There were several commentators in the weekend prior to Christmas Eve 2019 saying the calendar year returns both for the Australian share market and overseas would be 20%. Are these numbers correct?
The 30th June 2019 financial year was a tale of two halves – the stock markets fell 8-10% in the six months to December 2018. This fall continued in Australia until the release of the Hayne Royal Commission report into banking and superannuation. The market took the view this report was not a doomsday book and rallied thereafter to recover not only the fall in the six months to December 2018, but to rally by approximately double the falls so as to finish up 8-10%. Both the Australian ASX S&P 200 index and the US S&P 500 rallied over 17% in the period January – June 2019, erasing all of the losses in the period to 31st December 2018 and posting 7-8% return for the June financial year.
In the period from 1st July 2019 until 10th October 2019, both the Australian and International stock markets did nothing – the Australian market seesawed around the 30th June 2019 level of 6619 five times as did the international indices.
In the two months since mid-October, the Australian market has had a muted performance so as to currently be up 2.5%. This may be explained by the less than exciting economic statistics for the Australian economy, the impact of the severe drought and the subsequent bushfires.
In contrast the BREXIT vote and the anticipated first stage of the China/US Trade agreement has seen UK and US stock markets rally so as to currently be up 7-9% since 1st July 2019.
Readers might be forgiven for thinking the 20% number has no relation to their observation of Australian and International portfolios doing nothing between 1st July 2019 and mid-October. Moreover the Christmas Eve 2018 falls should not be ignored in considering portfolio returns.
A more appropriate commentary is that following a fall of 8% in Australia and internationally to 31st December 2018, the markets produced a stellar turnaround of double this amount to finish the June financial year up around 8%. Then followed 4 months of geopolitical concerns globally, resulting in the markets producing no net gain. Since mid-October, a reduction in geopolitical risks, particularly the US/China Trade War and BREXIT, have seen a Santa Claus rally in overseas markets. Poor economic
statistics including downgrades to GDP, higher unemployment, different messages from the Reserve Bank and the government on the need for stimulatory infrastructure spending and the drought mean that Australian portfolios have not seen a Santa rally.
Smoothing Returns Using Unlisted Assets
Over the past decade, a number of fund managers have wanted to deliver portfolio returns with less volatility. This has meant allocating funds to assets which are not valued with the same efficiency as listed securities. For example, a portfolio of direct properties may be revalued on a three yearly cycle with a sixth of properties revalued every six months. This gives the impression of a lower volatility return as compared to listed property trusts which would be valued by the market on a daily basis. It is important not to confuse the efficiency of the markets for listed securities i.e. their ability to discover prices on almost a continuing basis with the inefficiency of a process which only re-values properties once every three years.
A further example is the trend to invest in private equity. Private equity or venture capital is a sector involving materially higher risk than a diversified portfolio of Australian equities insofar as private equity funds are looking for mergers and acquisitions and other corporate activity. It’s often difficult to value such investments on anything like the listed equity cycle, so that these higher risk investments give the impression of lower volatility, quite contrary to the true position.
During the global financial crisis, the Australia Post Superannuation Scheme utilised a number of these investments and investments in “alternatives”. These investments were spectacularly unsuccessful during the GFC, resulting in large losses for the Australia Post Superannuation Scheme. Fortunately
Australia Post employees were in a defined benefit fund and the employer being the Australian government/Australia Post made good the losses.
A more successful example in recent times is the Future Fund. The Future Fund was formed when the government transferred shares in Telstra to build a fund to be available for unfunded Superannuation liabilities for Australian Government employees. Unlike private employers and the Queensland State Government who pay their Superannuation contributions on a regular basis, the Australian Government was not paying on an as-you-go basis. Rather the amounts are paid out of government revenue as pensions are due. The Future Fund did not start auspiciously – it sold most of its Telstra shares at low prices - $2.65 being a memorable number. However since that time, the Future Fund has reported good returns with low volatility. It is interesting to reflect on the asset allocation below, the relatively high allocations to unlisted assets not requiring regular valuations and thus giving the impression of lower volatility. It is also interesting that whereas individual Australian investors receive a credit for franking credits and thus have a bias for Australian equities, also reflecting that their retirement expenditures will be in Australian dollars, the Future Fund has no such bias and as at 30th September 2019 showed only 7.1% of the fund in Australian equities.
There are four key asset classes: Australian Equities, International Equities, Property and Fixed Interest. Virtually all other products are a rebranding or the addition of a corporate or trust shield or a combination of these four asset classes. Investors should be careful of products whose low volatility is dependent upon a corporate or trust structure which hides the true volatility and underlying market value of investment assets.
In the January blog, themes from 2019 will be reviewed with a view to whether such themes may be useful in 2020.
Wishing readers a Merry, Holy and Safe Christmas and a Prosperous, Fun and Enjoyable 2020.
Let’s hope the monsoon arrives in Northern Australia to provide some weather relief.
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