Despite the December quarter being dominated by concern around possible tapering of quantitative easing (QE) by the US Fed, equity markets enjoyed solid gains which saw the MSCI All-Country World Index rally for its biggest annual gain since 2009. The Australian market was also buoyed by the positive investor sentiment, with the ASX200 Index gaining 3.4% in the quarter and 20.2% for the year (including dividends). Emerging markets however underperformed, with the MSCI Emerging Markets index ending the year down.

With the Australian dollar continuing to fall against the USD during the quarter (it ended the year down -14.2%), in common currency the Australian equity market actually lagged all other developed markets in 2013. The local currency weakness was unfortunately not limited to the greenback only, in fact it fared even worse against the Euro and British pound losing -17.3% and -16.1% respectively.

Global bond investors continued to experience tough times as average yields kept rising. Domestic bond investors fared slightly better than their international counterparts, but the UBS Composite Bond Index nonetheless gained only 0.4% and 2.0% for the quarter and year respectively. Credit spreads continued to narrow (a positive for investors), which resulted in non-government bonds (including corporate) outperforming government bonds.

In essence, with global growth continuing to improve and central banks around the world still providing liquidity, it was a quarter and year where growth assets massively outperformed defensive ones.

For clients with diversified asset allocations, tactical positioning was thus on balance overwhelmingly successful in adding value during 2013 due to the following decisions:

• being overweight both Australian and International equity;
• within International equity being currency unhedged with a bias to developed markets;
• being underweight both cash and Property; and
• within fixed income having minimal exposure to interest rate risk with a preference for credit.

Looking more closely at the domestic equity performances, the yield-heavy Banks sector outperformed again, joined during the December quarter by Materials which gained 5.2%.  As shown below, the strong finish to the year was not enough to prevent the Materials sector suffering the only negative total return for 2013 though.

While the positioning across client portfolios obviously differed depending on the choice of Australian equity option, the main themes in constructing portfolios last year were:

• being underweight retail banks and overweight non-bank financials;
• being overweight both Industrials and Materials in the ‘Blend’ and ‘Growth’ equity options only

Notwithstanding the strong returns generated by the big banks, the underweight to retail banks vis-a-vis the non-bank financials was indeed the correct call, with asset management companies in particular enjoying some of the best returns amongst all shares included in our investable universe.  Unfortunately our stock selections included some underperformers in the sector.

The overweight to Industrials (Blend and Growth Australian equity options only) detracted slightly from relative performance as the sector underperformed the broader market, though this was more than offset by stock selection where client holdings on balance performed better than the broader sector.

The overweight to Materials (again Blend and Growth Australian equity options only), was the major disappointment from a sector positioning perspective, and unsurprisingly was the largest detractor from relative performance.  Once again stock selection however helped to lessen the negative impact as our holdings on balance performed better than the broader sector.

As we look ahead to 2014 we are persisting with the aforementioned tactical positions as we expect the grinding global economic recovery to continue, the reduction of bond buying by the Fed to again weigh on rates and the A$ to remain weak as Australia transitions to non-mining led growth.  Despite the negative impact on economic growth from the mining capex peak, we see mining companies benefitting inter-alia from capital allocation & cost control discipline as well as increased volumes.

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