Optimists bemoan ‘annus horribilis’

Substantial falls in all three of the Adviser Fund Index benchmarks reflect the extent of the market downturn over 2008, which has led many to regret their hardline stance on equities.

Tis the season to be jolly, or so we are reliably informed by television advertisements. For many in the financial services industry, however, the Christmas break offers a chance to reflect on what has been one of the most traumatic 12 months in financial markets for the past 15 years.

The three benchmark Adviser Fund Index (AFI) indices illustrate the extent of the downturn seen since the turn of the year. The crisis has, unsurprisingly, hit the Aggressive index hardest, producing a fall of 31% over 12 months to December 8, while the Balanced index has lost 25%.

Even the defensive Cautious index has lost more than a fifth of its value over the year, reflecting how deeply the crisis has affected the industry.

Looking back on the year, many of the AFI panellists bemoan their early optimism about the prospects for equities and their faith in diversification strategies, both of which ultimately proved unsuccessful.

“It’s really been about gilts and cash, and with hindsight I probably would have taken more defensive positions,” says Ben Willis, the head of research at Whitechurch Securities. “We probably shouldn’t have taken such a hardline equity stance.”

Traditionally during an economic downturn, investors flock towards large-cap stocks in a flight to quality. As with many aspects of the crisis, however, investor behaviour did not follow conventional wisdom, driven in many cases by forced sellers needing to sell liquid holding to fund margin calls.

To illustrate this, the FTSE 100 index of Britain’s leading shares has fallen by 38.7% over the past year to December 8. The situation worsened markedly in July as the commodities story that had seen crude oil prices rise to $147 per barrel reversed sharply, unwinding one of the most successful investment strategies of the first six months of the year.

Julian Chillingworth, the chief investment officer at Rathbone Investment Management, says the year has brought the collapse of the easy monetary policy introduced by Alan Greenspan during his term as chairman of the Federal Reserve.

In a testimony given to a Congressional panel in America on October 23, Greenspan admitted that he had been “partially” wrong in his policies as Fed chairman.

“This crisis,” he said, “has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount.”

The problem, which originated in the American mortgage markets, quickly swept through the financial sector before its effects began to be felt by the so-called real economy in the form of job cuts and company bankruptcies.

“This year has been the apex of the problem,” says Chillingworth. “We haven’t seen a slowdown like this in Western economies in the past 15 years.”

The scale of the problem was such that many of the AFI panel were, like most investment professionals, caught out by the speed at which the crisis unfurled.

“At various times I felt like we were probably at the bottom of stockmarkets,” says James Davies, investment research manager at Chartwell and an AFI panellist. “That seems to have been wrong on several occasions and I’ve ceased trying to predict when markets will stop falling.”

With nowhere left to hide, money started to pour into absolute return vehicles, swelling Mark Lyttleton and Nick Osborne’s BlackRock UK Absolute Alpha fund and Tim Russell’s new Cazenove UK Absolute Target Fund, launched in July.

The BlackRock fund grew to more than GBP 1.5 billion, soaking up most of the retail money moving into the sector until Russell’s fund arrived. The Cazenove fund took GBP 60m when it was launched into what Robin Minter-Kemp, the managing director of Cazenove Capital, describes as “one of the most challenging investment climates of my career”. The fund has since grown to over GBP 142m.

“Absolute return funds did have a place in our portfolios [earlier in the year] but we added to it again in November,” says Willis. “We’ve included the Cazenove fund as we met up with Tim before the launch and we were confident he could produce the same returns as in his hedge fund. Even in the aggressive portfolios you might have exposure to these products to protect against a downturn.”

One of the key problems identified by the AFI panellists in 2008 was that many of them feel they were caught up in the crisis and were not able to take a broader perspective as it unfolded.

“I think I would have been a little less caught up by the noise, although I’m certainly not the worst for this,” says Davies. “Across the board there has been significant asset destruction, but to have got the big fundamental calls wrong on each occasion would have been poor.”

Of the asset management groups, Davies says Neptune and Jupiter look strongly placed going into 2009 as they have sound cash positions and dynamic business models.

Panellists also suggest that Invesco looks in shape to weather the crisis, thanks in no small part to the appeal of star managers such as Neil Woodford.

The Adviser Fund Index series comprises an Aggressive, Balanced and Cautious index each tracking the performance of portfolio recommendations from a panel of 18 investment advisers. For each risk profile, all panellists specify a weighted portfolio of up to 10 funds from the authorised UK unit trust and Oeic universe that, when aggregated, define the constituents and weightings of the three AFIs (see www.fundstrategy.co.uk/adviser_fund_index.html).