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Investor appetite for risk improves

Investment in post-crisis Ireland is all about a sensible balance of risk and return

Growth may not be what it could be, but there are positive signs, says Davy director Pat Cooney
Growth may not be what it could be, but there are positive signs, says Davy director Pat Cooney

If the appetite for risk among Irish investors is beginning to revive slightly, it’s mainly because they have little choice if they want to protect their savings. With interest rates at historic lows, they’re looking for safe and sensible options – with a whole new emphasis on balancing risk and return.

The fact is that Ireland has had artificially high deposit rates – 1-1½ percent higher than they should have been – in recent years, as banks aimed to repair their balance sheets by attracting and holding savers. Now though, another “new normal” has kicked in.

“It was obvious that rates would have to return to the norm eventually, and that’s what we’ve seen happening, perhaps a little bit later in Ireland than in other European countries,” says Pat Cooney, head of portfolio management and a director at Davy.

“We anticipate interest rates staying low across the EU for at least the next year or two to try to counteract weak growth in key economies, particularly France and Germany – and that’s the challenging economic environment that investors are going to have to work with.”

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‘New normal’

This “new normal” of low interest rates has been the catalyst, says Cooney, for investors to start examining their options and shaking off the paralysis that set in immediately after the financial crisis and the banking collapse.

“We were facing into the abyss. There was a lot of anxiety. People were very nervous about doing anything bar saving. That has now passed. Growth may not be what it could be, but there are positive signs – and while investors remain in defensive mode, risk appetite is improving.”

Before the crisis, investing in Ireland was focused almost exclusively on return. But we’ve learned the hard way and now there’s a new and healthy acknowledgment of risk. So, not before time, investment in Ireland post-crisis is all about a sensible balance of risk and return.

Away from deposits, much of the activity has been in equities, says Tim O’Rahilly, partner in private wealth management at PwC, with the emphasis on exchange-traded funds – funds that track, for example, the top 30 companies in a particular sector or in a particular market, such as the FTSE.

Government debt

“At the point in the cycle that we’re at, this type of investment is doing well and has been since 2008/2009. The markets last year were up 10 per cent-plus. The fact that deposits and Government debt are performing so badly has also driven money into equities and fuelled that growth.”

A good example is the S&P 500 which broke through the landmark 2,000 level at the end of August, six months or so earlier than analysts had anticipated, marking a six-year-long rally and making it one of the top investments of 2014.

While a properly balanced investment portfolio depends very much on an investor’s age and appetite for risk, says O’Rahilly, a typical example in the current low-interest environment might comprise 40 or 50 per cent equities, some cash, some real estate, and perhaps alternatives such as private equity making up the final 10 or 15 per cent.

Irish investors famously got their fingers burned with property. The extent to which the market was overblown is illustrated by the fact that at the end of August, Irish house prices stood at 42.3 per cent below their 2007 peak, with the Dublin residential market 43 percent below its peak.

In terms of property investment, real estate investment trusts (Reits) – property investment companies listed on the stock market – are regarded as a good alternative to purchasing entire properties, raising more than €865 million since they were introduced last year.

Tim O’Rahilly sees them as positive. “Rather than investors owning one of two units, this is a way of getting diversification across a broad range of property assets. Also, the fact that these companies are listed on the stock exchange means they’re controlled in a way the broader real estate market is not.”

Exposure

Interestingly, AIB has extracted property altogether from the vast majority of its investment offerings.

“We find that most of our investors have property exposure already, and so, in terms of diversification, we’re not keen that they double up on that,” says the bank’s chief investment officer, Philip Kearney

On Reits in general, he says: “They’re getting properties at a decent yield, but perhaps not the yield that first attracted people to property. Instead of 6 or 7 per cent, they might be getting 3 or 4 per cent. That’s not bad when Irish bond yields are under 2 per cent – but we shouldn’t automatically assume it’s an easy investment.”

Kearney agrees with O’Rahilly that equities should make up about 40 per cent of a typical portfolio, which might contain, for example, global equities, emerging markets equities, commodities, absolute-return funds, cash, short-dated and long-dated sovereign bonds, and corporate bonds.

“It’s about getting the mix of those asset classes right to match the risk the investor is willing to take on,” says Kearney.

Emphasis

With risk always in mind, an emerging trend, says Pat Cooney of Davy, is a new emphasis on financial planning, taking into account succession, taxation and insurance, for instance. “In the same way as you would have a financial plan for a business, it’s about having a financial plan for your personal or family affairs. Some of that may lead on to investment – but mainly it’s about sound financial planning.”

Interest rates: a crucial question

How long is the current low-interest-rate environment going to last? That’s a crucial question for Irish investors . . .

The answer from Ian Quigley of Investec Wealth and Investment is unequivocal: “We need to see negative real – after inflation – interest rates for possibly a couple of decades because we have so much debt in the developed world.

“The fact is that in order for countries to rebalance financially, essentially the cost of debt has to be negative. So we’re seeing a transfer of wealth from savers to borrowers – or more specifically, a transfer of wealth from individuals to governments.”

For that reason, and because people tend to invest in line with the most recent economic cycle – in Ireland’s case the financial crisis – Quigley says it’s time for investors to move away from having relatively large cash weightings in their portfolios and start to invest “more sensibly”.

By more sensibly, he means “in a way that’s more analogous to how money is managed in other countries, such as in the UK and the US, for instance, where there’s a focus on multi-asset investing, on generating wealth and on building long-term investment portfolios.

“That didn’t really exist here in Ireland before the financial crisis because people didn’t really think like that. Now that mindset is changing.”

Even so, Quigley counsels caution, warning that when interest rates are low and investors starved of income, this can cause – and is already causing – mispricing of some assets.

He points to the recent decision by the Financial Conduct Authority in the UK to ban Britain’s banks from offering highly complex CoCo (contingent convertible) bonds to the retail market.

In terms of building a diversified portfolio, he has one key message: “Ninety per cent of returns can be explained by asset allocation and only 10 per cent by stock or fund selection.

“The problem is that for most investors it’s all about the 10 per cent. They agonise over this share as against that share rather than over the structure of the portfolio. That is the wrong way around.”