Monday 23 November 2009

Another Brick in the Wall

Something that caught my attention in the recent Queen’s speech was the Government’s intention to set up a new financial education agency to be funded by the banks.

I’m a big believer in financial education - I wouldn’t have spent the best part of 18 months building this site if I wasn’t! But I’m rather sceptical that government initiatives on this front will actually succeed.

If this new agency does end up seeing the light of day, which is questionable given the lack of time to pass bills in the House of Commons before the general election, I fear it might turn out something like this...

The Government, not really understanding personal finance and being rather busy anyway will delegate the task of setting up the agency to some highly paid senior civil servants.

The highly paid civil servants, themselves not very clued up on personal finance matters, will have a series of ‘strategic’ meetings then pat themselves on the back for deciding to call in a team of very expensive private sector management consultants to help out.

The very expensive management consultants don’t understand very much about personal finance either, but they like ‘strategic’ meetings and talk a good game so the civil servants are happy.

The banks, who are indirectly footing the bill for all this, are getting a bit worried. They understand enough about personal finance to know that the better the public understands it, the harder it’ll be for them to pull their very profitable wool over public's eyes. Fearing shrinking bonuses, they insist on being involved ‘for the good of the project’ with the intention of protecting their own interests. The big insurers will also be pretty keen to do the same.

Meanwhile, the civil servants and management consultants are too busy having meetings to actually get any work done, so they employ lots more civil servants and expensive consultants to do it for them.

Many months and millions of pounds later, the agency proudly launches a glossy website and series of brochures covering a few basics of the personal finance world. It’s not bad, but it’s not that good either. And, because of the banks’ influence, it doesn’t expose many tricks of the trade or really help consumers that much.

I hope I’m wrong, but I don’t expect to be.

Trail in a Twist

There’s been quite an uproar in financial circles recently after the boss of financial adviser Towry Law admitted that his firm receives £6 million of annual trail commission from products previously sold to 300,000 clients they no longer look after.

For the uninitiated, trail commission is an annual payment from financial providers to commission-based advisers after a product has been sold, usually paid for as long as the client holds that product. For example, unit trusts typically pay advisers 0.5% of the fund value each year as a trail commission.

While this might sound like money for old rope, trail commission should enable advisers to continue looking after clients post sale without charging additional fees. It also means that clients can take their custom (and trail commission) elsewhere if they feel their adviser is not providing satisfactory service.

So, all in all, while I’m not a fan of commissions, trail commission is actually not a bad thing.

However, it becomes a problem when advisers pocket the trail commission and do diddly-squat to earn it, a 'hit and run' sales approach. Clued up clients would almost certainly take their business and trail commission elsewhere, but less savvy clients (of which Towry Law appears to have about 300,000) add to the pile of victims in an industry that all too often seems more focussed on lining its own pockets than those of its customers.

I’m pretty fed up of such practices, so I’ve come up with three proposals that could help prevent this type of situation arising in future.

1.Compel financial advisers to get a written (or online) authority from their clients every two years confirming they’re happy for the adviser to continue receiving trail commission. If not received, the ongoing commission would then be diverted into a ring-fenced Financial Services Compensation Scheme (FSCS) ‘pot’ until such a time that the client appoints another adviser to receive the commission. This would remove the trail without service problem and the ‘pot’ could then help reduce the extent that decent financial advisers have to subsidise the actions of irresponsible ones via their FSCS levies. [When advisers who mis-sold become insolvent, client compensation claims are passed to the FSCS to sort out. The FSCS is partly funded by annual levies on financial advisers.]
2.Where an adviser buys the assets of another troubled adviser firm and leaves the FSCS to pick up the pieces regarding clients with compensation claims, the adviser must get authority as above within a year of acquiring the assets.
3.Ban initial commission on product sales that involve moving from another product sold within the five previous years (with a few obvious exceptions such as a pension being used to buy an annuity).
These measures won’t solve every woe in the industry, but I do believe they could make a worthwhile increase to the likelihood of customers being treated fairly. Something which, to be fair, Towry Law states as a key objective.

Commercial Property Ripe for Picking?

Commercial property fund sales have started to make a comeback after a couple of very difficult years. Is this renewed interest founded on solid rock or sinking sand?.

Let’s start with a quick recap. Commercial property funds are available in two flavours: those that invest in physical properties and those that buy shares in companies whose business is to invest in property. Physical (or ‘direct’) property funds have tended to be most popular with private investors and offer a more exposure to the market, so we’ll focus on those.

Direct property offers two ways to make money: rental income and increases in the price of property. Unlike residential property the rental agreements on commercial buildings (e.g. offices, factories and shops) tend to be very long term, typically 10 – 25 years. This means that income should be steady provided the tenants continue to pay their rent and don’t move out during the lease leaving the property vacant. Commercial property prices have historically tended to be more stable than residential prices (less so recently!), but they do still vary and you can lose money.

The sector had been chugging along quite happily for a few years until mid to late 2007, when declining economic fortunes started hitting commercial property prices. This continued through 2008 to mid 2009. According to the IPD UK Annual Property Index (which measures these things) during 2008 UK commercial property prices fell by an average 26.3% while the income return was 5.6%.

Rental income has been hit, largely due to vacant space and downward pressure on rents charged on new agreements, but the proportionately bigger fall in prices means that yields (income / price) currently look attractive at an average of around 7% (they’ll be less on funds due to charges).

Prices also appear to have stabilised over the last few months (for now at least), seemingly due to improved economic optimism and a weak Pound making UK property rents very attractive to foreigners.

So, on the surface, it looks like quite a sensible time to be buying into the sector. If things remain stable, which you might argue is a big if, then rental income should be steady and you might even make a bit of money from rising prices over the next few years.

The downside is that if our economy deteriorates further there could be more downward pressure on rental income and prices will likely be hit, meaning you could lose money.

If you’re looking to invest in a direct property unit trust then a few important things to consider.

1.Up to 10% of your initial investment could be swallowed up by charges and tax. Initial fund charges are around 5% and the fund must pay 4% stamp duty when buying properties plus agent’s commissions and legal expenses etc. These costs are usually reflected in the buying price of the units. They are, to an extent, potentially avoidable. You can reduce or avoid initial charges by using a discount broker and, when you come to sell, if there are more buyers than sellers a fund manager might buy back your units including the stamp duty costs as they can effectively be passed straight to a waiting buyer.

2.There’s a risk you won’t be able to get your money out when you need it. Unlike stockmarket funds, direct property funds can’t simply sell some of their assets (i.e. a property) every time they need to pay back an investor who wants to sell. Because of this they must hold some cash (and quite often a few property shares too), called ‘liquidity’. But if so many investors want to sell that there’s not enough liquidity to pay them all, the fund will likely close its doors to withdrawals until it can sell some property to fund them. This could take several months or more and in a depressed market the prices they achieve could be poor, reducing your ultimate investment return. Always look for funds with reasonable liquidity (15 – 20%).

3.Does the annual management charge come from income or capital? If the manager takes their fees from rental income, then while this reduces the fund’s yield it’ll avoid them eating into your underlying investment.
Whether investing now is worthwhile really depends on your views for the economy. I’m a little pessimistic but there’s plenty who’d disagree. At least the bubble of two years ago has burst, so if the downturn persists there’s probably less far for the commercial property market to fall.

Monday 9 November 2009

Pension Protection Fund in the Red

The Pension Protection Fund (PPF) today announced that its deficit has more than doubled to £1.2 billion. Could this threaten the future of the scheme?.

The PPF, which is funded by pension schemes, was introduced by the Government in April 2005 to protect employees with final salary pensions should their employer go bankrupt. Good job too, as since then more than 30,000 people have been transferred to the scheme, with around 13,000 already receiving compensation (and many more waiting in the wings).

The deficit exists because the PPF’s existing pension assets (the pension funds of schemes they’re already bailing out and annual levies) plus those of pension schemes they reckon they’ll have to bail out in future are less than the total estimated liabilities (i.e. future payments to members) of both. Put simply, if future expectations were rolled up into one big payment today, the PPF would be short by around £1.2 billion (actually, probably less, as this figure applies to 31 March 2009 – markets have risen since).

Most of the anticipated compensation payments are in years to come, not right now, so the PPF does have some time to address the potential shortfall. Rising markets would obviously help plug the gap and could reduce the number of final salary schemes that ultimately need bailing out.

Nonetheless, it’s a problem. Because the PPF is funded by final salary pension schemes themselves, the more pension schemes that get into trouble the fewer left to pick up the tab. This could increase the annual levies demanded from the remaining schemes, potentially jeopardising their health – a downward spiral.

Based on its own projections, there’s a reasonable chance the PPF can move from deficit to surplus within about 10 years. But if economic conditions are worse than expected, and I wouldn’t bet against that, then I can see the PPF doing one or more of three things:

1.Cutting the level of compensation it pays out – unlikely, as too unpopular.
2.Increasing its annual levies on ‘healthy’ final salary schemes – probably limited on how far they can push this.
3.Going cap in hand to the Government – most likely, although the Government would probably only cough up as a last resort.

If you’re setting up in business today the thought of providing a pension for your employees where you, the employer, take all the risk, is laughable. However, it’s no laughing matter if you’re in a final salary pension and concerned over your employer’s financial stability. The PPF provides a vital role and I’m sure it’s here to stay – just hopefully without need for outside intervention.

Sunday 8 November 2009

The Cash Conundrum

So you’re nervous about stockmarkets, think property prices are more likely to go down than up and fed up with getting next to no interest on your savings. If you’re fortunate enough to have some cash, what do you do with it?.

Well, if you’re in this boat you’re not alone. Although stockmarkets have started to bounce back this year, the storm clouds still loom, especially in the UK and US. And while property prices have been creeping up in some areas, they could struggle if the UK economy’s poor health persists.

Gold, often a salvation in times of gloom, is hitting all-time highs of around US$1,100 an ounce, so jumping in now risks buying at what might prove to be near the top of the market.

If you’re happy investing for 10 years or more then spreading money across a range of investments should stand you in reasonable stead. You may lose out short term if markets remain choppy over the next year or two, but if you can hang in there, there’s light at the end of tunnel.

However, if you’ll need the money sooner I’d generally be nervous about investing heavily right now. Trouble is, with the Bank of England Base Rate at just 0.5%, most savings accounts aren’t an enticing alternative.

There’s no magic answer, but there are some options worth a look:

Savings Accounts
With typical easy accounts paying just 0.17% a year (source: Bank of England) there seems little point in bothering. But look beyond this and you can find ‘best-buy’ savings accounts paying over 3% gross a year. They mostly include bonuses, so be prepared to move elsewhere down the line, but worthwhile nonetheless.

Fixed Interest Accounts
Even better, if you can tie up your cash up for at least 3 years you could enjoy an annual fixed rate of 4.5% gross or more.

NS&I Index-Linked Certificates
Not great right now given inflation (measured by the Retail Price Index) is negative. But if inflation does pick up again these could look pretty smart, especially for taxpayers.

Offset Mortgages
Appealing, as you can effectively enjoy tax-free interest on your cash equal to your mortgage interest rate. With variable rates currently around 3%, higher rate taxpayers could earn the equivalent of 5% gross a year. Because of charges and rates etc, they tend to be most worthwhile if you have cash equal to around 10% or more of your mortgage.

Corporate Bonds
Unlike the above options, investing in corporate bonds could lose you money. But with investment grade UK bonds yielding around 6% they’re catching investors’ attention. Low interest rates and inflation mean the current environment is as about as good as gets for bonds. But if either rises, the value of bonds will probably fall. So are bonds, like gold, maybe riding near the top of the market? Difficult to tell, but my gut feeling is more likely than not. Worth a dabble for the attractive yield, but don’t bet your shirt.

As always, investing is a gamble. If you like taking risk I’m sure you could probably find investments that’ll either make or lose you a fortune over the next year or two. But if you can’t afford to lose much, or potentially tie up your cash for a long time, then despite low interest rates I think cash is probably king for now.

Take a look around the site to find out more about the types of savings and investments mentioned above. You might also find our calculators useful.

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Stockmarkets & Economies Divide

The UK economy has been sick as a dog for well over a year now and remains in recession. So why has the UK stockmarket been performing pretty well this year?. Aren’t stockmarkets supposed to be a good indicator of a country’s economic health?

The possible reasons for this are many, but let’s look at the most likely, starting with the obvious. Fears of a global financial meltdown during 2008 hit stockmarkets incredibly hard, so when the banking system didn’t collapse investors breathed a huge sigh of relief and markets (especially bank shares) rose as a result, despite many global economies still being in deep water.

In the UK this has been exacerbated by the dominance of the financial sector on the stockmarket. Financial companies make up about a quarter of the FTSE 100 Index, so they have a big influence on overall performance.

Aside from financials, the other big UK stockmarket sector is oil & gas. Performance of these shares has very little to do with the UK economy and a lot to do with global demand for energy, especially from emerging markets such as China.

So we can’t ignore the fact that Britain is not an island when it comes to stockmarkets. Many companies listed on the London Stock Exchange trade globally, meaning their fortunes depend on economies overseas and not just the UK - only around a third of UK stockmarket revenues come from Britain. The weak Pound (a symptom of our depressed economy) has also helped boost these overseas revenues, as they’re worth more when converted back to Sterling – good news for some share prices.

Companies in areas that rely heavily on UK customers, such as construction, leisure and retail have found the going harder and these sectors continue to lag most of their stockmarket peers.

Finally, let’s consider expectations. If stockmarkets are efficient then they should reflect where investors think the future is headed. They’ll buy shares (pushing up prices) when they think prospects are rosy and sell when they think the future is grim. Does a rising stockmarket this year mean investors think the economy will be taking a turn for the better sometime soon? Is there simply a lag between the two? History suggests this might be the case, but also that investors are quite often wrong too!

My own view, for what it’s worth, is that this time they’ve got it wrong. I think the UK economy will remain troubled for at least another year or two yet and the stockmarket will struggle too, despite some possible respite for the reasons covered above.

In summary, while stockmarkets do appear to generally reflect economic health over periods of several years, it’s less likely short term, especially in the UK.

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