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IMPROVED MARKET CONDITIONS, BUT BUFFETED BY ECONOMIC, POLITICAL AND ENVIRONMENTAL FACTORS
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Recovery in global economy continued
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Global equity market returns outpaced most
other asset classes
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Increasing and changing regulation in our sector
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Andrew Formica
Chief Executive
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Review of 2010
The year was characterised by recovery in the global economy, although the effects of the global financial crisis continued to be felt. Market conditions improved and equity markets were on average 20% higher in 2010 compared to 2009, but there were notable episodes of volatility and uncertainty. As can be seen in the chart below, there were a number of economic, political and environmental events each of which troubled markets for a period of time.
Following the recapitalisation of banks in 2009, the realisation came in 2010 that risk and liabilities had simply changed hands from the private to the public sector. As a consequence, the governance of the Eurozone came into question as significant current account deficits had been run up by countries such as Greece, Spain, Portugal and Ireland. The Greek debt crisis was followed by the near-insolvency of the Irish banking system and bailout packages reached a staggering EUR200bn. It now seems that, in order for the Eurozone to prosper, the rules governing the Eurozone will need to be rewritten.
In Asia, China overtook Japan to become the second largest economy in the world. Halfway through the year, in order to reduce the risk of importing inflation, it decided to de-peg its currency from the US dollar. In the US, on the other hand, with a fall in the popularity of President Obama and a faltering economic recovery, the Federal Reserve embarked on a second wave of quantitative easing. In the UK, markets broadly welcomed the spending cuts agreed by the Coalition Government following the General Election in May. Gilt yields remain low by historical standards, but household disposable incomes are under severe pressure from tax increases and rising prices.
MSCI All Country World Index
Sources: Bloomberg and UBS
The market outlook for 2011
Looking at 2011, world trade and industrial output continue to recover, despite continuing concerns over rising inflation, the sovereign debt crises and the instability of banking systems. Strong demand from fast-growing developing countries has led to increased sales and improved profitability of manufacturing companies around the globe. Our central tenet is that this theme is set to continue with industrial stocks poised to deliver good returns to shareholders whereas consumer-facing stocks in Western markets are likely to disappoint.
From a regional perspective, the turmoil in sovereign debt markets held back European equities in 2010 and we believe valuations of these equities have the potential to improve in 2011 as investor interest returns.
We expect Asian companies could grow earnings by a further 15% in 2011. In addition, the region has a young demographic profile and relatively strong fiscal background, which contrast with those of the West. The monetary expansion in the US is feeding through to commodity prices and asset prices in Asia. The danger is that inflation accelerates, requiring a strong reaction by central banks, although early moves by Australian, Chinese and Indian authorities to tighten monetary policy have been encouraging.
When it comes to continued economic support, US policymakers have been more accommodating than most. The Federal Reserve has persisted with stimulus measures aimed at fuelling growth long after other countries adopted more hard-line austerity measures. The signs are coming through, however, that the economy is beginning to respond and US companies have shown impressive profit growth. However, investor sentiment is weighed down by the high unemployment rate and weak housing market. This dichotomy between strong corporate earnings growth and a slow US economy is likely to continue in 2011.
In bond markets, the days of significant capital appreciation for bond funds are gone and the year ahead will likely focus on capital preservation whilst generating a consistent level of income. Given uncertainty over how the sovereign debt crisis will play out, and its impact on the banking and corporate sectors, identifying clear sector themes and combining them with company fundamental analysis will be the key to exploiting these challenging conditions. The ability to adjust to the ever-changing environment will be critical. In an environment where a sustained period of rising yields could be detrimental to overall bond market returns (should interest rates rise), the ability to utilise a broad range of investment instruments could prove invaluable in helping to preserve capital.
UBS Global Equity Risk Appetite Indicator
Sources: UBS, Bloomberg and Datastream
In the UK and Europe we believe the weight of money chasing a limited supply of prime property assets is likely to overheat this sub-sector of the market whilst Asian growth markets, such as China and Singapore, will continue to look attractive. In the US, we expect property markets to continue making a steady recovery.
Regulatory changes
Of the many regulatory developments there have been, one of the most prominent for our business is the UK Retail Distribution Review, originally launched in 2006, which aims to promote a resilient, effective and attractive retail investment market. Whilst there are aspects of these rules still to be finalised, we are working to get our business prepared for its expected implementation in 2013. Another important development has been the Alternative Investment Fund Managers Directive. The purpose of this Directive has been to provide more transparency and additional regulatory oversight of the alternative funds industry and has been in development for several years. At this stage, we do not expect this Directive to have a significant impact on our business. However, much of the practical ‘rule making’ that stems from this Directive has yet to be promulgated. We observe developments with interest and participate where we can to influence the outcome for fair markets for the benefit of investors.
The FSA has also been reviewing the remuneration practices of financial services firms in the UK and published its revised Remuneration Code in December 2010. Our remuneration structures are consistent with the revised Code.
The outlook for the Group
Keeping our clients’ needs at the centre of everything we do will drive our success. Joined-up thinking across product development, fund management, sales and client service, should ensure that we provide clients with more valuable investment products. We continue our efforts in making this business more efficient and more profitable and ultimately, increasing the value of our franchise. In so doing, we will deliver good returns to our shareholders.
By combining organic growth with being alert to opportunities to accelerate our strategic goals, the overriding focus remains our clients and ensuring that we have the capabilities required to help them achieve their investment objectives.
We are optimistic about the outlook for markets. We are well positioned to grow our existing product range and develop new products to distribute through all the channels in all the geographies in which we operate.