Hedging Against Brexit

As we edge towards an abrupt Brexit as agreement with the EU has turned into a game of chicken, it’s worth considering some options. Or as my M.P. Bob Neill said about divorce on Twitter “the current system of divorce creates unnecessary antagonism in an already difficult situation” (he was talking about personal divorce in the UK as head of the Justice Committee but our EU divorce is looking very similar – acrimony is the word for it).

Perhaps the Prime Minister will find a way through to a sensible settlement now she is reported to have personally taken charge of the matter. But as investors we should not rely on such a chance.

One solution is simply to move your share investments into companies that are listed overseas and do most of their business elsewhere than the UK. Don’t wish to buy overseas companies directly? Simply buy one of those “global” investment trusts or trusts focused on particular sectors – Europe, the USA, China, India, et al. Or ensure you invest in UK companies with large exposure to overseas markets other than the EU – there are lots of those.

One aspect that caught my attention this week was the suggestion that the UK should stockpile food and medicines to ensure there were no shortages. But taking food alone, fresh food does not generally keep for very long unless you have a refrigerated warehouse. Even then there are limits. As one supermarket chief was reported as saying in the FT today that it was “ridiculous” and showed “complete naivety”. The reason is simply that supermarkets and their suppliers operate “just in time” systems where deliveries often depend on overnight shipping of goods from Europe. Likewise car manufacturers and other engineering companies rely on complex supply chains that depend on the same “just in time” processes and very quick delivery times. There is a solution to this problem which is to store more items. Non-perishable goods can be stored for a very long time to provide a buffer to the flows of goods. One hedge tactic might therefore be to invest in warehousing companies – Segro and Tritax BigBox REITs come to mind (I own them), although Lex in the FT suggested today that “optimism is already baked in” to the share price of Segro after their interim results announcement. The share prices of those companies have been driven by the internet shopping boom where goods are held in warehouses rather than shops, and rapid delivery is essential. More warehouse demand caused by Brexit might add another wave of warehouse building and increase rents.

When it gets nearer the date next March for Brexit, perhaps we should be doing some personal hoarding of French cheese, Dutch salami and German sausages to guard against short-term supply chain disruptions, but I doubt I will be panicking. UK producers can gear up and many other suppliers in the rest of the world will suddenly find they are much more price competitive. Tariffs on imports of food from outside the EU can currently be very high (e.g. an average of 35% on dairy products which is why you don’t see much New Zealand or Canadian cheese in the shops lately – see https://www.ifs.org.uk/uploads/publications/bns/BN213.pdf for details).

That does not mean of course that food will be much cheaper as the UK Government might impose some tariffs to protect our own farmers, but you can see that it is quite possible that the supply chains will rapidly adapt once we are outside the EU regime. But long haul supply lines will require more warehousing and more dock facilities.

Or our Government could take the Marie Antoinette approach to food shortages – “let them eat cake” she said, or “let them buy British products” instead perhaps. Was that not a past Government campaign which could be revived? Such “Buy British” campaigns ran in the 1960s and 1980s to inform my younger readers. I am of course joking because so far as I recall they had little public impact. They did not have any influence on the preference to buy German or Japanese cars, although many of the latter are now made in the UK. But in a new post-Brexit world we should expect some surprises and the need to change our habits.

One joker suggested we might need to eat more non-perishable food, i.e. tinned peaches rather than fresh. But that just shows that there are ways around every problem. If the current heat wave persists we will of course be able to grow our own peaches. But betting on the weather is as perverse as betting on the outcome of Brexit. All I know is that we are likely to survive it. Hedging your bets is the best approach.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Investment Platforms Market Study

The Financial Conduct Authority (FCA) have just published an interim report on their study of “investment platforms”. It makes for very interesting reading. That is particularly so after the revelations from Hardman last week. They reported that the revenue per assets held on the platform from Hargreaves Lansdown (HL) was more than twice that of soon to be listed AJ Bell Youinvest. HL is the gorilla in the direct to consumer platform market with about 40% market share. HL earns £473 per £100,000 invested while Youinvest earns only £209.

That surely suggests that competition is weak in this market. Indeed the FRC report highlights that investors not only have difficulty comparing the charges of different platforms, but they do not seem too concerned about high charges as they focus more on other aspects of the service provided. It also says on page 23 of the report: “Our qualitative research also found that consumer satisfaction levels are sometimes linked to satisfaction with overall investment returns, which tend to be attributed to the performance of the platform. This suggests some confusion about consumers’ understanding about platforms’ administrative function as opposed to the performance of investment products. So it is possible that consumers’ relatively high satisfaction levels with platforms could be influenced by the positive performance of financial markets in recent years”. In other words, the consumers of such services are very complacent about the costs they pay at present.

Another piece of evidence that this is not a competitive market obtained by the FRC was that they found that when platforms increased or decreased prices it had no significant impact on flows in and out of the platform. No doubt some platform operators will read that with joy, but others despair! 

Indeed when I made some comments on Citywire effectively saying I thought it suspicious that there were so many positive comments about Hargreaves Lansdown in response to an article reviewing the Hardman news, particularly as they were clearly much more expensive than other platforms who provided similar effective services (I use multiple ones) I was bombarded with comments from lovers of the HL service. Bearing in mind that platform charges can have a major impact on overall returns in the long term from stock market investments, you would think investors would pay more attention to what they are being charged.

One particular problem is that switching platforms is not only difficult and a lengthy process but can also incur charges. This is clearly anti-competitive behaviour which has been present for some years and despite complaints has not significantly improved.

The FRC summarises its findings as:

  • Switching between platforms can be difficult. Consumers who would benefit from switching can find it difficult to do so.
  • Shopping around can be difficult. Consumers who are price sensitive can find it difficult to shop around and choose a lower-cost platform.
  • The risks and expected returns of model portfolios with similar risk labels are unclear.
  • Consumers may be missing out by holding too much cash.
  • So-called “orphan clients” who were previously advised but no longer have any relationship with a financial adviser face higher charges and lower service.

That’s a good analysis of the issues. The FCA has proposed some remedies but no specific action on improving cost comparability and the proposals on improving transfer times are also quite weak although they are threatening to ban exit charges. That would certainly be a good step in the right direction. Note that a lot of the problems in transfers stem from in-specie transfers of holdings in funds and shares held in nominee accounts. Because there is no simple registration system for share and fund holdings, this complicates the transfer process enormously.

One interesting comment from the AIC on the FCA report was that it did not examine the relative performance of different investment managers, i.e. suggesting that lower cost investment trusts that they represent might be subject to prejudice by platforms. They suggest the FCA should look at that issue when looking at the competitiveness of this market.

In summary, I suggest the platform operators will be pleased with the FCA report as they have got off relatively lightly. Despite the fact that the report makes it obvious that it is a deeply uncompetitive market as regards price or even other aspects, no very firm action is proposed. But informed investors can no doubt finesse their way through the complexities of the pricing structure and service levels of different platform operators. I can only encourage you to do so and if an operator increases their charges to your disadvantage then MOVE!

The FCA Report is present here: https://www.fca.org.uk/publication/market-studies/ms17-1-2.pdf

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit – Good or Bad?

Prime Minister Theresa May convinced her ministerial colleagues to back her Brexit vision, but now our Brexit negotiators David Davis and Steve Baker have resigned and there are grumblings from the “hard” Brexit wing of the Conservative Party. Like no doubt many Brexit supporters I am somewhat puzzled by this outcome mainly because it is not at all clear what the plan is in detail, nor what the ramifications are. But it’s worth reading the letter sent by Mrs May in response to David Davis’s resignation letter. It included these words:

“At Chequers on Friday, we as the Cabinet agreed a comprehensive and detailed proposal which provides a precise, responsible, and credible basis for progressing our negotiations towards a new relationship between the UK and the EU after we leave in March. We set out how we will deliver on the result of the referendum and the commitments we made in our manifesto for the 2017 general election:

  1. Leaving the EU on 29 March 2019.
  2. Ending free movement and taking back control of our borders.
  3. No more sending vast sums of money each year to the EU.
  4. A new business-friendly customs model with freedom to strike new trade deals around the world.
  5. A UK-EU free trade area with a common rulebook for industrial goods and agricultural products which will be good for jobs.
  6. A commitment to maintain high standards on consumer and employment rights and the environment.
  7. A Parliamentary lock on all new rules and regulations.
  8. Leaving the Common Agricultural Policy and the Common Fisheries Policy.
  9. Restoring the supremacy of British courts by ending the jurisdiction of the European Court of Justice in the UK.
  10. No hard border between Northern Ireland and Ireland, or between Northern Ireland and Great Britain.
  11. Continued, close co-operation on security to keep our people safe.
  12. An independent foreign and defence policy, working closely with the EU and other allies.

This is consistent with the mandate of the referendum and with the commitments we laid out in our general election manifesto: leaving the single market and the customs union but seeking a deep and special partnership including a comprehensive free trade and customs agreement; ending the vast annual contributions to the EU; and pursuing fair, orderly negotiations, minimising disruption and giving as much certainty as possible so both sides benefit.

What exactly are the moaners complaining about if that deal can be achieved? Their concerns seem to be focused on points 5 and 6 above. Will adopting common product standards (or whatever EU standards they might determine subject to UK Parliamentary consent) really hobble the UK and make it difficult for us to negotiate trade deals with other countries? I do not see why – it just means that exporters to the UK will need to comply with UK/EU regulations just as UK exporters to the USA now have to comply with US products rules and regulations. What is so difficult or damaging about that?

Note that only industrial and agricultural products are covered by these proposals. Services are not so such matters as financial regulations where the EU has been particularly inept will presumably fall into abeyance unless we decide to conform. But such phrases as “A commitment to maintain high standards on consumer and employment rights and the environment” do need explaining more – does this mean we have to accept EU regulations or what in those areas?

With those reservations otherwise my view is that if Mrs May can achieve her objectives this would look to me to be a reasonable outcome as it will meet the main objectives desired by Brexiteers. Sovereignty and the ability to lay down our own laws and regulations in most areas and in a democratic way will be returned to us. Would anyone care to explain to me why it is otherwise?

But whether these proposals can be agreed with the EU is another matter of course. Perhaps David Davis has resigned because he sees the impossibility of getting their agreement to this “fudge”. The borderless objective in Ireland looks particularly problematic. We need a clearer explanation of how that might work in practice.

My conclusion therefore is that this might be a way forward, but the game of Brexit negotiations is a long way from being concluded.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Beaufort Settlement Improved, But…..

It’s good news that PWC have revised their proposals for the administration of Beaufort and the return of client assets. No doubt due to the efforts of ShareSoc and others. But it still leaves many issues that need properly tackling. These are:

  1. The Special Administration Regulations that allow client assets to be used to cover the costs of the administration. Client assets should be ring fenced and they are what they are called – client assets not assets of the broker or bank.
  2. The fact that most investors now have to use nominee accounts and they are therefore not the legal owner of the shares they hold. We need a new electronic “name on register” system and the Companies Act reformed to reflect the realities of modern share trading.
  3. The UK needs to adopt the Shareholder Rights directive as intended, so that those in nominee accounts have full rights. The “beneficial owners” are the “shareholders”, not the nominee account operator.

We must not let these matters get kicked into the long grass yet again due to the reluctance of politicians and the civil service to tackle complex issues.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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GKN and Melrose – The Reality

Melrose has won the battle to take control of GKN although the Government might yet step in to halt the takeover. On what grounds is not exactly clear. Never having held shares in either company, I thought it worth looking at the facts rather than the hyperbole surrounding this deal as there seemed to be some myths being propagated.

Is GKN a key business in the UK’s engineering and technology infrastructure based on a long history of innovation? Or is it a financially poorly performing conglomerate that was vulnerable to a bid?

It has been said that GKN produced Spitfires in the Second World War but in reality they did not develop the plane but were just one of several assembly plants that were subcontracted to produce it in volume, In the 1960s I well remember the company under the name Guest, Keen and Nettlefold and in Birmingham they had large factories producing nuts and bolts. Hardly high-tech engineering even at that time. Later they did make a success of car parts production particularly with constant velocity joints (CVJs) as used in the Mini and other front wheel drive vehicles. But they are now proposing to split off the driveline business and merge it with another company. They plan to focus on the aerospace business. You can see a “polished” version of the history of the company here: https://www.gkn.com/en/about-gkn/history/ . In reality a long history of dubious diversifications, followed by later rationalisations.

The recent financial performance has been disappointing. Reported earnings per share in 2017 were the same as five years previously with a trough in between. Dividends in that period grew slowly and at the current share price equate to about 2% yield. Return on assets a measly 5.6% last year, and even that was an improvement on previous years. Although the financial prospects based on analysts’ forecasts might be slightly improving, is it not simply a case that institutional investors might have become disillusioned with the management in recent years and seen an opportunity in the Melrose bid to improve the financial returns?

There will no doubt have been some activity by share traders, arbitrageurs and hedge funds of late who might have influenced the outcome. But that’s capitalism in action. Holders, even long-term ones, sell to higher bidders.

Personally I oppose any suggestion that short-term holders should not be allowed to vote, and the use of other “poison-pill” mechanisms that can defeat takeovers. If I purchased a share in a company last week, I want to be able to vote it! I may not have known that a bid was coming and how I vote will depend on the arguments put by both sides. Clearly in this case GKN simply lost the argument.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Aviva Preference Shares – FCA Announcement

Readers who take any notice of financial affairs will be aware of the furore over the threat by Aviva to redeem their preference shares by a “share cancellation” process – they claimed that is a different legal process, even though the shares were described as “irredeemable”. The shares concerned dropped in price to a significant extent because their high coupon interest rate meant they were trading at a premium when cancellation would have meant redemption at the original par value. Aviva have reconsidered the matter, but the interesting aspect today was a response from the Financial Conduct Authority (FCA) to a letter from the Treasury Select Committee. You can read it here: https://www.investegate.co.uk/financial-conduct/rns/fca-response-to-tsc-on-aviva-plc-preference-shares/201803280704471964J/

It basically gives lots of reasons why they cannot yet respond to some of the questions as they are still looking into the issues, but in response to Question 4 they seem not to concede that they should be involved in “the resolution of the legal questions”. In other words, they would be quite happy to leave it to an enormously expensive law suit by investors to resolve the key questions.

They do not seem to accept that they have an overriding objective to ensure a fair market for securities and that investors should not be prejudiced by small print, concealed or opaque legal terms and other sharp practices.

The response to Question 6, seems to try and excuse the problem by saying the shares were issued more than two decades ago and the FCA has taken subsequent action “in order to restrict the retail distribution of regulatory capital instruments….”. This is surely not an adequate excuse. The shares concerned were and are publicly traded and there is nothing stopping any investor (at least a “sophisticated” one) from trading in them. But even sophisticated private investors and some institutions were caught out by the unexpected threat from Aviva.

The FCA is again proving to be toothless in the face of seriously unethical practices. In other words, they are not doing their job competently and should be reformed in my personal opinion. I believed the FCA adopted an objective of more “principle-based regulation” a few years back but now seem to have abdicated that responsibility and are quite happy to let lawyers argue over the wording of a prospectus while ignoring the ethical issues. Just as they did with the RBS and Lloyds cases. It’s simply not good enough to issue the kind of response they have to the Treasury Select Committee.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Libel Settlement – Peace Breaks Out

Some readers of this blog may have become aware that I was pursuing a libel action against Tom Winnifrith of ShareProphets. Tom writes a newsletter which many private investors read, and he often tackles the dubious activities of some public companies and their directors – particularly AIM companies – which can only be applauded.

Our legal dispute has now been settled and Tom has withdrawn his allegations to my satisfaction. He is in the process of removing them from the web. He has even gone so far as to call me an “underlying good person” in a recent podcast so I am feeling quite saintly at present. I hope readers will not hear more about this matter.

The following statement was agreed by both parties as part of the Settlement Agreement.

Roger Lawson & Tom Winnifrith: a joint statement

Roger Lawson and Tom Winnifrith have agreed that Mr Lawson’s legal action against Tom Winnifrith for libel will not be pursued further. Life is too short. Both men are agreed that nearly all of the work done by each other on seeking reform of AIM and in campaigning against poor corporate governance is worthwhile. There are too many ways in which the stock market needs reform and too many individuals who break the rules that do exist, for energies and money to be wasted on a fight that will enrich only lawyers. 

Tom Winnifrith stated: I stand by my assertion that Roger Lawson should have declared ownership of shares when writing about them at all times and it would have been better practice to have advised readers to sell before doing so himself. But Roger acted in line with the rules for the ShareSoc blog and other publications. More importantly I am sure that he did not act in the way he did in order to secure personal financial gain. Nor did he secure a gain as a result. Roger can be somewhat cantankerous but his heart is normally in the right place; he is not the sort of man I want to be fighting, especially as on most issues we are in agreement. My energies should be focussed on the bad guys and Roger is not one of them. 

Roger Lawson stated: Like most people I find Tom Winnifrith’s language not always to my liking. However on most occasions when he goes after a company his judgement is shown to be correct and in doing that he performs a valuable service. In publishing the Globo dossier he showed bravery other journalists baulked at and with hindsight he asked all the right questions of blinkx and Globo. Since we agree on far more than we disagree on it is right that instead of making lawyers rich with any law suit we both move on and continue to offer fair criticisms of the London market and to fight on behalf of ordinary investors.

<End>

Part of the dispute was about the fact that I sometimes commented on shares that I owned. That continues to be the case on this blog, although I frequently comment on shares that I have never had any financial interest in whatsoever (for example Autonomy in my last blog post simply from my knowledge of the IT world). Excluding shares that I have owned would not make sense as I often have a deeper understanding of those companies than any financial journalist could quickly acquire. Readers should read the About page on this blog to understand the legal terms that apply to the content and use of this blog which covers that point, although I would normally declare any interest in shares when I write about them.

Postscript: Readers are reminded that I never give buy or sell recommendations on shares, and have never done so in the past. I try to give a balanced view about companies so if I point out positive aspects I am likely to also include the negative aspects. A good example is my recent comments on Rightmove Plc. Whether my comments are fair and accurate at the time you will need to judge for yourself, and hindsight can distort the picture. I am generally dubious about the ethics of those who comment negatively on companies in public while shorting the shares and likewise I do not appreciate those investors who puff shares they hold – even institutional fund managers are frequently guilty of “talking their own book” which I consider a dubious practice. It is unfortunate that the ethics of the financial world leave a lot to be desired and “fake news” is a growing problem.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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