GMI Performance 2008

PERFORMANCE DATA IS ALSO AVAILABLE FOR FOR 2007, 2006, 2005, 2004 AND 2003

Years like 2008 bring into sharp relief our number one priority – “don’t lose the bloody stuff”. Massive swathes of financial wealth were destroyed in 2008 across almost all asset classes; some individuals in so-called safe investment lost almost everything (think of ING and the litany of failed finance companies).

Although our investment portfolios were not immune to collapsing world markets, clients can at least take heart in a performance that substantially exceeded the market benchmark – by 7.5% for growth clients. So on that count we’re thankful that our decade-long streak of delivering better annual returns than the relevant benchmark continues. But of course we would have far preferred to have accomplished this and made clients money as well. There is something a little more unfortunate about beating the market but still losing money!

The reality is that one year in three sees equity markets fall. One year in ten, we see markets fall by 20% or more. Even by those standards, 2008 was a particularly calamitous year, with major indices like the S&P500 down 38%. History tells us that despite gut-wrenching years like 2008, over the long-run shares still produce returns that substantially exceed the returns available on money in the bank. Out-performance is just as important in the down years as the up years to ensure that client returns compound and exceed the benchmark over the long run. So on that score I guess we should be happy.

Plummeting share prices and unprecedented market volatility in 2008 highlighted the value of being a discretionary asset manager. 2008 was not the time to be running a “set and forget” asset-allocation strategy, and DIY investors would have found that keeping tabs on market developments was a full-time job. However, our approach allows us to adopt a highly defensive position in unusual market conditions, and this freedom was a major contribution to our ability to out-perform the benchmark. Of course with the benefit of hindsight it would have been nice to come out of markets completely. We never contemplated that as the risk of being out of the markets when they did a fast 20% run upwards (as they did over just one week in November 2008) could ruin the longer term out-performance credentials of the portfolio.

Asset Classes

Each year we look at portfolio performance from two aspects - the performance of each of the asset classes we identify (apart from cash) - fixed interest, income stocks, core growth stocks and satellite growth stocks - and then 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 the portfolios. The graph below presents the average performance for client portfolios in each of the 4 investment asset classes we identify. The returns referred to in this section are net of taxes and brokerage.



Fixed interest

The fixed interest asset class posted a return of 3.3% over 2008, which we regard as a fairly good result in the context of a global credit crisis. The massive blow-up in corporate spreads has led to capital losses on a number of securities, with heavy rates of defaults now priced in for 2009. However, fixed interest returns lagged a long way behind the benchmark, which consists largely of government bonds (including foreign government bonds, which also posted gains from currency appreciation). A flight to safety and massive monetary policy easing has pushed government bond yields to bubble-like lows.

For clients with a mandate for world bonds, these returns understate portfolio performance. In 2008 our overseas exposure came through foreign cash not bonds. The strong gains on the foreign cash are not included in our fixed interest return, however the sharp increases in the world bond benchmark are included in the fixed interest benchmark. The analysis of total income portfolios returns (below) demonstrates that on average clients with fixed interest exposure still out-performed the relevant benchmark.

Income stocks

Our income stocks, which remain predominantly high dividend New Zealand companies, lost 24.7% in 2008. This was broadly in line with the world sharemarket return of -24.2%, but better than the underlying NZSE50 index which lost 34%. New Zealand stocks followed world stocks down this year, but lacked the buffer of foreign exchange gains to dull the losses. Thankfully, our holdings of income stocks were greatly reduced over the course of the 2008 in response to New Zealand’s early plunge into recession so clients all had much reduced exposure to this asset class.

Core growth

The core asset class consists of managers we believe can produce returns broadly in-line with the global equity benchmark and hopefully provide a small amount of extra value over time. In that regard, core was a disappointment in 2008, more or less matching the benchmark with a return of –25.7%. But to a large extent this is explained by an increasing discount to net asset value of listed vehicles as investors shunned less liquid investments and ran for the cover of bank deposits.

Satellite growth

The satellite stocks reflect a combination of securities identified through our internal selection process that best represent our over-arching investment themes. In that respect, the -29.6% return over 2008 was disappointing. However in context, it was a fair result, as many satellite picks are high beta stocks (meaning that they lead the pack both on the way up and the way down). Our globalisation theme – stocks in emerging markets or reliant on demand from emerging markets – got whacked in the second half of the year as the recession went global and commodity prices took a nose-dive. Nevertheless satellite stocks were still big net gainers for us over the last global growth cycle. The defensive selections in Satellite (McDonald’s, Coke and their ilk) had an excellent year in relative terms.

Client portfolio returns

2008 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 taxes, fees and brokerage. There are limitations on how many of the client portfolios we can include in this performance analyses. We exclude:

1. portfolios that haven't been with us for 12 months;
2. portfolios where the client has specified any specific instruments be held;
3. portfolios where the investment mandate has been changed significantly in the last 12 months; and
4. portfolios where there has been a substantial amount of money added or withdrawn over the year.

Together these restrictions eliminate a significant proportion (about half) 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

Of the 311 portfolios that qualify for our growth sample, average performance was -15.6%. Growth portfolios exceeded their mandated benchmarks by 7.5% on average, with returns ranging from -21.7% to -5.0%. The large out-performance in the growth portfolio class largely stems from the high foreign currency cash holdings that we switched into from mid 2007 as the global recession started to become a possibility. Although most growth clients are mandated to invest up to 100% of funds in equities, actual investment levels ranged from 50%-70% over 2008, finishing the year 50% invested in shares (for a 100% growth mandate).





Balanced portfolios

We have taken these to be any portfolio with a mandated asset mix of between 35% and 65% in income stocks or fixed interest. 106 portfolios qualified for this sample and the returns ranged from -18% to -3.5%, the average performance being -8.9% and the average out-performance of the relevant benchmark being 4.7%. Mandates for higher equity exposure resulted in lower absolute returns, but higher returns relative to benchmark.





Income portfolios

Our income portfolios are those where the client mandate is for less than 35% allocated to growth securities. There were 126 portfolios in the sample satisfying this criterion. The results are in the following graphs. The average return after tax and fees was -4%, the range in performance was from -16.6% to 6.4%, and the average out-performance of the relevant benchmark was 0.9%. The large variation in portfolio returns was because of variation in client mandates, with those portfolios that stipulated a higher weighting towards New Zealand fixed interest ending up with higher absolute returns but lower relative returns compared to benchmark. The benchmark includes NZ government bonds and they had an outstanding year. Our NZ fixed interest portfolios however contained dollops of corporate rather than government bonds, and there the picture was a lot more grim.

2008 Review – The year in review

Although the effects of credit crisis were front and centre throughout the year, equity markets suffered the bulk of their losses in the final months of 2008. The key turning points for markets was the collapse of Lehman Brothers, forcing the realisation that the crisis could wipe out the entire financial sector without significant and expensive injections of capital from governments.

Our initial hope was that developing world economies could decouple from the train-wreck taking place in the US and Europe. The meteoric rise in oil (and other commodity) prices suggested this was a possibility. But ultimately it was not to be. As export markets dried up, so did growth in emerging economies. We are now facing one of the most severe global recessions of the last 50 years, and we are already close to the limit of what central banks can do to rescue economies through traditional monetary policy.

It is impossible not to be extremely wary in a high-volatility environment with tremendous uncertainty. Our instinct was to be defensive, and that was expressed by:

• large holdings of cash, with portfolios only 50-70% invested over the course of the year;
• defensive stock selection (companies with strong profitability and balance sheets);
• staying well clear of direct holdings in financial stocks – we exited these back in 2007.

All of these decisions contributed to large gains relative to the benchmark. The decision to largely avoid any New Zealand dollar exposure also returned a big dividend. High interest rates were not sufficient to tempt investors into a minnow currency like the kiwi in a environment where the desire for liquidity is paramount.

20/20 hindsight would have argued for an even more defensive allocation. The reality is that there is always a need to strike a balance between fear and greed. At various points, we were tempted into increasing our equity holdings – the combination of distressed share prices and ambitious attempts by monetary and fiscal authorities to jumpstart the economy was at time irresistible. Of course, no policy has stuck so far and pulled shares out of their funk. But at some stage something will, and the risk is that the market takes off with us the sidelines.

The global recession still has some way to run in terms of job losses, company collapses, and house price falls. The bad economic news still to come is likely to keep stock market in check for the time being. Nevertheless, current dividend ratio and risk premiums are consistent with a strong equity returns over the next five years.