Operations and results in 2007A dramatic year
Despite financial uncertainty, Första AP-fonden delivered strong results in 2007. The year’s net investment income of SEK 9.7 billion is equal to a total return after expenses of 4.6%, of which 0.4 percentage points, or SEK 870 million, is attributable to successful active management.
This section begins with a look at market development, the Fund’s operations in 2007, investment income and returns, portfolio composition and corporate governance activities. The section ends with a description of the Fund’s management and the work of the Board and auditors during the year.
The past year came to be marked by financial turmoil that started already in February-March with a correction in the equity markets. In August the fixed income market struggled with problems that would later escalate into a full-scale financial crisis.
Subprime residential mortgages in the US were a triggering factor, but the problems went far deeper. An extended period of abundant liquidity had resulted in a search for yield, where the credit market was apparently perceived as less risky. A large share of the banks' indiscriminate lending was held off the balance sheet.
Once the crisis was a fact it proved difficult to get a firm grip on who actually bore the risks, which damaged confidence in the financial system and sent interbank lending rates spiraling upwards. The leading central banks have injected liquidity into the market to ease investor fears, but the crisis has continued nonetheless.
It is likely to take some time before the risk implications are understood and full confidence in the financial system can be restored. One critical question is what effect this will have on the real economy.
Stock market (index = 100 January 2003)
10-year bond rates
Slowing in the US
Activity in the US economy remained buoyant throughout much of 2007 despite a slight drop in consumer spending and a dramatic downturn in building activity. However, these weakening tendencies were offset by robust export growth fuelled by a falling dollar rate and strong growth primarily in the Asian markets, contributing to some narrowing in the massive US trade deficit. The employment rate has risen further and resulted in higher household incomes.
There are also clear signals that the US economy is headed for a recession, resulting from the burst housing bubble and increasingly restrictive lending in the wake of the financial crisis.
The US Federal Reserve has started a series of a key rate cuts to dampen the impact of the crisis on the real economy. One complication is a comparatively high inflationary rate, mainly caused by rising prices for energy and food products.
Asia steaming ahead
Expansion in Asia appears to be continuing unabated. Growth in China has topped 10% and India, like many other Asian economies, is also exhibiting high growth rates. Internal trade between these countries is becoming increasingly important and dependency on the US is gradually waning.
So far the financial crisis has had a relatively limited impact on the region, although there are concerns that certain economies, particularly the Chinese, are headed for overheating that must be corrected with restrictive economic policy.
Inflation is on the rise in this part of the world, here also led by higher food product and energy prices. The Japanese economy remains sluggish despite export help from vigorous growth in neighbouring countries. The deflationary problem has yet to be solved.
Change in the consumer price index
Mixed picture in Europe
2007 was a relatively good year in Europe, with growth above the long-term trend. Unemployment continued to fall but the consumer spending rose only moderately due to relatively low income growth. Investments showed favourable development and exports remained steady, in spite of the strong currency.
However, the ECB was concerned by inflationary risks and chose not to follow the Fed's example in lowering key interest rates. Economic growth appears likely to weaken in 2008, partly as export companies feel the effects of slowing in the US and the high euro rate.
Strong Swedish economy
Growth in the Swedish economy continued to outpace the rest of Europe, although signs of deceleration began to emerge. The previously so rapid export upswing lost momentum, while household spending rose sharply and the labour market strengthened further.
The year's strong economy, relatively high salary growth and rise in inflation have caused the Swedish Riksbank to hike up key rates in several increments. Growth is likely to level out gradually in 2008 as a result of the international slowdown.
Sizeable market movements
Stock market movements were substantial in 2007. A correction took place at the end of February/beginning of March, but the most violent swings arose in connection with the autumn's financial turbulence.
Although the crisis arose from excessive activity in the credit market, it came to impact investor attitudes toward risky investments in general. Rather than mispricing, the year's falling prices were instead caused by investors abandoning stocks in favour of "quality" assets, primarily treasury bills.
Stock markets in the emerging economies performed generally well, while the Stockholm Stock Exchange was among the losers.
Credit market in focus
The spillover effects of the crisis on the fixed income market have been severe with the flight to quality pushing down interest rates on government bonds, not least in the US. Meanwhile, several central banks have begun lowering their key rates.
However, uncertainty in the market has also led to widening credit spreads. Due to the difficulty of determining what risks the various banks and credit institutions are exposed to, liquidity in the interbank lending is deteriorating and lending policy has tightened significantly. It will most likely take some time before the situation has normalized.
Continued dollar plunge
The year was marked by persistent weakening of the dollar, driven by a narrowing interest rate gap between the US and other countries, increased differentiation of currency reserves by many central banks and a large foreign trade deficit in the US. The euro rate has thus climbed to record levels, while Swedish krona fluctuated upwards and downwards but ultimately showed a slight weakening against the euro during the year.
International key interest rates