Commentary
INSTITUTIONAL INVESTMENT | , Singapore
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Ipac: ‘2008 – tough year on many fronts’

We are deeply conscious that the last year has been exceptionally difficult for investors. The impact of the unfolding global financial crisis has been brutal on capital markets, producing exceptionally weak returns for most asset classes. All long-term investors have had to endure sharp declines in the value of their portfolios.
In many ways, 2008 was a year when the financial system failed and the complacency of virtually the entire financial sector came home to roost.

The financial crisis is unprecedented in its scale and the speed with which it has translated into slowing global economic activity. To draw a mechanical analogy, the supply of oil (akin to the provision of finance) has stopped flowing to the engine (the real economy) causing a rapid deceleration. The challenge for policy makers around the world has been to quickly restore the flow and deal with any problems the shock created. This has called for equally rapid and unprecedented economic policy responses. While there have been missteps along the way, the actions to date have been nothing short of spectacular.

It will take time before these measures work to stabilise conditions. It is difficult to know exactly when these actions will begin to bear fruit, restoring confidence to businesses, decision makers and investors. Markets aim to anticipate these trends. As the flow of new data is “priced in,” market views constantly re-adjust. In the shorter term, the general run of economic indicators will remain uncomfortable for at least the first six months. The cross currents created by mixed economic news and policy responses could mean volatility remains elevated as markets continually reassess growth prospects.

Our baseline outlook assumes the global economy shows signs of recovery late in 2009, but more likely 2010, under the influence of massive economic policy stimulus. However, we cannot entirely rule out the possibility that the global financial crisis and associated dislocations in credit markets persist for longer than expected, both lengthening and deepening the duration of the global economic downturn. It is important to test the validity of investment strategies and the sustainability of manager arrangements in the context of this potential scenario.

Equity valuations are currently at considerable discounts to normal levels in most markets. This is understandable when the momentum of profits is downward but current pricing does appear to have taken this negative trend into account. The potential exists for sound returns to be generated from diversified portfolios should the world economy track as expected.

Attention has been re-focused on market risk. The graph below shows the number of days each year in which the market moved up or down by more than 2 percent. What was a rare event in 2005 and 2006 became a weekly experience in 2008. The return of volatility encourages more discriminating investor behaviour and provides reduced support for leverage. Further, an environment of higher volatility in investment markets argues for well researched and diversified investment portfolios.

Each year ipac reviews its medium-term (five-year) asset class forecasts. Our latest analysis is that cash return expectations are below our forecast of 12 months ago reflecting the weakening of the global economy and the impact of aggressive monetary policy easing on cash rates.

Also, bond forecasts mask a large divergence occurring within the fixed interest market. Yields on government bonds are low. They will eventually rise and this is a restraint on returns. By contrast, yields on corporate bonds are high and are likely to fall when conditions eventually normalise. This adjustment would produce strong positive returns from corporate bonds.

Finally, returns across a large spectrum of growth assets appear more appealing than a year ago following sharp price declines that have improved valuations. However, investors seeking to capture these returns are likely to need to display continuing patience and some courage.

The year ahead presents continuing challenges. However, the repricing of risk is presenting new opportunities for investors over the medium term. This is an area where our research effort is focused and where we are looking to add well rewarded opportunities to client portfolios.

The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Investment Asia. The author was not remunerated for this article.

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