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PSSap Fund Performance for September 2008

Welcome to the monthly update on your Fund's investment performance.

ARIA’s primary responsibility is the management and investment of the PSSap Funds in the equitable and best interests of all members. ARIA approaches this task by setting an investment objective to maximise the real returns earned on investments subject to a tolerable level of short-term volatility.

Table 1:  PSSap Option Earning Rates for periods ending September 2008  

* All Earning Rates are after fees and tax

Table 2: Historical Fund Earning Rates (%)

* All Earning Rates are after fees and tax

Commentary:

The credit crisis reached new depths in September, with the global financial system struggling to remain viable in the face of financial institutions refusing to deal with each other due to heightened fears of corporate collapses. This culminated in a dramatic shakeout of global financial firms, massive government intervention and extreme levels of financial market volatility.

In September, the major global investment bank Lehman Brothers filed for bankruptcy and the huge insurance company AIG was saved from the same fate by a $US85 billion loan from the US Central Bank. Two US government sponsored mortgage enterprises, Freddie Mac and Fannie Mae were nationalised to prevent bankruptcy, as were the Benelux financial services company Fortis and the UK mortgage provider, Bradford and Bingley. Meanwhile, two other major global investment banks, Goldman Sachs and Morgan Stanley transformed themselves into banks to stave off future bankruptcy. 

Amidst this backdrop, financial market volatility reached extreme levels. The Australian equity market saw only four trading days out of 22 in which its movement was less than 1%. In an attempt to limit market volatility, regulators in the US and UK placed a near-term ban on the short selling of financial stocks, while authorities in Australia placed a one month ban on the short selling of all stocks. Additional government intervention came in the form of a US bailout package of $US700 billion, which aims to buy poor quality assets from banks, thus freeing up their balance sheets, a $US50 billion loan package to US car makers and a number of measures by the major Central Banks to inject liquidity into global money markets.  

Global economic activity continued to weaken in September. In the US, housing starts fell further, house prices are now 16.4% below the levels of a year ago and employment levels contracted further. European economic growth fell by 0.5% in the June quarter, with manufacturing activity particularly weak. The UK economy has also stagnated, as evidenced by declines in industrial production, employment levels and the willingness and ability of consumers to borrow. In Australia, while employment levels remain robust for the moment, more forward looking economic indicators suggest that a sharp slowdown in activity is likely in 2009. These include weakness in the housing sector, private consumption and business confidence.

Amidst this gloomy backdrop, equity markets experienced very large declines and excessive volatility in September. Global equities fell by 10.8% in hedged terms, with all major markets suffering large declines. The US fell by 9%, Japan by 14%, the UK by 13%, France by 10%, Germany by 9%, Hong Kong by 15% and China by 4%. Another large decline in the value of the Australian Dollar meant that the return from global equities in unhedged terms declined by only 3.6%.

The Australian equity market shared in the global pain, recording a decline of 10%. The falls were concentrated in Resource shares which dropped by 20%. Industrial stocks fared well in a relative sense, declining by just under 5%. Small stocks again underperformed their large counterparts, maintaining the trend evident over the last year. In terms of sectors, Materials was the worst affected, dropping by 22%. Declines of 13% were experienced by Utilities and Energy, while the best performing sectors were Financials (down 2.5%), Consumer Staples (down 3.4%) and Telecoms (down 4.7%).

In September, further economic weakness and another large fall in commodity prices resulted in a reduction in official short-term interest rates in Australia (by 0.25%), New Zealand (by 0.50%) and China (by 0.27%). In other markets, although official short-term interest rates were not lowered, expectations increased that they would be reduced in coming months. In this environment the largest bond market gains were achieved in those markets where official short–term interest rates were cut. Reflecting this, 10 year government bond yields fell by 0.35% to 5.4% in Australia and by 0.4% to 5.65% in New Zealand. Consequently, Australian bonds rose by 1.3% in September, again outpacing the gains from global bonds, which advanced by 0.65%. These rises compared with a return of 0.6% from cash.  An escalation of the credit crisis meant that short-term market interest rates increased despite the reduction in official rates in some countries. Furthermore, credit spreads on longer dated securities continued to widen as counterparty risk increased.

Commodity prices again experienced significant declines in September, continuing the pattern evident in July and August. The largest losses were recorded by nickel (down 22%), copper (down 14.5%), oil (down 13%) and aluminium (down 11%). Gold prices went against this trend, rising by 5%. The latest decline in the price of oil means that it has fallen by around 30% from its mid-July peak.

The Australian Dollar again fell sharply in September as investors fled high yielding, commodity currencies and moved back into the Yen and US Dollar. The move into the Yen reflected an unwinding of carry trade positions, which are notable for capital flows into high yielding currencies such as the Australian Dollar and out of low yielding currencies such as the Yen. US Dollar strength may at least be partly explained by a shortage of US Dollars experienced by those investors who need to roll-over US Dollar denominated debt. In September, the Australian Dollar fell by 10% against the Yen, almost 8% against the US Dollar, 6% against the Pound and 4% against the Euro.

Alison Tarditi
Chief Investment Officer
21 October 2008