Carey Olsen's Graham Hall looks at how investors are coming back to the markets in search of returns.
2013 started as a bull market with a lot more confidence as investors see the debt crisis in Europe getting under control and the US managing to avoid the fiscal cliff.
Carey Olsen, which advises on the largest total number of funds and assets under management in Guernsey, believes there will be slow and steady growth in fund creation and the breadth of investments. Corporate partner, Graham Hall, examines where this growth will come from and what innovations investors and private equity houses are employing to realise a return.
As the economic situation in Europe appears to be stabilising and the US has avoided the fiscal cliff, equities have started to move this year. Having locked up money for four years, keeping their money in "safe" investments, investors are now getting interested again in areas where they see the potential for higher yields.
The EU is moving ever-eastwards. Bulgaria, Hungary, Czech Republic, Slovenia, Poland, Slovakia, Estonia, Lithuania and Latvia all joined the club in the past eight years while Montenegro, Serbia, the Former Yugoslav Republic of Macedonia and Turkey are all waiting in the wings. With interest rates remaining at historic lows, investors are chasing yield and the focus is firmly on this region. In 2011, central Eastern European countries like Poland grew 3.8% and Austria grew at 3.3%, while eastern countries like Moldova, Estonia and Lithuania all grew between 6% and 7% in real gross domestic product (GDP) terms. These figures compare to Germany's 2.7% growth and the Eurozone's blended growth rate of around 1.6%, over the same time period. Even the U.S. posted just 1.7% growth.
This growth in Eastern Europe means there are opportunities for investment in the development of infrastructure and commercial property where there are low property values and predicted high returns – an attractive combination for investors recently starved of promising investments.
If the past four years has taught anything it is that it often pays to be innovative and funds are seeking unusual opportunities where the risk is seen as manageable. Historically emerging markets have a history of under investment but growth. Debt is also seen as attractive as banks get rid of their loan books and finance houses adjust their loan-to-asset ratios. They are selling off their debt, sometimes their whole debt portfolios, and debt books can be picked up relatively cheaply by smaller operators at significantly reduced rates. Of particular interest, but not openly discussed ,are lease car debt books.
These books are sold at significant discounts and it is an area of significant potential returns as the economy improves and the risk of holding this debt reduces.
There is, of course, some residual skittishness but recent movement in the markets indicates there is a lot more confidence and enthusiasm. There have been rallies in the past which have not stuck and the question mark is whether this one will hold. However, the market does seem to think there is a way to go before there will be any sort of correction.
There's even been a rally in hedge funds which suffered acutely in the economic crisis. Hedge funds are performing better than they have in a long while and investors are beginning to recoup, or certainly looking to, the losses of the past. Whether it means more money being invested in hedge funds remains to be seen. It is difficult to give a time frame on when we might see a return to more halcyon days because, while there are individuals and select funds rallying, it is the big institutional pension funds that are needed to ensure a true return to performance. This sector is traditionally cautious and, having been severely hit in the crisis, their return will be slow and steady. It is really only 10% of the market that is prepared to take a risk and they appear to be a lot more open to the idea this year.
There was a flight to Luxembourg by many hedge funds during the economic crisis thinking they needed to be seen to be onshore. Many are now realising this was a false perception as Luxembourg is an expensive and bureaucratic place to do business which has an impact in the efficiency of the funds and the returns that can be made. These funds are starting to look at other jurisdictions that offer stability and pragmatic regulation without the expense or bureaucracy. As ever, Guernsey is ideally placed to reap these opportunities.
According to the Guernsey Financial Services Commission, the net asset value of total funds under management and administration increased in Q3 2012 by £3.6 billion (1.3%) to reach £274.4 billion. For the year since 30 September 2011, total net asset values increased by £3.3 billion (1.2%). Guernsey is indicative of the worldwide trend where the interest in open-ended funds has decreased by £1.6 billion (-3.2%) over the quarter to £51.5 billion. The closed-ended sector increased over the quarter, by £4.2 billion (3.3%) to reach £130.3 billion. This represents an increase of £4.6 billion (3.7%) over the year since 30 September 2011.
The market recognises Guernsey's proven operating model with highly skilled professionals across the board. It is up to Guernsey to ensure it does not become too expensive but this is a secondary consideration to investors with the level of expertise and experience being far more important. Investors and funds, now more than ever, want to know that a jurisdiction has breadth and depth.
It would be overstating the matter to suggest the fund markets are entirely out of the woods but there are definitely strong "green shoots". Guernsey certainly remains the most popular jurisdiction for private equity albeit with fewer funds being created. There is activity from global PE houses investing in infrastructure (Terra Firma, Permira, Apax). They continue to invest but at lower levels. For example, the focus has been on global farmland as a sound investment for some of these closed-ended funds with investments being made in cattle stations in Australia and New Zealand (beef and dairy) and in China.
It is tighter market and funds are looking much harder at efficiencies and costs. It is harder to raise the money and it takes longer and funds are launching with lower expectations which, arguably, is no bad thing.
Closed-ended funds are the majority of the market now and will continue to grow. 2013 has started as a bull market. The driving sentiment is one of optimism. There is a movement away from bonds and corporate gilts but there will not be a return the pre-2008 activity for a long time – slow and steady seems to be this year's watchwords.
An original version of this article was by published by FTSE Global Markets, March 2013.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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