Painful correction precedes recovery

The slowdown poleaxed stocks, hitting investment strategies that targeted soft commodities and property making the adviser\'s task more challenging. But risk takers will be rewarded again.

This has been quite a year. The credit crunch rumbles on; an African-American was elected to the White House; a global economic slowdown developed with frightening speed; central bankers and governments are co-operating like never before to head off a damaging recession, with the result we have the lowest interest rates on both sides of the Atlantic ever, with the prospect of more cuts to come.

On the investment front it has been challenging in the extreme. The broad numbers are bad enough, but on an individual stock front it has been devastating. Several household names are disappearing. Shareholders in some of Britain’s biggest banks have been wiped out or found their investment shrunk to a fraction of its worth. This may have been the year of the stockpicker, but the performance of star-rated funds has shown that extreme volatility can cut both ways.

Advisers have found it particularly difficult. The arrival of opportunities to access asset classes hitherto the province of the wealthy has not proved timely. Funds targeting soft commodities, property and hedge funds have been hard hit, as have several investment areas that delivered stellar growth in the past. And to make matters worse, some hitherto reliable sectors, such as UK Equity Income, have fallen victim to the malaise that engulfed financial assets.

One of the cardinal rules of investing – that asset prices over-react in both directions and that prices revert to the mean over time – is firmly in place and meting out severe punishment to those who said riskier areas such as emerging markets were a one-way ticket. Indeed, Global Emerging Markets was the worst performing Investment Management Association (IMA) sector – bottom out of 30.

Smaller Companies, both domestic and European, were within a whisker of each other – just 0.01% separating their performance. Again, these are sectors displaying high-risk characteristics. Smaller companies are less liquid than the market leaders, so when the going gets tough you have to expect prices to suffer more than the average, whatever the longer-term prospects.

When it comes to the winners in 2008, there are no surprises on the sector front. As interest rates come down around the world and investors flee to the perceived quality of sovereign debt, so global bonds have benefited, bringing this relatively risk-averse sector to pole position. And the only other sectors to produce a positive result for the year drawing to a close are just as conservative – UK Gilt and Money Market funds. This year has not suited those who take risks.

Further down the table and you will find a bunching in performance terms that more closely resembles the overall outcome for the year. About half the IMA sectors recorded falls in the 20-40% range. UK Equity Income came in the centre, falling 32.7% on average. This does not seem too bad (UK All Companies was down by 35.6%, putting it in the worst five sectors for performance in the first 11 months of the year) but this has been viewed as the low-risk option by advisers for years, demonstrating just how difficult the investment climate has become.

But what of those sectors in which we placed such hope for protecting our assets in a downturn? Absolute Return has managed to creep into the top five, but still failed to produce a positive result. While a fall of 2.7% is above average for the year, it is an average for the sector itself that encompasses such a range of styles that little comfort can be gained from the sector description.

As for Cautious Managed, the fall in value of not far shy of 20% must be of little comfort to those who were sold the concept on the basis of surrendering some of the up side to protect against a downturn. Balanced Managed did even less well, but the message that managers continue to rely on equities to deliver the long-term performance comes across clearly.

As for the individual funds, there are few – but some – surprises in the winners and losers tables. Eighteen of the top 20 funds are in the Global Bonds sector – as you might reasonably expect. But these funds are bracketed by numbers one and 20. In 20th place the Insight Absolute Currency fund must be an unsurprising entry. But for Neptune’s Japan Opportunities fund to top the tables, with a rise in value of nearly two-thirds, is an achievement deserving of special recognition.

The tail-end Charlies are a more mixed bunch. Specialist funds dominate, filling nine of the bottom 15 places, but the honours – or lack of them – are more widely spread than at the top. Melchior has had a tough time in its home territory of Asia Pacific, while Global Emerging Markets were bound to deliver some duds, though not as many as their overall position might have suggested.

We must look back at 2008 as a year of reckoning, when the excesses – in terms of past performance – were corrected rapidly and painfully. It is hard to see just how much and how far any reversal of fortune might be taken in 2009. We can hope that the worst is behind us and the prizes will once again go to the risk takers as the global economy stabilises.