Castlestone Management View Point

The ending of an era of unprecedented quantitative easing was announced on October 28th by the US Federal Reserve. The end of the third quarter of 2014 showcased two significant events across global financial markets.

Castlestone Management View Point

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First, the selloff of global equity markets culminating on the 15th and 16th of October, followed by the much anticipated announcement that the US Fed would end its asset purchases which has helped fuel equity market returns since 2009.

The asset purchasing, known as QE3 was the third instalment launched in September 2012 when it pledged to purchase $85 billion of assets every month until there was significant gains in the labour market. Since then the US unemployment rate has fallen from 8.1% to 5.9%. The programme has been controversial from the start raising fears of an overheated equity market as global stock markets hit historical highs.

The equity market selloff which began back in September was triggered by a faltering European Economy compounded by the announcement of a lacklustre European Central Bank programme to buy covered bonds across the Eurozone which only fanned the flames of uncertainty.

This, as well as geopolitical risks stemming from the Middle East saw global equity markets plummet. The US dollar jumped in value and the US 10 year treasury yield fell close to 2%.

Consistent and stable returns

Castlestone Management’s new equity fund which was launched in December of 2013, in comparison, performed well over the extremely volatile months of September and October. The strategy that can provide consistent and stable returns through periods of increased volatility, is a strategy that fits today’s economic uncertainty and investment climate.

October’s selloff that saw the S&P 500 fall 7.4% did not leave Castlestones Equity High Yield & Premium Income Fund (EQHY) unscathed, yet the funds’ performance only fell 4.6% in comparison over the same time period. Other global indexes didn’t fare better with the UK’s FTSE 100 falling 9.9%, the German DAX falling 12.5%, the French CAC down 12.8% and the Australian ASX down 8.9% from Septembers high.

Performance of the EQHY Fund derives its performance from two key components: dividend income derived from large, blue chip semi monopolistic stocks like AT&T, Sydney Airport, GlaxoSmithKline, HSBC and American Electric and by selling covered call options on the underlying stocks within the fund.

As we know, this is an advantage when equity markets decline or remain flat (like we saw in 2008 and in 2011) as it limits potential downside. When selling a call option the seller receives a premium, or income committing to sell the option buyer a stock at an agreed price in the future.

What it can do in a quickly rising market is limit the potential upside in equity price appreciation. But with the outlook for equity market returns looking to be flat over the next decade, Castlestone believes that a buy write strategy focusing on blue chip, dividend paying stocks should be the main focal point within any investment portfolio.

Predictable income – the way forward

Angus Murray, the head of the investment committee at Castlestone Management believes that predictable income over unpredictable returns (appreciation or depreciation of equities) is what investors should be focusing on.

If what we have seen over the third quarter has taught us anything, it’s that this global economic “recovery” is uncertain. European peripheral bond yields jumped over October. Greece’s 10 year bond yield increased briefly over 9%, a yield we have not seen since the days of the Eurozone crisis in 2011.

Increasing concerns over the European economy have weighed on global markets. Europe’s slow growth and fears of deflation, which makes debts harder to bear, has taken hold and threatens to once again impact global financial stability. Stability that we have only seen tested a few times over the last decade.

Austerity tired Europe is on the verge of falling into a deflationary environment without the necessary stimulus. Equity markets have rebounded from the global selloff in October but to a point where we are not sure how much further they can rise.

What we are focusing on is providing “enhanced” predictable income within a plain vanilla equity fund. We are aware that no one is able to “judge the directions of markets” accurately over time.

Assuming equities will broadly be the same price in the long run; then income from dividends and premium will provide the added return for investors. Irrespective of this, in today’s world investors need funds that are fully transparent, do no use leverage, are easy to understand, offer real liquidity and provide consistent returns.

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