As we move from the year of the Snake into the year of the Horse, a few key movements in 2013 are worth a conscious review.
In 2013, long term inflation expectations increased, with the 30 year zero-coupon RPI swap ending the year around 0.5% higher than it started at 3.74%. This compares to the lows of around 3.2% in 2012 and recent highs over 4% seen in 2008. Real yields generally fell back into negative territory over the course of the year.
Overall, interest rates in most major markets ended the year higher than they started. In the UK, long dated interest rates (measured by the 30-year zero coupon swap rate) ended the year close to their highs at 3.4%, up 0.5% from the start of the year. The yield on the 2042 gilt ended the year at 3.61%, rising by slightly more than the corresponding swap rate and highlighting the increasing attractiveness of gilts compared to swaps for long-dated liability hedging.
Benchmark 10-year interest rates in major developed markets all followed a similar path over the year, reacting to investor expectations on the tapering in the US. The US 10 year yield rose from 1.6% to 3%, the UK gilt from 1.8% to 3%, and the German bund from 1.4% to 1.9%.
Economic fundamentals in most developed economies improved, especially in the UK and the US. The UK’s improvements resulted in economists’ upward revision of 2013 GDP estimates, enabling an upbeat Autumn Statement. Sterling strengthened against both the dollar and the Euro in the second half of the year, the pound closing the year on its high against the dollar of $1.66, having started the year at a similar level and fallen at times to lows of $1.48.
Most developed equity markets experienced returns well above long term averages, with the highest annual return since the 2009 bounce from the market lows. Significant differentiation among markets continued. The MSCI World was up 24%, compared to 14% in 2012, with the Nikkei and S&P500 leading the way with a 50% and 30% return respectively, which took the S&P into new highs, some 30% above the 2007 peaks. The FTSE 100 index experienced a gain of 14% in price index terms, compared to a gain of 7% in 2012, a -2% return in 2011 and a +11% return in 2010. In Europe, the DAX and Eurostoxx both experienced higher returns than the FTSE in 2013, with the DAX up 25% and the Eurostoxx up 18%.
Emerging Markets performed badly, reacting to tapering, with the MSCI Emerging index falling 5% over the year. The volatility experienced by most equity indices during 2013 was low by historical standards, with the market pricing of option hedging against market falls reflecting this.
The three main classes of credit all performed strongly for the second year in succession. For example, UK Investment Grade credit returned 5% in excess of swaps over the year compared to returns of 7% in 2012.
Commodity indices generally fell during 2013, with the DJ-UBS index ending the year around 10% lower than it started, having been flat in 2012. The main driver of this was Gold.
There is a continuing, growing appetite for risk- based and risk-controlled approaches to investing such as Volatility Controlled Equity and Risk Parity, particularly when they are combined with portfolio downside protection. Given the large divergence in returns this year between equity, commodities and fixed income (with equities substantially positive and both commodity and fixed income negative) multi-asset portfolios with an overweight to equities have outperformed those with an equal balance of risk among asset classes.
Please note that all opinions expressed in this blog are the author’s own and do not constitute financial legal or investment advice. Click here for full disclaimer.