The financial year began on an optimistic note. The COVID-19 vaccine roll out had begun in New Zealand and was in full-swing across most other developed countries. In New Zealand, there was no known community transmission, which allowed us to enjoy a high degree of freedom. The Reserve Bank of New Zealand (RBNZ) was holding the Official Cash Rate (OCR) low at 0.25% and was buying bonds to support the economy through the pandemic. Overseas, authorities were also focused on supporting economic growth. Equity markets had recovered strongly from the March 2020 correction.
Inflation rears its head
Equity markets continued to rise until the end of 2021, while other asset classes traded flat to slightly lower. As the year progressed COVID-19 related supply shocks emerged, leading to higher rates of inflation around the world. Central banks initially dismissed this, assuming that higher inflation was a transitory phenomenon. However, markets fell in the first quarter of 2022 as evidence mounted that this inflation was less transitory than initially thought, leading to a rapid rise in market interest rates. Geopolitical uncertainty and further supply shocks also arose as Russia invaded Ukraine.
Asset class performance was mixed for the year to 31 March 2022. Cash and international equities delivered a positive absolute return while Australasian equities, New Zealand fixed interest and international fixed interest fell. This resulted in strategies with a higher allocation to international equities generating a positive absolute return, while strategies with a higher allocation to fixed interest experienced a negative absolute return.
The rate-rising cycle begins
Given that bond prices move in the opposite direction to interest rates, rising global interest rates drove bond prices lower. Our Private Wealth Series (PWS) International Fixed Interest Fund returned -5.4%* over the year to March 2022 and the PWS New Zealand Fixed Interest Fund returned -6.3%. This rise in interest rates was caused by central banks responding to inflation rising sharply around the world. The inflation rate in the US rose to 7.9% in February 2022, which is the highest level since 1982, while in New Zealand inflation came in at 6.9% for the year to March 2022. Adding to this inflationary pressure, the labour market continues to strengthen, with unemployment in New Zealand falling to 3.2% in December 2021. The RBNZ led other central banks by commencing its rate-rising cycle in October 2021. As such, it is well into its rate-rising cycle, having raised the OCR four times to 1.5%, with more expected through the course of 2022. The influential US Federal Reserve has also started raising rates with a 0.25% hike occurring in March 2022.
There was a notable divergence between the performance of Australasian equities and international equities. While international equities gave up some of their gains at the start of 2022, the PWS International Equity Fund still delivered a return of 6.1% over the year. Australasian equities significantly lagged their international counterparts with the PWS Australasian Equity Fund falling 1.5%, as rising interest rates weighed on performance. Interest rate sensitive stocks constitute a significant proportion of the New Zealand equity market.
Discipline remains crucial
Markets delivered mixed performance over the financial year, with some asset classes delivering performance well below what investors have become accustomed to over recent years. Although fixed interest has performed poorly over the past year, interest rates are higher now, which increases the likelihood of higher returns from this asset class in the future. Since the depths of the global financial crisis in 2009, equities have performed strongly most of the time. Despite a few bumps along the way, investors have experienced a relatively favourable investment environment for some time now. While a well-diversified, disciplined investor with a long investment horizon should be rewarded over time, we anticipate that returns over the next ten years may be more modest that those enjoyed over the recent past.
* All fund performance data is provided on an after management fees but before tax basis. Past returns are not an indication or guarantee of future results.
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