Posted on 19/12/2017
“No, I'll stand my ground
Won't be turned around
And I’ll keep this world from draggin’ me down
Gonna stand my ground”
Writers: Jeff Lynne, Tom Petty
The numbers keep rolling in and returns for investors remain healthy across the various investment options. Members have received low-to-mid single-digit returns in the defensive asset classes and high single-digit and double-digit returns in shares and the high-risk growth asset classes over the past 1-3 years.
The past is however just that, and like the late great Tom Petty, we won’t back down from our forecast of lower returns across all options for the next 3-5 plus years.
The table below shows Superannuation option returns over 1, 3 and 5 years ending 30 September 2017.
|Super Returns to 30 September 2017*||1 Year||3 Year||5 Year|
*Note: Selected Statewide Super Pre Retirement Member Investment Options, returns are net of investment fees and tax. Administration and other fees apply. Refer to the Fees and Costs Booklet available on the Website for further details. Pension options are not shown but are available on the Website.
The chart below shows the returns of the default MySuper option since inception relative to the median MySuper return. We continue to comfortably exceed most of our peers since MySuper was launched in 1 July 2013.
Source: SuperRatings Performance Survey
A Global and Local Economy in Better Shape
How do we ultimately decide the performance of an economy? One good measure is unemployment. On that front, the global economy including Australia is doing well with employment growth reducing unemployment. The conundrum is the lack of wages growth globally that typically comes with lower unemployment.
Similar to wage growth, global inflation has remained stubbornly low. Economists measure the relationship between unemployment and inflation via the “Phillips Curve”, which normally shows a lower unemployment rate (i.e. more people working) leads to a higher inflation rate. Waiting on the “Phillips Curve” to awaken is the most anticipated phenomena amongst geeky policymakers, albeit the next Star Wars movie “The Last Jedi” is a close second (true they should get out more).
We do believe that after nearly 10 years since the start of the global financial crisis, global interest rates can finally start to gradually move up from their incredibly low levels. That said, the balance of higher rates and tighter monetary policy will imply a bumpy road for shares, bonds, property and infrastructure returns particularly given their high current valuations.
The other challenge facing policymakers, including Australia, is the balancing act of setting an interest rate relative to inflation, economic growth and financial stability. Trying to set an interest rate today in Australia, whilst serving an inflation target, to maintain employment growth and manage record household mortgage debt and house prices will not be easy, particularly as our largest exporter, China, has its own issues regarding sustainable growth and runaway debt.
Finally the last and most non-forecastable event continues to be Geopolitical Risk. It could be “Rocket Man” from North Korean letting off missiles like firecrackers, a US president using social media like an over-eager teenager or a Russian leader plotting like a Game of Thrones character. The geopolitical situation remains ever elusive and at times deeply concerning.
Market Outlook and Summary
To sum up (and similar to June quarter’s commentary), we believe future returns will be lower and with greater volatility due to:
1) low interest rates moving higher
2) high current valuations for most asset classes
3) very low volatility in the recent returns of asset classes; and
4) geopolitical issues.
It will therefore not surprise our regular readers that our preferred approach is to continue to diversify the portfolio, maintain a large foreign currency exposure (i.e. we will benefit from a fall in value of the Australian dollar), and keeping optionality by holding a higher level of cash.
Members are often asking for a simple explanation of the term “diversification”. Basically it means that we seek to allocate capital broadly across the various asset classes with their allocation weightings being a function of their expected return and risk targets. For example, taking the default MySuper option, our current asset allocation is approximately 50% in shares split equally between Australian and International shares, 20% in property and infrastructure, 8% cash, 6% bonds and the rest in various alternative strategies ranging from low volatility absolute return funds right through to private equity and credit strategies. In our share portfolios, we have equity in over 200 Australian companies and 1,100 international companies. The asset allocation is constructed over the long term (7+ years) to meet its investment objective of inflation plus 3.5%, subject to risk of not having more than 4 in 20 years of negative returns. In other words, we hope over the long term our diversified portfolio will meet our objective and not be reliant on a few Australian shares.