Surprise! Another referendum.

By Eoin Fahy, Tuesday, 28th February 2012 | 0 comments

Against most expectations, the Government has announced this afternoon that a referendum will be held on the "fiscal compact" deal. At a time when many things seemed to be going well for Ireland, this throws the cat among the pigeons and raises serious risks about Ireland's ability to continue to receive bailout funds after next year. This uncertainty is likely to continue at least for a couple of months, and there is of course absolutely no guarantee that the electorate will vote Yes.


The government surprised the country, and the financial markets, by announcing this afternoon that a referendum will, after all, be held to approve (or not) the Fiscal Compact. This was not at all expected as the treaty text had been drawn up with the explicit intention of avoiding the need for a referendum, and as the government presumably wanted the referendum about as much as a turkey looks forward to Christmas! The euro weakened after the announcement, and Irish bond yields rose, though in both cases the moves were not especially large.

The timetable is not fully clear, but this will not be a quick process. As a first step, the government will have to publish the legislation to provide for the holding of the referendum. Presumably that will take a week or two, at the least. Then that bill will have to be approved by the Dail and Seanad and signed by the President. While that process can often take several weeks, it can be done quite quickly, say within a week or two, if it is seen as a very urgent priority.

After the legislation is passed, the date for the referendum will be set, which is usually at least a month after that. So if we assume that the Bill passes sometime in late March, a guesstimate for the date of the referendum would be sometime in May.

The political merits or otherwise of the Fiscal Compact are not a matter for this blog, but from an economic/investment point of view it is worth taking a look at the consequences of a No vote. The key "black and white" issue is that Ireland will not be able to borrow from the ESM (the EU bailout fund that takes over from the current bailout mechanism, the EFSF, next year) if it does not sign up to the Compact. So the current bailout funds are not at (direct) risk from a No vote, but if Ireland cannot return to the markets within the next year or so, and fund itself, it will be in very severe difficulties as it will not be able to get a second bailout.

Of course there are "greyer" consequences as well. While Ireland can continue to draw down funds from the current bailout, it will certainly lose goodwill from other EU countries [except the UK of course, which has opted out of the compact], and could hardly be expected, for example, to get concessions re the €30bn+ promissory note on which there is so much focus by government at the moment. A No vote might also make some inward investment companies, and bond investors, think twice about the wisdom of investing in a country that (again!) votes against an EU treaty, if they think that that might mean that Ireland will leave either the eurozone or the EU.

On the other hand, of course, the irony is that the Compact is supposed to give taxpayers in richer countries such as Germany some comfort that their money will not be used to support countries which cannot, or will not, get their fiscal affairs in order. But most economists agree that even if it had been in place during the boom years in Ireland, it is unlikely to have made much, if any, difference, and Ireland would not have broken any Compact rules until after the bubble burst, by which time of course the damage had already been done. Many economists also argue that the fiscal rules in the Compact are not well designed and would be quite difficult to enforce in practice.

No doubt we will all be discussing these and related issues in much greater detail in the weeks ahead, but for now, perhaps the biggest impact will be in the uncertainty that will not be resolved for, perhaps, two to three months while we await the vote.

 

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Recent blog posts

Upbeat outlook maintained

Apr-3-2013
By KleinWB  | 0 comments

The first quarter of the year turned out to be very strong for equity markets in particular. The strong returns were driven by a combination of a better macro outlook for 2013 and investors’ increased appetite for risk assets.


The MSCI World equity index gained almost 11% in euro terms (10% in local currency), though bond market returns were low, as the over 5-year eurozone bond index returned a barely positive 0.4%. There was a large return divergence across equity markets with Japan and North America leading the way with gains of almost 22% and 13% (in local currency) respectively. At the other end of the spectrum, local currency returns from Emerging Markets and the eurozone were weaker at minus 0.4% and plus 2%. In other asset classes, commodities had a poor quarter, with most indices showing small losses (though energy prices were generally up). It was a positive quarter for other familiar alternative asset classes such as Hedge Funds and Currencies.


Global equity markets bottomed approximately four years ago during March 2009 and since then - despite the persistent macro worries and crisis headlines - have posted strong returns. The bellweather S&P500 index bottomed in March 2009 and has since returned over 130%, recently hitting new all-time highs. It’s important to note, of course, that the rise hasn’t been in a straight line and there have been about a dozen falls of 5% or more along the way, including two that saw falls of more than 10%. In all cases it turned out to be the case that they in fact represented buying opportunities. Throughout that period there have been persistent predictions and highlighting of “doom and gloom”. The old adage that “The stock market always climbs the wall of worry” has yet again been validated...... so far.

Outlook

I have maintained for some time a positive outlook for both overall global economic growth and (in particular) for equity markets. This has been despite the context of a more fragile and volatile world as we recover from the excesses of the last economic cycle and the associated “brakes” applied by deleveraging and austerity. Against these headwinds, the tailwind combination of continued extraordinary easing measures from central banks and the very strong focus by companies on delivering solid and consistent earnings and dividend growth has been a winning combination! This trade-off between “growth vs. risk” has been THE driver of markets over recent years and I expect that to remain the case for the coming quarters also. I maintain an upbeat outlook and expect further gains from risk assets such as equities over the next 12 months – although on a short term outlook it seems reasonable to expect that markets may consolidate recent strong gains or perhaps correct a little. Events such as further negative eurozone headlines or softer US economic data could provide catalysts for same.

The growth outlook for the US economy has improved since my last blog. After a stronger than expected first quarter of growth, data over coming months may well be softer as the effects of the various fiscal tightening measures finally agreed by Congress at the turn of the year take hold, but we and others expect the effects to be temporary and we will see a rebound in the second half of the year and a stronger 2014 also. Elsewhere Emerging Market economies remain solid (although not as strong as in the past) and Europe remains mired in negative growth for now and will be barely positive by year end in our view. An overall “OK” growth outlook for me means global central banks will remain central to events and will maintain strong liquidity support for financial markets. Restoring growth is now the primary goal of central banks generally and, as a result, they have a tolerance for higher inflation.

On the risk side, the eurozone for us remains at the top of the list. We have recently seen another “mini-crisis” in the eurozone, as events in Italy and Cyprus have – yet again – led to concerns about the future of the eurozone. But notwithstanding the extreme events in Cyprus in particular, involving losses to depositors, capital controls, and prolonged bank closures, it still seems unlikely, on balance, that this mini-crisis will deteriorate into a “full-on” crisis, with collapsing equity markets, soaring peripheral bond yields, large deposit outflows from peripheral countries, etc. Indeed, it has been very interesting to note just how subdued the market reaction has been to the events in Cyprus (to date at any rate). This tells us, probably, that markets really do believe what ECB President Draghi said last summer, that the ECB would “do whatever it takes” to save the euro.

There is still a long way to go in this economic cycle, and I continue to highlight that unemployment around the world remains very high, and that we are generally only in the early stages of the global capital expenditure cycle. Despite gradual signs of improvement, overall spending by both consumers and corporates remains low and allows plenty of potential for pickup. This alone is a reason that the cycle has much further to play out in my opinion.

Company profits

The strong gains in equity markets over recent quarters leave equity valuations in aggregate at a small discount to what we would consider fair value. Therefore, we don’t believe that equities are “cheap” anymore. However, I remain confident that company profits will continue to grow at high single-digit levels in 2013 and this combined with attractive dividend payments combine to an attractive total return for investors. Given that there is no major valuation cushion remaining, it is absolutely crucial that companies deliver the profit growth expected from them. For the next stage of the cycle, I expect any meaningful “misses” to be heavily punished by investors.

Government bonds continue to be “bubble-like” in terms of valuation. Yields are at historic lows and at valuation levels that go far beyond levels justified by the current or future expected fundamentals.....though where have we heard this before!

In summary, the first quarter has been a very positive one and 2013 is to date a case of “so far so very good”. For your portfolios we maintain a positive mindset towards risk assets but also continue to favour the familiar themes we have argued for some time. These remain a focus on quality, cash flow, management strength and a strong focus on dividend yield and growth. As the environment remains fragile, I continue to favour such themes and not advocate a lower quality approach towards underlying investments. A short term consolidation wouldn’t surprise me but equally we would see such a setback as a buying opportunity towards higher markets over the next 9-12 months.

Chalk it up as a win....

By KleinWB  | 0 comments

It has been a fairly bizarre 24 hours in Ireland, starting with leaks of an IBRC liquidation, then an all-night legislative sitting to pass emergency legislation, and ultimately ending with the ECB “unanimously taking note” of what seems to be a fairly credible and helpful deal on the promissory notes (details of the deal are below).  As the dust settles, Ireland is left with a significantly reduced cash outflow over the next ten years, and a reduced national debt in current value terms. So we can chalk it up as a win for Ireland, notwithstanding the odd circumstances.  Unambiguously Ireland is in a healthier position than it was before this deal. 

This short-lived but dramatic saga began late on Wednesday afternoon, with media reports that Anglo Irish Bank (or more correctly IBRC) would be liquidated as part of a bank rescue solution.

Later that evening the government, as rumoured, published legislation to liquidate the failed bank, but it gradually emerged that this move was not part of an agreed solution to the promissory note problem, but a quick response to the earlier rumours. In other words, once the media started to report that Anglo would be liquidated if a deal was reached with the ECB, it very quickly became a self fulfilling prophecy as then a liquidation became inevitable to protect the bank against attempts by creditors to seize assets ahead of others in the queue.

The emergency legislation and Anglo liquidation out of the way, all eyes then moved to Frankfurt to see whether a deal would be agreed or not. Then we had a further twist as instead of explicitly announcing a deal, ECB head Mario Draghi instead limited himself to saying that the ECB Council "unanimously noted" the arrangements. It was not until Taoiseach Enda Kenny spoke in the Dail, sometime later, that the deal was announced and the details released.

The deal is very much in line with what was expected, but a short summary of the main provisions is below:

  • The promissory notes will essentially be cancelled and replaced with a number of long-term bonds, which will not need to be paid back until 34 years from now, on average.  In the meantime, Ireland will of course need to pay interest on those bonds, but the amount of interest paid on the bonds will be far less, over the next eight years or so, than the €3.1bn per year repayment that would otherwise have had to be paid as part of the promissory note arrangements.
  • By agreement with the ECB, the Central Bank will take ownership of the special government bond issued to pay the 2012 installment of the promissory note.
  • The interest rate to be paid by NAMA/the Irish government on the bonds will  be about 3%.  This is higher than the very low rate that Anglo was paying to the Central Bank on the money it had borrowed, but in general terms is still very low for a 34-year loan.
  • As a result of all this, there will be a reduction of €20bn in the amount of money that the NTMA will need to borrow from the markets over the next decade.

The bottom line

There is no doubt that Ireland is better off as a result of the deal. Before the deal, the taxpayer was faced with an annual cash payment of €3.1bn for each of the next ten years. After the deal, the cash needed (to pay the interest on the new bonds) will be about €1bn. That is clearly good news and reduces Ireland’s funding needs over the next few years, when it is most stretched financially.   From 2023 onwards, however, the amounts that would have been paid back under the promissory notes were due to fall, to around €2bn in 2024 and to about €1bn in each of 2025 to 2030, before falling away after that. 

So if we think that the bill on the “new” bonds that replace the promissory note will be about €1bn, each year until 2038 and then falling slowly after that, we can see that the cash burden on the taxpayer is lower under the new arrangement each year until 2025, is about the same from 2025 to 2030, but is actually higher from 2030 onwards. Then in the period from about 2038 to 2053 the entire amount of the bonds will have to be repaid.

Importantly, it is in the next few years that Ireland badly needs the improved cash flow. To many policymakers, the years 2038 to 2045 can look after themselves! And on a more serious note, the value in today’s money of liabilities that don’t have to be repaid until 2053  is far lower than its current face value.

So the bottom line is clear. In today’s money terms, the cost of this debt has unambiguously fallen.

Could Ireland have got more?

Asking whether we are now better off than before the deal is not the only way of assessing today’s developments.  We perhaps also need to think about what other deal might have been done. 

Could the loans have been extended over an even longer period? Possibly, but 40 years is a very long period indeed, and it's hard to see it making much difference if it was extended to, say, 50 years.

Would the ECB have agreed to simply write off all of the debt? This was never a runner, realistically. Firstly it is almost certainly illegal under European law. Secondly, writing off debt is much more “visible” to taxpayers in other countries (most notably Germany), and thus much more controversial, than extending the duration of the debt. The impact is actually much the same in financial terms, but the political impact is very different.

Could the interest rate on the bonds have been set at a much lower rate? This might well have happened, and it would have been very helpful. The 3% rate on the bonds is significantly higher than the rate of around 1% that Anglo was paying on the money it had borrowed from the Central Bank, although it is much lower than the rate at which the government would be able to borrow money on the open markets, for such a very long period (if indeed it was possible to borrow the money in the first place).

One other consideration is that the debt is now directly owed by the Irish taxpayer, whereas before this deal it might, perhaps, be argued that the promissory note was owed to Anglo, and as Anglo was owned by the taxpayer, it wasn’t a “real” debt. That never seemed like a very credible argument, but it is certainly even harder to make that case now, given that the debt will be in the form of government guaranteed bonds.

Also, it should be noted that the EU has given a commitment to "break the link" between governments and their banks, which was interpreted to mean that European taxpayers might contribute to writing off some past debts run up by the Irish government to rescue its failed banks.  Today's deal is a very separate process to that, as it involves the European Central Bank, and not European governments.  The government should not necessarily give up on persuading other EU governments to take more measures by, for example, buying the stakes that the government owns in some Irish banks.

Conclusion

The strange twists and turns of yesterday and today will soon be forgotten, but the deal to reduce the burden of the promissory note is significant. It distinctly reduces Ireland's debt burden. We will never know, probably, whether a better deal could have been done if a different negotiating strategy was used, but we do know that Ireland is better off after this deal than it was before.

All that said, there is still a very large gap between government spending and government revenue, even after this deal (which is more about easing cash flow than reducing the accounting measure of the deficit), and austerity policies will need to remain in place – this deal is no panacea to Ireland’s fiscal woes.   But the deal is a significant step on the road to recovery, and should not be underestimated - for example the Taoiseach has already announced that the amount of austerity required in the next two budgets will be €1bn less as a direct result of this deal.

Announcement of Strategic Alliance with Virtus

By KleinWB  | 0 comments

Kleinwort Benson Investors (KBI) today announced a strategic alliance for the US market with Virtus Investment Partners, which operates a US-based multi-manager asset management business.   Sean Hawkshaw, KBI CEO, commented that Virtus has a proven track record in retail distribution, while the benefit to Virtus is that it gains access to KBI's institutional-quality investment processes specialising in income-oriented equities and resource strategies.  

See below for the full text of the joint media release.

 Virtus Investment Partners and Kleinwort Benson Investors Announce Strategic Partnership for U.S. Market

Dublin, Ireland and Hartford, Connecticut, January 10, 2013 – Kleinwort Benson Investors (Dublin) (“KBID”), which provides specialized equity strategies primarily to institutional investors, and Virtus Investment Partners, Inc. (NASDAQ: VRTS) (“Virtus”), which operates a U.S.-based multi-manager asset management business, today announced an agreement to enter into a partnership to develop business interests in the US retail marketplace.

The strong commitment of both parties to this agreement is demonstrated by Virtus acquiring a 24 percent interest in Kleinwort Benson Investors International, Ltd. (KBII), a 100%-owned subsidiary of KBID. KBII is a U.S. registered investment adviser that subadvises the Virtus Emerging Markets Equity Income Fund , an open-end mutual fund that Virtus launched in September1.

Sean Hawkshaw, chief executive officer of Kleinwort Benson Investors, said that Virtus’ multi-boutique model and its powerful distribution position in the U.S. retail market were important considerations in establishing the alliance.

“Providing specialist equity strategies to institutional investors has been the core of our U.S. business until now and our commitment on this front will continue. When we considered further growth opportunities for KBII, we looked to partner with a company that has a proven track record in retail distribution, which Virtus has clearly demonstrated.”

George R. Aylward, president and chief executive officer of Virtus, said the agreement was consistent with the Virtus strategy of bringing distinctive product from boutique investment managers to the retail marketplace. 

“Kleinwort Benson Investors is a distinguished firm with a global client base. Its institutional-quality investment processes specializing in income-oriented equities and resource strategies are very attractive. This agreement expands on the relationship when we first partnered with KBII to offer our new Emerging Markets Equity Income Fund, and provides for a strong alignment of interests in pursuing multiple growth opportunities,” Aylward said.

      Financial terms of the agreement were not disclosed. The acquisition is expected to be completed early in 2013, subject to customary closing conditions and regulatory approval.

About Kleinwort Benson Investors

Kleinwort Benson Investors (Dublin) (“KBID”) is a wholly-owned subsidiary of RHJ International (Euronext: RHJI): a financial services group with principal activities in wealth management, asset management and merchant banking.  KBID is an institutional asset manager with a global client base offering investors innovative strategies with a specialization in income oriented equities and global resources.  As of 30 September 2012 it had €3.4 billion ($4.3 billion) of assets under management.  KBII, the 100%-owned subsidiary of KBID, managed €742 million ($979 million) of assets for North American clients of December 31, 2012. Additional information can be found at www.kleinwortbensoninvestors.com

About Virtus Investment Partners

Virtus Investment Partners (NASDAQ: VRTS) is a distinctive partnership of boutique investment managers singularly committed to the long-term success of individual and institutional investors. The company provides investment management products and services through its affiliated managers and select subadvisers, each with a distinct investment style, autonomous investment process and individual brand. Virtus Investment Partners offers access to a variety of investment styles across multiple disciplines to meet a wide array of investor needs. Its affiliated managers include Duff & Phelps Investment Management Co. , Euclid Advisors LLC , Kayne Anderson Rudnick Investment Management, LLC , Newfleet Asset Management, LLC , Newfound Investments LLC , Rampart Investment Management , and Zweig Advisers LLC . Additional information can be found at www.virtus.com .

   

1 Investing internationally, especially in emerging markets, involves additional risks such as currency, political, accounting, economic, and market risk. A fund that focuses its investments in a particular geographic location will be highly sensitive to financial, economic, political, and other developments affecting the fiscal stability of that location.

 

 

2013 Outlook: More of the same

By Noel O'Halloran, Chief Investment Officer  | 0 comments

2012 was a very good year for asset returns with the MSCI World equity index rising by 14.7% in euro terms (16.4% in local currency), and the over 5-year eurozone bond index returning 15.4%. I had expected a positive year for returns but the eventual outcome was even more positive than I expected at the beginning of the year. As I look back on the year, the world did not end, many potential bullets and landmines were avoided, and unusually both risk assets (equities) and defensive assets (sovereign bonds) returned strong double digit returns. We avoided a euro meltdown or Chinese hard landing and a resolution, of sorts, was found for the US fiscal cliff issue. From my perspective the central bankers in whom we placed much faith in our views and decision making over the last 18 months “delivered” and Draghi at the ECB well deserved his award as “Financial Times Person of the Year”.

Outlook

Turning to 2013, my expectation is that we will see another positive year for market returns, although I don’t expect that returns will hit double digits for the second consecutive year. Sovereign bonds will struggle, at best, while equities and risk assets are best positioned to deliver superior performance.  

To me, recent quarters can be neatly categorised into three components:

A macro background that is both fragile and volatile from quarter to quarter

A micro background that has remained robust with companies delivering solid and consistent earnings and dividend growth, despite the fragile macro

A highly supportive policy-making framework, globally, as central banks and politicians continue to strongly underpin the macro environment and remain the key support mechanism until we have a less fragile and more positive and sustained global growth environment

For the first half of the year, at least, I expect that the pivotal support role played by global authorities will remain necessary. But this will fade into the background in the later part of the year as global growth becomes more robust and sustainable. This liquidity support from central banks is a strong support for risk assets.

Confidence has been a missing ingredient throughout the fragile recovery to date and this is particularly important, for example, when it comes to business decisions in relation to new hiring or capital expenditure. As political and economic uncertainty diminishes through the year, it is reasonable to expect a more material pickup in growth and indeed there is a scenario whereby growth in the US economy in particular could surprise to the upside.

Valuation:

As an update on asset class valuation, both asset prices and asset class valuations are higher than a year ago. Equities have seen their P/E ratios expand by a couple of multiple points during 2012 and bond yields have declined to multi-decade lows. Equities still look extremely attractive relative to bonds.  I continue to believe that bond yields are at “bubble-like” valuation levels and that at some point - as with all historic bubbles - that bubble will burst. The most likely catalyst will be more robust economic growth and/or an eventual return of material inflation. At a certain point in time, I expect that investors will be sufficiently worried about that risk to bring about a substantial switch from sovereign bonds to other assets such as equities.

Earnings growth will be key for equities during 2013. While central banks will continue to support recovery, stock picking will be increasingly important as those companies that continue to deliver solid earnings will continue to be rewarded. The search for yield and income was a major theme during 2012 and this will remain the case in 2013 and beyond.  A key focus for stock picking will continue to be to select companies that are delivering high, growing, and sustainable dividends.

Something to watch

There remain many potential issues and challenges that we continue to monitor and most of those appear on the front pages of the newspapers each day, so I won’t discuss them here.

One item I will highlight however is Japan, which has pretty much disappeared from the investment radar for a number of years now and is almost an ignored country!  Recently however there has been very significant political change there, with radical pre-election promises designed to end deflation, weaken the currency, and potentially reduce the independence of the Bank of Japan.  If the newly elected government follows through aggressively on these promises, it has the possibility to be a material event in a couple of ways:

a) the Japanese Yen could weaken significantly versus all its trading partner currencies. Apart from what this means for Japan, it could lead to many other countries attempting to competitively devalue their currencies

b) forcing the Bank of Japan to accept – and deliver – a higher inflation rate in Japan could be radical on its own but what if every central bank in the world decided it was going to explicitly target higher inflation? It certainly would be a catalyst to burst the sovereign bond bubble!

In summary, I expect 2013 to be similar to 2012 in many ways. We are, however, another year into the economic recovery so I believe the environment will be less fragile and therefore less volatile and more positive for risk assets than for government bonds. There are still many challenges to be faced but I do believe that neither company management nor global authorities are complacent. Both are striving to maintain growth.  At Kleinwort Benson Investors we too remain focused on managing your assets in an active way. I believe that themes that worked over recent quarters such as investing in companies with higher than average and growing dividends and quality companies with strong balance sheets and cash flows will continue to work. A move towards more cyclical and less defensive sectors also makes sense. At a regional level Emerging Markets should be strongly positioned to deliver, and as highlighted Japan is the potential wild card.


Budget 2013 Commentary

By Eoin Fahy  | 0 comments
Today’s Budget was very much as expected, both in its overall shape and as regards the detailed changes in it.  The modest stimulative measures aimed at the SME sector are helpful, but are very unlikely to have an immediate measurable impact on the economy, though they were probably a political necessity to show that the government is “doing something” to deliver economic growth.  The budget deficit will still be 7.5% of GDP next year, or €15.4bn, so more austerity is a certainty for at least the next two budgets, but the good news – such as it is - is that Ireland is perhaps 85% of the way through the austerity programme, if economic growth holds up as expected.
  
Very often, the main focus on Budget commentaries and media coverage is on a small but highly controversial measure.  This year, it seems probable that the new property tax will hog many of the headlines, but this new tax will raise far less than 1% of total tax revenue next year, and makes up less than 10% of the total austerity measures in this Budget.   So while the introduction of a property tax is noteworthy, it is also important to focus on broader and more relevant budgetary issues.

Tax Rates Unchanged

On broader issues, the government kept its commitment to avoid raising income tax rates, despite some suggestions that the Labour Party was pushing for a steep 3% increase in the Universal Social Charge rate for higher earners.  Marginal tax rates are important: too high a rate will discourage entrepreneurship in an economy and thus stifle economic growth, so the abandonment of this plan is to be welcomed.  Other measures such as pension tax relief restrictions will hit higher earners, of course, and all earners will be hit by the abolition of the weekly PRSI allowance, but these measures are a better way to raise revenue than an outright increase in the marginal rate of tax. 

Most social welfare rates unchanged.

On the spending side, a further cut to child benefit is one of the largest spending cuts, as expected.  Despite many years – even decades – of debate about whether and how to tax child benefit, or to means-test it, governments continue to avoid doing so and continue to pay this to all parents, regardless of income.  As expected, other basic rates of social welfare were unchanged – a key promise by the Labour Party, but money was saved in other ways, for example by reducing the length of time that non-means-tested unemployment benefit can be claimed. 

Impact on growth to be real, but limited

It is always difficult to be too precise about the impact of any budget on economic growth (though that doesn't stop many people trying!).  That's because the impact of the budget on sentiment and confidence is often more important than the actual impact on people's pockets.  If, for example, a budget was to reduce total take home pay by (say) 1%, but on the other hand it gave consumers and business people some confidence that we are turning the corner and getting out of the economic morass we are in, then consumers might actually spend more than last year, despite getting somewhat less income.

However, it would not be possible to say that Budget 2013 achieved that.  Yes, the Minister started off his speech with a recitation of the genuine achievements, in economic and funding terms, this year.  But it is hard to believe that this positive rhetoric will lead to consumers rushing to the shops, filled with confidence that the crisis is over!

Nonetheless, there seemed to be far fewer apocalyptic leaks in advance of this Budget, speculating about this that or the other savage spending cut or massive tax hike.  This has helped to mitigate the negative impact on consumer confidence that is often seen around this time of year.  And of course the budget did keep income tax rates and basic social welfare rates unchanged, and many of the tax changes were less "visible" than has been the case in the past, which again will help to reduce the negative impact.  All told, there is no requirement to cut our economic growth forecast for the year ahead as a result of the budget, but of course certainly there is no case to raise our forecasts either!  

Deficit remains very high at €15.4bn

As a result of the budget's tax increases and spending cuts, the government expects that revenue will amount to €42.3bn and spending to €57.7bn next year, so that the deficit will be €15.4bn, or 7.5% of GDP.  That compares with an estimated deficit of €16bn for this year (though a straight comparison is not valid due to certain technical factors including the treatment of the infamous Anglo promissory notes).  As always, reaching the deficit target will be dependent on achieving the expected level of economic growth (the government is forecasting real GDP growth of 1.5%, which seems reasonable) and on the ability of the government to ensure that spending does not grow more quickly than forecast – something it was not able to do in the Department of Health this year.

While the ultimate target is to eliminate the budget deficit entirely, the more realistic goal is to get it down to 3% by 2015.  Excluding bank bailout costs, the deficit peaked at 11.5% in 2009.  This means that by the end of 2013 Ireland will have achieved close to half of the necessary reduction in the deficit (the deficit has fallen to 7.5%, almost half way between the peak of 11.5% and the target of 3%).  That is not to say, however, that only half of the necessary austerity measures have already been seen, as over the next couple of years a good deal of the expected deficit reduction is forecast to come from a resumption of (modest) economic growth rather than from further austerity measures.  

Some small comfort?

Current plans indicate that the budget for 2014 will have tax increases and spending cuts of €3.1bn, and the 2015 budget equivalent number will be €2.0bn.  That compares somewhat favourably to this year’s figure of €3.5bn (and due to carry over effects, there will be a need for only €500m of new tax increases next year).  

Another way of looking at the scale of what has already been done versus what remains to be done is to compare the total amount of austerity measures since 2008, which is €28bn, with the amount remaining to be done after next year of €5.1bn.  Measured that way, 85% of the austerity measures have already been announced.  This will provide some small comfort to consumers, perhaps, on a difficult day.


Budget 2013: Main measures

By Eoin Fahy  | 0 comments
See below for a list of the principal measures in the Budget, or click here for a commentary on the overall Budget.

Overall Budgetary Position:

  • The main domestic measure of the budget deficit, the Exchequer Borrowing Requirement, will be €15.4bn in 2013, down from an estimated €16bn this year.  This still represents a frighteningly large 36% of all government revenues.  If no austerity measures were introduced in the Budget, the deficit would have risen to €17.8bn next year.
  • As a percentage of GDP, the deficit (using the EU measure) will be 7.5%, down from an estimated 8.2% this year.  Without the measures in this budget, the deficit would have risen to 8.9% next year.
  • Total revenue will rise by 3.6% to €42.3bn
  • Total spending will rise by1.8% to €57.7bn, of which €49.9bn will be for day-to-day spending and €8.1bn will be for capital spending.

Taxation:

  • The weekly PRSI allowance has been abolished.  Until now the first €107 of income was exempt from PRSI.  This measure will cost each earner about €250 per year.
  • Tax relief on pensions is being restricted.  From January 1st 2014, tax relief will only be available for pensions funds which "deliver income of up to €60,000 per annum".  Consultations will be held to work out the details of this new restriction. Tax relief will continue at the marginal rate, subject to the €60,000 restriction.  The pension levy is to be scrapped after 2014, as previously promised. 
  • Redundancy payments and ex-gratia pension lump sums will no longer be eligible for "top slicing relief" if they are exceed €200,000.
  • For the first time, withdrawals from pension scheme AVCs will be allowed before retirement, although they will be taxed at the marginal rate of tax.  The max withdrawal will be 30% of the fund.  It will be allowed for three years only.
  • Excise duty on cigarettes has been raised by ten cents.  
  • Excise duty on beer has been raised by ten cents per pint, on whiskey by ten cents per measure, and on wine has been raised by one euro per bottle, from today.
  • Excise duty on petrol and diesel will remain unchanged, and a rebate scheme has been introduced for diesel duty paid by hauliers.
  • A number of minor measures have been announced to aid the SME sector, including a higher R&D tax credit, a higher cash receipts basis threshold for VAT, extra funds from the National Pension Reserve Fund for the sector, and other miscellaneous measures. 
  • Real Estate Investment Trusts (REITs) will be allowed under new legislation, which is expected to make Irish commercial property more attractive to overseas investors.
  • As expected, a new Local Property Tax will be brought in from July 1st, at a rate of 0.18% of the value of the property up to €1m, and 0.25% above that level.  To help taxpayers, the Revenue Commissions will provide "valuation guidance" to which owners can refer.  The initial valuation will remain unchanged until 2016.  There will be a "banding" system, with €50,000 increments, and the tax payable will be set at the mid point of that band.  Local authorities can raise or lower the tax by up to 15% from the centrally-set government rate, but only from 2015 onwards.  The Household Charge will be scrapped. The tax can be paid at source from salary or certain State payments, as well  as in other ways.  The average payment will be €157 in 2013 as the tax will only be payable for half the year, it would double in 2014.  Any arrears in the Household Charge will be collected via the new property tax system.
  • New homes bought this year will be exempt from property tax for three years, as will any homes bought by first time buyers.
  • Film tax relief will be extended to 2020, though it will change to a tax credit basis in 2016.
  • Maternity benefit will be taxable for the first time.
  • Carbon tax will be applied to solid fuels for the first time.
  • PRSI will be applied to various sources of unearned income such as rental and investment income from 2014, though for some taxpayers this will take effect in 2013.
  • The DIRT tax rate is to rise from 30% to 33%, as is the rate of Capital Gains tax and Capital Acquisitions Tax.

Spending

  • Total spending cuts of €2bn were announced.
  • Child benefit has been cut from €140 per month to €130 per month 
  • Unemployment benefit (non-means-tested) will now be paid for only nine months, not twelve months as previously.
  • Other basic rates of social welfare will remain unchanged.
  • Some reductions will be made in the "household benefits" package for the elderly, though no details were announced.
  • Prescription charges will be trebled for medical card holders.
  • The pupil-teacher ratio will rise by two for fee-paying schools.
  • Public service staff numbers will be cut to  about 287,000 next year, down from 320,000 at the peak. 

Lifting of suspension on dealing on KBI Funds

By KleinWB  | 0 comments

As of November 1st 2012 dealing on all sub-funds in the Kleinwort Benson Investors Institutional Fund PLC and the Kleinwort Benson Investors Global Investment Fund has returned to normal.

 If you have any queries please contact Mr Niall Murphy at niall.murphy@kbinvestors.com or +353 1 4384451”

Eurozone crisis - change of view

By Eoin Fahy  | 0 comments
 

It would be going much too far to say that the last few days were “the week that saved the euro”, but real and substantial progress has been made, and the eurozone is in a far stronger position today than it was a year ago. We believe that the risk of a major crisis in the months ahead has fallen substantially and a “muddle through” scenario is now far more likely.


After the August lull for European policy makers, developments have come thick and fast in the last few days. Last week, the European Central Bank spelt out its plans to provide unlimited financial support for peripheral countries, and a relaxation of its collateral rules. Today, Wednesday, the German constitutional court gave the go-ahead to the German government to approve a key EU treaty setting up a new bailout fund, while the European Commission issued detailed plans for the creation of a new single bank regulator for the EU – which is a key condition before Germany will allow European bailout funds to provide direct assistance to troubled banks.

It’s worth looking at each development in turn, as they all have significant implications for the eurozone fiscal crisis.

ECB “Unlimited” support

It seems very clear now that the ECB has “got serious” about this crisis. This latest phase in its response began when Mr Draghi, the ECB President, spoke at a conference on July 26th, and said, 

“The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”

That was a very categorical and clear statement of intent, and the markets rightly sat up and took notice. It was followed up a couple of weeks later by an ECB decision, in principle, to buy peripheral government bonds on certain conditions, and this was further confirmed, with much more detail, last week when the ECB spelt out in detail how the bond-buying programme will work.

Probably the most important term in the announcement of the ECB plan was the word “unlimited”. The ECB has agreed that it will buy unlimited amounts of peripheral market bonds, albeit with conditions attached. This is enormously significant because it essentially removes what we think was the single biggest risk to the future existence of the eurozone, i.e. that a country would simply not be able to raise enough money from the financial markets or from other eurozone countries (through existing or new bailout funds) to pay its bills.

Before this change of plan from the ECB, if Italy was not able to fund itself on the financial markets, it would ask other EU countries, and the IMF, for help in the form of a similar bailout programme as Greece, Portugal and Ireland have already received. But Italy is such a large country and has such a huge amount of outstanding debt (about €2 trn) that the bailout funds (EFSF and ESM) just would not have enough funds to rescue Italy. In those circumstances Italy would have to default on its debts and that would very likely cause the eurozone to collapse.

Now, however, in the same circumstances Italy could apply not only to other EU countries (via the bailout funds) but also to the ECB, which – in exchange for conditions – would buy unlimited amounts of Italian debt. The ECB is in effect to become the lender of last resort to peripheral countries and - provided those countries comply with conditions - it is now almost impossible for a market crisis to force a sovereign default. This is a very significant change, as already stated.

Of course, as mentioned several times above, the ECB will insist on strict conditions in exchange for this assistance. Firstly, the country must explicitly ask for help by means of a formal request to other EU countries and their taxpayers for assistance. Next, the country must then agree with EU leaders, and possibly the IMF, on what austerity and other measures need to be taken in exchange for assistance. It is only when or if agreement is reached on these measures that the ECB would get involved as well.

This means that some level of risk remains of course – for example perhaps agreement might not be reached between EU leaders, the ECB, and the government of the country in question on the required measures to be taken. But the risk of a country running out of cash is dramatically lower now than it was before the new ECB plan.

Important hurdle cleared in Germany

In another very important development, the German constitutional court ruled today that its government could go ahead and ratify the European Stability Mechanism (ESM) and “Fiscal Compact” treaties. The ESM is a new and permanent bailout fund, designed to replace the more ad-hoc bailout fund that was used to provide funds for Greece, Ireland and Portugal. Opposition groups and individuals had challenged the treaties in the court, arguing that the treaties were not compatible with Germany’s Basic Law. While the technicalities of the case are not worth going into here, the implications if the court decision had gone the other way were very significant. If Germany had not been allowed to ratify the treaty, the ESM could not be established, bringing further into doubt the ability of Europe to deal with future crises.

The court did establish some relatively minor conditions, saying for example that both houses of the German parliament must approve future bailouts (not just the lower house), and setting a (very high) absolute cap on the total German payout to peripheral countries, but at this early stage it looks as if Germany will formally ratify the Treaty within days or weeks.

Proposals for new banking regulator

Today also, the European Commission published proposals to establish a single bank regulator for European banks, to replace the current situation where each country has its own regulator. Normally such a technical proposal would not get much media or financial market attention, but this time around these proposals are particularly important, especially for Ireland.

The importance of these proposals comes from the fact that at an end-June summit, EU leaders agreed to allow bailout funds to directly support troubled banks. In the past, bailout funds were lent to the government in the country where the banks were located, and then the government in turn gave the funds to the bank. That helped the bank, but only at the cost of increasing the national debt of the country. 

The EU also said,

“the Eurogroup will examine the situation of the Irish financial sector with the view of further improving the sustainability of the well-performing adjustment programme”. 

This was, and is, taken to mean that the EU would look at ‘retrospectively’ helping the Irish taxpayer in relation to the many tens of billions that have been poured into the Irish banks, and was very welcome news – although many details remain to be worked out.

However, there was a very important condition attached:  this will only be allowed after a single EU-wide banking regulator is established. Hence the rush to get one up and running as quickly as possible! Today’s proposals come just ten weeks or so after that summit, a very fast pace indeed for EU policymaking. The proposals, as expected, suggest a phasing in of the new regulation system, to be fully up and running by the end of 2013. Importantly, the proposed date for the start-up of the regulator is as early as January 1st of next year, so technically from then on it may be possible, under the terms of the June summit deal, to provide assistance directly to banks and to find an arrangement to ease the burden of past bank bailouts for the Irish taxpayers.

A Changed Landscape

As the dust settles after all these developments, it is instructive to think about where we are today, in September 2012, vs. where we were a year ago. 

·        Then, banks faced huge problems in raising funds and many were arguably short of liquidity. Now, about one trillion of liquidity has been provided in three-year funding to the banking system via the “LTRO” plan of the ECB.

·         Then, the ECB had stopped buying government bonds of peripheral countries, and had essentially made it clear that it would not do so again. Today, the ECB has explicitly stated that it is willing to do so on an “unlimited” scale, albeit with strict conditions.

·         Then, the Italian government was about to collapse, while Spain and Greece were due elections which the incumbent governments were expected to heavily lose. Today, a much respected technocratic government leads Italy with cross-party support, while Spain and Greece have governments with comfortable majorities and pro-European views.

·         Then, no funding was available from Europe to help rescue troubled banks. Today there are concrete proposals to do so very shortly.

·         Then, the Fiscal Compact and ESM treaties had not yet been agreed. Today both are nearing the very final stages of ratification, making it considerably easier to arrange future bailouts, if required.

Changed Views:

We have long held the strong view that the risk of a eurozone break-up is very small, at around 5%. But we also believed that there was a significant risk (around 45%) that there would be a further and much more serious crisis than anything seen to date, which would in turn bring about a much more substantial policy response than anything seen to date. And we put at about 50% the probability that the eurozone would “muddle through”, without either a dramatic crisis or a dramatic solution, but improving gradually over time.

Today, in light of the significant developments in the last few weeks, and particularly over the last few days, we are changing those probabilities.

We reduce our expected probability of a further dramatic and severe crisis to 25%, and raise our expected probability of a “muddle through” scenario to 70%, while retaining a notional probability of about 5% for a eurozone break-up (though even this, in practice, is probably overstating that risk).

As can be seen from those probabilities, we now think that the eurozone crisis is unlikely to get significantly worse in the months ahead. But we caution that that does not mean that the crisis will end. To forecast a “muddle through” scenario is certainly not to forecast that the crisis is over. There will be many twists and turns along the way before this crisis ends. But we do think that we are moving into a new phase, a phase where each wave of the crisis is somewhat less severe than the previous wave.

Investing in Drought Solutions

By KleinWB  | 0 comments

With the widespread drought continuing across the United States, water is very much in the news.  Which, in a way, is good.  We generally take access to clean water for granted.  Delivered from far away reservoirs or underground aquifers, it is essentially out of sight and out of mind until the tap turns on. But nothing sharpens our focus on what matters more than tragedy.  Drought is a tragedy, and water is, and should be, a priority.  Please click through to the blog entry to read more about this topic.

Matt Sheldon, co-portfolio manager of our Water strategy, has written a very topical article, published in Morningstar,  on Investing in Drought Solutions, in the context of the US experiencing one of its worst droughts for many years.  You can access the full article by clicking on the link below.


RTE's Primetime Programme

By KleinWB  | 0 comments
Our Chief Economist, Eoin Fahy, was interviewed on RTE TV's "Primetime" current affairs programme on August 2nd, to discuss the ECB's announcements that day.  Click here to see the programme.

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