Investment news

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.

^{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.

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. 

Note: Asset Class Returns are Gross Fees and Taxes

Summary

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.

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. 

Conclusion

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.

What have we done at StatewideSuper in response to the global financial crisis (GFC)?

In response to the GFC, StatewideSuper made a number of changes to the way it manages its investments, including:

• Amending its strategic asset allocations and investment objectives
• Replacing its investment adviser
• Strengthening its internal investment team
• Changing its Investment Governance Framework, and
• Making a number of changes to its investment manager lineup.

So how are StatewideSuper’s investment options performing*?

StatewideSuper’s previous investment style suffered badly during and following the GFC, which is why we made the changes described above. And while it’s always important to view your super returns over the long-term time horizon for your investment option, you’ll see in the table below that, due to the recent changes we’ve made, our one-year returns for the StatewideSuper Balanced (default) option have outperformed the average super fund default option: 

The following tables show how StatewideSuper’s other investment options have performed over the last one, three and five years when compared to the average Australian super fund. Our one-year returns have outperformed the average super fund in six out of seven options as shown:

We’ll keep you up to date!

Watch out for the next Investment Update for all the latest information on the current financial situation and your super investment.

In the meantime, why not check out the other pages in this Investment section for heaps of helpful information about investing your super? Or try the Risk Profiler to see what kind of investor you are.

^{*Figures taken from SuperRatings Fund Crediting Rate Survey, April 2012.}

If anything, the market rally looks a little overdone but valuations in Australian shares and International shares are not too stretched.  Added to this, with central banks around the world continuing to maintain low interest rates, shares should continue to enjoy good returns and government bonds continue to be expensive. 

The table below shows the returns from their lows for various markets.  Most risky assets have recovered nicely from the lows of September/October 2011.

Source: JANA Investment Advisers

Australia

The Australian economy continues to suffer from a two-speed economy.  Mining and mining related investment continue to boom while traditional sectors like housing, housing related construction and retail are struggling. The overall macro picture remains sound with low government debt, positive interest rates and low unemployment.  The recent good news on inflation implies that the Reserve Bank of Australia has room to cut interest rates and banks should pass most of it on to business and consumers.  The lower rates should help the economy.

International

Europe and the UK continue to disappoint with austerity measures effectively guaranteeing prolonged recessions for a while.  Sadly, policymakers are relying on central banks to do all the heavy lifting and the populations of the affected areas are tiring of the austerity measures that increase unemployment and deteriorate economic activity.  There needs to be a Plan B with measures that can increase aggregate demand (ie either stimulus via infrastructure spending and/or tax cuts) coupled with supply side reforms. 

China

Economic growth in China is slowing and the leadership has targeted a new five-year economic plan that calls for lower growth (7-8% as opposed to 10%) with growth coming from internal consumption as opposed to export and fixed investment.  This will be positive for the world in terms of helping to correct global trade imbalances.  It does take some steam out of the commodities run we’ve experienced and should also take some pressure off the high Australian dollar.

Bonds

We continue to run underweight positions in fixed income, particularly long dated government debt.  The Australian 10 year bond rates have recently touched 60 year lows at 3.6%.  We believe investing at those rates exposes our members to negative real returns over the next 10 years!  We have countered some of this by investing in 1 year term deposits and corporate credit where the returns on offer are better and contain less duration risk. 

We should state again - Government Bonds around the world are either too low (USA, Japan and Germany) or too risky (eg Greece and Spain) and in this market our investment managers and asset allocation stay underweight.

Summary

This was a great quarter for corporate credit and shares.  The problems around the world and the effects of the two speed economy in Australia are still with us, but conditions are generally better than they were six months ago. 

Markets will continue to be volatile as the world reacts to general uncertainty.  We will continue to run broadly diversified portfolios and be adaptive to the changing market conditions.  We still believe growth assets are well placed to outperform bonds and cash.