Global outlook colours long-term view

Friday 6th April 2001

The views of the country's largest investors may be self-fulfilling because of their clout but they are not so good at picking short-term trends, writes PETER V O'BRIEN

The state of major economies may be a slowdown, or the start of a recession, but the effect on world investment markets, particularly in the US has been dramatic.

The impact has been felt on the managed funds industry, which controls substantial investments locally and in massive overseas-based funds. Table I was compiled from IPAC Securities (NZ)'s quarterly review of managed investments for the three months ended December.

NBR Personal Investor selected the top 10 by fund size, summarised the rest under "other," added the percentages and compared the result with the position when the industry was examined in February 1999.

Table II summarises net funds flow for the December quarter but makes no comparison with the 1999 survey, because it would be misleading, given the industry's structural changes in the past two years. Structural changes also applied to table I but to a lesser extent.

The IPAC figures are not exhaustive. Many other people and organisations manage investment portfolios, so the "industry" at the retail level is probably a reasonable level above the $17.91 billion shown in table I. There are also some "cross-management" situations: Colonial and Colonial First State being an example.

Some local fund managers have been wary of international equity investment, in particular, for some time. They showed good judgment.

The Dow Jones average index of 30 US industrial stocks closed the year 2000 at 10,855.74, compared with 11,484.66 a year earlier. It was 9389.48 in the third week of March, the lowest level in two years and a 13.5 fall since December.

The Dow's all-time high was reached on January 14, 2000, at 11,722.98. Standard & Poor's 500 composite index, a broader-based benchmark than the Dow, was 1117.8 in late March, compared with 1330 at the close of 2000, a 16% decline. The S&P was 1464.6 in December 1999, later going past 1500.

Those indices may have suffered, but the performance of the Nasdaq composite index was a disaster. It has a heavy weighting of technology stocks. It was 1897 on March 22, after rising 67 points that day.

Unfortunately, it was 2507 at the end of December, so there was a 24.3% slump to late March. Even worse, the index was 4036.86 on December 31 1999, a year in which it soared 85%, and the recent 53% crash in less than 15 months took it back to 1998 levels.

Many investors, including managed funds, made fortunes during the rise but latecomers got burned and some are still igniting.

Among other companies, Amazon.com went from $US75 to $US10.25 in 14 months, Yahoo! from $US418 in December 1999 to $US14.85 in March this year, and even the solid and established Microsoft from $US118.12 to $US54 in the same period.

The bursting bubble of technology and internet-linked stocks was a repetition of investment mania that goes back centuries to the tulip phenomenon, the South Sea bubble and other crazes.

Declining US economic indicators were not the cause of the Nasdaq crash but they helped it. Local fund managers have differing views of whether the economic outcome of the US situation will be a "soft landing" (after a slowdown) or a recession.

Colonial First State Investments chief investment officer Mike Gibbs-Harris believes the US is in recession (in technical terms, two successive quarters with negative growth).

"The problem has been over-investment and under-saving," he said. "Companies have over-invested in capital assets. It will take some time to sort itself out."

Mr Gibbs-Harris considered the recent cuts in US interest rates and President Bush's proposed tax reductions would ameliorate the situation, but it would "quite possibly come too little too late."

He said there was "a chance there will be a recession in the first half of the year but not in the second half." Colonial First State has not changed its investment philosophy but has altered its asset allocations. "We were bearish all last year on equities," Mr Gibbs-Harris said.

The company liked bonds. "Bonds are no longer terrific value. We have sold some and put the proceeds into Australasian shares."

Mr Gibbs-Harris said there was not huge value in equities but they were not as overvalued as they were, given the equity market is a discounting mechanism that anticipates the effects of economic contractions.

Other fund managers had a different view. Armstrong Jones chief investment officer David McClatchey said there had been an enormous level of activity in 1999, but higher interest rates and oil price increases last year brought the crunch.

"We are in what you would characterise as a normal cycle contraction. The clue out of it is lower interest rates and fiscal relaxation," he said.

"There have been three interest rate cuts in the US and 33 globally, with 10 in developed markets ... Oxygen is being applied to the patient and the patient is responding."

Mr McClatchey said the most important aspect of this cycle, as opposed to the situation in the late 1980s and early 1990s, was that companies were not encumbered with overvalued property assets and had good balance sheets. Armstrong Jones took a long-term view and had done nothing dramatic to asset allocations in the current environment, while hysteria played itself out.

He said the forces affecting fund managers favourably were known changes in demographics (where there was an increase in people saving for retirement); IT, which was causing production and productivity changes in companies; corporate restructuring and consolidation, which has a powerful impact; and outsourcing of general business activities, the last again improving corporate profitability.

Tower Asset Management's Greg Whitten had a similar view of the economic situation and, subject to normal institutional variations, reflected a related investment philosophy.

He said the US Federal Reserve's interest rate reductions had an effect on the traditional relationship between interest rates and share prices.

"We have bought back in as markets have fallen. We are now holding a neutral position in shares and our 6-7% earlier in cash we have been putting into shares."

Mr Whitten used the same terms as Mr Gibbs-Harris when he said the world growth outlook was "not so good and will take time to sort out" but had reached a different conclusion.

"There is no substantial reason for prolonged recession." Tower would put more money into shares in "next couple" of quarters. The institution had traditionally put less proportionately into New Zealand equities than its competitors.

"Our long-term view has been that it is risk-reductive to have more overseas," Mr Whitten said.

"The New Zealand market has recently outperformed those overseas. We are a little concerned it might have been held up by the Fletcher Energy money. That could be a short-term phenomenon."

Along with other managers, Mr Whitten was adamant investors, most of whom were in funds for long-term returns, took more interest in returns over, say, three and five years, than periods of a year or less.

In the short term, the managers' strategy toward their funds seems to be summed up, with cautious variations, in Royal & SunAlliance's Anthony Quirk's description of his institution's current view: "At times like this the best thing is to batten down the hatches and accept variations in returns in the short term."

He added the interesting observation, coming as he did from an earlier sharebroking background, that fund managers did not pick short-term market shifts very well, being geared to the long-term investment philosophy of their investors.

Nothing wrong with that. Cowboys should stay on the range, outside the hemmed-in area of a market, where what you buy is not what it often turns out.

There is a major problem in assessing fund managers' views of the future and their ability to provide accurate forecasts.

The industry has the biggest clout of any group of market investors and, when individual managers agree on what will happen, their view tends to be a self-fulfilling prophecy.

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