Tomas Hirst and Shaun Cumming look back over a year when debt crises hit America and the eurozone, uprisings gripped the Middle East and North Africa, disasters struck Japan, markets tumbled … and political leadership appeared sadly lacking.
The past 12 months have provided a great deal of excitement for economists and market commentators. For market participants, however, it has been a rather painful experience.
Between the start of the year and December 6, the FTSE 100 index fell 2.28%, the Nikkei dropped 12.25% and the S&P 500 only just crept into positive territory with a 0.48% return, in sterling terms. If investors thought faster-growing emerging economies would offer some solace they were quickly disabused as the MSCI Emerging Markets index plummeted by 14.88%.
Within these underwhelming figures might lie a warning on the dangers of over-optimism, but more than anything they reflect the central failure of 2011.
Financial markets have been on the receiving end of criticism, some deserved, and face the prospect of an increased regulatory burden and additional financial transaction taxes. Yet if this year has had an investment theme it can best be characterised as a lack of political leadership.
Whether it be the earthquake in Japan, debt ceiling debates in America or sovereign debt crises in the eurozone, politicians have taken every available opportunity to demonstrate their inability to tackle the difficult questions. At times it has even appeared that they are not aware of the scale of the problems they are facing.
Given that, it is in many ways remarkable that equity markets have remained as resilient as they appear to have been. Volatility remains high and there is a palpable tension in market behaviour, but, nevertheless, the central case still appears to be that ultimately policymakers will find a solution to the economic woes of developed countries. (Cover story continues below)
In terms of cutting back government spending, America has been something of a laggard in the developed world. Partly this reflects deep divisions in academic circles over whether stimulus spending or fiscal tightening is the route out of the country’s slump, and partly it reflects the reality of political gridlock.
In November 2010 the Republicans romped home in the mid-term elections capturing 63 seats in Congress and regaining control of the lower house. Since then they have sought to use this platform to counter what they see as the reckless policies of President Barack Obama’s administration.
The result, predictably, has been gridlock. Republicans have refused to pass Democrat bills on spending reforms in the lower house, while the Democrat-controlled Senate has blocked Republican proposals.
Both sides seemed content to face-off until the 2012 elections, when the public will get the opportunity to decide. The problem is that many of the decisions over public debt and spending need to be taken before next November.
In May the American government hit its debt limit of $14.3 trillion (£9.1 trillion) which is set by statute and can only be raised by Congress. Timothy Geithner, the Treasury Secretary, managed to extend the deadline to August 2, but a deal to raise the limit was necessary by that date if the country was to meet its spending commitments.
In response, John Boehner, the Republican speaker of the house, announced that his party would refuse any increase in federal debt limits without a firm plan for spending reductions. During the ensuing debates both Republicans and Democrats found their plans blocked, and as the deadline drew nearer, markets began to fear a deal could not be struck between the two sides.
With 24 hours to go, a last-minute deal that included a $2.1 trillion deficit-cutting plan was finally agreed. The compromise included the creation of a bi-partisan “Super Committee”, which was charged with creating a mutually acceptable deficit-reduction package by November. In essence, it meant the conflict was not over but had been merely forestalled. The impasse resulted in the ratings agency Standard & Poor’s (S&P) downgrading America’s sovereign debt rating from AAA to AA+ for the first time in the country’s history.
”The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short”
“The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics,” S&P said in a statement.
Though the Super Committee’s failure to reach an agreement may have been predictable, the consequence of this partisan brinkmanship was that it triggered automatic spending cuts starting in 2012. These will include about $600 billion in defence cuts, bitterly resisted by Republicans, and $600 billion in Medicare and domestic spending cuts, equally fiercely opposed by Democrats. The worst of both worlds, you might say.
“We are going to have deficit reduction but the exact shape of the cuts remains to be seen,” says Paul Chew, the head of research at Brown Advisory. “The greatest impact could be in defence and the healthcare sector, especially if the Medicare cuts come through.”
There is still time for Congress to agree a package before the automatic cuts start to bite, but with neither side demonstrating any inclination for compromise it looks a slim possibility.
Of course, no overview of 2011 would be complete without looking at the difficulties facing Europe’s monetary union. Not only has the sovereign debt crisis facing southern European countries offered eurosceptics an opportunity to indulge in a bit of back-slapping, but it has threatened to derail the fragile global economic recovery.
Back in June 2010, European leaders thought they might have found the solution to the monetary bloc’s woes with the establishment of the European Financial Stability Facility (EFSF). Set up as a Luxembourg-domiciled limited liability company, it was funded by guarantees of the 17 euro member states to act as a guarantor in sovereign debt auctions.
The total lending capacity of the fund amounted to some €440 billion (£374.4 billion) sufficient to reassure the market when the problems were located in the relatively small economies of Greece, Ireland and Portugal. Unfortunately, by the start of 2011 it was clear that the problem was spreading.
In January, José Manuel Barroso, the president of the European Commission, suggested that the bail-out fund needed to be boosted by about €200 billion “within the next three weeks”.
Elsewhere, predictions were even worse, with commentators at Eurointelligence estimating the eurozone would either need to print as much as €2 trillion to buy state debt or bring governments’ pledges to its bail-out fund up to the same level.
European politicians, however, remained unmoved. As recently as September the German finance minister, Wolfgang Schäuble, said there were no plans to boost the size of the rescue fund.
“We are giving [the EFSF] the tools so it can work if necessary,” he said. “Then we will use it effectively but we do not have the intention of boosting its volume.”
Yields in Italian government debt were sent above 7% and the crisis even forced Silvio Berlusconi, the Italian prime minister, to resign. Yet it was not until the end of November, with French yields starting to creep upwards, that Europe’s leaders were forced to act.
Ministers agreed to create certificates that could guarantee up to 30% of new issues from troubled eurozone governments, though for many this fell substantially short of what was required.
”The greatest impact could be in defence and the healthcare sector, especially if the Medicare cuts come through”
“I still think it’s a noble project and it’s a terrible shame that it’s not been protected as it should have been,” says Nicholas Williams, the manager of the Baring Europe Select Trust and co-manager of the Baring European Smaller Companies fund. “Germany seems intent on a euro that looks like the deutschmark, but my worry is that they create a two-speed Europe.”
Angela Merkel, the German chancellor, has remained consistent in her opposition both to joint-liability Eurobonds and quantitative easing by the European Central Bank (ECB). The problem for Merkel and Nicolas Sarkozy, her French counterpart, is that commentators and market participants are increasingly seeing one or both of these measures as necessary to save the euro from collapse.
The game of chicken that Europe has been playing with bond markets may well be reaching a grisly conclusion unless policymakers become proactive in their efforts to avert a worst-case scenario.
Equity markets, however, do not to date seem overly concerned with what that could mean.
Analysing the fund management industry in 2011 reveals little in the way of obvious sales trends. What is clear is that investor sentiment, driven by conflicting natural, social, and economic factors, created a confusing environment where the Cautious Managed sector was the only IMA peer group to greatly benefit.
Several shocks occurred in the first half of the year, which immediately affected markets and specific sectors, while some of the effects continue to disrupt markets as the year comes to a close. The Arab Spring uprisings, which began in January, affected several oil producing countries. This led to soaring oil prices and helped fuel a commodity boom.
Meanwhile, Japan’s earthquake and tsunami in March immediately affected investor confidence. While initially suffering, some Japanese stocks rebounded as the country rebuilt. Political crises in the eurozone and America also took a toll.
Data supplied by the IMA showing the top-selling fund sectors provides few conclusions.
While the Cautious Managed sector won favour during the year, the rest of the data, according to the IMA, is inconclusive.
A defining point of the investment trusts arena in 2011 was the failure of newly planned products to achieve a listing. Of the few that successfully listed, most fell disappointingly short of their managers’ launch targets.
What makes this spate of unsuccessful launches unusual is that 2010 proved to be a successful year for new investment trusts. Aligning these failed launches with global turmoil throughout the year provides a credible explanation, but individual factors have also affected specific vehicles.
Earlier this year six launches were either delayed or aborted altogether. These included: Aberdeen Emerging Markets Smaller Companies, Fidelity India, Invesco Perpetual Global Income, Kotak Infrastructure, Schroder Opus Commodity and Securis Income.
Annabel Brodie-Smith, the Association of Investment Companies’ (AIC) communications director, says looking back over the past few years provides evidence that the success of investment trust launches is linked to market sentiment.
”Generally, launches had an income theme. Also, policy changes reflected an income approach”
“The market has had a huge impact on launches, and this can be put into context,” she says. “It has been a challenging year for launch activity, with just six investment company launches collectively raising £691m. This compares with 15 investment company launches in 2010, collectively raising £1.7 billion, but was ahead of a more muted 2009 [when investor sentiment was low], when four launches collectively raised £566m.”
Of the six trusts launched in 2011, two failed to raise £50m, which is typically considered critical mass for an investment trust launch.
One fund that achieved a strong launch was the Neuberger Berman Global Floating Rate Income fund, which raised £310m. The managers’ approach is to invest in an international portfolio of secured floating rate notes, which rise along with official rates – essentially protecting income.
Brodie-Smith says Neuberger Berman’s successful launch marks a theme, in which closed-ended funds that provide an income proved to be particularly popular during 2011. “Generally, launches had an income theme. Also, policy changes reflected an income approach,” she says.
This, she adds, also reflects the growing popularity of infrastructure investment vehicles, which provide “consistent income”. An example of this is the John Laing Infrastructure Fund (JLIF), which was launched in November 2010, and invests in private finance initiative contracts that guarantee a steady stream of income. JLIF announced a 3p interim dividend in its first half-year report, meaning it is on target to produce its targeted returns.
James Brown, an investment trust analyst at Winterflood Investment Trusts, says investor appetite for income products is driven by low bank rates. “In this low-interest rate environment, investors are looking for secure incomes of 6 or 7%,” he says.
The past year has also heralded the beginning of a potential low-cost trend. Three large investment companies have restructured their fees to provide lower costs, which Brodie-Smith says could create pricing competition among investment trust providers.
Henderson sent the British retail funds market into a whirlwind of rumours when takeover talks with Gartmore emerged in 2010, and in January this year it finally agreed terms to buy out the asset manager for £335m.
The merger raised questions for investors in Henderson’s open-ended products. Initial concerns focused on the fact that Henderson and Gartmore were similar in both product range and expertise. Loss of staff was inevitable, but many of Gartmore’s key fund managers were retained, along with some of its highly regarded products, with most of the key overlaps occurring within the British equity space. Speculation subsided after the firm settled in new staff and the funds were rebranded under the Henderson banner.
One of the key trends of the year is the slowdown in popularity of emerging markets products. In previous years, emerging markets, and the funds launched to take advantage of their growth, were highly popular. But during 2011 emerging markets suffered outflows because of fears of a slowdown in China and global financial turmoil.
Simon Ellis, a managing director at Legal & General Unit Trust Management, says spotting several “global mega trends” early helped product development.
One of these trends is climate change, which has led LGIM to develop products that take advantage of environmental opportunities. In June the group announced the launch of the Global Environmental Enterprises fund, which tracks an environmental index designed by Osmosis.
Another of the year’s prominent discussion points concerned the controversial IMA Cautious Managed sector. As IMA statistics show, Cautious Managed was the top-selling sector of 2011. But questions remain over whether investors are taking bigger risks than they realise as they are comforted by the “cautious” label applied to funds.
The performance of funds in the Cautious Managed sector can vary wildly. The IMA is taking the problem seriously, but its announcement in May proposing to rename the managed sectors sparked further debate.
Elsewhere, eurozone debt has created a perilous environment for income funds. Several countries appeared in danger of defaulting on debts at various points during 2011 as repayment terms reached unsustainable levels for some. Investors have had to balance the risk of sovereign debt problems spreading to the corporate sector against the increased yields distressed markets are providing.
Nevertheless, some fixed income providers thrived in this environment. Rebalancing statistics from the FE Adviser Fund Index (AFI) in November revealed M&G as the top provider in both the AFI Balanced and Cautious indices.
According to Tim Cockerill, the head of collectives research at Rowan Dartington and an FE AFI panellist, the firm is popular because of its “inherently cautious” approach. Cockerill, who favours the M&G Corporate Bond fund for this type of investment, said: “[M&G has] a clear macro view, and over the past few years they have been pretty accurate.”