Time for investors to be fearful, not greedy – and sell?

“Buy on the sound of cannons, sell on the sound of trumpets.” So runs the old investment adage, apocryphally attributed to a member of the Rothschild banking dynasty. The idea – that you should invest when everyone is panicking and assets are cheap, and sell when everyone is jubilant, and assets are expensive – makes perfect contrarian sense. Investing in March this year, when fear of coronavirus and its impact was at a peak, certainly took a lot of nerve, but the level of panic was unmistakable. Today the question is: as vaccine news sends many markets to new highs, is this the “trumpet” moment?

Not yet, perhaps – but we might be getting close. One sentiment survey that I like to watch – the monthly survey of global fund managers from Michael Hartnett’s team at Bank of America (BoA) – is flashing a few warning signs that big investors might be getting ahead of themselves. The fact that this month’s was the most bullish survey of the year so far isn’t a surprise given the year we’ve had. But significantly, the levels of cash held by fund managers have fallen sharply from 4.4% to 4.1%. That’s below the 4.2% recorded in January, before Covid-19 had gripped the public consciousness anywhere outside of China. More importantly, based on past readings, below 4% is a “sell” signal, notes BoA.

There are still areas that will benefit from the “reopening” trade – there has been a big shift (or “rotation”, as City traders like to describe it) into the sectors which suffered most during the Covid-19 sell-off – emerging markets and small companies have seen particularly large flows of money in the past month, along with banks and value stocks generally. What investments still look neglected? At a market level, the eurozone and Japan are still lagging, while the UK remains widely disliked (a constant in this survey since the 2016 vote for Brexit). But even Britain is less hated than the energy sector.

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In short, if you’re looking for good bets today, stick with value stocks and beneficiaries of re-opening, and be long Japan, the eurozone, the UK and energy. But be ready for a bumpier ride in 2021 when good economic news could spell pain for wider markets.

That brings us to one other point from the survey that’s worth pulling out: despite their belief in a relatively strong recovery, global fund managers are still remarkably complacent about inflation. While most expect prices to rise next year, only 4% anticipate that inflation will be “a lot higher”. Instead, a majority are still backing the conveniently ideal scenario of “above-trend growth and below-trend inflation”. A surprise resurgence of inflation next year is exactly the sort of scenario that could derail markets. So hang on to your gold (and bitcoin).

I wish I knew what carried interest was, but I’m too embarrassed to ask

“Carried interest” or “carry” is a perk enjoyed mainly by private equity executives. In short, it’s a performance fee. The managers typically take a 20% share of the profits of a fund (on top of management fees) with the idea that this aligns their interests more closely with the investors.

Note that the name “carried interest” has nothing to do with the interest you might get paid on your savings. The term originates with trade voyages in the 16th century, where captains of ships sailing from Europe to Asia or America would take a 20% share of the profit.

You might question why a performance fee would make an investment manager try harder to make good investments, but that’s not the most controversial thing about carried interest. The real issue is that it is taxed as a capital gain rather than income, and so incurs a lower tax rate. In the UK for example, the capital gains tax top rate is 28% – it’s 45% for income tax (see page 10).

One argument for taxing capital gains less aggressively than income is to encourage entrepreneurship and investment – the idea being that those who put their own capital at risk to set up or invest in a business should get to retain more of any gains they make by doing so. This makes carried interest contentious, because while there are a few defenders of “carry”, most argue that private equity executives are in effect getting a preferential tax rate on what in any other industry would simply be viewed as a bonus for doing your job, and therefore taxed as income.

Changing the rules on carried interest would not raise much tax. A study by the University of Warwick and the London School of Economics found that taxing “carry” as income in the UK would have raised just £440m in 2017. It might also have unintended consequences in terms of driving the industry elsewhere. However, the argument for fairer tax treatment is politically potent at a time when inequality is never far from the headlines.