July 2016 Review & Comments
Written by Tony Gray   
Monday, 15 August 2016 11:36

Portfolio Report – August 2016


2015-16 Financial Year

Individual positioning and performance for the financial year varied – depending upon your goals and the degree to which direct assets were used in comparison to managed funds or exchange traded fund exposures.

The lowest returning asset classes were Australian and global equities – traditional drivers of returns on the growth side of portfolios. Global equities suffered partly due to a recovery in the $A and also due to weakness in non-US global markets. In Australia weakness in the key mining, energy and banking sectors masked gains from a handful of larger growth companies.

Small and mid-cap companies, especially microcaps, added good value during the year. Gold and gold related exposures also rose in the second half – with the underlying price of gold rallying since January 2016 and breaking a 5 year bear market.

Local listed property was the strongest performer, continuing a run of strong returns since 2010. This was driven by falling interest rates, but with prices now trading well above asset backing (despite asset backing having risen with lower interest rates) we consider this a risky asset class.

Bonds outperformed deposits, but with 10 year Commonwealth Government bonds yielding barely more than 2% per annum the only way this sector can continue to generate excess returns is for rates to drop even lower. Whilst this is possible in Australia, as global investors desperate for a positive return buy, the risk of material loss rises. Should interest rates remain flat, then a 2% income less any associated fees is less than that paid by a decent at-call account or term deposits. Our feeling is that bonds may continue to generate higher than deposit returns in the short-term, but when rates turn losses will quickly mount.

Set out below is the Lonsec summary of annual asset class returns since 2002. One key take-out is that returns vary dramatically from year-to-year and those offering the strongest returns also generate the largest losses on occasion. Simplistically, it does seem to us that Australian and global property are overdue for a period of low or negative returns.

A word of caution – while there have been no periods of negative returns from fixed interest in this time-frame, this is due to the downward trend in interest rates (which lift bond prices). When interest rates do rise, the yield from bonds will provide a very narrow cushion against capital losses.


2016-17

We remain concerned about how the end game will play out with negative interest rate policies and compounding government debt and deficit positions.  Lowering interest rates is akin to pushing a piece of string when it comes to stimulating economic growth.

The creation of money from central banks to buy bonds has distorted what should represent the risk free rate (the basis of valuing future cash-flows). Asset prices rises, driven by interest rate falls, will result in lower long-term income and total returns.  The 'problem' is that in the short-term interest rates may continue to fall, growth assets and bonds continue to rally and asset price bubbles expand further?

Our positioning can be summarised as follows:

Australian Shares

We prefer microcap and mid-cap valuations and potential return over large companies. Whilst we can see the potential for banks to rally, we’re not brave enough to accept the credit risk. Despite all of the macro concerns, we buy assets when they represent worthwhile value and at this time we do see stocks worth buying.

International Shares

The US market continues to look expensive, but is also underpinned by an economy that has addressed consumer and bank debt issues and is better placed to generate growth. We are relying on active managers with good track records of handling negative markets – accepting they return slightly less than the index when markets are stronger.

Property

We are not adding to this sector and are prepared to lighten some holdings. We note that we were buying this asset class in 2009 and 2010 when it was a pariah.

Interest Bearing

The banks need to secure longer dated deposit funding due to regulatory incentives/changes, so we’re hopeful of seeing higher deposit rates for 2 and 3 year terms. Some unconstrained exposure to floating rate debt (via certain managers) also appears to be adding sufficient value to risk some allocation.

We’re not brave enough to buy bonds when a quarter of global government bonds generate losses to maturity and some 60% return less than 1.0% annually. All Swiss bonds on issue (out to 50 years) lose money for investors! This has come about due to central banks buying bonds. For instance, The European Central Banking is spending 80 billion euros a month buying government bonds!

Other (Gold)

Depending upon your portfolio and what is available via the structure you’re invested through, we have been talking through potential gold exposures for hedge and growth value. Back in February we noted the January break of a 5 year bear market in the gold price and the apparent negative correlations with growth assets (gold rose as shares fell). This trend continues, with the hedge value of gold apparent during Brexit.

We are using a range of $A and $US gold exchange traded funds (backed by physical gold); a global gold miner exchange traded fund; a supplier to the gold sector (equity) and local gold miners. Some of these may not be appropriate for your portfolio or position.

The gold price tends to move in long cycles and the previous upward cycle ran on for 10 years (ending in 2011). Whilst gold does serve as a hedge (i.e. rising when panic sets in) historically it has done best when other growth assets have also been rising.

The emergence of stagflation in the US and potentially other major economies (where inflation is higher than economic growth), and with bond yields below inflation, could see a more broad based appreciation of gold – as occurred in the 1970’s.

The drawback of gold is that there is no income yield – then again, the foregone income is at a (record) low level in Australia and indeed the world.

Superannuation

Both the ALP and Greens support the government planned limitations on contributions and extra taxation of pension benefits. The complexity of the system will increase enormously and we do not see how it is possible to work through legislation in a considered fashion and have in place all industry changes to systems by July 2017.

We have considered a range of contribution and pension strategies and early realisation of gains – but we expect that there will be no clarity until 2017. This will make planning in the lead-up to June 2017 a nightmare. If you don’t expect to be available late in the financial year, then best that we discuss planning steps early.

Reporting season is underway and so far there have been no negative surprises and a few positives. We continue to review portfolios and do not be shy in making contact if you feel any of the above comments need discussing in light of your position.

Best wishes,


A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin

Principal, TG Financial


Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.

Last Updated on Thursday, 18 August 2016 10:20
 

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