| High net worth individuals get a taste again for the stock markets |
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| Brian Weber says direct participation by private clients in the stock market was at its lowest in the second half of 2002 through to the first half of 2003, but that the tide has now turned and private client investor appetite has perked up since early summer. |
There have been a number of developments in the private client investment management world over the last year. Some of these form part of a longer-term structural shift as the demands of clients and regulators change. A notable feature of this shift is the growing demand for advisory services in place of the traditional commission driven model. Furthermore, there is a global trend towards the unbundling of charges for products from fees for services, driven by an increased demand for transparency which is gaining momentum as regulatory scrutiny increases and clients closely examine their costs.
There has been an increasing recognition of the importance of appropriate asset allocation after a three-year bear market. Private client sophistication continues to grow and many are recognising they have their own personal profile in respect of the risk and reward trade off. The importance of fixed income is being recognised as a result of the strong outperformance through the bear market, whilst hedge funds and alternative investments are attracting greater discussion during the asset allocation debate. Increasingly, we are seeing clients review their equity and property exposure.
Many are looking to diversify their risk across a broader range of asset classes and it appears from recent data that it is becoming increasingly possible to do this without suffering a commensurate drop in returns.
In the second half of the year there has been a tail-off in demand for guaranteed and tracker type products, demand for which had peaked in the last couple of years. It is safe to say that demand has fallen as a result of three factors. Positive returns from the underlying stock markets, the increasing availability of very attractive dividend yields and the emergence of reasonable stock market valuations have all contributed to the reduction in demand for guaranteed (tracker) products.
Generally the opportunity cost of a guarantee is the absence of a dividend and a cap on the upside participation in the growth of the underlying market. It is worth noting that dividend income historically accounts for up two thirds of the long-term returns from equities.
The international financial pages dedicated much space to China and emerging markets. The opportunities are perceived to be enormous as the regions develop. Foreign Direct Investment (FDI) has risen significantly in emerging markets on the back of strong economic growth and outsourcing to relatively low cost manufacturing bases. The economic forces at work suggest these markets will continue to record above average economic growth. However, it is very important for the private client to pay close attention to the volatility associated with these opportunities before investing.
Buying at the top of a cycle is best avoided and volatility will remain a feature of emerging markets.
Our experience indicates that direct participation by private clients in the stock market was at its lowest in the second half of 2002 through to the first half of 2003 although private client investor appetite has perked up since early summer. It is noteworthy that private client activity was at its lowest ebb just before the stock market reached its lowest point.
Many investors appear to be taking a back to basics approach to their stock selection and investment strategies and value investing remains a theme on many clients’ agendas. In Europe strong economic growth generally remains elusive and while some traditional sectors offer high dividend yields and relatively low P/E ratios there are fears that technology valuations are overstretched once again as the sector appears to be discounting a resumption of a relatively strong rate of growth.
As noted earlier, the stock market got off to a poor start this year. The first quarter created renewed fears of a fourth negative year in a row on forecasts of deflation and spiralling sovereign, corporate and personal debt levels. Stock markets rallied strongly from the lows of March 12th as we moved through the summer months and stabilised in the Autumn/Winter. Bond markets continued their very strong three-year bull run until June of this year and subsequently underwent a sharp correction as the economic outlook improved and the threat of deflation receded.
Many investors and company directors will fondly remember the year 2003 as the year that heralded a return to profit growth after the ravages of the post bubble recession. Profit growth resumed through the aggressive cutting of costs, hence the jobless recovery to date.
Europe has turned the corner and growth re-commenced in the second half of the year, however the rate remains sluggish. The Stability Pact was the subject of ridicule from various commentators. It was re-christened the ‘stupidity pact’ by one noted contributor to the debate. Many question the relevance of the pact to the economic diversity within the union. The peripheral areas of Europe performed better than either Germany or France. Poland attracted record levels of foreign direct investment (FDI) and the popular view is there is a great opportunity as Poland and many of its neighbours move closer to EU membership. In many cases, the popular view has had a tendency to exaggerate valuation.
The interest rate cycle turned in the UK in November and we saw the first interest rate increase in four years. This was widely interpreted as confirmation that the green shoots of economic recovery could be seen. As economists debated the strength of the recovery, the U.S. Federal Reserve and the European Central Bank gave signals to the markets that they were reviewing their thinking on the possibility of further rate cuts. Consequently next year the likelihood is that at some point we will see interest rate increases on both sides of the Atlantic. However, such moves remain contingent on a strong and sustainable economic recovery which at this stage is not a foregone conclusion. The issue of job creation (or the lack thereof) remains a problem for a sustainable economic recovery.
At home, although property remains the topic of conversation at most dinner parties we have benefited from the re-rating of the stock market and economic comment has become much less gloomy. The exodus of quoted companies from the Irish Stock Exchange has continued and looks set to resume in 2004 as the current list of potential candidates for MBO shows no sign of getting shorter. This poses a real challenge for the local market going forward. On a more positive note, many Irish companies are growing their overseas operations and making progress abroad. Strong international companies continue to bring their skills to the Irish market and the strong Irish companies are doing very well in international markets.
A corporate trend that continues to show no sign of abating is the decline in the number of diversified conglomerates. For just over a decade, the popularity of de-mergers has been steadily rising. De-mergers were born out of a desire to specialise. As many companies recognised that they lacked focus so specialisation has become a very strong theme, both in boardrooms and with investors.
Today companies are increasing their focus on excelling in their area of expertise and expanding globally. Firms are determined to employ the best people who are specialists in their sector, leveraging off their knowledge and obtaining significant economies of scale. This creates competitive advantage, helps to grow the business and prevents erosion of market share. It all makes very good corporate sense. It also results in a more efficient market place with lower prices and higher levels of service for the consumer. |
Brian Weber is head of the Irish branch of Morgan Stanley Quilter.
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| Article appeared in the December 2003 issue.
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