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Year 2002 - A private banker’s perspective Back  
In looking back over 2002 John Rockett writes that while returns in the commercial property market began to slow, Irish investors continued to invest strongly in property and from a private banking perspective the sourcing, arranging and financing of property transactions for individuals and syndicates was a major activity during 2002.
How will I remember the year 2002, or, more importantly, how will our clients remember it? After the equity market turmoil of the previous two years and the tragic events of September 11th 2001, most investors and investment professionals welcomed the New Year with an air of caution but quiet optimism. They were glad to see the end of the year 2001 and felt quietly confident that the New Year would bring a return to normality and steady growth.
Twelve months on - December 2002 - we now have the benefit of hindsight. Without doubt the year has been disappointing for most investors. Equity markets which showed signs of recovery in the first half capitulated in the 3rd & 4th quarters. The domestic commercial property market which had shown significant signs of over heating eventually slowed dramatically with both yields and rentals ending the year under considerable pressure. The residential market, spurred by changes in the 2001 budget resumed an upward path, although cracks began to appear in the ‘buy to let’ market as rentals reduced and a shortage of quality tenants emerged.
With the slowing global economy, the absence of serious global inflationary threats and a more accommodative monetary stance by Central Banks, bond markets performed well. Unfortunately however, bond markets do not account for a high level of asset allocation for high net worth individuals in the Irish market. So let’s have a look at the major markets that Irish investors have exposure to.

Irish equity market
The Irish equity market opened the year with an overall market capitalisation in excess of •80 billion. At the end of November 2002 the market capitalisation had fallen to c.•59 billion - a drop of over 25 per cent. This is the most dramatic fall in Irish equity prices since 1990 when the equity market dropped by just under 30 per cent.
In general, investors always find it difficult to make money in declining markets and it is only by astute stock picking and a fair measure of luck that investors could have avoided losses on the Irish equity market in 2002.
Interestingly there has been a significant shift in the top 10 companies within the Irish market. In January 2002, Elan Corporation was the largest capitalised company on the Irish market with a value of •17.2 billion, representing 21 per cent of the total stock market. By December 1st this year Elan’s market capitalisation had fallen to •858 million and it represented just 1.5 per cent of a very reduced total market. Smurfit Corporation, which had a value of •2.7 billion, has been taken over and is no longer quoted on the Irish Stock Exchange. Smartforce, which was the tenth largest capitalised company in December 2001 at •1.48 billion, is now re-named Skill Soft with a market capitalisation of •373 million.
Clearly the Irish market has experienced enormous turbulence which has gravely affected investor confidence. It was not all bad news however, and there were some winners. Anglo Irish Bank has performed exceptionally well in a very difficult market with the share price rising over 50 per cent and catapulting it to the seventh largest capitalised company on the market at the end of November 2002.
International equities
The grim returns experienced in the Irish equity market were generally mirrored on the international stage. At the end of November the FTSE world index was down c30 per cent in euro terms. Again investors can be forgiven for the disdain and despair which they feel towards equity markets. Notable features in the international area included the collapse of Enron and the financial reporting irregularities, which became commonplace for many global companies. The technology bubble was well and truly burst with the Nasdaq continuing its downward path whilst eventually bottoming just above the 1100 level in September 2002.
The collapse in share prices was not confined to small or medium sized stocks. Just as in the UK recession of the late ‘80s and early ‘90s, a large number of FTSE 100 stocks saw their prices decline sharply defying the myth that large cap stocks offer better long-term protection. In the UK, stocks such as Marconi virtually disappeared overnight despite, at one time, being market leaders in their field.
The impact of declining share values is likely to have a long lasting impact on Investor sentiment. Many clients have experienced a significant and unprecedented decline in their net worth. In the pensions arena the decline has forced many companies to re-appraise their pension schemes and accelerated the move from defined benefit to defined contribution schemes. For those investors with defined contribution schemes, the decline in fund values is likely to have altered their aspirations in terms of retirement. The combination of declining fund values and lower annuity rates have had a devastating impact on retirement affordability which will force lifestyle changes on many investors.

In Ireland, property has been the stellar performing investment class since 1994. When one takes into account that most private investors use gearing to part finance property acquisition returns on equity have been spectacular. The year 2002, however, will mark a major slowdown in commercial property returns. Overall returns before gearing are not expected to exceed three per cent in the current year.
Private investors acting individually or in syndicates and acquiring all available pre-let investment property have dominated the commercial property market in Ireland. Dissatisfaction with both cash and equities as alternative asset classes and the availability of low cost bank finance has driven investor appetite. Institutions who have seen their weighting in property rise significantly as equities have declined have been reluctant buyers and often net sellers in the property markets. Despite evidence of weak tenant demand, an upward movement in yields, a reduction in rental levels and an increase in developer incentives - all signs of an overheated market - investors continued to aggressively acquire available investment opportunities.
From a private banking perspective the sourcing, arranging and financing of property transactions for individuals and syndicates has been a major activity during 2002.
Perhaps one of the more surprising aspects in the property market has been the major move by Irish private investors into overseas markets, particularly the UK. Recent statistics would indicate that for the first time ever Irish private investors invested more in the UK market than the Irish market in 2002. The provision of sterling bank loans to finance both property acquisition and equity input whilst at the same time hedging currency risk kept private bankers fully occupied. The recent changes in the budget increasing stamp duty on domestic commercial property to 9 per cent for transactions over •150k is likely to dampen interest in Irish commercial property with the consequent shift of focus to external markets particularly the UK.
To date we have not seen huge emphasis on continental European property markets. We would anticipate, however, that clients may begin to look more seriously at opportunities on the continent in 2003 as a means of further diversification away from Ireland and the UK.

The best performing asset class in 2002 will be the bond market. Euro bond markets look likely to achieve returns in the order of 10 per cent in the current year whilst other international markets are likely to produce high single digit positive returns. The taxation treatment of directly holding bonds is not favourable to Irish investors. Most investors have, therefore, tended to use funds when investing in this asset class which reduced the overall returns due to the impact of costs associated with management.
2002 has certainly been a disappointing year for investors in equity markets in particular. With the exception of equities, however, investors are still likely to have experienced overall positive returns from property, bonds and cash. As the psyche of Irish investors is more deeply rooted in property than equities the importance of property in terms of overall well being is exaggerated.

As we come to the end of the year our thoughts automatically concentrate on the outlook for 2003. There are mixed signals for investors to deliberate. Interest rates remain low and indeed from a euro perspective they may even go lower. Investors will therefore be drawn away from cash and into real assets. Recent figures from the Central Bank highlight the very strong domestic appetite for property acquisition funded by historically low cost bank borrowing and this is likely to continue in 2003.
Equities which have produced very poor or negative returns for the last 3 years are dependent on a recovery in corporate earnings to justify existing valuations. We do not expect, however, any significant downward movement from current levels but recovery will take time.
The current prospect of hostilities in the Middle East is another inhibiting factor for markets to overcome. Governments’ ability to stimulate economies through fiscal policy and Government spending is also restricted by their existing deficits.
In the circumstances 2003 will again present challenges on many fronts and investors will have to be patient and discerning in their asset selection and allocation.

John Rockett is head of private banking at Allied Irish Bank

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