A spanner in the works
A spanner has been thrown in the works of the international financial markets. Since the turn of the century, events that statistics and statisticians claim should only occur every few hundred years have become more frequent. While volatility and setbacks in the context of the burst technology, media and telecommunications bubble from 2000 to 2003 were initially considered as significant within the normal parameters, this assessment has now changed. The events from 2007 to today urge us to take a closer look at their causes and effects. It is undeniable that certain parameters within which investors make their decisions appear to have changed. If this is the case, investors’ behaviour will need to change too. Even if it is individually weighted, the search for a desired return with seemingly acceptable risks attached remains the primary goal.

What were the drivers of growth in the past decades? One of the first points to mention is surely the steady reduction of global interest rates since the 1980s. This continuous interest rate cut led to never-before seen profits on the bond markets, and one of the side effects of falling interest rate levels is reflected in continuously rising equity markets. Companies gained access to affordable credit lines and more investments became more worthwhile. This process of ongoing interest rate cuts was accompanied by three key drivers: a removal of restrictions on capital transactions between the key global markets; an increasing speed of transactions due to the use of new computer systems and the worldwide web and, thirdly, globalisation. China joined the World Trade Organisation in 2001, laying the last essential stepping stone to link the world’s largest economies and allow a continuous transfer of goods and capital.

The changes in the geopolitical landscape that were driving growth were supported by liquidity provided by the large global central banks. As we know today, excessive supply of liquidity since the 1990s has contributed to the emergence of asset bubbles, and therefore the basis for rising volatility, as well as comparatively more severe and frequent drawdowns. Up until the beginning of this century most investors considered an individually balanced portfolio of bonds and equities the best of all allocation options. The global mega-drivers (interest rate reduction and globalisation) provided a stable increase in value – but this seems to have come to an end. Global trade has collapsed following years of rapid growth. It seems appropriate to wonder whether it will ever return to the past high levels of growth once the current financial crisis and crisis of the real economy is overcome. The driving force of interest rate cuts will permanently disappear. Optimists work under the assumption that a low interest rate level will be maintained globally. Pessimists, however, see inflation risks surface at least in the medium to long-term. There are uncertainties as far as the eye can see.

This is bad news for traditional investors. To complete the picture we should also look at the statistics. How did individual asset classes perform? In the past twelve months to the end of May 2009 the MSCI World (EUR) registered a loss of 24.9%. The FTSE 100 was down 27.2% and the DAX 30 retreated by 30.38%. The data for the maximum drawdowns presents an even clearer picture: MSCI World –49.01%, FTSE 100 –43.02% and DAX –52.35%. These indices provide an example of how most others performed, similar in direction and scale. Annualised, the losses are unacceptable to institutional investors. How did the bond market fare? As measured by the Barclays Aggregate Bond Index, the last twelve months have generated a return of 5.37%, the EONIA yielded 2.62%. The German bond index REX recorded 8.93%. Is this sufficient for institutional investors to build a lasting strategy for their distribution policy? I can only presume that is not the case. In light of implied risks of an interest rate increase, there is chatter among German investors that bonds do not offer risk free interest, but interest free risk for their portfolio.