Finance: Outlook - A good mix will lead to better returns

John Hildebrand, head of charities at Investec

Equity investments in a balanced portfolio will serve funds well, says John Hildebrand.

2004 was an unusual year for market analysts - they almost got it right. For charities, a balanced approach with a stress on equities has turned out once again to be the best approach, and prospects for the coming year look similar.

In 2004, a 13 per cent return from UK equities was just above consensus forecasts. Markets benefited from economic growth of more than 3 per cent. This led to earnings growth of around 12 per cent and dividend growth of approximately 10 per cent.

Calculated risk

The best returns were generated in emerging markets with Mexico up almost 50 per cent and Ukraine 300 per cent. Both areas benefited from investors' increasing willingness to take on risk. Chinese equities produced the most disappointing returns as worries grew about the authorities acting to slow economic growth.

The prospects for equities in 2005 are broadly similar to 2004, although economic growth is likely to be lower and so the outlook for returns is also slightly worse.

Many forecasted that interest rates would rise in the second half of 2004 and equities would consequently fall. While interest rates did rise (by 1 per cent in the US to 2.25 per cent, and in the UK by 1 per cent to 4.75 per cent) equities performed well in the second half of 2004. Interest rates in the US are expected to rise by a similar amount in 2005 but are close to their peak in the UK.

Durable bonds

Against a background of rising rates, bonds were surprisingly resilient. UK gilts produced a return of 6 per cent in 2004. Ten-year gilts start 2005 with a yield of 4.6 per cent so again look fully priced going into 2005.

Commodities produced the biggest surprises in 2004, with oil soaring by around 30 per cent. Perhaps more surprisingly, inflation remained subdued as consumers were reluctant to pay higher prices. If commodity prices don't moderate in 2005 and inflation stays low, company margins will be squeezed.

The least surprising asset class was hedge funds. The HFRI index produced a dollar return of 7 per cent. With money still pouring into them, the returns from the average hedge fund in 2005 are again likely to be muted.

Putting all the numbers together should mean that the average charity, as highlighted by the WM Charities index, will net a return of about 11 per cent in 2004. Prospects for markets in 2005 look similar to those for 2004. As always, the risks for equities are high, but they look well priced compared with other assets. With the recent market stress on dividends and with the environment and global poverty rising up the political agenda, the outlook for charities in 2005 should be reasonably bright.


- Charity funds with a balanced approach and a reliance on equities fared best in 2004

- The forecast for 2005 is similar although returns will be slightly smaller

- Bonds were resilient in 2004, but hedge fund returns will continue to be muted in 2005.

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