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The hypocrisy of some is that we like to think of ourselves as sophisticated and evolved, but we’re still also driven by primal urges like greed and power- Michael Leunig (Australian Cartoonist and Poet). [This posting serves as an adjunct to the latest Wendy Cook article, posted on Tuesday, regarding Structured CD’s in the US. What follows is a more UK-centric version of same].—Last week an adviser asked me about a new Structured Product a client had shown him. My first reaction was to rubbish it. However, I felt duty-bound to delve deeper into it. What I found made me wonder whether I had under-reacted! What I want to show today is not only how bad these sorts of things are for Investors, but how these firms make money on them (at the investor’s expense). Indeed, given access to these markets, investors could actually construct these products for themselves.

“Stocks have reached what looks like a permanently high plateau.” – Irving Fisher, (economist), 3 days before the 1929 market crash. We have covered this subject before (here, and in our Quarterly Review of Q2 2015), but it is always worth returning to, as Investors appear unable to shake off the conviction that they can “beat” the market. Passive inflows (and Active outflows) suggest the tide is turning, but as all politicians feel obliged to say nowadays, there is still much to do. It is gratifying to know that the ranks of Index investors are rising (through EBI, but others too), and that we are no longer the geeks at the party that no-one wants to talk to.

“Blessed is he who expects nothing, for he shall never be disappointed.” ― Alexander Pope [We have recently been asked to explain in more detail how we arrived at our Expected Rate of Return numbers used as our return assumptions. What follows is an attempt to rationalise the output numbers, in a way that can hopefully be understood as the basis for our investment philosophy]. Below is a copy of the latest ERR breakdown, (from our Turnkey Workbook), showing the sources of the Equity and Bond Risk Premium (ERP) we expect to achieve over time. We shall attempt to dis-aggregate them and look at the internal logic of the results. The Bond premium has 3 constituent parts:1) The Risk-Free Rate (RFR) – the interest payable on a risk-free investment.2) A Maturity Premium – as the maturity of a bond rises, so does the risks associated with that investment.…

“The Fed is now hostage to Wall Street. If the stock market pulls back a few percent the Fed becomes frightened. In a way I suppose, the Fed is justified in that belief because it is responsible to a great degree for the elevation of financial asset values”. Jim Grant (Grant’s Interest Rate Observer). On Friday, Janet Yellen, the Head of the US Federal Reserve, will speak at their annual Jackson Hole Conference, (in Wyoming), and is widely expected to comment on US Interest Rate policy. With an election in November, September may be the last chance to raise rates before the traditional pre-election purdah, as the Fed tries to maintain the illusion of political neutrality. But will they take it? Opinion is divided on the subject, despite what some Fed officials say.

Wendell: [Viewing the desert crime scene] It’s a mess, ain’t it, Sheriff?Ed Tom Bell: If it ain’t, it’ll do till the mess gets here. from No Country for Old Men (2007)

“Following the British referendum to exit the European Union, the paper value of global assets briefly fell by about $3 trillion. This decline in the market capitalisation immediately garnered headlines, suggesting that some destruction of “value” had occurred. No. The value of a security is embodied in the future stream of cash flows that will actually be delivered into the hands of investors over time. What occurred here was a paper loss” John Hussman, weekly comment, 4/7/16.

Duration is an important concept in the world of Bonds. It measures the sensitivity of a bond to changes in interest rates. Thus, a bond (or a portfolio of bonds) that has a duration of 5 will be expected to move 5% in price for a change of 1% in the discount rate (i.e .the market rate of interest). A bond/portfolio with a duration of 10 would see a 10% rise/fall in price for a given 1% move in rates etc,etc. Ceteris Paribus, the longer the maturity, and the lower the coupon, the longer the duration of a bond – think of it in terms of how long it takes to get your money back; the lower the coupon payment on a bond, the longer an investor must wait before his/her investment is fully returned.