Ensuring investments meet expectations for retirement

Scotsman Conference "Investment 2019" at The Principle Charlotte Square 05/03/19 Caspar Rock of Cazenove Capital

Two representatives from partner organisations of the event summarise their presentations given to delegates:

Mark Whitehead, Portfolio Manager of Securities Trust of Scotland

Living longer is forcing a dramatic change to how we financially plan for later life. If you are wondering how to fund a comfortable retirement there are three questions for you to consider – but also some simple solutions.

Firstly, can you afford to stop working? Research shows that not having enough money to retire is a common worry. One survey found that only 6 per cent of respondents definitely expect to have enough money in their final pension pot.

This is scarcely surprising. People are living far longer and this is putting significant pressure on retirement funds. According to a World Economic Forum report, the global savings gap between what people want to save and the final amount could rise to US$400 trillion by 2050.

The second question to be addressed is when can you take retirement? It is no longer black and white – either through necessity or choice, people are working past their retirement age.

There is now evidence of a “Grey Zone”, a period between a person’s early 60s and early 70s when they are still working. This group have some access to savings, but are not fully drawing down their assets – and, in fact, could still be adding to their pension. As a result, retirement income has to work differently. The simple two-stage process of accumulation and spend is no more.

The third question is where to look for income growth? Many of the traditional methods of accumulating wealth have also begun to lose their effectiveness.

Since the global financial crisis of 2008, the range of assets which provide the desired combination of attractive, sustainable and growing income has shrunk. In particular, the bond market was once the staple of retirement planning, but the falling yields – marginally above recent record-low levels – available from fixed-income asset classes have limited their use.

Nevertheless, there are answers out there. There remain higher-yielding, high-quality equities which can still deliver the necessary returns investors require as they approach retirement and when they finally leave work.

Over the longer term, equities have tended to outperform fixed-interest portfolios and a collection of investments built around quality, growing companies has the potential to provide an attractive, sustainable and growing income, as well as an element of capital growth.

At Securities Trust of Scotland, our objective is to deliver rising income and capital growth and there are a few core rules for stocks included.

Importantly, the stocks must be global. Political issues like Brexit remind us of the dangers of restricting ourselves to a single market, such as the UK or US.

As fund managers, a global remit allows us to “go anywhere” to find the world’s leading companies. Although investing in foreign markets does bring a measure of currency or political risk, it can be managed through effective portfolio diversification.

The stocks must also have quality. The companies should have certain characteristics, such as high returns on invested capital, which is a good measure of profitability and potential for value creation.

Lastly, the stocks should be sustainable. We look for companies that can provide durable dividend growth and subject any stocks included in a portfolio to extensive scrutiny to gain a greater understanding of their liquidity and capital structuring.

We stress-testing the dividend, modelling how it stands up to more challenging economic environments and examining how the company approaches environmental, social and governance factors, to ensure they are good stewards of capital.

There is no doubting the challenges for investors as they think about their retirement plans, but we believe there is a solution and quality equity income propositions, such as Securities Trust of Scotland, may be worth further investigation.

Caspar Rock is Chief Investment Officer at Cazenove Capital

Stocks and bonds have rebounded after a difficult 2018, which was a highly unusual year in investment. For only the third time since 1900, both equities and bonds delivered a return lower than cash.

Normally, when shares have a bad year, government bonds offer some respite. This was not the case last year. Concerns about US interest rates rising too far too fast meant investors sold both shares and bonds.

After such an unusual year, what can we expect for 2019? The good news is that both stock and bond markets have started the year on a much more positive note.

Both asset classes were buoyed by the Federal Reserve’s soothing words on interest rates.

Major equity markets have enjoyed the best start to the year in decades. Global equities, as measured by the MSCI World Index, rose approximately 8 per cent in sterling terms in the first two months of 2019.

The Fed has, for now, allayed concerns about the pace of interest rate hikes and the immediate political dangers that have weighed on markets may be easing.

However, while still positive, the economic backdrop is less supportive than it was and there are still significant political risks.

Schroders recently trimmed its global growth forecast for 2019 to 2.8 per cent, while making a small upward adjustment to its forecast for 2020 to 2.7 per cent. This reflects a recent slowdown in activity, with global trade volumes falling sharply at the end of last year.

We may see further disappointing data as firms run down inventories built up in anticipation of increased US tariffs on China.

However, we at Cazenove do not expect this slowdown to lead to a recession. We see a number of reasons why growth should stabilize this year and heading into 2020.

There have been encouraging signs of progress in the US-China trade talks and increasing hope that the US president and his Chinese counterpart will announce an agreement when they meet later this month. A deal will help support US growth in 2020 as the boost from higher fiscal spending dissipates.

However, even if a trade deal does materialize, the US and China are still at loggerheads over technology and we may yet see a “trade war” morph into a “tech war”.

Meanwhile, any Chinese agreement to buy more US products could lead to political tensions with trading parties squeezed out by the new arrangement.

It’s a similar story in the UK. It looks increasingly likely that we will manage to avoid a no-deal Brexit. Assuming this is the case, we envisage a modest rebound in UK business and consumer spending later in the year.

Yet it is unlikely that uncertainty over the UK’s relationship with the rest of Europe will be resolved any time soon and we expect this to weigh on Britain’s prospects.

Globally, the sharp fall in oil prices late last year should help support growth. Lower oil prices mean higher real incomes, particularly in the US where taxation on gasoline is low.

In addition to subsequent higher consumer consumption, rising real wages should help ease the political tensions that have been so apparent over the last few years.

The prospect of higher borrowing costs were a real concern last year. However, in January, the Fed said it would be “patient” about making changes to interest rates this year. We at Cazenove still expect one more increase in US interest rates in the current cycle. We have also pushed back our forecast for rate rises in the Eurozone and UK.

Cazenove portfolios have benefited from the rebound in global stock markets. However, equity valuations no longer look especially compelling. Having started 2019 at a discount to their 15-year average valuation on a price-to-earnings basis, global equities are now trading slightly above this level.

This doesn’t mean that equities can’t continue to rally. However, given we believe we are in the later stages of the business cycle, we think it makes sense to take advantage of improved valuations to reduce risk.

This will involve moving into less risky parts of the equity market and potentially reducing our exposure to corporate credit in favour of safer government bonds.

Cazenove is also increasing holdings of assets that have historically maintained their value during adverse market conditions, such as gold and cash.

Importantly, we will ensure that our portfolios remain well diversified. This is the best way to ensure that whatever the rest of the year brings, Cazenove portfolios should be able to deliver an attractive return without being fully exposed to any renewed volatility.