2013 September Quarterly Review
“If something cannot go on forever, it will stop.” Herbert Stein, Economist.
The September quarter was another good quarter for ‘risk’, with returns from shares, property and infrastructure assets doing better than cash or government bonds. Our range of member investment choice options were all positive for the quarter ranging from a measly 0.07% for diversified bonds to 9.56% for Australian shares. The default MySuper investment option and the Growth investment option returned 5.82%*. Our members with a longer-term outlook have been well rewarded. The longer-term 10 year numbers are starting to meet their investment objectives of beating their inflation hurdles.
The question I get asked every quarter is ‘where to from here?’. All asset classes are either overvalued to fair value, so we want the portfolios to be well diversified and will build up some cash in order to deploy whenever we get turbulence in the market. An equity biased portfolio continues to be our preferred option against the ‘ugly siblings’ of cash and bonds. Nonetheless, for the multi-asset class options, we have been taking profits and reducing our exposure to Australian shares, with the proceeds going to global shares and cash. We continue to remain underweight in bonds as the yields on offer do not compensate for the duration risk from the expected increase in longer-term interest rates. Within shares, our preferred investment managers have a bias towards companies with little debt, durable businesses and strong brand names/competitive offering.
Going back to the opening quote above, we believe the recent rise in Australian shares and even property, while welcome, is not sustainable and we expect longer-term returns to be in the mid to high single digits. The Australian dollar was slightly higher relative to the US dollar over the three months ending in September and flat relative to its trade weighted basket of currencies. After falling 11% over the past year, we believe it still has much further to fall and have kept our currency hedging at the low end of our allowable range.
The Australian economy continues to grow and has benefitted from a lower dollar, lower interest rates and election certainty. There seemed to be a holding back by businesses and some consumers over the very long election campaign. Finally, China has recovered quite a bit from the June wobble it experienced in bank lending and higher rates. The US economy (budget and debt ceiling deadlock notwithstanding) continues its recovery. European and UK economies have bottomed and are finally showing some positive signs of growth.
South Australia continues to lag behind the rest of Australia, although it too has benefited from lower rates and at least a State Government infrastructure program (new hospital, Adelaide oval redevelopment).
I’d like to say a few words on residential property. There have been many warnings recently in the press by the Reserve Bank of Australia about self-managed super funds gearing into domestic residential property. We believe increasing exposure via super to Australian residential properties fails for three key reasons:
1. The first relates to valuation, with property on a price-to-rent ratio, or price-to-income, at very high levels.
2. The second concerns the use of debt at very low rates to gear into an expensive asset class. Short-term rates cannot stay at 2.5% forever and the increase, when it happens, will catch many out.
3. Finally, the last relates to diversification. Most members already have exposure to property via their own home and some even have an investment property. Adding further exposure to property only makes your overall portfolio far too dependent on domestic property.
As always, please contact us if you need further information. Our team of Financial Planners can help you with your circumstances.
*The returns are based on unit prices for the member investment choice options.
2013 June Quarter and Annual Investment update
Members with a medium to long-term outlook were well rewarded over the 2012-13 financial year. The returns for those who picked member investment choice options with greater growth asset exposure were the best on offer since the 2006 financial year. Returns ranged from low single digits for Cash, higher single digits for Fixed Interest and mid to high teens for Balanced and Growth options. Share options returned above 20%.
Last year I concluded my Annual Report overview with 'we continue to believe that patient members will receive the benefits of maintaining to hold a well diversified portfolio containing growth exposure'. This indeed continues to be the case and I believe that broadly diversified portfolios are still the best way for members to meet their pre and post retirement needs. The issue today is the low rates for both cash and bonds. These traditional defensive asset classes barely cover the cost of inflation.
Australian and global outlook
It's been another interesting year with respect to policymaking responses to the issues post the Global Financial Crisis. We started the fiscal year with unprecedented monetary policies by the European Central Bank, the US Federal Reserve, the Bank of Japan and finally by the Reserve Bank of Australia. The net effect of these has been a good rally in shares, a lower Australian dollar, some evidence of a pick up in the US economy and a bottoming out of UK and Europe.
Towards the end of the financial year the markets have been volatile, with the US Federal Reserve signalling their intention to gradually scale back unconventional monetary policy on the back of an improving US economy. Furthermore, China has also tightened monetary policy as part of rebalancing its economy from investment and export led growth towards something more balanced.
Those actions have put an end to Australia's resources boom and we are now hopefully trying to sail through a declining mining investment sector coupled with a gradual increase in other parts of our economy.
It won't be easy, but the trick will be good policy responses that keep interest rates low, contain any populist response to go immediately back to a government budget surplus and have the Australian dollar fall back significantly below 90 cents against the US dollar.
The South Australian economy continues to struggle relative to the other states. South Australia will benefit from the lower dollar boosting exports in the mining, agriculture, food, manufacturing and services sector (particularly education).
MySuper and merger
StatewideSuper was early in getting a MySuper licence for the new default member investment choice option. The MySuper option will consist of a combination of the old Statewide Balanced Fund and Local Super Growth Fund with a new investment objective of inflation plus 4% over 10 years. As both funds are advised by JANA Investment Advisers, there aren't too many changes. In effect, the biggest change was aligning StatewideSuper's old default option to be more similar to the Local Super's Growth option in terms of growth/income asset allocation. We believe the MySuper/Growth option will be extremely competitive relative to other funds in the market for expected returns, risk and overall fees.
Finally as part of the merger with Local Super, from 1 July 2013 we've launched the new suite of investment options to fill out the return/risk profiles. The range contains the traditional asset classes, Cash, Australian Shares, Diversified Bonds and International Shares. We also have the multi-asset class options consisting of Conservative (target of inflation + 1.5%), Conservative Balanced (Inflation + 2%), Active Balanced (inflation + 3%), MySuper/Growth (Inflation + 4%) and High Growth (Inflation + 5%). Finally we have the Sustainable Diversified option (inflation + 3%). I believe the risk/return objectives across the 10 investment options provide ample strategies for both pre and post retirement goals.
Environmental, Social and Governance
StatewideSuper continues to implement reforms aimed at improving Environmental, Social and Governance (ESG) risk factors with respect to our investments.
This year we've implemented voting requirements and procedures for listed and unlisted investments. We've also formally adopted policies to review the performance of our independent Directors in our direct investments.
We will also look to implement carbon risk modelling into our overall portfolio level risk. We take the approach that ESG is part of the overall approach towards investing.
Additionally, StatewideSuper is proud to have been awarded Infinity Recognition from SuperRatings for the fourth year in a row, and is one of only 15 such funds to receive this accolade nationally. The Award recognises funds leading the super industry in sustainable practices, judged by SuperRatings as having genuine policies and procedures regarding sustainable operations and responsible investment.
Lower rates for cash and bonds imply lower forecast returns for all assets classes in the longer term. Returns of 4% for cash and bonds and 7-8% for Australian and international equities are expected for the next 7-10 years. That's not too bad and with good manager selection and medium term asset allocation we should be able to meet our stated investment objectives for each investment option. However, the path is expected to be volatile and we are still in a post global financial crisis world with lower returns and continued volatility. Nonetheless, I believe a patient approach, coupled with good diversification, is the only way for you to meet your overall retirement needs in today's economic environment.
Financial planning and advice
Our team of Financial Planners* are always available to discuss your needs. So, if you're looking for detailed personal advice about your financial situation, why not talk to one of our Financial Planners today? Your first appointment is free and without obligation!
*Financial information and advice may be provided by representatives of the Fund's Administrator and wholly owned company, Statewide Financial Management Services Limited, ABN 69 092 109 209 Australian Financial Services Licence No. 239063 or in their capacity as authorised representatives of Quadrant First Pty Ltd (Quadrant First) ABN 78 102 167 877 AFSL No. 284443. Fees may apply for financial planning advice.
Quarterly Review March 2013
We've had another strong quarter for members across all of the investment choice options. StatewideSuper Balanced and Local Super Growth have both achieved double digit returns over the past year. The returns have been primarily driven by the stock markets globally.
The table below shows the excellent returns across the main asset classes, particularly shares and assets that carry higher yields (or dividends) compared to cash and government bonds.
|Asset Class||Financial Year to Date|
Note: Benchmark returns that are gross of fees and taxes.
I've been asked by quite a few members, are the returns sustainable? The short answer, we believe, is No! Clearly the markets, particularly the Australian stock market was oversold and we were buyers when the All Ordinaries was trading below 4,750. What we've seen since August last year is the effects of lower interest rates both in Australia and around the world force investors to chase yield. Today the fact remains we get more income from an equity portfolio than a long dated government bond.
The chart below is a particular favourite and shows the difference between the dividend yield on the Australian share market and the 10 year government bond rate.
The Australian economy seems to be losing some momentum. Recent data from here coupled with data from China, Europe and the US shows economic conditions are deteriorating but still on track for moderate growth. In that type of scenario, we should expect interest rates to continue to be low and the global economy to chug along below its long-term trend growth rate. Australia has enjoyed the best of the developed world global growth rates but it comes with a sting in our tail. That sting is China. Its lower and more sustainable growth rate from 9+ to something like 7% does affect Australia's resources boom. Furthermore, the Chinese economy is changing from a predominantly investment and export led economy to one more balanced and relying on household consumption. In other words they don't need our minerals as much as we hoped for. So, the path for Australia will be difficult from here but with low rates, some productivity and good policymaking we should be able to manage this. The Aussie dollar seems ripe for a fall from its lofty heights.
Shares can't continue posting double digit returns. We are mindful that returns from here get harder but compared to cash at 3% and bonds at 3% they should beat them over the next 5 or so years. Furthermore, we think a well diversified portfolio containing all of the asset classes still remains the best medium term strategy for beating inflation and meeting retirement goals.
This was a good year for our members across all of the member investment options. Greater returns were on offer to those who had a higher proportion towards shares and maintained greater growth exposures. The table below compares the returns of the various asset classes for the calendar year 2012.
|Asset Class||Year Ending 2012|
Note: Benchmark returns that are gross of fees and taxes
I always get asked the question - what can we expect the following year? Well the honest answer is that nobody knows and those who correctly forecast 12 month returns are either lucky or ignorant! Stockbrokers and economists publishing one year targets should be read with extreme caution and properly dispensed to the waste basket. Instead of anchoring to those one year targets, we can discuss what we think may play out and, more importantly, form views about longer term return expectations.
Central bankers across the world, including Australia, continue to maintain low interest rates in order to spur consumption and investment. Another intended consequence is to entice returns in the riskier asset classes and from an Australian point of view, put a floor on the already high dollar. These are unusual times. We have not lived in a world where most of the developed world has short term rates near zero, and where there’s a change in Chinese leadership aspirations towards a lower more sustainable economic growth rate. This is a difficult world to forecast and policymakers will continue to impact markets. Given this backdrop, we shouldn’t be surprised if markets continue to be volatile (both on the up and downside) and it’s prudent to assume returns won’t go back to the double digit returns of previous eras, even after a strong 2012.
What to expect in 2013
Last year was all about yield chasing and lower interest rates driving up asset prices in shares, bonds and listed property. This year we think mid-single digit returns for shares will be a good outcome with low returns already priced in for cash and bonds. Hence shares can outperform just because everything else is already too low and the bar above cash isn’t steep (less than 3%). We therefore believe more than ever that a well diversified portfolio with exposures across the board is the best way to invest in this market. Against this backdrop, we maintain our view that the Australian dollar is too highly valued and the government bonds don’t offer enough in terms of prospective returns
The table below provides seven year forecast returns based on simple valuation measures, like existing interest rates (or dividend yields) plus economic growth/profit growth plus/minus valuation to long run averages.
|Asset Class||7 Year Forecast|
Note: Asset Class Returns are Gross Fees and Taxes
Finally a rewarding year for investors with returns vastly exceeding inflation outcomes for the mixed asset class options. It does get harder from here. We do believe the easy returns on offer from this time last year aren’t as prevalent today, and the way forward is to maintain diversification. Unfortunately for retirees’ the cash and pure income assets are much lower today. This forces some to carry a higher allocation to equities, particularly sustainable dividend paying companies and commercial property with good rent paying tenants.
Whilst equity, infrastructure and commercial property returns are forecast to be lower in nominal returns they will provide enough and moreover, be higher than cash, and government bonds and inflation. It may unfortunately be a little uncomfortable holding such positions due to their greater variability but ultimately it should prove to be more rewarding.
Latest Market News
The markets are again testing patience with shares falling by more than 10% over the past month across the world. At the same time, the Aussie has retracted from its 1.10 highs and flirting 95 cents whilst bond markets are pricing in their lowest 10 year bond rates since the depression. Moreover, the economic activity across the world has taken a material downturn with sluggish data in the US, continued problems in Europe and slower growth in China. To add salt in the wounds, Australian home prices are falling and lower interest rates have not been passed on in full by the major banks. Oh and I forgot to mention the carbon tax and Austerity light Federal and State Budgets.
There’s a lot to dislike at the moment.
What do we do? Whilst the past month has been very uncomfortable for investors we are not in the world is about to implode camp. Yes Europe is a basket case but maybe the markets have already priced that in with European shares selling at fire sale prices lower than the dark days of the global financial crisis in 2008. Long term valuations for European shares are at levels not seen in 30 years. Whilst Europe has issues they still make Siemens Engineering, VW Golf, BMW’s, Nestle, Champagne, Louis Vuitton bags, Italian Mens and Womens Clothing, Zara affordable fashion, Swiss Watches, life saving medicine and medical procedures, Cappuccino Machines, Pendolino Trains and Airbus Planes. In other words they make some great world class products that the rest of the world wants to buy. The US whilst sluggish is still growing and China has fallen from 10% growth to something more manageable like 7% economic growth.
We have at the margin built up our cash balances and stayed broadly diversified in the balanced fund. We have and will continue to add to Australian and Global Equities and replace government bonds with floating rate credit. The chart below shows the Australian 10 year bond rate and we believe buying a bond that only pays 2.8% is not a good strategy for long term investing.
We’ve mentioned a few times the high Aussie dollar relative to most other currencies in previous updates. Our balanced portfolio broadly hedges only 1/3 of its international exposure and this has worked nicely this year with the falling Aussie dollar offsetting most of the falls in global equity markets. We believe on a medium term basis that the Aussie still has more room to fall and wouldn’t be surprised if the Aussie-US rate tests sub 90 cents. Global equities are potentially in a sweet spot for an Australian investor. We can use our expensive Australian dollars to buy international shares selling at good prices.
The markets continue to be volatile and the fiscal year will not be kind to investors who have any exposure towards shares. The Australian share markets have been flat for nearly 2.5 years excluding dividends. However we once again ask for patience from our members as the conditions are set for good equity performance relative to cash and bonds over the next 3-5 years. To emphasize this point, cash income is approx 3.75% and heading lower, bonds sub 3% and dividend yields on shares near 5%. So all other things being equal (and they rarely are), we prefer to run portfolios that maintain diversification but have less government bond exposure compared to a normal economic environment. We don’t want to lend money to Uncle Sam at 1.5%, Frau Angela at 1.2% and Aunty Julia at 2.5% for ten years. I’d rather we buy companies that make or sell services that the world wants at really good prices. In other words think like a good seasoned shopper at sale time as opposed to a compulsive buyer.
September quarter 2012
It’s been a good quarter and year for our members who’ve maintained a long-term focus. Australian shares returned just shy of 15% over the year and international shares were approximately 13.6%.
The table below shows how the various asset classes fared over multiple time periods.
|Asset Class||Quarter||1 year||3 years||10 years|
Source: Heuristics October Investment Bulletin
The global and Australian economies have weakened over the past year as the problems in Europe and the slowdown in China dampen economic growth. The Reserve Bank of Australia and other central banks have reacted to this by lowering interest rates and therefore trying to make rates as low as possible to act as a stimulant to economic growth and longer-term asset classes. This has worked quite well for shares and corporate bond markets but the jury is still out in terms of overall business activity.
We continue to factor in an economic environment that’s subdued and where markets will continue to trade with volatility in the short term.
Despite the patchy growth, shares still contain good prospective performance compared to bonds or cash. The chart below shows the dividend yield on offer for Australian shares compared to the coupon on Australian 10 year bonds.
International shares offer better value over Australian shares with an overpriced Australian dollar purchasing various international assets at better valuations than comparable Australian companies.
Over the past two years we have been talking about the benefits of a longer-term commitment towards investing. This still stands although the markets today are not as compelling as that on offer 12 months ago. Nonetheless, we continue to believe that a well diversified portfolio containing all the asset classes is the best way to achieve long-term investment goals which are real returns after inflation. For those with a capital preservation focus, cash and options with lower allocations to shares and infrastructure, such as Conservative options, are preferred to fixed income.
We remain convinced that the best way members can attain real returns over the next five to seven years is to maintain well diversified portfolios with an exposure to all asset classes.
The information provided above is of a general nature. It does not consider your specific needs nor is it intended to be financial product advice. You should obtain independent financial advice, and consider the applicable Product Disclosure Statement before making an investment decision.
*Financial planning services may be provided by authorised representatives of the Fund's Administrator and wholly owned company, Statewide Financial Management Services Limited, ABN 69 092 109 209 Australian Financial Services Licence No. 239063 or in their capacity as authorised representatives of Quadrant First Pty Ltd (Quadrant First)ABN 78 102 167 877 AFSL No. 284443. Fees may apply for financial planning advice.