Investors must dampen short-term fuse to achieve long-term gains

Institutional investors, like all investors, are opportunistic by nature - their job is to look for value and return. In the case of pension funds, long-term capital gain on a 20- to 30-year horizon is what drives strategy, but annual performance still matters a lot. As fund managers wryly point out, if it's not right in the short term, there is no long term.

It's been an extraordinary year on global markets by any standards and significant developments on the Irish scene can be traced back to the introduction of the euro last January.

Domestic fund managers across the board are continuing to diversify away from the Irish equity market and, according to the latest report from Merrion Stockbrokers, their portfolio exposure to Irish stocks and shares has fallen from 32 per cent at the introduction of the new European currency to 23 per cent. They now own 21 per cent of the Iseq, down from 38 per cent 18 months ago.

As well as the establishment of a new economic order in Europe, the other major factor influencing investment decisions worldwide has been the tug-of-war between proponents of old economy and new economy stocks.

The Irish market was insulated from the wildest swings of the Telecoms Media Technology (TMT) mania, simply because this sector grouping has a low representation in the Iseq. The domestic market is concentrated in a few sectors, particularly finance and building materials, and not represented at all in others.

Institutional investors agree that the Irish market is offering decent medium- to long-term growth in well-established companies, but they have to think globally and will continue to diversify elsewhere. Pension funds may have a mix of up to 100 stocks from around the world and there is no reason for Irish equities to dominate the portfolio.

Private share ownership levels in the State have shown remarkable growth in recent years. The Goodbody Share Ownership Report 2000 shows that the rate has quadrupled from 4 per cent of adults in 1997 to more than 17 per cent at the end of last year. The market continues to be dominated by the small investor, with two-thirds holding portfolios valued at £5,000 or less.

Among the big investors, not everyone is moving away from the Irish market at the same rate. Mr Roy Asher, investment manager with Norwich Union, explains why his company still holds 27 per cent of its managed fund in Irish equities, somewhat more than the average of 23 per cent.

"We are slightly underweight internationally because we hold the fundamental view that there's long-term value locked up in the main Irish equities," Mr Asher said.

Norwich Union has 10 per cent of its pension fund in Eurobloc equities but they are not directing new money to the telecoms-dominated bloc at the moment because they feel the rally in the sector is mature.

Interestingly, Norwich Union is currently taking a positive view of property. "Given the market conditions, there's a guaranteed 10 to 15 per cent return on the year in property and we can always unwind that allocation if necessary," Mr Asher said. In the last year, the company raised its exposure to property from 9 to 14 per cent.

In March, Norwich Union invested cashflow into the UK market on valuation grounds. They are relatively overweight in North America at 16 per cent, on the Standard & Poors 500 index, and that has brought positive results enhanced by the strong dollar.

The US is experiencing the longest economic expansion since the war and Mr Asher is cautious that it cannot be sustained indefinitely. His protection against the Goldilocks economy going wrong later this year is a high property weighting.

At Ulster Bank Investment Managers (UBIM), chief executive Mr Gavin Caldwell does not see danger in the success of the US economy.

Overall, he is not concerned about the threat of inflation or recession and expects equities to continue to be the right asset for pension funds. UBIM asset allocation is in line with the market for Irish equities at 23.5 per cent but elsewhere they hold less in the Eurobloc - 13 per cent - and more in the rest of the world.

Property stands at 5.4 per cent and the equity breakdown shows 9 per cent in the UK, 14.5 per cent in the US and 7.6 per cent in Japan.

Friends First also favours Japan, with 5 per cent of its portfolio in that market, an increase on last year. In line with other institutions, its Irish equity holdings are shrinking and fund managers are diversifying into the Eurobloc, which is up to 20 per cent from 13 per cent at the beginning of 1999.

Mr Pramit Ghose, investment director with Friends First said the company's Eurobloc holdings could increase to 25 per cent by the end of the year. The US and the UK markets account for 12 and 11 per cent of holdings respectively, and Mr Ghose expects the US weighting will increase in the near future.

On the domestic market, Mr Ghose is a fan of construction stocks, big and small, and mid economy stocks such as Independent Newspapers and DCC. He is not over-enthusiastic on the Irish financial stocks. "The financials look cheap and we think that will continue to be the case. They could perform well but they are not our favourite area," Mr Ghose said.

The consensus seems to be that Irish stocks fundamentally look cheap in terms of earnings growth and average multiples, but technically they look weak because domestic investors are sellers. To put the size of the Irish market into context, it now accounts for about 1.3 per cent of the euro zone's total market capitalisation and it is inevitable that rebalancing will continue.

In many ways, the rise and rise of new economy stocks in the last couple of years had distorted expectations of reasonable investment returns. It wasn't until March 2000 that sentiment appeared to shift back towards old economy companies with less demanding valuations. According to Mr Chris Reilly, chief investment officer with Bank of Ireland Asset Management (BIAM), the two-tier market is well established now since most money has flowed into one sector for some time.

"We did see a fairly savage bear market in many old economy stocks but it hasn't been a one-way street and a considerable number of TMT stocks have halved from their peaks," Mr Reilly said.

He believes there is good value in middle ground companies with good cashflow and very little debt. "They've fallen in price over the last couple of years and after all, they are not going to disappear," he said.

Mr Caldwell of UBIM divides TMT stocks into two categories - "old new and new new". The older stocks are the well-established companies from the beginning of the technology boom, like Cisco and Intel. These companies have market multiples well in excess of traditional stocks.

According to his definition, the new economy is Internet-driven and it is here that wild valuations and extreme fluctuations are seen. What is underpinning this category is the huge valuations being put on future earning prospects in a changing technology revolution.

Friends First's Mr Ghose sees volatility and the recent reversal of fortune for some of the technology-related stocks as a good opportunity to buy wisely.

"We believe the leading tech companies that are making money from the technology boom present good buys into the future. Share price falls make stocks such as Nokia, Ericsson and Phillips attractive because they are still likely to outperform other equities," he said.

The average pensions managed fund increased by 6 per cent in the opening quarter of 2000, according to the latest figures published by Mercer Benefit & Remuneration Consultants.

In stark contrast to 1999, the Irish equity market led the way in the opening quarter, up 13.1 per cent, with North American equities returning 8.4 per cent for the Irish investor. The strong performance of the Iseq was mainly on the back of the success of Elan and Ryanair.

Mercer has recommended that more attention be given to longer-term returns for the simple reason that monies invested today may not be required to pay pensions for 20 to 30 years.

Nevertheless, the year-on-year strategy of Irish fund managers has a clear impact on the perception of the stock exchange in the short term, and where institutional investors lead, others are sure to follow.