Investment Market Update

The chart above shows the average 'Balanced Managed' fund performance for the past 12 months, from early July 2009. Balanced Managed funds are the typical fund offered by life assurance companies for pensions, and are very popular in particular for Group and Company pensions. (You will see further on in this newsletter some very good alternatives to these funds). This chart is probably more relevant to the average Irish investor than the S&P500 or ISEQ. 2009 ended with stock markets showing significant recoveries from the March 9th lows, but they still remain below the peak in the summer of 2007. In 2010, the markets in general have been very volatile, while trading within a range. The interesting periods to look at are the end of January and in May where markets dipped sharply. Markets are still extremely nervous, being particularly worried about the state of European government debt, and the overheating Chinese economy. With this in mind, we are expecting markets to continue to move up and down within a range for the next few months as good news and bad news stories compete for market attention.

There is no perfect solution for avoiding the uncertainty and volatility out there, as all asset classes have some weakness or uncertainty currently. A main concern for investors is the falling real returns for investment in cash. The alternatives are wide and varied, and the investment firms are all spending fortunes trying to get access to the ‘Wall of Cash’ currently sitting in deposit accounts. This ‘Wall of Cash’ is partly due to transfers out of risk assets during the past 2 years, but also due to the savings rate in Ireland hitting an all time high. So, what are the alternatives to cash, and associated risks?

Diversification is the key to any well designed investment portfolio. The mistakes made over the past 10 years globally, but in particular in Ireland were obvious. Overreliance by investors and the government on one asset class, property, with the added risk of significant leverage. In Figure 1.2, we analyse the average asset allocation of an Irish investor in 2006, where there was a significant weighting in property.

Even the 16% invested in equities was invested heavily in the Irish stock market, which accounts for less than 0.5% of the world stock market value. There is very little reliable data to show where Irish investors are currently invested, but from experience, we are now very heavily weighted in cash and secure assets. This would indicate that many Irish investors have missed out on the market gains of the past 12 months are still nervous about re-entering the market, which is very understandable. It is worth comparing this position to that of the Yale Endowment Fund, which is considered the benchmark for well constructed medium to long term investments.worth comparing this position to that of the Yale endowment, which is considered the benchmark for well constructed medium to long term investments.

It is clear that there was a significant difference between the two positions. The lesson we have learned from all this is an old and simple one, ‘Don’t keep all your eggs in one Basket’. Whether this means selling your stock options to diversify yourself away from financial ties to your employer, or establishing a more complex investment portfolio, it is a very important lesson. The challenge for us now is to slowly change our way of thinking and move across to this slightly more conservative but more diversified model. Firstly there has to be a process of de-leveraging and then re-distribution of the large cash reserves currently sitting with the banks, into other asset classes.

I have listed 3 options below, which give some alternatives to cash deposits. All of these have been mentioned before in previous newsletters, but which are worth highlighting again as a means of diversification.

1. Government Bonds – As a diversification away from cash deposits, the obvious option is investment in Government Bonds. All governments issue bonds, which are effectively loans issued by governments to investors. When you hear about the National Debt, it is almost completely made up of government bonds, with different maturity dates and coupon (interest) rates. While they are considered to be the safest and most secure form of investment, they vary quite widely. Greek government bonds, which are constantly in the news at the moment would be towards the riskier end or the scale, currently yielding over 6% (to reflect the risk of default), while German or US Government Bonds are considered the safest investments available, and yield in or around 3%. This asset class has been a favourite for institutional investors over the past 18 months, but is starting to look very expensive, and inflation / interest rate rises on the horizon will limit real returns. This is still however, a very safe investment and a reasonably alternative to cash. Currently the best performing Government Bond fund is the Eagle Star Active Fixed Income Fund (annualised 5 year performance of +5.83%)
   
   
   
2. Corporate Bonds – These are similar to government bonds but issued by companies. Noticeable examples of corporate bonds making a stir in the market at the moment are those issued by the Irish Banks. They are yielding over 10% per annum at the moment, so if you feel the banks are safe and have a future, this level of return is very attractive. Corporate Bonds sit somewhere between government bonds and equities on the risk scale. Direct investment in corporate bonds is possible, and there are also a range of Corporate Bond funds in the market, the best of which is the Friends First European Corporate Bond Fund (annualised 1 year performance of +33.84%). I used 1 year performance for Corporate Bonds as it is a new sector in the Irish fund market.
   
   
3. Structured Products – These are generally equity based investments but with an underlying capital guarantee or some form. They are designed to give some access to the returns of an underlying asset, such as an equity index (S&P 500), but also the protection of a capital guarantee. These can be an attractive alternative for someone who feels there is potential for stock market gains, but cannot afford the risk of complete exposure to market extremes. The disadvantage of these investment is that they usually have a medium to long term lock in period of somewhere between 3 -6 years. Structured Products are constantly evolving and changing, with new funds coming online every week. We keep a very close eye on the sector and constantly research the best offering. As we go to print the most attractive deal available is the Global Reach Autocallable Bond.

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