market pulse€¦ · 2 — kleinwort benson — first quarter 2014 when are financial markets most...

First quarter 2014

Market Pulse 2 — Investment strategy

Riding the waveDespite a few wobbles, stockmarkets across the developed world

delivered strong returns in 2013. Yet equity valuations are starting to

look stretched and history reminds us that bull runs come to an end

eventually. Should investors stay in for the ride in 2014?

www.kleinwortbenson.com

In this issue

4 — EquitiesEmerging market valuations are attractive following a difficult year and sentiment is negative. Within sectors, we continue to prefer financials.

5 — Government bondsYields are beginning to return to their long-term average levels in response to an improved outlook for global growth and monetary policy changes.

6 — Corporate bondsAlthough credit spreads have tightened further over the past year, opportunities remain for investors searching for additional yield.

7 — CurrenciesRobust economic growth in the US and UK has supported the dollar and sterling, which are likely to remain strong against other major currencies.

8 — CommoditiesThe price of gold tumbled in 2013. Prices are likely to remain low owing to few inflationary pressures and the fading of a number of market risks.

9 — Real estateThe UK’s commercial real estate markets offer attractive opportunities to enhance investment returns.

10 — Markets at a glanceCentral bank monetary policies continued to drive the market’s performance over the fourth quarter.

2 — Kleinwort Benson — First quarter 2014

When are financial markets most likely to reward investors who take risk? Unfortunately, there are rarely clear signals. Yet as we enter 2014 this question remains as crucial as ever. Many investors begin the new year concerned that the prolonged equity rally may have run its course.

Our concerns for the year ahead are similar to those at the beginning of 2013. Once again investors are nervous about any reduction in central bank liquidity and the prospect of higher interest rates, the pace of global economic growth, high government deficits, US political deadlock and the euro zone’s stability.

At the beginning of 2013 many investors asked if a “mature” equity bull market was about to end. Yet they have been well rewarded for taking equity risk over the past year. Key indices hit record highs, and global equities returned almost 20 per cent. Investors have been well rewarded for taking risk across most asset classes over the past five years.

Clues from the pastWill 2014 also reward those who invest in risky assets? We look to the S&P 500 Index for clues (figure 1). Since 1929 there have been 12 bull markets (not including the current one). On average they have lasted 57 months. At the end of 2013 the current bull market was 57 months old.

On average these periods have delivered cumulative returns of 165 per cent. The S&P 500 has risen by 150 per cent on a total return basis during the current bull market. On an annualised basis this bull market is again average – it has delivered returns of 21.3 per cent (the average is 21.2 per cent).

Across various measures, the current bull market is unremarkable. It is of average length. Even if it were to last another 12 months, it still would not register in the longest top three. It has

produced below-average cumulative returns – it would need to gain another 20 per cent to be average. Based on this analysis this bull market could have further to run.

Valuations look stretchedWe believe that the most important measures of a bull market’s maturity are its starting and ending valuations. On average, bull markets have begun when valuations are at 13.2 times their cyclically adjusted price-to-earnings ratio (CAPE). This measure is useful because it uses 10 years of inflation-adjusted earnings data to smooth out the distortions that occur owing to business cycles. On average, previous bull markets have ended when CAPE values have hit 21.5 times.

This bull market, which began at the peak of the financial crisis, had a starting CAPE of 13.1 times, which is almost exactly the long-term average. However, CAPE is now 25.1 times, which is significantly above the average of where previous bull runs have ended. In fact, of the previous 12 bull runs, 10 ended at CAPE multiples lower than the current multiple of 25.1. Additionally, the

The markets could continue to reward investors for taking risk

Market Pulse — Investment strategy

average multiple expansion – the ending CAPE value divided by its starting value – has been 1.7 times. This bull run has expanded 1.9 times since it started.

A disciplined approachThe characteristics of past bull markets suggest the current one could have more to give despite uncertainty about central bank policy and other risks. We remain focused on implementing our disciplined approach of investing in cheap and positively trending assets, especially when sentiment is overly negative.

We continue to believe equities offer the best value of all main assets. Price momentum in the global equity markets remains strong, and we prefer European and emerging market equities. They offer good value on a risk-adjusted basis, and therefore positive expected returns. In contrast, US equities appear expensive, which is why we have had little exposure to this region.

Government bonds look expensive and the prospects are poor – monetary policy is likely to become unfavourable as the economy strengthens. We continue to prefer high-quality and cash-generative corporate and emerging market issuers. They introduce diversity into multi-asset portfolios, generate income and reduce volatility. Also, in an environment where expected income returns for most asset classes are significantly lower than the long-term averages, the yields on offer from selected real estate investments are attractive at current valuations.

Figure 1: Equity bulls of the 20th centuryWe have used a logarithmic scale on the vertical axis to show the magnitude of rises and falls in the S&P500 Index over the past 80 years. Does history suggest today’s bull market could come to an end soon?

Source: Bloomberg and Kleinwort Benson. Data as at 31 December 2013.

1932–37324%

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1949–56267%

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Kleinwort Benson — First quarter 2014 — 3

Market Pulse — Investment strategy

House views

Equities Positive We are positive on equities given reasonable valuations and strong price momentum.

Europe (excluding UK) Positive Relative value still exists in some markets even after recent outperformance. Positive price momentum continues, supported by favourable economic surprises.

Japan Positive Loose central bank monetary policy is supportive. Fiscal position and demographics remain structural hurdles.

Pacific (excluding Japan) Neutral Price momentum has turned positive but valuations are mixed.

UK Neutral Valuations are increasingly expensive relative to other markets by some measures. Recent economic data has surpassed consensus expectations but a strong dependency on the housing sector is a cause for concern.

US Neutral Relatively overvalued but price momentum is strong and economic fundamentals generally continue to improve.

Emerging markets Positive Valuations are attractive and price momentum has recently turned positive. The market continues to be sensitive to the shifting views on central bank policy.

Private equity Neutral Improved transactional activity is supportive over the medium term.

Government bonds Negative Government bonds are expensive by most measures. We continue to hold them to reduce volatility in multi-asset class portfolios.

Conventional Negative Yields remain unattractive even though they have risen recently.

Index-linked Negative Inflation is muted and we expect inflation-linked bonds to perform similarly to conventional government bonds.

Credit Positive We continue to prefer high-quality and cash generative corporate and emerging market issuers.

Investment grade (corporate) Neutral Despite being expensive, we expect investment grade bonds to outperform government bonds.

High yield (corporate) Positive In the current environment, where yields are rising, combined with economic recovery and low default rates, high yield debt is likely to outperform investment grade debt.

Emerging market Neutral Capital flows and currency risk are likely to weigh down on emerging market bonds in the short term.

Currencies

Sterling Positive Positive momentum behind economic growth in the UK should continue to support sterling against other G10 currencies excluding the US dollar in the near term.

US dollar Positive The start of quantitative easing tapering is likely to contribute to short-term volatility. We expect stronger relative economic fundamentals to give a tailwind to the dollar against other G10 currencies.

Euro Negative The ECB’s loose monetary policy, and its divergence from other major central banks, is likely to put the euro under pressure against other major currencies, particularly high-yielding ones, such as the Australian dollar.

Yen Neutral We expect the yen to remain range bound against the euro and sterling and weaker against the US dollar in the medium term. Longer term, expansionary monetary policy is likely to weaken the yen.

Real estate Positive Some areas offer strong income returns and protection against inflation. We continue to favour the UK commercial market. We also like certain investment opportunities in infrastructure.

Commodities Negative Price momentum is negative. Sharp falls in most markets in 2013 suggest value is emerging.

Gold Negative Gold has defensive characteristics in times of financial stress, and its sensitivity to inflation is better than most other asset classes. However, price momentum remains negative.

Alternatives

Hedge funds Neutral We prefer hedge funds that offer lower correlated returns to our asset allocation.


At the start of 2014, we are mindful of the continued strength in equity markets. An analysis of the past 100 years suggests bull markets last 4.8 years on average. It has been nearly five years since the March 2009 lows and so the duration of the current bull market is now only slightly longer than average.

Yet lessons from history can be difficult to apply. For example, should we rely on the simple long-term averages? Or should we pay closer attention to the precedents set during periods most relevant to prevailing market conditions? A straightforward average of the past 100 years may not be the most suitable guide to the next one.

Notably, the deep crash of 2008

is likely to have a lasting impact on an entire generation of investors – not unlike the Great Crash of 1929. This generational unease could go some way to explaining the tepid recovery in economic confidence. Importantly, the current recovery has been slower than the average, giving reason to believe it will also continue on for longer.

Waiting is the hardest partThe returns from the equity markets varied considerably during 2013 (figure 2). On a regional basis, we favoured continental Europe. Although it got off to a somewhat rocky start, this region gained 28.6 per cent in US dollar terms over the year compared with the global

market’s return of 23.5 per cent. Our investment case for favouring Europe focused on its attractive relative value, while overly negative sentiment at the beginning of 2013 offered an attractive opportunity to be a contrarian investor.

As we head into 2014, the relative value case for Europe has diminished and investors have begun to warm to those markets, leaving us with reduced conviction. However, as the region’s economy begins to recover, its relatively weak corporate earnings growth should rebound, providing scope for further outperformance (figure 3).

For reasons similar to those for Europe, emerging markets have been another preferred area for investment. However, 2013 was a difficult year for these regions. The relative valuation case remains attractive but we continue to wait for investor sentiment to turn positive.

Sector selectionOn a sector basis, 2013 was a strong year for consumer discretionary sectors, which benefited from a partial recovery in consumer confidence. Our biases to autos, civil aviation and house builders proved to be well placed.

As we move into 2014, we continue to prefer financials, where a steeper yield curve should lift profitability and ultimately lead to greater shareholder returns. We also favour information technology, and particularly those companies set to benefit from any improvement in corporate spending.

Opportunities may also arise in the energy and materials sectors. Both have suffered from significant and structural challenges. Yet many companies have been facing up to these issues and adjusting their capital spending plans accordingly. With investors maintaining an overly pessimistic outlook towards these sectors, any substantial improvement in cash flows should present an opportunity to take a contrarian view. For now, we are content to wait for further developments before making any decisions.

Which regions and sectors are likely to offer the best returns?

Figure 2: A year of two halvesThis chart shows total equity returns in US dollars. The US and Japan started the first half of 2013 with a burst of outperformance but Europe had managed to catch up by the end of the year.


Figure 3: European (excluding UK) company earningsThe chart shows continental Europe’s actual trailing earnings compared with consensus forward earnings. Actuals have been flat for the past year while consensus numbers have fallen.


Market Pulse — Equities

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Government bond investors continue to face a variety of uncertainties. They include the tapering of quantitative easing (QE) by the US Federal Reserve; the sustainability of economic growth across developed markets; and a resolution of the US debt ceiling issue in the New Year. Accordingly, we have positioned our portfolios in short duration strategies with a unifying theme that yields are set to rise further.

In anticipation of continued QE tapering in 2014, markets have already priced in substantial moves at the long end of the curve. For example, 10-year US Treasury yields have risen by 1.6 per cent to 2.9 per cent and are expected to exceed 3.3 per cent by the end of 2014.

The Fed is likely to remain cautiously optimistic about the economic recovery and is not in any hurry to scale back its monthly asset purchases completely. A full exit could take longer than many expect and extend into 2015. In the meantime, headline risk from the Fed’s monetary policy is likely to remain in the spotlight and could generate occasional bouts of risk aversion.

The process of bond yields returning to their long-term average levels is not limited exclusively to the US. Medium- and long-term yields in the euro zone and UK are also likely to rise (figure 4). The impact on Japan is less obvious due to offsetting factors – the impact of aggressive asset purchases by the Bank

of Japan, which helps lower yields, and the effect of rising inflation expectations, which pushes them up.

Fed tapering will continue to be important for emerging markets (EM). Any correction in EM government bonds is likely to be short-lived since prices have fallen a long way already in US dollar terms in 2013. Between May and December they fell by about 9 per cent.

The Fed and Bank of England are likely to keep interest rates on hold until early 2016. In addition, we do not rule out the possibility of both central banks altering their forward guidance (conditions to change policy rates) by adjusting their unemployment rate thresholds. The European Central Bank (ECB) remains alert to low and decelerating inflation in the euro zone. The risk is skewed in the direction of an ECB deposit rate cut for banks or other unconventional forms of easing to counter potential disinflationary pressures in 2014.

Investment strategy We prefer inflation-linked over conventional government bonds (figure 5). Specifically, within our government bond allocation, we allocate 60 per cent to inflation-linked bonds and 40 per cent to conventional bonds. Markets expect a higher inflation rate next year compared to what is priced in today, supporting our slight preference for inflation-linked bonds. Regionally, we favour UK and US inflation-linked bonds due to the lower risk of prolonged pressures of decelerating inflation compared with the euro zone.

Investors holding safe-haven bonds such as US Treasuries, German Bunds or UK gilts are facing the risk of capital losses if they sell before maturity. Short duration bonds of less than five years should help to reduce the impact of rising yields.

Contagion from rising US yields is likely to affect global markets

Market Pulse — Government bonds

Figure 5: UK inflation-linked bonds look attractiveThis chart shows the UK’s inflation rate (the Retail Prices Index) and the 5-year expected inflation rate in one year’s time. Inflation-linked bonds look attractive owing to expectations of higher inflation.


Figure 4: Forward rate expectationsThis chart shows the expected 10-year rate in one year’s time. Although the US has begun to slow its quantitative easing programme, interest rates are likely to stay low for some time.


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Corporate bond investors will remember 2013 as the year when yields set their course for a return to more normal levels, marking the end of the bull market. We expect corporate bonds to remain sensitive to the beginning of Fed tapering in 2014. Yet investors are likely to continue to hunt for yield by taking on incremental risk.

The health of company balance sheets continues to remain solid and we do not foresee any major credit risks. Against this background, we prefer to take on higher credit risk than duration risk since default rates should remain low. For 2014 default forecasts are about 3.0 per cent according to Moody’s compared with a 10-year average of 4.5 per cent,

which is likely to give confidence to yield hungry investors.

Corporate bonds are likely to outperform government bonds on a total return basis. We expect high yield (HY) and leveraged loans (below BBB-) to do well, and investment grade (IG, above BB+) to take a back seat (figure 6).

In the near term, valuations remain stretched by historical standards with little room for price appreciation (or credit spread tightening) – credit spreads are at depressed levels of 125 basis points for IG and 430 basis points for HY. Therefore, in the year ahead, income yield (bond coupons) should be the main contributor to total returns for bonds.

Geographically, we favour euro

zone and selective emerging market companies with a global presence. Positive economic growth in Europe should support peripheral credit, which looks more compelling relative to core countries. At a sector level, we prefer financials over utilities and industrials because changes to the regulatory landscape are likely to strengthen both the banking and insurance sectors.

Reduced issuanceA reduced net issuance of credit (new supply minus maturing bonds) should be driven by continued deleveraging in the financials sector and increasing demand for outstanding bonds in the new year owing to relatively better yields from financials compared with other sectors (figure 7). HY net issuance in the US and Europe is forecast to shrink by around 15 per cent in 2014 compared with 2013 as companies refinance in the loan markets.

To navigate the challenges of the year ahead, we believe an investment process that combines a top-down (macro strategy) and bottom-up (credit selection) approach is key to delivering performance. While the top-down strategy helps to define the risk appetite (maturity, rating and sectors), the bottom-up process provides fundamental analysis on individual bonds.

Investment strategyThe combination of low yields and economic recovery poses a threat to the market value of bond portfolios. To manage this risk we prefer floating rate notes and short-dated fixed-rate bonds maturing in less than five years. These securities should help portfolios preserve capital values, while offering a high degree of liquidity.

Fundamentals remain positive despite some headwinds

Market Pulse — Corporate bonds



Figure 7: Global sector yield to worstContinued deleveraging in the financials sector is likely to reduce the issuance of credit next year. One consequence is that yields could remain attractive compared with other sectors.

Figure 6: 2013 total returns and 2014 expected returnsCorporate bonds are likely to outperform government bonds on a total return basis owing partly to reduced net issuance of credit over the next year.

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The New Year is likely to bring plenty of opportunities in the currency markets. Optimism about the global economy and rising bond yields should lead to greater differentiation between high- and low-yielding currencies. A strong US dollar (USD) against high-yielding currencies (Australian dollar, New Zealand dollar and emerging market currencies) is likely to pause in the near term. Continued improvements in the US labour market could drive money market interest rates higher, and put pressure on the Fed to change its policy rate (currently 0.25 per cent) earlier than expected (the middle of 2016). Overall, we expect this, together with strong US growth, to be positive for the USD against the low-yielding G10

currencies (figure 8). The strength of sterling (GBP) is not a

surprise given the momentum behind the UK’s economic growth. It should remain steady, supported by domestic demand, an improving labour market and a healthy financial sector. This could force the Bank of England to alter its forward guidance, leading to an interest rate hike before 2016. We are positive on GBP relative to other major G10 currencies. We expect a weaker euro (EUR) and a flat USD against GBP in early 2014. Long-term valuations (based on purchasing power parity) show the GBP is undervalued relative to the Swiss franc (CHF) by 30 per cent and against the Scandinavian currencies by 20 to 25 per cent.

Currency divergence should create opportunities in 2014

Market Pulse — Currencies



Although EUR has strengthened, downside risk cannot be ruled out in the New Year. There is the possibility of a further policy rate cut, caused by worryingly low inflation. In addition, any sustained deceleration of inflation might push the ECB to follow unconventional monetary policies, such as outright asset-purchases and a new round of liquidity injection into Europe’s banking system. Against this backdrop, the EUR could weaken against USD and GBP in 2014.

Negative on the yenWe expect the weakening of the yen (JPY) to pause against other major currencies in the first quarter of 2014 given its 7.0 per cent weakening (on a trade-weighted basis) during the fourth quarter of 2013. However, the aggressive monetary expansion by Bank of Japan (BoJ) should lead to medium- and long-term currency weakness as the central bank attempts to achieve its 2.0 per cent inflation target and stimulate growth (figure 9). Yet we have some exposure to JPY in multi-asset class portfolios for diversification purposes and its defensive characteristics.

We continue to remain cautious on the CHF due to its expensive valuation against major currencies even if economic fundamentals suggest the currency could appreciate. Nevertheless, the safe-haven nature of the currency means economic fundamentals are playing less of a role. Accordingly, we recommend exchanging the CHF for GBP, USD or EUR.

Emerging market (EM) currencies reflect Fed tapering but could fall further against the G10 currencies. A GDP-weighted basket of EM currencies has fallen by about 10 per cent since the end of May 2013. Our top picks are the Polish zloty (PLZ) and Mexican peso (MXN) against low-yielding G10 currencies. PLZ should be supported by export-led growth and a stable current account deficit, while MXN should benefit from the improving competitiveness of export and budget balances. In the short term, we maintain our negative stance on Turkish lira, Brazilian real and South African rand, while remaining neutral on the Indian rupee and Russian ruble. For multi-asset portfolios, we use a basket of currencies, which we implement using third-party funds.

Figure 9: USD/JPY relative balance sheet expansion between BoJ and FedThe Bank of Japan’s aggressive quantitative easing programme should lead to medium- to long-term weakness for the yen.

Figure 8: Annual change in US real GDP vs trade-weighted US dollar indexAs the US economic recovery continues, we expect the dollar to strengthen further, particularly against lower-yielding G10 currencies.

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We sold gold from our portfolios in the second quarter of 2013. Yet we have continued to monitor price movements as well as price momentum closely. The looming threat of the tapering of quantitative easing by the US Federal Reserve continued to depress prices throughout the fourth quarter but did not result in the collapse that some commentators had forecast. Between the start of October and end of December prices fell a further 9.3 per cent to end the year 28.0 per cent lower.

At around $1,200 per troy ounce at the time of publication, gold is trading back at its lowest point since the summer of 2010. If prices go below this level there could be further pressure for them

to fall further. That is because from a technical trading perspective, which many investors use as a guide, the next support level is the 2008 high of $1,000 per troy ounce.

Is value emerging in gold?Lower prices suggest some value could be emerging. The divergence of the real gold price (which is adjusted for changes in the rate of inflation) from the medium-term average (figure 10) suggests gold is trading at a 15.0 per cent discount. In nominal terms, gold has now fallen by more than 35.0 per cent from the all-time high it reached in September 2011. Reduced concerns about inflation – at least in the short term – and a surprising

Fed tapering concerns continue to weigh down on gold prices

Market Pulse — Commodities

Figure 11: Prices remain weak across most commoditiesThe Dow Jones UBS Commodity Total Return Index is a broad measure of prices across these markets. It fell by 9.5 per cent in 2013, driven lower by falling prices across most commodities.

Figure 10: Gold prices have been on a downward trend for some timeThe price of gold fell dramatically throughout 2013 as investors became less concerned about market risks or the threat of rising inflation.



absence of geopolitical and economic crises in 2013 made gold less attractive as a hedge against rising apparent inflation or broader market crises.

However, sentiment is now extremely bearish on gold, which may indicate that prices have reached a low point for now. Holdings in the 14 largest gold exchange-traded products (passive investment vehicles) collapsed by 31.0 per cent over the course of 2013 as investors lost faith in gold and became less interested in disaster insurance. Net speculative futures positions on gold remain only 56 per cent bullish having increased from June’s multi-year low of 26 per cent.

Nevertheless, gold’s long-term price momentum remains downwards. Additionally, the opportunity cost of holding gold continues to increase with rising government bond yields for it is an asset class that yields nothing. On balance, we are content to remain on the sidelines for now.

Diversified commoditiesUsing the Dow Jones UBS Commodity Total Return Index as our benchmark, diversified commodities fell by 3.6 per cent in the fourth quarter of 2013. The index fell some 9.5 per cent in 2013 and as a broad group, this asset class continues to show negative price momentum (figure 11).

Specifically, oil prices continue to be in negative momentum with West Texas Intermediate falling by 3.8 per cent in 2013 despite growing confidence in the global economic recovery. Easing tensions in the Middle East as well as concerns over growth in emerging market economies continue to act as a brake on increasingly bullish speculation.

Recent data appears to support an improving economic climate. However, while price momentum remains negative, we are content not to own diversified commodities within our portfolios.

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We have supported investing in broad UK commercial real estate throughout 2013. Our analysis in the first quarter revealed that after a prolonged period of decline, capital values were starting to recover and the asset class continued to offer strong income returns.

There have been some stories in the press about property sales where yields (reflecting the purchase price) appear overpriced. For example, the recent Great Portland Estates sale of an office in St. James Street, London to a German pension fund for an initial yield of 2.1 per cent rings warning bells. But a closer look reveals the full story. The property is only partially let with an average remaining lease length of 1.75 years. The seller

has made a 28.0 per cent profit in three years. Notably, it is a redevelopment project with the purchase price based on a redevelopment value.

The wider question is whether the market looks expensive. UK commercial real estate values fell 44.0 per cent from peak to trough between 2007 to 2009, measured by the IPD monthly index (figure 12). Despite recovering 15.0 per cent from their lows, values remain 36.0 per cent below the peak of the bubble.

Initial yields are a measure of valuation, and were 6.2 per cent in November 2013. Although below the long-term average of 6.7 per cent, which suggests property values could be overvalued, they remain within the core

Market Pulse — Investment opportunities: real estate

Figure 13: Comparing yieldsUK commercial property yields are in their core range of 6.0 to 7.6 per cent, where they have traded for half the time since 1986. Current levels are attractive compared with UK gilts and equities.

Figure 12: UK commercial property valuesThe market has experienced two substantial corrections over the past 15 years. Today’s prices remain some 36.0 per cent below the peak of the bubble, suggesting properties are not overpriced.

Source: Investment Property Databank (UK Data). Data as at 31 December 2013.

Source: Investment Property Databank (UK Data). Data as at 31 December 2013.

range of 6.0 to 7.6 per cent. Initial yields have traded in this range for half of the time since 1986. The sector has returned 8.9 per cent in the 12 months to the end of November 2013. But most of this return has been generated by income, and capital values have risen only 3.0 per cent since the start of the year (figure 13).

Returns for investors seeking incomeIncome from UK commercial property remains compelling because interest rates are so low. The sector has generated a higher income than UK gilts, and well above the normal premium expected to compensate investors for the illiquidity. Interest rates are unlikely to rise rapidly and so we expect the market to continue to offer an attractive return for investors seeking income. When interest rates do rise, and the income margin from the market over the risk-free rate closes, we will reassess the merits of this market. If we see signs of initial yields softening, indicating negative price momentum, we would again revisit the fundamental investment case.

Sentiment towards UK commercial real estate – often used as a contrary indicator for our investment decision making – remains strong. The market remains popular with overseas investors. They are attracted by its maturity and the relative safe haven of owning a physical sterling-based asset. But with the exception of central London, where yields on some transactions suggest we are in expensive territory, we believe the market continues to offer diversification and attractive returns.

Remember though that property is a longer-term investment. One of the themes of 2013 was investing in secondary property markets. Many investors were attracted by the relatively high yields. This capital inflow could result in investors overpaying for properties with a high risk of depreciation or lack of alternative use. Investors will depend on the skill of their asset manager in redeveloping or repositioning assets. The attractions of “alternative” property asset classes, such as student accommodation and residential apartments for lease, may also be left behind in 2014 as investor interest continues to push yields into expensive territory.

Attractive opportunities in UK commercial real estate markets

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Market Pulse — Markets at a glance

There were encouraging signs about the health of the global economy in the fourth quarter with data suggesting the rate of growth is picking up (figure 15). The US recovery remains on course, the UK showed particular strength and Japan is growing. In the euro zone, figures showed that after nine consecutive quarters of contraction the Spanish economy grew by 0.1 per cent from July to September. Yet growth in many major emerging markets, including Russia, Brazil and India, remains sluggish.

The announcement in China of reforms following the ruling Communist Party’s “third plenum” meeting were also encouraging. But some commentators wonder whether they will be sufficient to maintain the pace of growth as its economy rebalances away from investment and exports towards services and domestic consumption. There were also doubts about the effectiveness of ongoing structural reforms in Japan. Additionally, relations between these two Asian powerhouses have become strained in a territorial row over a group of islands in the East China Sea.

Low interest rates and quantitative easing (QE) continued to support equity markets, which delivered healthy gains in 2013. But speculation about the Federal Reserve’s monetary policy dominated and distorted markets. On 18 December the US central bank announced it would begin to scale back its bond-buying programme from $85 billion a month to $75 billion. Although this reduction was less than markets expected, the Fed committed to keeping interest rates low in order to dampen the effects.

This decision suggests US policy-makers are more confident of a sustained recovery in the US economy. Stock-markets jumped in response to the news and the US dollar strengthened against major Asian currencies, sterling and the euro (figure 16).

Monetary policy continues to drive the market’s performance

Figure 15: The global economic recovery is gathering paceThis chart shows the changes in real GDP across the world’s largest economies (based in local currencies and seasonally adjusted). After several volatile years, these regions are showing synchronised growth.

Figure 14: Investment returns (%)

Fourth quarter 2013 Full year 2013

Developed market equities 8.4 29.0

Emerging market equities 3.2 3.9

Developed government bonds 0.1 0.0

Emerging market government bonds 0.5 -0.3

Global investment grade corporate bonds 1.0 0.1

Global high yield corporate bonds 3.5 7.5

Oil (WTI spot price only) -3.8 7.2

Gold -9.3 -28.0

Agriculture (spot price only) -5.7 -22.1

Hedge funds 2.2 6.5

Global property 0.4 8.6

Private equity (in US dollars) 6.4 37.2

Source: Datastream and Kleinwort Benson. Data as at 31 December 2013.


Returns are in local currency unless stated and assume net dividends and interest payments reinvested.

Figure 16: the US dollarThe US dollar has been losing ground against both sterling and the euro for most of the second half of 2013. But it strengthened after the Fed announced the slowing of its quantitative easing programme.

Source: Datastream and Kleinwort Benson. Data as at 31 December 2013.

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Key risksThis publication is intended to give an insight into the thought processes that lie behind our investment views and our investment strategy. They do not necessarily reflect the current investment policy of Kleinwort Benson.

The information in this publication is provided for information purposes only and does not take into account the investment objective, the financial situation or the individual needs of any particular person. It is not an offer to buy or sell any particular security or investment. In no event will any entity of the Kleinwort Benson group assume any liability for loss or damage of any kind arising out of the use of information contained in this publication.

This publication does not constitute advice. All potential investors should seek and obtain advice specific to their circumstances from a qualified financial adviser before making investment decisions. The value of investments, and the income from them, may fall as well as rise and the investor may not get back the amount initially invested. Past performance does not guarantee future performance. Fluctuations in exchange rates may cause the value of investments denominated in currencies other than sterling to fall or rise. The effects of charges and an investor’s personal tax circumstances may reduce any returns. Tax treatment depends on an investor’s individual circumstances and may be subject to change.

Regulatory informationThis publication is a financial promotion. It has been approved and issued in the United Kingdom by Kleinwort Benson Bank Limited. Kleinwort Benson is the brand name of Kleinwort Benson Bank Limited. Kleinwort Benson is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority, reference number 119269 and is a member of the London

Stock Exchange. Kleinwort Benson is a company incorporated in England and Wales with company number 2056420.

Kleinwort Benson is the brand name of Kleinwort Benson (Channel Islands) Investment Management Limited which is a company incorporated in Jersey with company number 13270. Registered Office Kleinwort Benson House Wests Centre St Helier Jersey JE4 8PQ. It is regulated by the Jersey Financial Services Commission, the Guernsey Financial Services Commission for the conduct of investment business and is also regulated by the South African Financial Services Board as a licensed Financial Service Provider.

Kleinwort Benson is the brand name for Kleinwort Benson (Channel Islands) Limited which is a company incorporated in Guernsey with company number 52103. It is regulated by the Guernsey Financial Services Commission for Banking and Investment Services. Kleinwort Benson places all client deposits with a spread of approved counterparties and other parts of the Kleinwort Benson Group. As such their financial standing is linked to that of the Kleinwort Benson Group. Depositors should form their own view of the financial standing of the Bank and the Group based upon publicly available information. Kleinwort Benson is a participant in the Guernsey Banking Deposit Compensation Scheme. The Scheme offers protection for ‘qualifying deposits’ up to £50,000.00 subject to certain limitations. The maximum total amount of compensation is capped at £100,000,000.00 in any 5 year period. Full details are available on the Scheme’s website www.dcs.gg or on request. Kleinwort Benson is authorised and regulated by the Financial Conduct Authority in respect of UK regulated mortgage activities and its firm reference number is 310344. Registered Office Dorey Court Admiral Park St Peter Port Guernsey GY1 2HT. Telephone number +44 (0)1481 727111.

Kleinwort Benson is the registered trading name of Kleinwort Benson Bank (Isle of Man) Limited company number 07856C. Registered Office St George’s Court Upper Church Street Douglas Isle of Man IM1 1EE. It is licensed by the Isle of Man Financial Supervision Commission and is a participant in the Isle of Man Depositors’ Compensation Scheme as set out in the Depositors’ Compensation Regulations 2010. Kleinwort Benson places all client deposits with a spread of approved counterparties and other parts of the Kleinwort Benson Group. As such their financial standing is linked to that of the Kleinwort Benson Group. Depositors should form their own view of the financial standing of the Bank and the Group based upon publicly available information. Latest Report and Accounts are available at www.kleinwortbenson.com. Kleinwort Benson Bank (Isle of Man) Limited is a subsidiary of Kleinwort Benson Channel Islands Holdings Limited, incorporated in Guernsey, the ultimate parent of which is RHJ International SA which is listed on the Brussels Stock Exchange.

Kleinwort Benson is the brand name of Kleinwort Benson Fund Services (SA) (Pty) Limited which is a company incorporated in South Africa with a company registration number 2006/028378/07. It is regulated by the South African Financial Services Board as a licensed Financial Service Provider. It is a wholly owned subsidiary of Kleinwort Benson (Channel Islands) Fund Services Limited which is registered in Guernsey and regulated by the Guernsey Financial Services Commission for the conduct of investment business and the provision of fiduciary services. Both are subsidiaries of Kleinwort Benson Channel Islands Holdings Limited the ultimate parent of which is RHJ International SA which is listed on the Brussels stock exchange. Directors: Mark Bright*, Jacobus Cronje, Adam Moorshead*, *BRITISH.

Telephone calls may be recorded.


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For details of our services and general information about Kleinwort Benson please visit www.kleinwortbenson.com

UK+44 (0)20 3207 [email protected]

Isle of Man+44 (0)1624 643200 [email protected]

Jersey+44 (0)1534 613 [email protected]

South Africa +27 (0)21 529 4860 [email protected]

Guernsey+44 (0)1481 727 [email protected]

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