Icebreaker We will are living in tumultuous times; On the Australian front, ASX setting records again, closing at ???? Overnight The Australian market is verging on having it’s first $100 stock with Macquarie, Rio Tinto and CSL in the race China sharemarket corrected in February 2007 to go from returning 135% to a paltry 125%! Macquarie Bank continues to make billions by aiming to own every piece of concrete and bitumen in the world Federer finally beat Nadal on clay breaking his 212 record And Paris Hilton is still going to Prison Times are changing! This is the agenda we will be covering today The key message is that although markets have been exhibiting some volatility of late, the economic fundamentals are strong and auger well for economies and corporates alike
High levels of global liquidity Excess savings is Asia As we all know there has been a global trend downwards in interest rates Slowing in the global economy plus inflation targeting and vigilance by central banks will keep interest rates at low levels. Large amounts of cash savings exist in the Asian markets and this money will need to be channeled into better returning investments Law of economics is that you will accept low returns for a short period of time and will then look for alternatives. We saw an example of this in mid 2006 when Japanese investors sought our Australian LPT sector because of it’s strong yields.
US will no longer drive global growth, but will continue to support reasonable global economic activity. A hard landing in the US is unlikely Expect growth to slow in all major markets except China and Australia in 2007. US to accelerate in 2008, but growth in Europe, China and Emerging markets to lag. Expect very respectable global growth of 3.3% this year and 3.2% in 2008. In China, cities the size of London are being built every year. This has an enormous impact on infrastructure, employment and economic growth Some recent stats on construction for Q1 2007 from the National Bureau of Statistics of China; - Construction output had a year on year increase of 21.5% - Income of construction enterprises had a year on year increase of 28.1% - Total profit of these construction enterprises had a year on year increase of 59.7% No wonder BHP and Rio are excited about China and the region in general!! Last week a 170 strong Chinese trade delegation visited the US. In readiness for the visit the Chinese government did 3 key things; Increased the trading band of the RMB(Yuan) from 0.3% to 0.5% Increased interest rates by 18bps Increased cash deposits held by the Central Bank The Chinese government signalled to the US government that they were serious about trade but also in the discussions highlighted that they are not reliant on the US anymore with Japan and other Asian Pacific neighbours including Australia highlighted as growing partners. China will be 20% of World GDP by 2020 and the third largest economy in the world 85% of the world population lives in emerging markets with 60% of the population in Asia ex-Japan. We have spoken extensively about China, however think of another growing neighbour being India. The 2006 Merrill Lynch/Gap Gemini report showed that India currently has over 200million, USD millionaires. This means that India has as many millionaires as the US has people. This means a high demand for financial services, health care, IT and consumables.
Strong economy has put some pressure on inflation. We are fortunate here in Australia in that the RBA has a clear target for inflation and is still one of the only central banks in the world to do so. Resurgent inflationary pressures are, however, evident in the US, the UK and Germany. Clearly, some central banks are not done yet. The Fed is, however, probably on hold. The current slowdown in global economic growth will ease inflationary pressures in key markets. Globalization of labor markets – e.g. outsourcing to India and China – will continue to exert a dampening effect on inflation. Outsourcing is global phenomenon; 75% of US and European multinationals now use outsourcing or shared services to support their financial functions Overall 29% of US and European companies expect to increase their use of outsourcing of financial functions, with spending expected to be nearly 16% higher than current levels We are aware that India is now a major destination for the outsourcing of IT, Financial and Telecommunications process and services. Examples of these are; IT : IBM, Dell, EDS, Hewlett Packard, Yahoo Financial Services : Accenture, AMEX, Barclays Capital, Citibank, Deutsche, Fidelity, HSBC Telco’s: Hutchison 3G, Telstra, Singtel There is a much greater emphasis these days on standardisation of security such as data and IP and thus these standardisation along with an educated workforce will encourage more companies to set up outsourcing arrangements in places like India. These arrangements enable inflationary pressures to be less of an impact
The current slowdown will enable the Federal Reserve to hold off on any additional rate increases. As long as employment and income growth remain robust, the economy should continue to grow, albeit at a more moderate pace. Business investment will be another key area of activity to monitor closely as we look for signs of spreading weakness. The housing slowdown will manifest itself in two ways: a reduction in economic activity directly related to housing and the wealth effect, which will impact consumer spending with a lag Subprime market is the equivalent of the Australian low doc market Federal Reserve in the US took interest rates from 6.50% in Dec 2000 to 1% by June 2003. This increased the number of borrowers in the market. Let’s put things in perspective: According to the Federal Reserve, there were $9.2 trillion worth of outstanding mortgages at the end of 2005. About 12% of these are subprime mortgages or about $1.1 trillion. If 15% of these go into foreclosure, which is a high estimate, the value of these foreclosed loans would be $165 billion spread out over several years. Given that consumer spending is $8.6 trillion, the impact on consumer confidence and spending will be modest at best.
With the economics as a backdrop are corporates vulnerable?
Run thorough recent events Talk about the contagion effect of Asian(Thai Bhat, flood of cash to emerging markets)/Russian (Gov. defaulted on bonds)/ LTCM crisis
Recall that in 2002 all CEO’s of the top 500 US companies had to reaffirm their annual reports and statements in the wake of the Enron and Worldcom debacles Thus due to this and tighter international accounting standards, company balance are a more accurate picture of their operations Due to buoyant financial markets, tighter controls on reporting and increasing share prices (the E in D/E), leverage ratios have been failing
In line with the previous chart, coverage ratios are high as debt is low Companies are making money (cash) and are not taking on less debt, they are funding expansions from cash or equity
Explain slide – relationship between High Yield spreads and default rates Moody’s have been predicted a rise in default rates for 2 yrs now – they will eventually be right! An anticipated 3% default rate will still be low by historical standards especially compared to the early 90’s and 2000’s where default rates where 10%
Let’s now turn to stockmarkets abnd compare how equity markets and companies have been performing….. As you can see there has been strong growth in all the major developed markets across the world
Although stockmarkets have been performing they are not expensive in our analysis compared to the late 90’s run up in Equity markets fuelled by TMT (Technology, media, Telco’s) phenomenon. Comparing the market today from a PE and EPS perspective the US stock market does not look overvalued. PE is lower than mid-90’s average, earnings growth is solid, suggesting low risk of major correction
What does the economy look like?
652 stocks meet our criteria for inclusion in the investment universe. 337 of these 652 stocks are in the index
The red section shows the investment opportunities you’re restricting yourself to, in these global growth industries, if you only have Australian assets. If you include offshore assets, the opportunities are enormous.
We think there are going to be even more reasons to invest offshore going forward because of the fast pace of globalisation. Every day, Australian consumers support global brands, and this is nothing new. It’s investors that haven’t necessarily been investing in them. It’s this disconnect that is changing around the world.
Lets look at previous bear markets in US Peak to trough performance in the is bear market only exceeded by 1973-74 bear market when economy was in severe recession and the PE rating of the market was downgraded to single figures as inflation increased to 10%
Crises always cause a short term setback in markets, but typically markets recover strongly. Tendency to think that current crisis is much bigger than previous ones. Let me assure you Pearl Harbour was big as was the Iraqi invasion of Kuwait (oil prices trebled and Saddam was close to control of 60% of the world’s oil reserves September 11 saw the same reaction as previous crises and the MSCI rebounded % after one month and today is % higher than it was prior to September 11. Despite this recovery, international equities still performed poorly for the calendar year as the markets had already fallen considerably prior to this event. But we are here tonight to talk about investing fundaments – so lets change gear……
One of the most dramatic examples of the power of asset allocation was reported in a study done in the early 1990s. The study looked at the performance of several pension plans in the United States. The study found that more than 91% of performance over 10 years was due to how assets were allocated among different classes, rather than the individual investments chosen. In other words, picking “hot” stocks or bonds for a portfolio was less important than how the overall mix worked in combination.
So what is the outlook for Corporates?
What does the economy look like?
Principal Global Investors Wealth Management February 2008 Giles Gunesekera Director, Head of Third Party Sales
Agenda <ul><li>Global Markets, the Economy and US Housing </li></ul><ul><li>Is Corporate America Vulnerable? </li></ul><ul><li>Product innovation – how is the market evolving? </li></ul><ul><li>Where to from here? </li></ul>
<ul><li>Global Markets, the Economy and US Housing </li></ul>
Where are Global Interest Rates Headed? Source: FACTSET and Principal Global Investors
US No Longer the Engine of Global Growth Source: Economic Intelligence Unit, JPMorgan and Principal Global Investors
Modest Inflationary Pressures Remain in the Global System Source: FACTSET and Principal Global Investors
The Subprime Debacle: Is it Overdone? Source: Principal Global Investors
<ul><li>Is Corporate America Vulnerable? </li></ul>
Credit Spreads (US Corporate Quality Spread Aaa vs Baa) Source: Moodys & Principal Global Investors
Leverage Ratios Are Low Source: DB Global Markets Research, FACTSET
Coverage Ratios Are Solid Source: DB Global Markets Research, FACTSET
Low Default Rates – Modest Rise Forecast Source: Merrill Lynch, Moodys and Principal Global Investors. %
Stockmarket Returns Source: Principal Global Investors
Stockmarket Conditions US stock market does not look overvalued: PE is lower than mid-90’s average, earnings growth is solid, suggesting low risk of major correction. % PE Ratio Source: Principal Global Investors S&P 500 Price Earnings Ratio S&P 500 Earnings Per Share % change over 12 mths
<ul><li>Product innovation – how is the market evolving? </li></ul>
The Australian advantage <ul><li>Australia's retail funds management market has been described by US-based Cerulli Associates as ; </li></ul><ul><li>" the most sophisticated retail funds management marketplace outside of the US ". </li></ul><ul><li>A recent report by Boston Consulting Group said that Australia is home to the world's fastest growing high-net-worth investor market. </li></ul>
Growth and characteristics of the Australian Funds Management Industry <ul><li>Growth primarily attributable to: </li></ul><ul><li>Low barriers to entry: sophisticated investors, mature market and efficient regulatory regime. </li></ul><ul><li>Government mandated retirement income scheme, Superannuation </li></ul><ul><li>Characteristics of the market include: </li></ul><ul><li>77% of the market is dominated by 30 managers </li></ul><ul><li>Of the top 30 managers, 17 are foreign owned and manage 46% </li></ul><ul><li>Leading domestic funds managers are connected to Banks </li></ul><ul><li>Increase in demand for alternative assets: hedge funds; infrastructure investment, listed and unlisted property </li></ul>
Risk-Adjusted Performance 1 January 1998 – 31 December 2007 Sharpe Ratio Source: FTSE EPRA/NAREIT Global Index, MSCI World Equity Index, JPMorgan Global Bond Index
Gross Dividend Yield by Country as of 31 December 2007 Source: FACTSET
Increasing Opportunity Set As of January 2007 Source: UBS Investment Research Global Real Estate Handbook
A More Efficient Portfolio Portfolio A 0% Global Property Securities, 55% Global Equities, 45% Bonds Portfolio B 10% Global Property Securities , 50% Global Equities, 40% Bonds Portfolio C 20% Global Property Securities, 45% Global Equities, 35% Bonds
What is risk? Domestic indices now biased towards global titans Source: FACTSET Jan 2008 France Germany Japan UK USA Europe (ex-UK) World
Why is diversification important? Source: FACTSET/IRESS at 31 December 2007 Global investment opportunities are enormous Market capitalisation in A$ billion
Why is diversification important? Increasing pressure to invest offshore Coca-Cola Procter & Gamble Nescafé … none of these global brands are owned by Australian companies, but they all feature in our daily lives As consumers, have been ‘buying’ offshore for many years
Why is diversification important? Markets are volatile S&P 500 Bear Markets in the Past 35 Years -48% -20% -27% -48% - 36% 29% 58% 38% 44% -60 -40 -20 0 20 40 60 80 1969 - 70 1973 - 74 1980 - 82 1990 2000 - 06 % Peak to trough price index change Subsequent 12 month price index change Source : Bloomberg 65% Trough to 28 February 2006
Why is diversification important? Source : Bloomberg/IRESS US MARKET REACTION TO CRISES -30 -20 -10 0 10 20 30 40 50 60 Pearl Harbour Korean War JFK Assasination Iraq Invades Kuwait Terrorist Attack on US % Peak to trough after crisis 1 year later from trough 2 years later from trough 135 days 30 days 1 day 60 days 11 days S&P500 Index 22 April 2004 from trough
Why is diversification important? The roller coaster of investor emotion Source : Frank Russell
Why is diversification important? Source : ING Funds Managment
The Power of Asset Allocation 91.5% asset allocation 1.8% market timing 4.6% selection of individual investments 2.1% other More than 91% of pension plans’ returns depended on their asset allocations.* *Source: “Determinants of Portfolio Performance II: An Update,” Brinson, Singer, Beebower, Financial Analysts Journal, May-June 1991. Past performance cannot guarantee future results.
Global product trends <ul><li>Increasing global asset focus (including emerging markets) </li></ul><ul><li>Higher concentrated & volatility & alpha products </li></ul><ul><li>More benchmark customisation or unaware behaviour </li></ul><ul><li>Performance fees </li></ul><ul><li>Increased prevalence of long / short (equity & credit) </li></ul><ul><li>Multi-managers growing / changing shape </li></ul><ul><li>Alternative asset classes </li></ul><ul><li>Structured products (SP, ETF, managed accounts) </li></ul><ul><li>After-tax considerations </li></ul>
Corporate outlook <ul><li>Underlying credit fundamentals remain solid: </li></ul><ul><ul><ul><li>corporate balance sheets remain strong in aggregate </li></ul></ul></ul><ul><ul><ul><li>attractive valuation levels </li></ul></ul></ul><ul><ul><ul><li>solid upgrade/downgrade ratio </li></ul></ul></ul><ul><ul><ul><li>continuing low default rates </li></ul></ul></ul>
Economic Outlook <ul><li>Economic fundamentals are sound: </li></ul><ul><ul><ul><li>US housing in extended slowdown, but offset by resilience in Europe, UK and emerging markets </li></ul></ul></ul><ul><ul><ul><li>Global growth solid & supported by low rates </li></ul></ul></ul><ul><ul><ul><li>US Federal Reserves to cut interest rates again </li></ul></ul></ul><ul><ul><ul><li>Stability will return to financial system under watchful eye of central banks </li></ul></ul></ul><ul><ul><ul><li>Liquidity is available </li></ul></ul></ul>
Summary - key influences on the industry <ul><li>Longer investment horizons (“retirement of retirement”) </li></ul><ul><li>More sophisticated portfolio construction techniques </li></ul><ul><ul><li>Drive for diversification, Risk budgets, Core / satellite philosophy </li></ul></ul><ul><li>More efficient implementation (focus on fees & taxes) </li></ul><ul><li>Greater customisation (products & portfolios) </li></ul><ul><li>Greater product choices available (wholesale, global sources) </li></ul><ul><li>Improved information and transparency and tools </li></ul>