28/05/2008

Global Horizons - Reversal of fortune

The financial sector is going through some turbulent times. Whether this signifies a temporary setback or the turning of a financial super-cycle is a key question that investors need to address, according to analysis published today by leading fund manager, Standard Life Investments. Certain sections of the real economy, in contrast, have been basking in investor attention. Could parts of the real economy represent long-term investment opportunities for investors?

In the latest edition of Global Horizons, its regular look at long-term investment themes, Standard Life Investments examines some of the fundamental drivers of the global financial system, such as liquidity, leverage and securitisation, and considers how their interaction has contributed to the current situation. Furthermore, the research addresses the question of whether changes in the financial sector are likely to detract from, or alternatively boost, the progress of several identified real economy themes.

Frances Hudson, Global Thematic Strategist at Standard Life Investments, said:

“In the past decade, the financial sector has expanded considerably. It benefited from major developments in liquidity flows, private and public, leverage and securitisation. At its recent peak, the US financial sector contributed about one third of S&P500 profits. These trends are set to reverse for some years. This partly reflects the lengthy workout from the financial crisis as banks and non-deposit-taking financial institutions take action to bring balance sheets back into order. More importantly, the regulatory pendulum is swinging. The counterpart to the provision of liquidity by central banks will be a series of steps to tighten up regulation, thereby controlling future profitability and the risk of losses across a range of financial companies.

“One of the key roles of financial markets is to allocate capital efficiently between differing demands. There is increasing recognition of the growing capital requirements of parts of the ‘real’ economy.

“The main areas we have analysed include agriculture, commodities, environmental and infrastructure projects. Such real economy themes can offer substantial investment opportunities, even without taking direct commodity exposure. Projected global spending on infrastructure, for example, is in excess of $2000bn a year for the next decade. A more discriminating approach could focus on the ‘picks and shovels’ equivalents, say in construction services and controls, or the irrigation and agrichemicals industry or alternatively amongst oil services and exploration companies.

“Some of the current pressures are cyclical, say short-term disruptions to the production of some commodities. More of the pressures look to be structural. This is more than just the well publicised growth of an urbanised middle class in many global emerging markets. There are profitable opportunities for many investors in OECD type societies concerned about energy, environmental transport constraints. The financial sector will have an important role to play, although more traditional methods of finance may be involved. As ever those organisations who survived the recent crisis in strongest shape, in terms of their capital strength and reputation, will be best placed to profit from the long term shift away from the financial back to the real economy.”