The financial crisis began just over five years ago. In August 2007, BNP Paribas froze three funds, indicating it had no way of valuing the complex assets in the portfolios. BNP was the first major bank to acknowledge the risk of sub-prime mortgages but it would not be the last. In the UK, the collapse of Northern Rock heralded the start of the financial crisis.
Globally, events unfolded rapidly. In early 2008, analysts announced the largest single-year drop in US home sales in a quarter of a century. By the third quarter of 2008, the US government was forced to bail out mortgage behemoths Fannie Mae and Freddie Mac.
Heavy exposure to sub-prime mortgages also sunk Lehman Brothers. This was the move that really triggered worldwide financial panic. In October 2008, US Treasury Secretary Hank Paulson pushed through the Troubled Asset Relief Program, an initiative that involved buying or insuring toxic sub-prime mortgage securities owned by major banks.
Since then, much of the focus has been on quantitative easing. In theory, this provides lenders with extra liquidity to lend, thereby boosting the economy. Whether this has happened in practice is a bone of contention, so it is worth taking a look at how various asset classes have fared since the QE button was first pressed.
With interest rates pinned at ultra-low levels, keeping your money in cash would have returned 12.3 per cent over the last five years. One of the main criticisms of QE is that it has unintended inflationary consequences. UK inflation has risen by 17.3 per cent in five years, making the return on cash negative in real terms.
Meanwhile, gilts have delivered a return of more than 50 per cent, boosted both by QE and by a raft of regulations encouraging insurance companies and pension funds to buy low-risk assets.
UK equities have lagged. The FTSE All-Share returned around 7 per cent on a total return basis. That said, returns have varied greatly across the different sectors. Technology has risen 83 per cent while financials have fallen by 41 per cent. So where can investors now look for returns?
Equity markets are currently subdued. Trading volumes in the UK and US are close to their lowest levels since 1999. However, those investors that remain appear to be desperate for another shot of QE. As a result, any bad news is being taken as good news as it increases the chances of more QE. This results in newsflow of almost any type boosting markets.
Going forward, QE is likely to remain the weapon of choice for those setting monetary policy although variations in the way it is used are likely.
Countries are attempting to create an inflationary environment, which is easier to control than a deflationary one (see Japan) and enables western consumers and governments to erode their debt although this is clearly going to take a long time.
But there are encouraging prospects for investors. Over past five years, corporate balance sheets have improved significantly. When confidence improves, companies will use their cash for mergers and acquisitions. However, against the ongoing low-growth environment, it is necessary to seek those companies that can boost profits despite the tough macroeconomic outlook. Such companies tend to have niche products, strong pricing power and are in industries that have high barriers to entry.
Andrew Perham is investment director of multi-manager investment solutions at SWIP