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2003 will be a year of modest returns say pension fund managers Back  
Equities are expected to outperform fixed interest over the coming year as bonds are priced for a period of sluggish growth. Returns however, will be modest say Ireland’s leading pension fund managers as give their forecasts for 2003 and look back on one of the worst years for the Irish pension fund industry, which saw the average pension fund falling by 19 per cent.
Tim Walsh, Associate Director, AIB Investment Managers

Looking back on 2002

Last year was the third consecutive year of significant weakness in equity markets. In this respect, the market downturn turned out to be more protracted than expected. Our investment returns were impacted as markets continued to decline and sectors sensitive to economic growth fared poorly. As the year progressed, and the market and political uncertainties persisted, we took a more cautious view and made some adjustments within our equity portfolios, reducing our exposure to stocks where valuations were more demanding and increasing our exposure to stocks where the earnings prospects were more visible.
We also introduced some additional stocks to provide a greater degree of diversification. On a regional basis, an increased exposure to Asian markets (which outperformed global markets generally last year) was beneficial in terms of restraining overall equity losses. In addition, our relatively high exposure to Irish property (which had a small positive return) provided some support to portfolios.

Outlook for 2003

As always, what happens global equities this year will depend on what happens the US economy and how the US equity market reacts to this. At one level, the US economic outlook looks reasonably benign, with historically low interest rates and a government prepared to spend to keep the economy moving, especially in the run-up to election year. However, there are concerns that the consumer - who has so far responded positively to low interest rates - will ‘run out of steam’, while a high level of spare capacity will constrain the extent of a recovery in investment. On top of those concerns, there is the risk of war against Iraq and it is far from clear whether foreign investors will continue to be prepared to finance the US’s substantial current account deficit.

At time of writing, equity market sentiment was very poor and it is difficult to determine in a quantitative way when such an intangible influence will improve and push markets ahead. On balance, the substantial policy stimulus should enable the US economy to ‘muddle through’ at a growth rate somewhat below the long-term trend. This should give some support to equity markets although, given that valuations are not cheap, gains are likely to be modest.

In this respect, however, equities do not have to perform too strongly to outperform bonds (where yields are exceptionally low) or cash. In terms of investment returns, we believe that stock selection will be the important factor this year and will be focusing on this, within a disciplined framework, in order to enhance investment performance.

Other asset classes such as hedge funds, asset-backed securities, etc. may have a place in portfolios, depending on their risk / return characteristics, prevailing market conditions and the appetite in the market place for alternative investments. The prospective issuance of Irish asset - covered bonds (debt instruments backed by property) is a welcome development and their prospective structure is attractive. Our involvement will depend on their yield attractiveness relative to conventional bonds and likely liquidity.

Eugene Kiernan, Head of Asset Allocation, Irish Life Investment Management

Looking back on 2002

Investors will want to draw a line under 2002. It was about as bad as it gets. Compared to manager averages, our own funds delivered in line returns and allowed us to build on solid medium term returns, which now see us, on a three-year view for example, comfortably ahead of the median manager. Drilling into the portfolios, 2002 was a year for us of several individual decisions going our way.

Our value discipline once again proved its mettle and guided us, in the UK for example, to good performances from some of our holdings in the utilities sector such as Kelda, Innogy and Lattice. This desire for defensiveness and yield in volatile market conditions was also emphasized by our holdings in stocks like Cadburys, Unilever and Scottish & Newcastle. Our value discipline helped us most on our Japanese portfolio where we added over five per cent to market returns. What went less well?

We were underweight in equities relative to the average fund but in hindsight would have benefited from more cash and bonds given the slaughter in stock markets. We have about a third of our managed funds in cash, property and bonds and view this as appropriate for longer-term strategic reasons.

Outlook for 2003

Going forward, we believe stock markets will finish 2003 at higher levels than where we are today. But these will not be spectacular returns. We don’t have the conditions for such returns; neither a spectacular environment nor a spectacularly cheap market. We have reasonably priced markets and a moderate environment. On top of all this we have the huge uncertainty of how events will turn out in Iraq.

The core of our investment strategy will be to continue to exploit mis-pricings at the individual stock level by adhering to our value discipline. Our process of picking stocks highlights dividend yield as an attractive buy signal and we believe this income stream will only become more important in a world of more modest returns.

For bonds, this may well be a year of inflection. Today’s yield levels don’t leave much room for price upside but the absence of inflation and the volatility in stock markets may give fixed interest assets a bit longer in the sun.
However as the year goes on, assuming some resolution in Iraq and against a background of greater bond supply from public and private sector, bond prices may come under pressure. Best returns will go the nimble.

There will also be a time to add selectively to corporate bond exposure. Taking that risk may get relatively better rewards than it has done in the past 12 months.

We envision a world of modest returns from the major assets classes. We will continue to drive value out of the type of stocks we own. Investors may well have to grind out results. The devil is in the detail but so are the rewards.

Martin Nolan, Chief Investment Officer, Hibernian Investment Managers

Looking back on 2002

In 2002 our Pension Balanced Managed Fund outperformed the Mercer Managed Pension Fund Survey. The big contributors to this were our consistent overweight positions in bonds and property assets. Also we had relatively good out-performance versus indices in Ireland and Europe. Our asset allocation decisions worked well for us in the first and fourth quarters as equities outperformed bonds. However, purchases of equities in the second quarter turned out to be premature in light of some of the sharp falls in equities in the second and third quarters.

Within the geographic regions during the course of the year we went from overweight to underweight in the Pacific Basin, neutral to underweight in Japan and Europe and underweight to overweight in the US and neutral to overweight in Ireland.

Outlook for 2003

Looking to 2003, the potential war in Iraq is taking centre stage. The second big story for 2003 will be the progress of the US and European economies. At present the prospects don’t look good, with unemployment rising and investment spending weak, despite low interest rates. Increasing house prices and falling interest rates have encouraged consumer spending, especially buying of consumer durable goods. This activity is beginning to slow. Overall, we expect an anaemic economic recovery in 2003.

Despite all this gloom, there are some positive influences, not least the fact that investors now have very low expectations, but also the prospect of further ECB interest rate cuts, a build up of cash by investors, low bond yields, and quick action by many companies to reduce costs.

However, the markets, for the moment, are range bound. Without a resolution of the potential war in Iraq, lower oil prices and an improvement in economic prospects, there is little room for a sustainable rally. When these issues are resolved, and before interest rates go up, equity markets could well record big gains. Bond prices can hold their current levels, as inflation is not currently an issue (unless you live in Ireland!), and interest rates will stay low for the next year.


We expect profits growth of 8-12 per cent. Valuations, while not expensive, are unlikely to provide much positive momentum and consequently we expect equities to return 10 per cent in 2003.

Unless we get a period of global stagnation, the scope for bond yields to fall further is limited. Bonds are priced for a continued period of sluggish growth.

There will be support for property in the year ahead from a number of sources. Barring a recession, positive total returns should continue to accrue from this asset class.

Sector Recommendation
• Financials Overweight
• Healthcare Overweight
• Industrials Overweight
• Materials Overweight
• Consumer Neutral
• Information Neutral
• Utilities Neutral
• Consumer Underweight
• Energy Underweight
• Telecom- Underweight
Noel O’Halloran, Director - Chief Investment Officer, KBC Asset Management Ltd

Looking back on 2002

Looking back, it was without doubt, one of the most volatile and worst years in decades for pension fund performance. At a global level, it was a case of two up and two down - with equities delivering a positive result in quarters 1 and 4, only to be swamped by the more negative returns of quarters 2 and 3. For the year as a whole, global equities under-performed global fixed interest. This was the first time since 1939 - 1942 that such an underperformance occurred for three consecutive years.

In January 2002, the major theme was economic growth. The consensus outlook for US GDP growth for the year was for 1 per cent growth or less. As it turned out, the US economy grew by an estimated 2.5 per cent.

Thus, economic growth actually surprised positively. The major unforeseen negative was the accounting and corporate scandals that arose during Q2 and Q3, which led to a major rise in ‘desired risk premia’ for equities.

This risk aversion amongst investors caused a major de-rating of equities and corresponding re-rating of fixed interest, where yields fell to levels not seen for 40 years.

KBCAM balanced portfolios suffered in relative performance terms, as we were overweight equities at the expense of fixed interest. However, in Q4, this position helped recover some of the poorer relative performance during the year, as KBCAM took first place in the league tables.

Outlook for 2003

As we look ahead into 2003, the major theme at present is ‘uncertainty’. As was the case last year, there are question marks surrounding the economic and corporate earnings outlook. There is uncertainty about war, oil prices, inflation or deflation etc etc. In fact in many ways, it feels that things were never so uncertain!

On the other hand, cast your mind back to the last time that the consensus was very ‘certain’ on the outlook; a time when the outlook was considered extremely rosy, people spoke of new paradigms, the ending of economic cycles and downturns etc. At that time (Q1 2000) it was felt that equities could outperform bonds indefinitely.

Less than a month later, global equity markets peaked and entered a three-year downturn.
The reason I refer to this point, is to illustrate and contrast where we are currently in Q1 2003. Today, the consensus view is that the balance of all risks is to the downside; equities have limited upside and equity rallies should be opportunities for selling and re-investing into fixed interest. Fixed interest is currently viewed as a ‘safe’ asset class where investors can be protected from further capital loss.

As fundamental long-term investors, at KBCAM we must consider the risk/reward balance at all times as well as the relative attractiveness of asset classes, especially fixed interest versus equities. Looking into 2003, like the consensus, we agree that there are very uncertain times ahead indeed. We do believe that much of the good and bad news is currently in the price of equity and fixed interest markets respectively. As we move through the year into what we believe will be a more certain environment, we expect that equities will outperform fixed interest over the year 2003. The short-term direction of markets is impossible to predict and will be driven mostly by war rhetoric. For the year as a whole, we conclude that investors are being paid to buy the risk of equities over fixed interest. Fixed interest markets aren’t building in the potential that economies do actually return to meaningful growth and/or inflation.

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