Outlook: Another new economy bust comes down the line

Ethical HSBC; End of equities?
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The Independent Online

Another one bites the dust. OK, so perhaps not quite, but there's no doubt that on most definitions Energis is now technically bust, and in any other recession, administrators would already have been appointed. The fact that they haven't is only because bankers and bondholders would get so little back if they were.

As it is Energis's chief executive, David Wickham, will either have to give away or close his European operations in order to stem the losses. The core UK business is said to be fundamentally sound, but who would buy it in this environment? Cable & Wireless is virtually alone in having the money for such an acquisition, but the market is in no mood to back such a purchase after recent disappointments and, as things stand, nobody wants to add more network capacity to what they've already got.

Bankers have no option but to bide their time in the hope that eventually the telecoms business will recover enough to make Energis a viable company again. Meanwhile, bondholders' only hope of salvaging something from the wreckage would seem to be a debt-for-equity swap.

When Energis first warned on profits and a possible breach of banking covenants last month, the whole thing was presented as little more than a failure in internal reporting systems, which had led to some faulty forecasting. We now know it was much more than that. Energis appears to have been skating on thin ice for most of the past year. Now it's become an object lesson in the old adage that when you owe the banks £1,000 it's your problem, but when you owe them £1.1bn, it is very much their's.

Ethical HSBC

Two-and-a-half cheers for HSBC for yesterday's announcement that $50m of the company's money is to be spent over five years on a project to help clean up three of the world's largest rivers. It's easy to be cynical about corporate conscience solving of this type. Nor is HSBC's position helped by the fact that it is co-financing Alstom in its production of turbines for the Yangtze dam, a project that will inflict appalling ecological damage on one of the rivers the money is meant to be targeting. When HSBC turns down bankable business propositions on the grounds that they might also harm the environment or infringe human rights, that really will be something.

Even so, it's a start and, interestingly, the response from a straw poll of HSBC shareholders yesterday was highly supportive. Five years ago that certainly would not have been the case. What on earth is HSBC doing wasting our money on ethical causes, would have been the response, still less sending its employees off to study mountain lions in the American Rockies or frogs in the Australian rainforest. Isn't that something people do in their gap year?

The world has changed and the idea of the socially responsible corporation has gained a real foothold even among commercially hardened bankers such as HSBC's Sir John Bond. Big corporations have come to regard it as part of their job to be engaged in environmental protection and the racheting up of standards in human rights, healthcare and even workers' rights.

This is not happening because of altruism alone, but because good corporate citizenship is increasingly regarded as simply good business, since it enhances reputation, enables companies to recruit better, more socially responsible people, and opens doors to new markets.

None the less, companies are not finding the transition easy to make. There's already a sentimental yearning among many business leaders for the days when business was just business. To be required to take a whole series of other judgements on top of the purely commercial one confuses and complicates matters enormously. Oh for the past, when companies just paid their tax and left governments to do the social responsibility thing. Helping to cure the world of its troubles is not what most executives went into business for, but more and more they are finding it thrust upon them.

End of equities?

There's plenty of food for thought in the latest annual Barclays Equity-Gilt Study, but can its writers really be right in their assertion that the cult of equity is dead? This column has long argued that investors may be in for a prolonged period of poor to negative rates of return on equities.

This is not the same thing, however, as saying there's no future for equities. For that to happen convincingly would require the relationship between equities and bonds to revert to their pre-1950s position, when the yield on equities was a good deal higher than the yield on bonds. At some stage in the 1950s, as the world moved into a more inflationary age, this relationship reversed, so that bonds came to yield more than equities. The cult of equity was born. Now that we live in a period of low inflation or even deflation again, might not the relationship flip back the other way once more?

Well, anything is possible, but it would require a very gloomy view indeed of the outlook for corporate earnings to justify such a reversal. Things are bad, but they are surely not yet that bad. The Barclays study is none the less plausible enough in suggesting that equities face an exceptionally rocky road ahead. The cult of equity may not yet be quite dead, but it seems to be losing followers by the day.

The report's central statistic that both corporate bonds and gilts hugely outperformed equities last year will come as little surprise. Perhaps more surprising is that even on a 10-year view, the average annual real return from corporate bonds exceeded that on equities by 1 per cent. Over the last two years, equities have underperformed gilts by an astonishing 35.5 per cent, making it on that measure the worst bear market for shares since 1973-74.

If it were just the business downturn and the bursting of the technology bubble that was causing this equity-averse environment, then it might not be much to worry about. Eventually the economy will recover and everything will be OK again, right? Wrong. Institutional investment in the UK, particularly that by pension funds, is undergoing a paradigm shift away from equities and into bonds. In no particular order, Barclays lists the reasons as the changing regulatory environment (the Minimum Funding Requirement), the new accounting regime (FRS17), the growing maturity of final salary pension schemes as the population ages, the desire by companies to limit the risk to profits arising from pension fund deficits, and the growing trend among companies to pay little or no dividend at all on their share capital.

To this might be added the more general observation that an ageing population equals a more risk-averse population, this because the older people get, the more they have to lose and the less time they have to make it back again.

It all argues for less equity and more bond investment, but it is not clear that it spells the end of equities altogether. There will always be those prepared to take the risk of equity investment in the hope of a higher return, and most companies will continue to want the capital cushion that equity financing delivers.

Nor does it solve the problem for companies to buy back their shares with finance raised from bonds, the investment banker's fee earning wheeze of the moment, since in terms of reducing investment risk this is a zero-sum game. Just look at poor old Energis, whose equity value has collapsed from £14bn to £67m in the space of two years. Can you imagine where bankers and bondholders would now be without that buffer against insolvency?

Barclays has raised some intriguing issues, but don't write off the equity markets quite yet.

j.warner@independent.co.uk

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