Performance 2009

Portfolio performance in 2009 was dictated by a decision we made early in the year.  Faced with the worst financial crisis of the last 50 years, we considered wealth preservation to be paramount, even if that meant running a risk of relative underperformance to our benchmark. As it happened, our portfolios still did outperform their benchmarks. It was an interesting year.

Cast your mind back to the investment environment in January of 2009.  We knew the world was in a severe recession.  We didn’t know if this was the start of the next great depression.  We didn’t know if any sustained recovery was possible in a world with dysfunctional credit markets.  Our mission statement is “don’t lose the bloody stuff”.  Running to cash in our equity portfolios was the only action consistent with that policy and the truly scary market developments we were witnessing.

The rally in equity markets that followed would have been remarkable even if it had not occurred despite such adverse economic circumstances.  From the low point reached in mid-March, global equities rallied some 74% in USD dollar terms.  But the same rush back into risky assets that pushed up shares also sent the Kiwi soaring, wiping out most of the equity gains in New Zealand dollar terms.  As frustrating as this was for an investor in unhedged global equities, it was the flipside of the boost given to 2008’s returns by a plunging Kiwi.

Our defensive cash holdings weighed down our portfolio returns when markets started to rise, even as we started to edge back into equities.  Although the rally that started mid-March lasted throughout 2009, it was not until the final months of the year that we started to see economic data that justified market confidence.

The fact that we still finished year-end slightly ahead of our benchmarks (1% for growth portfolios) is a testament to a sharp out-performance of our stock selections.  Fixed interest assets also enjoyed a strong year as 2008’s blow-up in credit spreads reversed itself. 

Picking every turning point in the markets with 100% accuracy is impossible.  We pride ourselves on being more right than wrong, and often using our discretion to be more conservative than the client has mandated (we are never more aggressive than the client allows).

Measured over the credit-crisis period, the benefits of this tactical allocation approach are clear-cut.  We outperformed the benchmark, and we did so by taking on less risk – we avoided the roller coaster ride taken by the asset managers who remain fully-invested regardless of conditions.

The “Noughties” proved to be one of the worst decades for equity investors ever.  In New Zealand dollar terms, investors who got the benchmark return lost 5.2%pa.  We’re proud to have beaten that benchmark in every one of those years – remember, only 30% of fund managers beat the benchmark in any one year.  As a result, the average GMI growth client finished the decade up 3.8%pa after tax and fees.  That is a demonstrable case of adding value despite treacherous conditions for investing.

ASSET CLASSES

Each year we look at portfolio performance from two aspects:

• The performance of each of the asset classes we identify – cash, fixed interest, income stocks, core growth stocks and satellite growth stocks.
• The performance of client portfolios themselves, which of course are a mix of the various asset classes.  That mix is driven by the client's mandate and our own tactical management of asset class weightings as we try to navigate the investment cycle.

This section deals with the asset classes, and the next section will deal with the portfolios. The graph below presents the average performance for client portfolios in each of the 5 investment asset classes we identify. The returns referred to in this section are net of withholding taxes and brokerage.
 

Fixed Interest

The fixed interest asset class enjoyed a very strong year in 2009, returning 7.5% compared to a benchmark of -0.8%.  As the credit-crisis eased, the corporate spreads started to normalize, resulting in large capital gains on fixed interest assets.  Liquidity has steadily improved in credit markets as investors became more tolerant towards credit risk.  But the appeal on government bonds began to fade as investors eyed up the tsunami of issuance on the way, and yield rose from historically low levels.  Our portfolios remained weighted towards quality local corporate issuers, allowing us to benefit from spread compression, and to avoid getting squashed by rising government bond yields. 

Income stocks

Our income stocks fell 1.7% in 2009, behind the benchmark performance of 2.9%.  The NZSE50 Index had a gross return of 14.9%.  Our income stocks holdings have been diversified to include more foreign stocks with strong balance sheets.  However, these companies did not benefit as much from 2009’s recovery in equity markets (the improvement in credit conditions saw low-quality, debt-laden companies benefit the most).  Foreign income stocks were also adversely affected by the rise in the New Zealand dollar. 

Core growth

The core asset class consists of managers we have selected to replicate the underlying exposure of the global equity benchmark, while adding a bit of extra performance through stock selection and tactical positions.  The core asset class was successful in that regard this year, returning 9.6%, far in front of the MSCI benchmark of 2.9%.  Core growth benefitted in part from improved liquidity on listed UK investment trusts, which enjoyed narrowing discounts to net asset value. 

Satellite growth

Our satellite stock picks enjoyed a very strong year, climbing 13.3% on average, over 10% ahead of the benchmark.  Satellite is the asset class we use to express our macroeconomic themes through stocks we have identified as representing excellent value in their respective sectors.  Our exposure to emerging markets was rewarded as the Chinese economy was quick to return to rapid economic growth, dragging other developing economies along with it.  This theme is expressed in several holdings within the portfolio: global companies with increasing sales in emerging markets; commodity producers that benefit from rapid economic growth and ensuring demand for food and raw inputs; and direct holdings of emerging market companies themselves.

Cash

Cash is not an asset class in its own right but instead reflects uninvested funds arising from other asset classes.  Hence the cash benchmark is the client’s overall portfolio benchmark.  2009 was a rough year for cash returns reflecting the low (or zero) global interest rates on offer and a rapidly appreciating New Zealand dollar, resulting in cash holdings losing 5.6%, as the (equity-based) benchmark climbed 2.2%.

Client portfolio returns

2009 client portfolio performance reflects a mix of the performances of the above asset classes depending on:

(a) the client's investment mandate;

(b) within the mandated constraints the extent to which we under- and over-weight specific asset classes to reflect our own view of the outlook for the individual asset classes. Being a discretionary manager we have scope to be tactical. The returns referred to in this section are net of all taxes, fees and brokerage. There are limitations on how many of the client portfolios we can include in this performance analyses. We exclude:

1. portfolios that haven't been with us for 12 months;
2. portfolios where the client has specified any specific instruments be held;
3. portfolios where the investment mandate has been changed significantly in the last 12 months; and
4. portfolios where there has been a substantial amount of money added or withdrawn over the year.

Together these restrictions eliminate around a third of our portfolios from consideration for this measurement exercise.

For this measurement exercise, we have considered the income portfolio group to include those with more than 65% of the assets mandated to be in fixed interest or income stocks; balanced to have between 35% and 65% of assets in fixed interest or income stocks (the rest in growth stocks); and growth portfolios to have less than 35% of funds mandated to fixed interest and income stocks (more than 65% in growth).
 

Growth portfolios

507 portfolios qualify for our growth sample, with mandates for between 65% and 100% growth assets.  On average, these portfolios finished 2009 up 3.8%, 1.1% ahead of their benchmark.  Portfolio returns ranges from 7.9% to -1.8%.  Growth performance was handicapped this year by our decision to maintain a large defensive allocation to foreign cash.  However our equity holdings in both core and satellite strongly out-performed, more than making up the difference to benchmark.  Growth portfolios finished 2009 85% invested in equities, reflecting a more optimistic outlook for returns in 2010. 

Balanced portfolios

We have taken these to be any portfolio with a mandated asset mix of between 35% and 65% in income stocks or fixed interest.  130 portfolios qualified for this sample and the returns ranged from 9.1% to -2.0%, the average performance being 3.7% and the average out-performance of the relevant benchmark being 2.3%.   With fixed interest assets enjoying a strong year, balanced portfolios earned returns in line with growth portfolios despite the lower allocation to risky assets. 

Income portfolios

Our income portfolios enjoyed a good year, increasing 3.6% and out-performing the relevant benchmark by 3.4%.  There were 79 portfolios in the sample satisfying this criterion for income of less than 35% allocated to growth securities.  The range in performance was from 8.9% to -3.1%.  Corporate bonds spent much of 2009 in recovery mode as credit conditions returned to normal and interest rate spreads (to government bonds) compressed, pushing up prices.  Although we emphasized high credit quality in our income portfolios in 2009, we avoided government paper which was the big loser as 2008’s “flight to quality” reversed.

 

2009 YEAR IN REVIEW

2009 began where 2008 left off, with markets in free-fall, despite the scrambling efforts of policy-makers.  The MSCI was off 18% in the first two months of the year.  With central banks closing on the limits of conventional monetary policy (a cash rate of zero percent), the world appeared to be on the verge of a liquidity trap in which conventional monetary policy becomes powerless.  

It is a bit convenient to trace the ensuing rally to a single initiative, especially after so many earlier programmes had done almost nothing to pause the slide in markets.  But two moments stand out as potential turning points at which faith was restored that monetary and fiscal authorities would do whatever it took to prevent the recession deepening.

• The US Federal Reserve announced a program of quantitative easing – direct purchases of government bonds with newly printed cash, aimed at directly lowering long-term interest rates (which underpin US mortgages) and raising inflation.  The zero percent lower bound for interest rates had been bypassed.
• The US government passed a $800bn stimulus bill to increase aggregate demand.  The traditional Keynesian remedy was being applied – if consumers wouldn’t spend, the government would be the buyer of last resort. 

Although the US attracts the most attention, similar fiscal programmes were put in place across the world.  Particularly noticeable was the early and sizable infrastructure stimulus program enacted by the Chinese government.
In the first quarter of 2009, we began to see inflection points in key economic indicators like new job losses and manufacturing indices, although it was not until late in the year that these series moved into positive territory.  It now seems clear that most developed economies exited recession in the second half of 2009, although indicators like unemployment have continued to rise even as firms start to restock their inventories.  The equity market rally was helped along by strong productivity growth and ruthless cost-cutting, which allowed firms to begin rebuilding earnings despite the economy remaining moribund.

One notable phenomenon has been the passing of the torch for global growth from the US to China.  Chinese growth quickly responded to the stimulus, increasing demand for commodities, and their closing trade surplus provided a fillip to growth in developed economies.  

We maintained a fairly defensive portfolio outlook throughout 2009.  Our equity weighting was slowly raised from 40% to 85% in response to continuing good news, and our cash allocations were moved back to commodity currencies.  In our equity selections, we continued to emphasize strong balance sheets – in other words the companies that we knew would still be here even if the recession worsened or credit markets froze again.  We also remained heavy in our exposure to global growers – companies that were able to look outside the US for consumer demand growth – and stocks poised to benefit from continuing emerging market growth.  This decision in particular was rewarded as emerging markets led the world out of recession.