Two months into 2015 and financial markets in developed countries have exhibited considerable buoyancy. Despite a weak global macroeconomic backdrop, equity markets in the United States, Europe and the UK have tested new highs, while bond markets continue to remain broadly supportive.
All this should provide good news for UK investors many of whom endured a challenging 2014. Although gilts or government stocks prospered during the year, the UK equity or shares market remained flat. Furthermore many alternative asset classes, such as hedge funds, private equity and property also found the going tough during 2014.
Sterling-based investors could have boosted portfolio returns by either increasing their UK gilts and/or international equity exposures. The likelihood is, however, that relatively few opted for this strategy. As a consequence, most wealthy investors would probably have experienced sub-par returns during the year, at least as far as their financial assets were concerned.
But investors and especially the wealth management firms that invest on their behalf are nothing if not optimistic.
So despite a number of potential headwinds, such as geopolitical tensions in Eastern Europe and the Middle East, continuing problems surrounding Greece and the eurozone, a slowdown in China’s economic growth, uncertainties surrounding the outcome of the UK’s general election in May, and the prospect of an eventual increase in interest rates, any one of which could spook markets, at least in the short-term, the consensus remains broadly upbeat.
BLACK SWAN
Indeed the markets already seem to have discounted some risks, not least the prospect of a Greek exit from the eurozone. Markets remained unfazed by the stand-off between Greece’s new government and the troika overseeing its rehabilitation or indeed by the prospect of a default.
Of course, there is always the prospect of the emergence of an as yet unseen “black swan” or surprise event in the aftermath of either a so-called Grexit or Greek default. But the €320 billion at risk is not too dissimilar to the debt outstanding when the US city of Detroit defaulted in 2014. Financial markets and investors’ portfolios can probably cope.
Equities still remain the financial asset of choice for most rich investors
A big fall in the price of oil, the prospect of extremely accommodating monetary policies remaining in place, coupled with evidence that economic recovery in the UK and US is gaining traction and may even impact on the eurozone, could all provide both developed, as well as a number of emerging economies’ financial markets, with supportive tailwinds. And these could help boost financial asset prices during the remainder of the year.
Equities still remain the financial asset of choice for most rich investors. But significant exposures to UK equities were probably best avoided during 2014. Notwithstanding the UK’s economic recovery strengthening during 2014, both the FTSE 100 and the broader market, as measured by the FTSE All Share index, both failed to make any progress.
Both indices finished 2014 down in price terms. Hampered by its bias towards oil and mining companies, the FTSE 100 fell by 2.71 per cent. Taking dividends into account, however, it managed to generate a 1.04 per cent total return for the year. The broader FTSE All Share did slightly better, falling by 2.13 per cent in capital terms while generating a total return of 1.47 per cent.
Fixed income and international equities performed much better. Gilts once again confounded expectations as continuing yield compression enabled the asset class to post a 14.67 per cent return during the year, according to the IBOXX Gilt Total Return Index. Boosted primarily by US equities, which still account for a significant proportion of the index, the MSCI World produced a capital return of 9.43 per cent for sterling-denominated investors and 12.32 per cent on a total return basis.
Alternative asset classes did very little to boost investor returns during 2014. Hedge funds failed to generate positive returns for sterling-denominated-based investors, at least according to the HFRX Global Hedge Fund Index.
The FTSE 100 generateed a 1.04 per cent total return in 2014
Although some segments of the UK property and real estate sector continued to make progress, notably trophy assets in central London, the IPD Total Return Index, a much broader measure of the global market, fell by 24.37 per cent. Private equity, or at least listed private equity, generated a total return for sterling investors of 4.18 per cent, according to the LPXSI Listed Private Equity Index. Commodities also endured a torrid time, as epitomised by the fall in the price of oil.
PRIVATE CLIENTS
Perhaps not surprisingly, it was not a vintage year for wealthy UK investors. Indeed, three of the four private client indices (PCIs) produced by Guernsey-based Asset Risk Consultants (ARC) registered sub-par returns in 2014.
Only the ARC Sterling Cautious PCI, the least risky of the four indices, which encapsulates portfolios with equity weightings of between 0 and 40 per cent, performed in line with its historical annualised return of 4.6 per cent.
The ARC PCIs reflect the performance of around 50,000 real portfolios managed by the 54 of the UK’s leading private banks and private client investment managers. Each PCI represents a different measure of relative risk.
Despite a significant variation in relative risk, as measured by their holdings of equities, the riskiest financial asset class, all four PCIs generated similar returns during the year.
The ARC Sterling Balanced Asset PCI, which encapsulates portfolios with equity weightings of between 40 per cent and 60 per cent, produced a return of 4.8 per cent, 100 basis points below its
annualised return of 5.8 per cent.
The ARC Sterling Steady Growth PCI, which encapsulates portfolios with equity weightings of between 60 per cent and 80 per cent, generated a return of 5.0 per cent in 2014, 140 basis points below its annualised long-run return of 6.4 per cent.
The ARC Equity Risk PCI, which encapsulates portfolios with equity weightings of between 80 per cent and 100 per cent, produced a return of 4.6 per cent, 260 basis points below its annualised long-term return of 7.2 per cent.
Clearly it paid UK investors to have significant bond holdings during 2014.
INVESTMENT OUTLOOK
Notwithstanding recent events, private client asset allocators and investment strategists have reiterated the advice they gave their clients at the beginning of 2014. Given the ever-present threat posed by a market correction or worse, portfolio diversion should remain a paramount objective; nonetheless, return-orientated investors should favour heavier equity weightings relative to bonds.
“[Equity] valuations are no longer cheap, but corporate earnings growth should be sufficient to drive mid to high single-digit per annum returns over the medium to long term,” advises UBS, the world’s biggest private bank with around $2 trillion of assets under management. It prefers to overweight US equities relative to the UK.
Portfolio diversion should remain a paramount objective; nonetheless, return-orientated investors should favour heavier equity weightings relative to bonds
Although bonds yields are very low by historic standards, UBS believes they will continue to provide stability during periods of equity-market volatility. But investors should increasingly look to credit as a source of return.
Rothschild advises that roughly two thirds of a long-term balanced portfolio should consist of growth-related, compounding return assets with the remainder devoted to diversifying assets, such as bonds.
It favours both US and euro area stocks ahead of most others during 2015. “We have little conviction in either direction on Japan and Abenomics [measures introduced by Japanese prime minister Shinzo Abe aimed at stimulating the economy]; and we think the UK large-company market is likely to continue to lag, given its heavy resources – oil and mining – content, though we do prefer it to gilts,” Kevin Gardiner, Rothschild’s global investment strategist, concludes.
