GMI Investment Performance 2011

2011 almost looked like a re-run of 2010, although for slightly different reasons. Early in the year it looked like we were heading for calmer waters. The economic news was improving and share valuations looked attractive. However, the Japan earthquake and a re-acceleration of the sovereign debt crisis in Europe firmly put the kibosh on 2011 being a better year.

As 2011 progressed, concern began to mount that China could be in for a hard landing. Chinese authorities were working hard to contain a possible property market crash, rising inflation and sagging export demand from developed countries. Over the period July to September it looked like we were in for something akin to 2008 with emerging market and European shares performing particularly badly.

From October it was becoming increasingly clear from the economic data flow that the US economy was slowly recovering. In addition, the European Central Bank began providing European banks with liquidity, helping to ease stresses in funding markets. These two factors were enough to help turn share markets around in the latter months of the year.

The S&P 500 ended the year at 1257, exactly where it started. The MSCI World AC Index (which covers all global markets) fell 8.3% in US dollar terms, a worse performance than the S&P 500. This reflected the headwinds both emerging market and European stock markets have faced.

The NZ dollar was unchanged over the year at around 78 cents against the US dollar. However, it did trade in a range as wide as 72 to 88 cents as investors went variously “risk on” or “risk off” with various commodity currencies.  

Bonds had another fantastic year as investors ran for so-called “safe” assets and central banks engaged in various activities designed to keep interest rates low. The US 10-year bond rate fell from 3.6% to 2%, but the real rate fell to 0%, indicative of a sag in economic growth. It was a similar story in NZ where the 10-year government bond rate went from 5.9% to 3.8%.  


 
Our MSCI benchmark fell 8.2% over the year. GMI clients with growth style portfolios finished the year slightly above benchmarks (after tax and fees), continuing a long streak in which we have exceeded this target goal. Clients with balanced and income style portfolios were slightly behind their respective benchmarks (after tax and fees).

Strategy Review

Broad-based global economic growth and a favourable environment for companies made us confident about strong earnings growth in 2011. That, combined with the low returns on bonds, suggested to us that share prices would be revalued higher in 2011. As such, we started the year with a reasonably high level of share market exposure (87.5%).

There were risks on the horizon in the form of sovereign debt defaults in Europe and rising inflation worries for China and other emerging economies but we saw these as adding to market volatility rather than being game-changers to our fundamentally positive view.

As we inched towards the middle of the year it became ever more apparent that a sustained global recovery was no sure thing. By then we’d had the Japan quake and a period where oil prices had risen well in excess of US$100 per barrel, putting pressures onto a still fragile global economy. To cap this off there was the strong possibility of a default of Greek debt and all the implications that would have if there was contagion through financial linkages to other markets. 

Our focus is always first and foremost on wealth preservation, and with growth estimates coming under pressure and the Greek situation looking like it might spiral further out of control, we made the decision to park more money on the sidelines by reducing our share market exposure to 75%.

Life didn’t get any easier from there on in, and we continued to face significant uncertainties as the European sovereign debt crisis began to spill into a funding crisis for European banks. Would the authorities act responsibly to calm markets, or would the market just keep screwing the policymakers to the wall? This was what we faced on a daily basis as we attempted to navigate the portfolio through some very choppy waters. We stayed pretty much in defensive mode for the remainder of the year. Share market exposure went under 70% at one point, but we were back to 75% by the end of the year.

It’s been a difficult year to navigate and growth portfolios were only slightly ahead of benchmark. What we gained on being under-invested through the worst of the market swoon was in part eaten away by our decision to retain our strong emerging market tilt in the portfolio.

Asset Class Performance

Each year we look at portfolio performance from two aspects:

• The performance of each of the asset classes that comprise client portfolios – 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 portfolio groupings. The graph below presents the average performance of the underlying asset classes that comprise client portfolios. The returns referred to in this section are only net of withholding taxes and brokerage.
 
 

Fixed Interest
Fixed interest assets rose 7.4%, behind the benchmark return of 13.3%. The benchmark is a government bond index while we hold corporate bonds, which did not do as well as government bonds in 2011.  In almost all developed economies, interest rates are now at a record low. We extended the duration of fixed interest portfolios at the start of 2011 when it became apparent that NZ Inc was not going to recover as quickly as we first thought, particularly in light of the Christchurch earthquake. We don’t expect substantial changes in NZ rates over the coming year. In 2011 we also made our first foray into global bonds. Global bonds give a much larger and more diversified opportunity than is available in the NZ market.

Income Stocks
Income stocks rose 3.9% during the year, well ahead of the benchmark. Stocks in this part of the portfolio are mostly in defensive sectors such as consumer staples and health care, which generally have very strong balance sheets and less volatile earnings streams. These companies were strongly bid as investors ran for safe assets in 2011. Income portfolios also benefitted from having 100% hedging.

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 tactical positioning. We were not successful in that regard this year with core stocks falling 11.2%, almost 3% behind benchmark. Our decision to retain an overweight tilt to the emerging markets cost us heavily at the beginning of the year, and Platinum International has also been a disappointing contributor. Core returns include the gains from hedging on core stocks.

Satellite Growth
The satellite asset class strongly outperformed its benchmark for the year, declining by 3.5% compared to a benchmark decline of 8.2%. Satellite is where we express our macroeconomic themes through stocks we have identified as representing value in their sectors. We maintained a core position in defensive stocks such as McDonald’s, Coca-Cola, and YUM Brands throughout the year, and these did particularly well. Global leaders, such as Visa and Apple, also made strong contributions as they continue to expand their footprint in emerging markets. Our mid-year holding in gold was another strong contributor.

Cash
Cash predominantly reflects the un-invested funds from other asset classes. Hence the cash benchmark is the client’s overall portfolio benchmark. Cash returns were slightly negative reflecting the low cash interest rates globally. For portfolios with hedging requirements, free cash is now mostly held in New Zealand dollars to meet our New Zealand dollar hedging target.

Client Portfolio Returns

2011 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 analysis. We exclude portfolios:

1. that haven't been with us for 12 months;
2. where the client has requested specific instruments be held;
3. where the investment mandate has been changed significantly in the last 12 months; and
4. 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
549 portfolios qualify for our growth sample. On average, these portfolios finished 2011 down 6.8%, a result that was 0.6% better than the benchmark. Portfolio returns range from 0.3% to -10.5%. Growth portfolios took a hit from a poor year for emerging market shares and the on-going crisis in Europe. Our decision to maintain a hefty weighting towards emerging markets (especially Asia) was especially costly. With hindsight we should have moved more quickly when the China inflation bogey raised its head. However, keeping a decent swag of cash on hand and focusing on companies with solid fundamentals helped GMI portfolios to hold ground against the benchmark overall. 

Balanced portfolios
232 portfolios qualified for this sample and the returns ranged from 2.6% to -5.7%, with the average client portfolio falling 1.6%. Balanced portfolios were slightly behind (-0.2%) their benchmark overall. Bonds were up and shares were down during 2011, so the absolute return for individual portfolios depends heavily on the exact asset mix. Those with a heavier tilt to bonds did better and vice versa. While the growth portion of balanced portfolios held their ground, the fixed interest component was slightly behind its respective benchmark. 

Income portfolios
107 portfolios qualify for our income sample. They recorded a small positive return after tax and fees in 2011, increasing 2.3% on average, with returns ranging from 6.7% to -4.0%. The poor year for equities and low yields on offer reduced income portfolio returns. Income portfolios underperformed their benchmark by 1.1%. The benchmark for the fixed interest component of income portfolios is the government bond index, whereas our portfolios largely comprise high quality investment grade credit bonds. While credit had a good year, it was not as strong as government bonds.

Past Performance Summary

Calendar Year and after all tax and fee returns since 2003.