthew Partridge The audiotape of Donald Trump boasting about groping women seems to have put paid to his chances of becoming US president. While other politicians have managed to get away with sleazy behaviour, sexual assault is something else entirely. With nearly a month still to go, it’s also likely that worse revelations will emerge. Even if they don’t, the stampede of Republicans running away from him, Trump’s deficit in the polls and the huge lack in both organisation and fundraising present insurmountable obstacles. Nonetheless, the markets are still offering 1.18 (84.7%) on the Democrats retaining the White House. If you haven’t bet on this market before, this is probably the last decent opportunity you’ll get. But I wouldn’t suggest that you follow the example of the punter who bet €550,000 on Hillary with William Hill, since putting that much on a single bet is poor money management. I make it a rule never to double down on a bet that I’ve made, whatever happens (closing bets is obviously another matter). The big remaining question is how this scandal, and Trump’s decision to descend into the gutter by attacking Hillary for her husband’s alleged misbehaviour, will affect turnout. The University of Virginia Centre for Politics admits to being “torn” on this issue, with early voting data giving “mixed indications”. I’m sticking with my bet that turnout will be between 50%-62%, a level not breached since the 1960s, which you can get on Betfair for combined odds of 73%. Last week, Home Secretary Amber Rudd unveiled a raft of new measures, including making it unlawful to rent property to illegal immigrants and making companies publish the numbers of foreigners that they employ. At the same time, Theresa’s May’s conference speech also promised to slash the inflow of people coming to the UK. Good news, says the Daily Mail’s Peter Oborne, who approves. Immigration “means cheap and efficient domestic service” for the “Chipping Norton set” and “cheap labour” for “the big corporate bosses”. However, “many ordinary people” have paid a “heavy price in job insecurity and living standards”. What nonsense, says the FT’s Martin Sandbu. Immigrants don’t stop locals getting jobs. Studies have found “no correlation between changes in immigration and changes in native pay or employment by location”. One suggests that “nearly one in two recent migrants were in the highest educational category, compared to one in four of the UK-born population”. In any case, “it’s not as if British workers don’t have jobs”, since “the unemployment rate is 4.9% and the share of Britons in work has never been greater”. So much for the PM’s boast that we are “open for business”, says Simon Jenkins in The Evening Standard. The government is now telling the world to “get lost”. This is “mad”. Politically, however, this is a shrewd move, says Daniel Hodges in The Mail on Sunday. The immigration crackdown is aimed at bridging the “lethal chasm between voters and the political class”. Despite “cries of anguish” from the “salons of Islington” the policy is strongly supported in the “pubs, supermarkets and school gates of middle Britain”: 60% of voters approved of Amber Rudd’s push to shame firms who supposedly employ too many foreigners. So it’s a push for the centre ground. The proposals are yet another example of how May is offering “a ‘Red Tory’ brew”, adds Anne McElvoy in The Guardian. This comprises not just economic nationalism, but also a “grab at left-of-centre themes of discontent about under-addressed market failures” – witness her cry for “tax justice”, which “recalls a slightly smug Ed Miliband”. Then there’s the rhetoric designed to highlight “compassionate conservatism”, including the statement that there is more to life than individualism. How much of all this survives the inevitable squabbles over the “Brexit recipe”, however, remains to be seen. May offers a Red Tory brew ©RexFeatures 16 politics & economics Amber Rudd: pushing for a crackdown on immigration politics & economics XX by Matthew Partridge
- 17. moneyweek.com 14 October 2016 MoneyWeek How can we persuade Putin to stop the bombing? Russia’s continued bombardment of Aleppo continues to generate international anger, writes Matthew Partridge. During Tuesday’s parliamentary debate on Syria, the Foreign Secretary Boris Johnson said that he “would certainly like to see demonstrations outside the Russian embassy”. Beware, says The Guardian’s Mary Dejevsky. “Unleashing your own crowds on someone else’s embassy is tantamount to an invitation to someone else to unleash their crowds on yours.” Still, the real fault lies with MPs, who rejected action against Assad in 2013. This “arguably opened the way for the desperate situation in which eastern Aleppo finds itself today”. The “atrocity unfolding in what was once Syria’s biggest city ranks with the worst of the past century”, according to The Times. A no-fly zone, as some are calling for, could lead to “a rapid escalation to full-scale war with Russia in the event of a confrontation between Nato and Russian aircraft over Syria”. “That does not mean that the West is powerless.” War crimes have no statute of limitations; the longer Putin and Assad bomb, “the longer the indictments drawn up against them by international prosecutors are likely to be”. However, despite their words, Britain and the US seem to have “little appetite for becoming too involved in Syria’s complex civil war”. The “chronic absence of Western leadership” has convinced the Russians that “they, together with their pro-Assad allies in Damascus, can do very much as they please”, says The Daily Telegraph’s Con Coughlin. However, the West “could still bring a halt to the carnage around Aleppo simply by proclaiming the area to be a civilian safe haven, and daring the Russians to continue at their peril”. Russia might not like this, but since it “has nothing but contempt for international law, then it can have no complaints when the rest of the world chooses to ignore its objections”. Even if shooting down Russian jets seems too risky, targeting Assad’s helicopters “would at a touch reduce civilian deaths by around 90%”, argues Hamish de Bretton-Gordon in The Guardian. They drop illegal barrel bombs loaded with napalm and chemical weapons, and “nobody could argue” that they “are precision strikes to kill terrorists”. Overall, “it is time for Britain to stand up and show that Putin’s desire to turn Aleppo into a modern-day Stalingrad will be tolerated no further”. Donald Trump is poised to revert to the “bare-knuckled campaigning that won him the Republican nomination”, say Courtney Weaver and Demetri Sevastopulo in the FT. A day after House speaker Paul Ryan’s public announcement that he was no longer backing his candidacy, Trump broadcast a series of tweets describing his party’s most senior official as “weak and ineffective” and rejoicing that the loss of “party restraint” meant he was now free to go after Democratic rival Hillary Clinton. “It’s so nice,” he wrote, “that the shackles have been taken off me and I can now fight for America the way I want to.” Republican support for Trump has evaporated since the release last Friday of a video in which Trump boasts about “grabbing women by the p***y”. Trump initially dismissed the comments as “locker room banter” and issued a video apology, but leading Republicans have abandoned him in droves: 160 have now declared that they will not support him. These defections are “particularly galling” since the video “showed us nothing new about Trump”, says Andrew Rosenthal in The New York Times. He’s been insulting women all year, along with immigrants, Muslims, gay Americans and the disabled. What the Republican leadership don’t like is not so much Trump’s “fringe views”, but his way of expressing them. They are walking away because he has become what The Atlantic’s Ronald Brownstein calls a “political black hole for the party”. His debate performance – a vicious affair in which he attacked Bill Clinton for his treatment of women and said Hillary would be in jail if he were president – shored up his core support, says Jason Riley in The Wall Street Journal. But the fact that this needed doing a month before the election is a “problem”. Trump’s core supporters don’t make up a majority of the electorate. While Trump took to feuding with the GOP establishment on social media after the debate, Clinton released advertisements highlighting her growing support among independents and disaffected Republicans. According to a new WSJ/NBC News poll, Clinton is now leading by nine percentage points among likely voters. This is an “absolute worst-case scenario” for Republicans, says Chris Cillizza in The Washington Post. Republicans knew that this version of Trump – “angry, cornered, vengeful, selfish” – existed when they backed him as their nominee, but they thought they could control him. What appears to be happening is the Breitbartization of Trump’s campaign (Steve Bannon, Trump’s campaign chairman is CEO of conservative news website Breitbart). He is “adopting a strategy of full-on attack against anyone who doesn’t see the world as he does” and “effectively turning the guns on his own troops”, a move that will result in “near-certain carnage for lots of Republicans”. Had Trump’s poll numbers sagged then as they have now, “extricating themselves from the dumpster fire might have been painful, but it was possible”. Any real distancing from him now will be hard. Trump is not only losing the presidential race, but jeopardising the Republican control of the House and Senate. “The disaster scenario – an electoral college wipeout, losing the Senate and the House – now has to be on the table.” The GOP’s worst-case disaster scenario ©PressAssociation politics & economics 17 Trump is said to be adopting a strategy of full-on attack politics & economics 17 by Emily Hohler
- 18. MONEYWEEK 14 October 2016 moneyweek.com The high-tech credit card combating fraud Bank-card fraud has become a huge global problem in recent years, thanks in part to the rise of online shopping. Credit-card fraud in Britain alone came to £755m last year, according to Financial Fraud Action UK. But a technology called Motion Code from French digital security firm Oberthur Technologies could make life harder for fraudsters. How does Motion Code work? On the reverse side of every credit card, next to the signature box, is the card verification value (CVV) – a static three-digit number you input whenever you buy something with your card online. With Motion Code, that three-digit number is constantly changing at random on a tiny digital display powered by a very thin lithium battery with a three-year lifespan. This means that if criminals get hold of details of a Motion Code-equipped card by using “skimmers” – devices fitted onto cash machines that “skim” the data off your card’s magnetic strip – or other means, they won’t know or be able to guess the CVV. Of course, a randomised CVV number won’t help you if your physical card gets stolen. And you won’t be able to memorise your own CVV so that you can pay online without having the card to hand. But that might be a small price to pay to keep your card details safe. In France, where the cost of card fraud stood at €395.6m in 2014, banks BNP Paribas, Societe Generale and Groupe BPCE have trialled the Motion Card on a sample pool of customers, in preparation for a wider roll-out that may begin later this year. Pilot schemes are also under way in Poland and Mexico, and British banks are in talks with Oberthur to bring it to the UK. “In some ways, it’s surprising it has taken so long for this to appear,” Prof Alan Woodward, a cybersecurity expert from Surrey University, told the BBC. “The technology has existed for some time so now it will be a case of persuading card processors that it is worth doing.” 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 Administered,housing and commodity prices Private sector goods and services (ex-fuel & light) Private sector goods and services Decomposition of UK retail price inflation Annualinflationrate(%) moneyweek.com 18 opinion The notion that grindingly slow economic growth will be accompanied by long-term stagnation in consumer prices has had a powerful grip on the bond market. Throw in the demographic and technology arguments, and the “new normal” crowd reckon that a future of low or no inflation is a slam dunk. Then came Brexit and an abrupt 13% depreciation of Sterling. How have the new normal crowd reacted? It is no surprise that their instincts are to downplay the inflationary impact of Brexit. They expect headline consumer price index (CPI) inflation to rise only moderately over the coming year, touching 2% at worst and averaging only 1.5% for 2017. Sluggish domestic demand will open up a large output gap and exert disinflationary pressure. Weakness in core goods and services prices will counteract the partial recovery of the oil price, and the impact of the drop in sterling on import prices. Those of us with long memories tend to take a very different view. The UK has been one of the most inflation- prone countries in western Europe over the past 25 years. Our 20th century peak inflation rate was 25% a year, in 1975. We managed double-digit CPI inflation as recently as 1990. The UK is heavily dependent on imports across a wide swathe of manufacturing sectors, susceptible to bouts of money madness and protective of oligopolies in consumer-facing sectors such as megastores and car dealerships. Ripping off the punter is a national sport. A decomposition of the retail price index (RPI) shows private sector inflation (excluding fuel and light) rebounding over 3% – see the grey line on the chart to the right. We prefer the old RPI measure for this analysis because it includes housing. The chart shows that UK inflation remains elevated in comparison with the 1992-2007 period. The global financial crisis marked the beginning of a new era of erratic, generally higher UK inflation, because the crisis weakened domestic competition and allowed the profitability of the service industries to soar to new heights. In common with other advanced economies, headline CPI inflation flirted with negative inflation last year under the full force of the energy price collapse. But the starting gun on inflation normalisation was fired in May 2016 and over the next 12 months, the bias will be to an annual increase. The new normal crowd are dismissive of normalisation and Brexit-related pressures, which they expect to be muted and temporary. Yet we can observe already a substantial impact on imported inflation in the July and August producer price inflation data. Based upon the historical relationship between import inflation and CPI inflation for non-energy industrial goods, headline CPI inflation should move up by 1.5 to 2.0 percentage points from its current 0.6% by mid-2017. For RPI, the implied shift is from 1.9% currently to around 3.5% by mid-2017. Lower forecasts for inflation suggest a marked degree of compression in companies’ profit margins. Our sympathies are with the conventional view of producer-price inflation being passed through to higher consumer prices. Any output loss from Brexit is likely to be gradual and cumulative over the next three years, not sudden – so the domestic economy should not suffer an “air pocket” effect and resulting disinflationary effects. Anyway without an initial post-referendum output and spending slump, there is no justification to expect prices to drop sharply. UK inflation break-evens – the inflation rate implied by the difference between the yield on nominal UK government bonds and inflation-linked ones based on RPI – have risen in anticipation of the changing landscape. However, they have still risen by too little properly to reflect the higher inflation coming our way. Peter Warburton is the founder and chief economist of Economic Perspectives Inflation forecasts are wishful thinking opinion XX Inflation forecasts are wishful thinking Peter Warburton
- 19. The Week_Classic advert_OL.indd 1 07/10/2016 11:25
- 20. MoneyWeek 14 October 2016 moneyweek.com Europe’s gender pay gap Executives at some 8,000 companies with over 250 employees are poring over spreadsheets ahead of new rules that will force them to publish by April 2018 any pay disparities between men and women. That should give female workers a little extra leverage when it comes to seeking equal pay with their male colleagues, says Stephanie Baker on Bloomberg.com. Taking her cue from David Cameron, Prime Minister Theresa May has vowed to fight the “burning injustice” that means “if you’re a woman, you will earn less than a man”. In Britain, women earn 19.1% less on average, compared with 16.4% less across the European Union, according to Eurostat data from 2012, as the map shows. Should you pay for your funeral in advance? Pre-paid funeral plans allow you to pay up front for your send-off – either in a lump sum or monthly instalments – to take the strain off your friends and family when you pass away. They offer a number of benefits. First, they guarantee you a service regardless of any price increases – which may be a plus, given that funeral prices are currently rising faster than pensions, prices or earnings. A simple, no- frills cremation plan with the Co-op currently costs £2,945 – much less than the £3,897 average. They also allow you to choose the send-off you want, specifying your preferences in details such as music, flowers and the coffin. However, think carefully before buying a pre-paid funeral plan. Check the small print: many of these deals have costly exclusions. Some only put a contribution towards burial costs, while others have a limit on how far they will travel to collect the body. Any funding gaps may have to be filled by your estate, or friends and family. If you choose to pay in monthly instalments, take into account interest payments that can significantly bump up the total cost. You should investigate exactly what the plan includes, and compare this to the cost of organising all aspects separately (bearing in mind that the prices are likely to rise). You may find that a more DIY approach will work out cheaper overall. For example, you could drip-feed a monthly sum into a savings account that you set aside solely as a dedicated funeral fund. Banks usually release money early from an estate to pay for funeral costs if you provide a copy of the death certificate and an itemised account from a funeral director. It may sound morbid to think about the cost of a funeral, but dying is an increasingly expensive business. The cost of a funeral has risen by 103% since 2003, according to research from insurer SunLife. It will now set you back an average of £3,897, pushing up the overall cost to £8,802 per person. Funeral directors are a large part of the cost, at an average of £2,411. They’ll deal with all the arrangements – organising the funeral, storing the body of the deceased, handling all the paperwork, and arranging the coffin and hearse. You can also expect to shell out hefty burial and cremation fees. The average burial costs £1,950, although this can shoot up to £4,700 in London, while a cremation costs roughly £733. Of course, these costs don’t account for additional expenses, such as doctor’s fees, minister’s fees, a reception, or probate charges. So what can you do to keep funeral costs in check? It may sound obvious, but remember to shop around. While hospitals may recommend using a particular funeral home, this is by no means mandatory. The two biggest chains – Co-operative Funeralcare and Dignity – make up 30% of all funeral parlours in Britain, according to The Guardian, but you may well save money by going to a smaller firm. If you’d like to avoid using a funeral home altogether, it’s possible to arrange a DIY funeral. This involves taking on all the jobs usually handled by a funeral director, but is likely to reduce costs significantly – although many people may not want to take on all this responsibility at such a difficult time. Another option is to consider a direct burial or cremation. This means that the body is taken straight from the hospital or home and buried or cremated whenever there is space in the schedule. Families can then plan their own ceremony separately. This costs less than a traditional funeral, at roughly £1,600. A number of organisations offer woodland burial plots, which may work out significantly cheaper than a traditional cemetery. Lastly, it’s possible to avoid burial or cremation costs altogether by donating your body to medical science. The soaring cost of funerals 20 personal finance by Natalie Stanton personal finance XX Choose a smaller funeral firm to save costs ©iStockphotos 14.4% Ireland 16.9% Netherlands 22.4% Germany 6.4% Poland 22% Czech Rep 23.4% Austria 20.1% Hungary 18% Croatia 9.7% Romania 14.7% Bulgaria 15% Greece 19.1% UK 14.8% France 17.8% Spain 15.7% Portugal 6.7% Italy 15.9% Sweden 19.4% Finland 30% Estonia
- 21. moneyweek.com 14 October 2016 MoneyWeek Pension news round-up n The Pensions Regulator should have more powers to intervene in mergers and acquisitions transactions involving firms with final salary pension schemes, the watchdog’s CEO has told the BBC. Lesley Titcomb, whose organisation has faced criticism for its failure to deal with the pension scheme crisis at BHS, where a £600m pension fund deficit emerged after the retailer was sold and subsequently went under, argues that there is currently no requirement for companies to tell the regulator in advance about transactions. Nor does the regulator have any powers to intervene in a deal, even where pension benefits look vulnerable. “We may need new powers in certain situations,” Titcomb said. “Where a company is being sold and the scheme is significantly underfunded, it may be appropriate for the regulator to be told in advance about the transaction, and it may be appropriate for us to have the power to intervene in some way, which we don’t have at the moment.” n Asset managers investing money on behalf of workplace pension schemes will have to be more transparent about their fees under new regulations proposed by the Financial Conduct Authority (FCA). The FCA wants asset management firms to provide data on costs in a much more transparent and consistent fashion, amid complaints from pension scheme trustees and governance committees that they often receive little information about the fees that their investment managers are levying for activities such as buying and selling assets. The Transparency Task Force, a campaign group, has claimed that asset managers routinely charge pension schemes for up to 200 different types of cost without providing any detail. n Reforms to encourage pension schemes to invest more in key infrastructure projects could be a key focus for next month’s Autumn Statement, according to a report in The Sunday Telegraph. The Chancellor, Philip Hammond, is understood to be working on reforms that would make it much easier for pension schemes to invest in energy projects, transport initiatives and technology infrastructure. Hammond believes the reforms could deliver vital new capital for such projects while providing pension scheme savers with access to an asset class offering potentially attractive long-term returns. Are inflation-linked annuities good value? A 65-year-old man in good health living in the southeast of England with a pension fund worth £100,000 might currently expect to obtain a level annuity income of £3,501 a year, assuming he also takes 25% of his savings as tax-free cash on retirement, according to the Money Advice Service. However, adding inflation protection to the annuity contract – guaranteeing his income rises in line with prices each year – would reduce the starting income to £2,072. Which annuity product works out to be best value will depend on how long the man lives and how inflation changes over time. The Office for National Statistics says the typical 65-year-old man can currently expect to live for a further 19 years. At the current 0.3% of inflation, the inflation-linked annuity will be a significantly worse deal: after 19 years, it would still only pay £2,186 a year, by which time someone on a level annuity would have received almost £27,500 in additional income. Even if inflation were to run at 2% in future – the Bank of England’s target rate – the inflation-linked annuity would still pay less, only £3,017, by the time the man turns 84. By then he would have missed out on a total of £19,700 worth of pension income. If inflation runs at 5% a year, however, our 65-year-old man would be receiving a pension worth £5,233 at age 84, and would have received more pension income in total by his eighty-fifth birthday. The exact figures will vary according to factors such as health, gender and age, but the lesson is that inflation-linked annuities only offer value if inflation rises significantly higher than today’s unusually low levels. Should struggling company pension schemes that have offered guaranteed levels of retirement income to their members be allowed to drop a promise to protect them from inflation? Frank Field, the veteran Labour MP who chairs the House of Commons work and pensions select committee, says the cross-party group will debate exactly this. The idea would be to lighten the burden for around 6,000 defined benefit company pension schemes that collectively provide pensions to 11 million current and future pensioners. In most cases, these schemes raise pensions- in-payment each year in line with the change in the consumer price index (CPI) or the retail price index (RPI), or at least by a minimum percentage that is linked to inflation. Trustees are rarely allowed to cut back on this guarantee. Field’s argument is that with company pension schemes suffering huge funding issues, particularly as bond yields have fallen, employers could be forced to fall back on the Pensions Protection Scheme, which protects savers where a scheme is unable to make good on its promises. The MP fears this would see many members even worse off than if they lost their inflation protection. By contrast, giving trustees more discretion to vary the inflation link might help employers cope with pension-scheme costs. The debate will focus on the cost of inflation protection, which tends to be expensive, even though UK inflation currently stands at almost zero. But the discussion will also be of interest to anyone with private pension savings, since they too have the option of buying inflation protection on retirement if purchasing a guaranteed annuity income. In fact, the merits of doing so look highly questionable at the moment. The cost of building annual inflation-linked increases into your pension income is so high – in terms of the lower starting income you must then expect – that inflation would have to rise substantially to make it worthwhile. Against that, however, inflation-proofing does offer peace of mind – certainty that however high inflation rises, your pension’s purchasing power won’t be eroded. MP: let schemes ditch CPI link pensions 21 by David Prosser pensions 21 Frank Field: let trustees vary the inflation link ©RexFeatures
- 22. MoneyWeek 14 October 2016 moneyweek.com I first mentioned Charles Heenan and his new firm Kennox Asset Management in print back in January 2011. At the time his fund – the Kennox Strategic Value Fund – was tiny and his record short. But my interest had been caught by the fact that his seed investors included the rather wonderful Angus Tulloch of First State, alongside several other very good investors. His performance record over his first few years on the job wasn’t bad either. We should take note, I said. Heenan was holding the things we should all be holding – “solid companies at reasonable prices” – and working on the very sensible principle that “if you can protect your capital when the markets fall, longer-term performance over the cycle will be good even if you give some ground up when the markets run”. I hope some readers did take note. The last couple of years were dull ones for value funds, but look at the longer term and his fund is doing well. The annualised return since inception is 9.4% (it was up 30% to the end of September this year) and it isn’t particularly small any more (it has around £200m under management). So what’s going right? The key, he says, is to stick to what works. “We are value investors... that means price matters... we really do believe that if you pay too much for an asset, it’s a huge risk.” He believes in quality – and won’t buy low-grade companies just because they are cheap. Doesn’t that make finding things to buy in markets such as ours hard, I ask. It does. “We have 29 stocks and the turnover is about 15%, which means we buy one to two stocks a year. In the last year, I’m afraid to say, we haven’t bought a single stock. So it doesn’t happen often. You have to be patient. We’re firm believers that it’s one of the hardest things to do... to wait for the great opportunities there”. I agree: too many managers feel a need to justify their position by trading even if they have to do so in the wrong stock or at the wrong price. Not Kennox: half the stocks in the fund now were in it in 2007. The ability to be inactive with confidence is often the thing that sets the good managers apart. That confidence was much needed in 2014/2015 when value stocks were very, very out of favour: anything cheap and anything with problems was ignored. A great example, says Heenan was (and is) Neopost, a smallish company that makes franking machines. Overall post might be declining, but parcels are growing and Neopost has 800,000 customers. Its earnings were under some pressure, but still “it’s a lovely little business”. Heenan bought shares in it on ten-times earnings: “there are not many quality companies out there with ten-times earnings”. Okay, a quality company on a price-to-earnings (p/e) ratio of ten is good value. How expensive does it have to get before it isn’t a value stock? Heenan will buy quality companies on up to 12 times what he considers to be their sustainable level of earnings (which implies returns in the high single digits), but “we find it very hard to hold anything over 20. So in the high teens, we get nervous”. Johnson & Johnson was an example: Kennox held it in 2008/2009, but as its price rose from 11-times earnings to 18 times, they started to sell: “at some point, you say, ‘Actually, now, we just think it’s time to go’”. This is hard: it is very easy to hang on to good performers just because they are going up. “We struggle with that,” he says. You have to sell when things get expensive, but not too early or to have a high turnover. Remember that industrial cycles last seven years and firms in infrastructure or oil will be making 40-year investments. “Market trends last longer than you think.” We move on to the markets. At the MoneyWeek conference last week I introduced our speakers as either optimists or pessimists. Had Charles been there, he would have been the latter. “I am,” he Patience pays for value investors 22 the moneyweek interview The secret of success? Stick to what works, buy cheap, hold out for quality and – above all – bide your time, Charles Heenan tells Merryn Somerset Webb Heenan is keen on Newmont Mining – it’s properly diversified with a solid reserv “Too many managers feel a need to justify their position by trading, even if they have to do so in the wrong stock or at the wrong price”