Although the world economy froze significantly in the last year, other important dimensions of the external scenario, such as the terms of trade and international financial conditions, took a course that is favorable to us. Actually, Chile’s economic performance has been quite different from that of many other countries. The main advanced economies are still struggling with the consequences of the financial crisis that resulted in the world recession of 2009. They have a long road ahead to resolve the imbalances and weaknesses associated with this situation before they can resume sustained growth. The Eurozone countries have made progress in resolving their fiscal and financial problems, as well as strengthening the institutional pillars of the monetary union. These steps have been welcome by the markets, but the efforts must continue. Achieving a solution is a slow, costly and complex process, considering the great number of players involved. There is also the ongoing deterioration of the economic situation, which only makes things worse and complicates the required adjustments. Countries suffering negative growth rates and high unemployment for too long already cannot easily implement new austerity measures. Furthermore, the core European economies, which until recently had been relatively spared of the recession of the peripheral countries, have begun showing signs of weakness. Accordingly, the risks in the Eurozone remain. In the United States, the recovery of output and demand is weak, insufficient to quickly absorb its high unemployment.
To explain this, allow me to draw your attention to developments in yields on bonds with a BBB rating, i.e. among the less high quality bonds in the Fund’s portfolio. The above chart shows the pronounced changes in the difference in yield between these bonds and government bonds, or the credit spread. This does not per se reflect a higher risk of bankruptcies. If this were the case, perhaps half of these solid companies would have to file for bankruptcy in the course of a few years. In this analysis from the Bank of England, risk premiums on corporate bonds are instead divided into three components. One component takes account of expected losses and another uncertainty with regard to expected losses – in other words, fear. The third primarily indicates that these bonds have become illiquid, or more difficult to buy and sell. These liquidity premiums, and perhaps also premiums for the initial panic and fear, do not pose a problem for a fund like the Government Pension Fund. On the other hand, a prolonged period of fear and liquidity shortages – if the authorities are not able to reverse these developments – could lead to higher future losses. The Fund’s fixed income portfolio is well diversified across different types of bonds and different regions and the active strategies had low correlation in normal markets. However, the financial crisis revealed that these strategies were exposed to more underlying, systematic risk.