Today I am in slightly dreamy, opportunistic mode pondering some useful advances that might be helpful for all of us.
I will start with practical investment thoughts and then move on to the knotty subject of tax (!).
Let’s kick off with what I think would be the single best innovation in investment at the moment – portfolio insurance and specifically simplified, long-dated put and call options. There’s a growing moral panic in the US at the moment about the inexorable rise of private investors dabbling in options, almost exclusively of a short dated type. All the usual headlines are emerging, and I have no doubt that plenty of speculators will lose a pickup truck load of losses.
We cynical Brits will sigh at this debate because it is a retread of a familiar debate around spread betting. I have never spreadbet and have no intention of doing so, largely because I have zero regard for my short term trading expertise. I am also completely convinced that all the research is right when it shows that most spread betters – between 75 and 95% – lose money, most of the time. That said, I also have no doubt that there are many investors who find these options based tools very useful. It is (still) just about a free world and as long as there are significant protections in place for punters – and they are availed of the right information – then I have no particular issue with the spread betting industry. In fact, I think it highly profitable and a great hedge against market volatility – thus I own a small number of shares in Plus500 and CMC.
But the vast majority of spread betting-based trading is short term in duration. The same goes for the more mainstream listed alternatives, such as daily leveraged products. These are fantastic for short term speculators but over a matter of weeks, and certainly months their time value decays at an extraordinary rate because of market volatility. Anyone who holds a leveraged tracker for say six months needs their head examined.
This brings us to medium-term portfolio protection – by which I mean periods of a year or two. In the world of professional fund management, investing in put or call options for a period of a year or two is perfectly normal. Some hedge fund managers such as Bill Ackmann at Pershing Square have used credit default swaps instead and make huge profits. The motivating idea is dead simple – downside portfolio protection over the medium term.
In fact, this form of portfolio protection is so rife at the institutional level that it has helped fuel the growth of the structured product industry which makes ample use of calls and puts for periods ranging between 1 year and 5 years.
So, on paper, if its good enough for fund managers and professionals, why not private investors? Why can’t we build some portfolio downside protection into our portfolios? The vast majority of us do not want to open a spread betting account and have zero inclination to invest in daily leveraged trackers. We simply want some not overly expensive 1 to 2-year duration puts and calls on mainstream benchmarks. We are also probably all aware that said options will expire worthless but we’d be happy to pay a sensible premium.
What are our choices?
In essence, zip, nada, nothing.
French investment bank SocGen used to – and still may -have a range of listed structured products (their website is down the last time I looked) which included covered warrants and the rather more useful turbos. Covered warrants were intermittently useful but boasted slightly odd, complicated structures (who’d have guessed a French bank full of quants would make a complicated structure) which served some value over periods of months. Turbos were much longer-dated and a bit simpler – and very useful in my opinion. But despite strenuous efforts to market them (and I was involved in writing content at one stage for said products), they never really took off.
One could argue that was because there were spread betting products kicking around but I’m not convinced that was true. I would finger the complicated structuring, regulatory interference, and the general tendency of most private investors to use individual stocks as a way of gaining leverage.
Step back from this and I think the need is still there for these medium duration portfolio protection products. They should be a) sensibly priced, b) not over complicated and c) come with plenty of content that explains they will be leveraged structures. As with all mainstream listed products they should only risk the initial capital and be available on most mass-market platforms. Ideally, we’d want the time value to be fairly linear in its decline over time and the leverage to be enough to be sensible – say 2 to 6 times – but not too high so that they look a bit bonkers – forget ten times. The benchmarks should be easy to understand – the FTSE 100, the S&P 500, the MSCI World and a China index. And the range should be limited. Ideally one might also add a useful app-based, digital component so that investors can easily track their products and understand the leverage.
Sticking with the theme of Nice to Haves, please, please can we have many, many more Emerging Market products excluding Greater China. Depending on the index you choose, China, Hong Kong, and Taiwan account for anything between 45 and 60% of most EM indices. If we include South Korea, which has strong links to China, that number can go above 60%. In simple terms, we have an integrated economic block that is closely intertwined and increasingly moving as one.
This is not, I think, what most investors believe they are getting with EM products. They mistakenly think it’s about the other BRICs plus the smaller, arguably more interesting countries such as Indonesia or Colombia. More pertinently, they are also buying aggressively into investments where the Chinese Communist Party has super-sized influence. As I have written before, there are plenty of reasons to be worried about the CCP and its likely actions in the next decade. Crucially its actions are, essentially, unpredictable and cannot be modelled in any sensible way by investors.
So, fund marketers and index designers speed up those development plans. Use the concept of excluding Greater China (China, HK, Taiwan, and South Korea) from your products.
Nice to have taxes?
Changing gear slightly on the Nice to Have argument, let’s take a detour into tax. Yikes.
I have been banging on in this blog for ages now about the likely uplift in the tax burden to pay for the fiscal largesse of the last year. I have suggested that I do not think tax rises, beyond a few small changes, are imminent but I think the debate is intensifying about what to do with taxes in the period 2022 through to 2025.
There is currently a great deal of posturing going on in this debate with many Conservatives solemnly declaring that virtually any tax rise would be a disaster. We also have various business lobby groups claiming ( entirely unfounded in my view) that if things like the Entrepreneurs Allowance are toughened up, again, we’ll have an exodus of business people and that incentives will be destroyed. Poppycock. In my experience, the vast majority of business people are not motivated by tax considerations when they start businesses. Some, more libertarian-minded, may resent paying taxes once they are successful (a perfectly reasonable ideological position I might say) but then again we don’t take any notice of people who hate paying taxes to fund military spending, so why should we care about these libertarians?
We also hear much moaning about disincentives to saving if we get rid of the higher rate pensions relief, which is another specious argument because it presupposes that investors put tax as their priority for choosing a structure which in the vast majority of cases is not the case. And frankly, if they care about that much about tax on savings, use an ISA.
Anyway, all this brings me back to wealth taxes.
Recently something called the Wealth Tax Commission (heavily influenced by academics at the LSE) reported on the feasibility of said wealth tax. You can see the report here: ‘A wealth tax for the UK’ (https://bit.ly/2JQCyWZ)
The Guardian, as you’d expect, had a nice summary of the report (here : https://www.theguardian.com/business/2020/dec/09/economic-cost-of-covid-crisis-prompts-call-for-one-off-uk-wealth-tax).
The in house daily journal of the Left reports that the “wealth tax could raise £260bn over five years if the threshold was set at £1m per household, with a levy of 1% payable on the value of their assets above this level….The tax would apply to a person’s total wealth – including their home and any other properties, pension pots, business and financial wealth. Any debts, such as mortgages, would be deducted. At thresholds of £500,000, £1m and £2m per person, a wealth tax would respectively cover 17%, 6%, and 1% of the adult population.”
I have my severe doubts about a wealth tax. Sure, there are countries such as Switzerland which operate a sensibly structured wealth tax, but there are also plenty of places that have tried it and abandoned it. Perhaps the idea of time limiting it might make more sense but again I have my doubts. The ability of the Great British state and especially HMRC to introduce a whole new tax into its existing structure is, I would argue, highly debatable. I also think it wouldn’t raise as much money as its proponents argue.
But a good old-fashioned debate has been sparked nevertheless, which is useful. In the pages of the Times newspaper, the ex-Liberal MP Michael Meadowcroft has resurrected the idea of a Land Value Tax. This is I think an excellent idea and it’s one of those ideas that virtually every economist, left or right, agrees with. Sadly, it’s another new tax that I think would be a stretch to administer. It’s also problematic as Robert Rhodes QC argues in a letter to The Times because most land is agricultural and would probably have to be exempted.
Sticking with the idea of a tax that every economist likes, we come to a carbon tax. I’ve vacillated about this fantastic idea. I think on paper, it is a brilliant idea, not least because a) it would raise considerable revenues, b) it would provide signals to the market to intensify fossil fuel alternatives, and c) it could be easily implemented. BUT the track record so far of carbon taxes being implemented isn’t great. In Canada, provincial governments have kicked up a stink and that’s sensible Canada where the public have already been softened up for the tax through a debate around climate change. I worry that we’ll have hordes of protestors on the street screaming “don’t tax my livelihood” and we’ll get a repeat of the lorry driver blockades. Then again, maybe the debate has moved on considerably and perhaps we can outthink the sceptics and introduce protections and allowances. If we can make it work, then a shiny new carbon tax in 2022/23shoots up my list as the next most likely source of extra tax revenue.