Research & Strategy

FYI Winter 2011-12

FYI Winter 2011-12

For your investments

In brief

Inside track


In brief

Since July, markets have been driven by escalating concerns over the Eurozone debt crisis and signs of slowing global growth.

The 21 July rescue package announced by the Eurozone leaders for Greece failed to satisfy market fears that Greece’s solvency would be restored. Contagion has spread to Italy and Spain which have far larger bond markets; if they were to default it would have devastating knock on effects. Eurozone leaders are battling to find ways of ensuring that they can refinance at affordable yields, but solutions are proving elusive. Meanwhile, Eurozone growth has slipped towards stagnation, with knock-on effects throughout the world.

In the US, growth has held up, but fiscal uncertainty remains uncomfortably elevated, highlighting the extent of political division heading into an election year. Obama is pushing for an extension of the payroll tax cut and unemployment benefits. Without these measures, the US would face a fiscal drag in 2012 equal to roughly 1% of GDP.

Nonetheless, there are some positives in the current environment: – Emerging Markets are still delivering strong growth and China is managing to slow its growth without reversing it, – The European Central Bank, with its new Chairman Mario Draghi, seems to be adopting a growth oriented policy by providing liquidity to financial institutions and by purchasing government bonds to reduce speculation.

As you will see in this edition, we continue to expect volatility in the coming months although we anticipate an “exit on the upside” with a stronger and more integrated Eurozone with healthier fundamentals.

Inside track

The year is wrapping up with high levels of political risk and consequential investor fear. 2012 will now be eyed for much needed clarity on the institutional solution to the European Monetary Union’s structural weaknesses, necessary for an easing of global risk aversion.

In this context, where markets are driven by political decisions, we remain cautious in our investment decisions. Although, global companies may benefit from the remaining strong growth in emerging markets and show some robust earnings, we fear that markets will continue to be choppy until any comprehensive agreement is obtained in Europe.

In the short term, we continue to favour corporate bonds with strong fundamentals and predictable cash flows as we see some very good opportunities in the asset class.


Financial instability and the risk of another recession in Europe continue to weigh heavily on the markets.

The strong market rebound recorded in October was nothing more than a temporary blip. The debt crisis still remains the undisputed centre of market attention: systemic risk continues to increase even as a more massive ECB intervention looms larger on the horizon. Economic conditions are rapidly deteriorating throughout the Eurozone. It is likely that the fourth quarter in 2011 reveals a recession engulfing the entire region.

On the other hand, the United States has registered solid gains buoyed both by sustained activity in its export sector and strong private consumption. In this relatively unfavourable setting, the markets continue to exhibit extreme volatility and have shown considerable sensitivity to all market whispers, constructive or not, swirling around any scenario of saving the Eurozone from its debt crisis.

We have a preference for the US and Japanese markets, yet are sticking with our overall equity underweighting in developed markets globally speaking.


Preference for corporate debt and emerging market debt.

The bond markets are also shaken by effects of the Eurozone debt crisis. The search for safe investment havens along with central bank buying have contributed to lowering long-term bond returns in the United States and United Kingdom. In the Eurozone, contagion has since reached the core countries with risk premiums now exceeding 100bps between France and Germany, with long-term returns still at levels below inflation. The securities issued by leading sovereign issuers strike us as overvalued in light of deteriorated public finances.

With regards to state-backed bonds, we are staying on the sidelines due to low rates of return on even the safest issuers and because of the speculative nature of peripheral European issuers. Corporate bonds still offer a better risk return trade off. The widening of risk premiums seems to us unjustified by the cut to issuer ratings, explained rather by a renewed rise in risk aversion coupled with a slight reduction in market liquidity. Emerging market bonds remain attractive when factoring in higher returns for the same quality and a more optimistic overall macro-economic picture.


Gold has broadly continued its upward trend, albeit with increased volatility towards the year end. We believe that continued very low interest rates and concerns about the solvency of governments will allow the trend to be extended further. Hedge funds have had a difficult year and careful strategy and manager selection remain key. Commodity Trade Adviser (CTA) strategies in particular have continued to show good defensive characteristics and can often provide strong positive returns when markets are correcting.


With interest rates low, holding cash can seem unattractive, but it does provide flexibility. As well as providing some comfort, this can allow investors to pick up bargains at times of market dislocation.

Our asset allocation remains defensive and favours yielding assets. The time for buying equities may be in 2012 but there are still some political issues to tackle before the market can start an upside trend again.

Changes in major indices (year on year, 31 December 2010 – 31 December 2011)

Equities -5.6%
FTSE 100

Dow Jones

DJ Euro Stoxx 50


Bloomberg/EFFAS Government Bond
(all maturities >1 year) Indicies
16.8% 10.0% 1.5% 2.0%

Indices are for guidance purposes only. Equity percentages are based on capital returns in local currency. Bondpercentages are based on total returns in local currency
Source: Thomson datastream

Past performance should not be seen as an indication of future performance

Recommended asset allocation*

Equities underweight underweight neutral underweight neutral neutral
underweight underweight underweight underweight neutral  
Investment grade
corporate bonds
overweight overweight overweight overweight    
High yield bonds neutral overweight neutral neutral    

*In relation to the SGPB Hambros benchmark allocation, as at 31 December 2011

Actual weighting and investment allocations are subject to change on anongoing basis and may not be exactly as shown. Investors should understandthe different asset classes which make up the strategy as they have differentrisk characteristics.



Changes in major indices(30 September 2011 – 31 December 2011)

UK FTSE 100 8.7%
US Dow Jones 12.0%
Eurozone DJ Euro Stoxx 50 6.3%
Japan Nikkei -2.8%

Source: Thomson Datastream

Past performance should not be seen as an indication of future performance

United Kingdom
The UK market recovered slightly during the fourth quarter amidst mixed economic data and the ongoing gyrations inEurope. The chances of the Eurozone falling back into recession appear to have increased and the Chancellor reduced his growth forecasts for the UK economy. Debt levels are likely tobe higher than previously anticipated but the government is benefiting from lower interest payments relative to its peers.

The list of best performing stocks was dominated by those inthe resources sector. The miners rallied sharply from the lowsand BP was also a notable contributor. A big faller was Admiral which announced operational difficulties in its core business. Lloyds fell on concerns across the banking sector but also onthe news that the CEO was temporarily stepping down from his duties due to poor health.

Outside of the FTSE 100, there were a string of disappointments in the retail sector with a number of high street names falling heavily including Mothercare and Game Group.

Despite this, the UK index is more dominated by global players than in previous cycles and many of our favoured companies continue to have good balance sheets and cash levels.

Equity performance of major economies

United States
The Eurozone crisis continues to have an impact on the US market, particularly from a sentiment perspective leading to heightened volatility in all assets. This comes, however, via a backdrop of improving economic data in the US: with ISM Manufacturing numbers remaining above 50 (signalling expansion), continuing increases throughout the year in Nonfarm Payrolls, and Durable Goods orders remaining seasonally strong. The equity market has recovered someground lost in the third quarter, signalling hope for continued recovery, though the bond market remains unconvinced, with Treasury yields still close to all time lows.

This optimism for a US recovery has led to a broadly flat performance over the year, which is markedly better than the steep falls in Euroland and most of Asia over the year. The year end comes with further difficulty in predicting where markets will end 2012, with the only consensus agreement being that global growth will continue to be slow. Positively, record earnings for S&P 500 in 2011 show that many large cap stocks are still managing to perform well in this tough environment with both strong earnings and dividend growth.

US inflation

The fallout from political indecision has left Europe facingthe likelihood of another painful recession, and investor nervesare stretched to breaking point. The risk of the single currency disintegrating is still significant.

Rather surprisingly, although we have seen tremendous volatilityin equity markets in the fourth quarter, the index has really just traded in a broad sideways range, and set against all the bad news there have been some positives. The European Central Bank (ECB) has cut interest rates back to 1%, and has taken several steps to improve banks’ liquidity on an ongoing basis. We have seen concerted global central bank action to provide dollar liquidity, and China has started to ease monetary policy.

The current round of negotiations about the future of Europe look to be more constructive, but the path to reforming the Union will be long and difficult, and we expect short-term volatility to remain high. The price of failure would be hard to bear.

GDP in the Eurozone (year on year % change) (Dec 2001 – Dec 2011)

The final quarter began with a significant turnaround in global equity markets. US economic data continued to surprise to the upside and expectations of a final solution to Greek sovereign debt issues pushed most Western markets significantly higher.

The rally in Japan was less pronounced as, towards the end of October, investors were wary of adding exposure to Japanese equities ahead of the release of interim results. The scandal at Olympus has also hurt the global perception of Japanese corporate governance and weighed on their equity markets.
Many companies in the export sector reduced their full year forecasts citing a combination of Yen strength, production disruption from Thailand's flooding and weak demand in developed markets. The government and Bank of Japan tried to support growth with another round of currency intervention.

As the quarter progressed, events in Europe continued to dominate market sentiment, but US economic data was supportive, with fears of a double dip recession receding. In Japan, the key positive remains the expected tailwind from rebuilding efforts over the next twelve months.

Emerging markets
Weakening economic activity in developed countries has recently led to downward growth revisions and a flight to safety, weighing in turn on emerging market equities. Major emerging markets have focused on fighting inflation amid slowing growth at home and abroad, but there are initial signs of this ending with China loosening policy.

On the plus side, emerging markets still have stronger growth vis-à-vis developed markets, better earnings growth prospects, and strong corporate and government balance sheets. This latter point is particularly important in that it puts emerging markets in a better position to weather the current crisis. Valuations of emerging market equities are now very attractive and although we expect them to remain volatile this should provide support.

China remains our preferred market. Chinese equities, which have lost ground over the summer, should continue to be supported by evidence that growth is holding up better than expected while inflation is likely to have peaked and will start to trend downwards. We have already seen a cut in reserve requirements. In summary, China is expected to avoid a hard landing.

Political risk in Russia remains elevated although valuations are cheap and credit markets stable. Russia's 2011 budget relied on an average oil price of USD115/bbl to balance (likely to rise to USD125/bbl in 2012). Presidential elections take place in March, which may cap the upside for Russian investments in the short to medium term. From a long-term perspective, this may provide a buying opportunity.

Equity performance of emerging markets

Past performance should not be seen as an indication of future performance


Changes in major indices(30 September 2011 – 31 December 2011)

Bloomberg/EFFAS Government Bond (all maturities >1 year)

UK 5.4%
US 0.8%
Eurozone -1.2%
japan 0.4%

Source: Thomson Datastream

Past performance should not be seen as an indication of future performance

The positive sentiment after the European Summit at the end of October only lasted a few days before the bond vigilantes struck. Italian and Spanish government bond markets exploded. Italian 10-year yields breached 7% and Spain touched 6.7%. Over 6% is considered unsustainable. Attention soon focused on France, amid concerns that it may lose its AAA rating. Since then the market has steadied and yields have eased, thanks in no part to the ECB which has been buying peripheral debt and the change of government in Italy and Spain. Investors are keenly awaiting the countries debt-reduction proposals which will be important for their credibility. Greece has moved slightly away from centre stage, but ongoing discussions about the Greek PSI (level of haircut on debt) remain key.

Despite their debt management problems US Treasuries are still seen as sound. Fiscal policy is at grid lock, with the Super Committee unable to agree a debt reduction plan. In September the Fed announced operation Twist. Instead of increasing the Fed balance sheet Quantitative Easing (QE), it decided to shift the composition, moving to longer dated treasuries, in an attempt to lower longer dated borrowing costs.

10-year government bond yields (Jan 1999 – Dec 2011)

Past performance should not be seen as an indication of future performance.

Changes in inflation, interest rates and the rate of exchange may have an adverse effect on the value, price and income of investments. Your capital may be at risk and you may not get back the amount you invest.

In the UK the strong performance of gilts masks underlying volatility. Domestic news would ordinarily have greater influence, but as the continued European travails dominate headlines, the government benefits from the Bank of England's role as lender of the last resort and the unlikelihood that it will default on its debt. The Bank of England (BoE) announced it was extending QE by £75 billion and in the November Inflation Report it downgraded both its growth and inflation forecasts. Inflation is expected to undershoot the 2% target in the medium term and the BoE believes it necessary to inject further monetary stimulus.

he recent corporate earnings season in Europe and the US is encouraging. Companies have managed their balance sheets well since 2008 and are in a strong position financially. Generally we prefer investment grade corporates to sovereign bonds.


Investors sought alternative currencies during the summer as bad news continued to unsettle the currency markets. Whilst the Eurozone crisis has dominated the headlines for most of the year the currency's value is little changed against both sterling and dollar from this time last year; a reminder that this is a debt crisis that is not just confined to the Eurozone.

The story of 2011's Foreign Exchange (FX) performance is the yen's strength on one hand, and the weakness of the vast majority of emerging market currencies on the other. Despite generally stronger economic fundamentals, risk aversion and fear of recession have reversed the strength of some Emerging Market currencies.

Going forward, sterling is likely to remain under pressure. A weak, deleveraging economy is likely to be further undermined by exposure to a recessionary Eurozone, while we expect that further QE will reduce foreigners' demand for the currency, especially as they are already overweight gilts.

With the ECB under new President Mario Draghi, now cutting rates, and the crisis worsening, we expect the euro to weaken; something desperately needed in order to improve competitiveness.

USD relative to other currencies (Jan 2001 – Dec 2011)


2011 has been a disappointing year for hedge fund performance, with all sub-strategies posting negative returns. Despite a better backdrop for risk markets in the fourth quarter,
hedge funds have continued to struggle, with only the Event Driven sub-strategy managing to post a tangible gain.

Going forward, our preference remains for Directional Trading strategies as we view this group to be best placed to take advantage of, or cope with, significant shifts in the price of risky assets. Directional Trading consists of two main sub-strategy groups: Global Macro and CTA (Commodity Trading Advisor).

Global Macro managers employ a "top-down" global approach, and may invest in any market using any instrument to participate in an expected market movement. Such movements may result from forecasted shifts in world economies, political fortunes or global supply and demand for resources.

CTA managers generally utilise computer models to identify trends and price patterns and implement systematic trades, with limited manager intervention.

Another strategy we now favour is Event Driven. This strategy aims to capture price movements from anticipated transactional events. The sub-class of particular interest at present is Merger and Arbitrage, an area currently supported by a healthy and increasing volume of corporate activity. This strategy also offers the benefit of being reasonably decorrelated from equity markets.

Performance of hedge funds relative to equities (Sep 2000 – Nov 2011)

Past performance should not be seen as an indication of future performance.

This investment included herein may not be suitable for all investors and you should seek professional advice before investing.

Most investments should be considered as a medium to long-term commitment, meaning investors should be prepared to hold them for at least five years. For products with a fixed term investors may get back significantly less than originally invested if there is an early withdrawal. Furthermore some asset classes may be less liquid than others and they may be difficult to sell before their maturity.


This year has been tough for commodity markets with most commodities falling in price and the mining sector underperforming general equity markets. Performance has een weighed down through several factors; concerns over the slowing Chinese and other emerging market economies, the Japanese earthquake and resulting Fukushima disaster, the re-surfacing of the European sovereign debt crisis and data in the US suggesting a slow down in the US economy.

Brent oil is back up above USD100/bbl following a brief fall below at the end of September. We continue to hold our view that the global economic slowdown, mostly attributable to the moderation of growth in the United States and European recession fears will weigh on oil demand. However, growth in emerging economies should remain robust, thus giving support to the oil price.

Gold has had a great year and remains relatively sound compared to other commodities through the sovereign debt crisis and we believe that as long as the crisis lingers and market fears do not recede markedly, gold will continue to hold popularity status. Large holdings by hedge funds have contributed to volatility in the gold price recently and whilst this may continue we expect the upward trend to remain in place.

Brent oil vs gold (Jan 2011 – Dec 2011)

Past performance should not be seen as an indication of future performance



SGPB Hambros calculates composite benchmarks appropriate for different investor objectives, based upon MSCI Equity indices, Bloomberg/EFFAS Bond Indices, overnight cash rates and HFRI fund of hedge fund indices. The proportions vary according to strategy and are available on request from your private banker.

A strong October for equity markets was followed by volatility, but no clear direction in November and December. The Dow Jones was the only major market to be up for the year with European and Emerging markets experiencing large losses. UK, US and German government bond markets were strong in marked contrast to credit markets and weaker sovereign bonds. Hedge funds stabilised in the fourth quarter, but had a poor year overall. In general lower risk benchmarks show better annual numbers, but this performance was difficult to capture for portfolios as only a concentrated long dated exposure to core government bonds worked.


Bond portfolio 4.3% 11.7% 14.1% 13.4%
Defensive 4.1% 4.4% 5.4% 5.2%
Income and growth 5.0% 2.6% 3.6% 3.5%
Balanced 5.8% -1.0% -0.5% -0.3%
Capital growth 6.0% -5.9% -5.8% -5.3%
Aggressive growth 7.2% -6.9% -6.8% -6.2%
Bond portfolio 4.3% 11.7% 14.1% 13.4%
Defensive 4.0% 4.1% 5.2% 5.0%
Income and growth 4.9% 2.2% 2.2% 3.2%
Balanced 5.6% -1.8% -1.8% -0.9%
Capital growth 5.7% -6.8% -6.8% -6.1%
Aggressive growth 6.8% -8.0% -8.0% -7.2%

Bond portfolio 0.7% 5.9% 8.1% 8.0%
Defensive 1.8% 0.2% 1.1% 11.8%
Income and growth 2.8% -1.8% -1.1% 0.2%
Balanced 3.7% -4.4% -4.1% -2.2%
Capital growth 5.1% -9.6% -10.0% -7.3%
Aggressive growth 6.1% -11.3% -11.7% -8.6%

Bond portfolio -0.9% 1.7% 2.3% 1.4%
Defensive 1.1% -0.9% -1.0% -1.6%
Income and growth 2.5% -2.3% -2.9% -3.4%
Balanced 3.7% -3.6% -4.5% -5.0%
Capital growth 6.1% -6.5% -8.1% -8.2%
Aggressive growth 7.4% -7.7% -9.5% -9.8%

Source: Datastream and Bloomberg

Hedge fund returns are estimated based upon HFRI data as of 29 December 2011

Past performance should not be seen as an indication of future performance.

Investments may be subject to market fluctuations and the price and value of investments and the income derived from them can go down as well as up. Your capital may be at risk and you may not get back the amount you invest.