KEY POINTS:
The year 2007 is almost over and none too soon for the many retail investors who lost money in the finance company sector locally and the collateralised debt obligation (CDO) meltdown overseas.
Some 13 finance companies have gone out of business in the past 18 months and it remains to be seen how many cents in the dollar debenture holders will eventually recover.
In contrast, while many people knew that finance companies were risky, the problems in the CDO market surprised local investors and, for some, the first time they knew they owned a CDO was when the price of their managed fund tanked.
In fact it is a little ironic that those investors in ostensibly safe, locally managed fixed-interest funds, who prudently steered clear of the finance companies but tried to earn a couple of per cent more than bank rates by investing in structured credit products, have had losses of up to 40 per cent.
Finance companies have made the headlines but so far some $270 million of Kiwi savings, invested in managed fixed-interest funds that were promoted as low-risk, have been lost as a result of the repricing of the CDO market and the commentators are suggesting that there's more woe to come.
Elsewhere, retail investors in managed funds, while not losing their capital, have found that the investment markets in 2007 frequently offered the risk without the return.
Mum and Dad who invested in a typical balanced portfolio, as per the average New Zealand pension fund or balanced unit trust, and whose fund manager was able to do as well as the relevant benchmarks, would have received a total return of around 2 per cent in 2007, below inflation. Unfortunately that 2 per cent is also before fees and tax.
Nevertheless this disappointing result follows an excellent 13.8 per cent return in calendar 2006. Long term, over 10 years the average pension fund in New Zealand has returned an estimated 7.5 per cent before fees and tax.
Knock off 1-2 per cent in annual fees and another 1.5 per cent in tax and investors certainly are getting rich slowly.
In 2007, just about every asset class underperformed its long-term average returns.
In fact, the conventional risk-return orthodoxy, whereby risky assets produce higher returns than safe ones, was turned on its head in 2007. Far and away, the best performing asset class was, perversely, the least risky: cash, which returned about 7.9 per cent for the year. Unless, of course, your cash fund invested some of its money in CDOs.
Over 10 years, high-yielding bank deposits have returned 6.6 per cent a year so 2007 was better than normal.
That's where the good news finishes, however.
Next up in terms of riskiness are government bonds and the index of their performance underperformed cash. At 3.3 per cent for the year, they managed just half their 10-year average return of 6.4 per cent a year.
The market price of most government bonds, which are more volatile than cash because they are invested for a longer term and thus should be expected to outperform cash deposits, actually fell in value as interest rates rose.
Further out along the risk/return curve local equities managed only 0.9 per cent for the year. A poor effort considering the 10-year average is 10.2 per cent a year and dividends, cash payments as a percentage of the share price, average about 6 per cent a year.
Not much compensation there for the higher risk of holding shares.
Investors fared no better in international stocks with the benchmark MSCI index down by - 0.1 per cent in New Zealand dollar terms thanks in large part to a stronger kiwi dollar, which appreciated by 17 per cent against the United States currency.
In terms of currency-adjusted world stockmarket returns the US dollar is particularly important because the US stockmarket represents about half the world stockmarket and many other countries' currencies are pegged to the greenback.
In US dollar terms, the world stockmarket actually rose by 10.3 per cent in 2007. The Japanese market again disappointed investors with a 9.1 per cent fall. Japanese stocks have returned an average of just 2.3 per cent a year in the past 10 years.
But while New Zealand and the broad international sharemarket index didn't fare well in 2007, there were excellent returns available if you were fortunate enough to be invested in the right sectors and countries.
Foremost among the strong performers was our next door neighbour. Australian equities had another record year returning 22 per cent, largely on the back of demand for resources, the country's proximity to Asia and the fact that the banking sector in Australia has managed to avoid much of the subprime mortgage/CDO problems.
Emerging markets too have been running hot for five years now, returning 26 per cent in 2007, and an average of 27.1 per cent a year for the past five years.
One of the largest UK-listed emerging markets funds, run by Templeton and listed locally too, returned 48 per cent in the year.
Of the more exotic areas, hedge funds had a subdued year with gains of just 3 per cent, although gold bullion had one of its best years up 24 per cent in US dollar terms and 14.2 per cent in New Zealand dollars.
