Ray Griffin
You know this as well as I do – the investment world has changed markedly due to the continuing effects of the Global Financial Crisis. As a result portfolio growth will generally be low for several years to come and the retiree’s search for income yield has become more challenging at a time of low interest rates and impeded company profits the world over.
So the question to be answered is how do you invest in these changed economic and market conditions?
Firstly, let’s see what hasn’t changed too greatly. In Australia inflation remains low and within the Reserve Bank’s ‘target’ range of 2% - 3% p.a. Interest rates are still low in historic terms despite rises over the last year or so but it’s reasonable to expect them to continue on an upward trend for some time yet. In addition, the prospect for some Asian economies to become the drivers of world economic growth remains strong however, such export driven economies now need to
re-weight their economies toward domestic growth - the customers of Asian exports will be buying less for a few years to come!
The key differences now to pre-GFC conditions primarily relate to debt in households and some business balance sheets. Domestically, the ‘Achilles Heel’ of our economy continues to be household debt. The GFC and the effect of rising interest rates moderated the seemingly unquenchable thirst of Australians for debt and the direct effect of this has been a reduction in consumption – albeit a relatively small reduction to date. With consumption being around 65% of the Australian economy, you can see that many Australian businesses are experiencing lower revenue simply because consumers are spending less. This flows through to profitability now and into the foreseeable future.
One of the business sectors which has been hardest hit by debt problems is the property trust sector. For very many years this sector provided reliable income returns of around 6% p.a. to 8% p.a. Well constructed portfolios in the 1990s and early part of this decade included a strategic allocation of from around 10% to 20% as a means of supporting overall income returns (yield) from portfolios.
However, in the ‘this time it’s different’ mantra pre the GFC, many property trusts borrowed way too much money and generally investors are now receiving much lower yields as property trust rental income is more heavily allocated to interest payments and debt reduction. Internationally, debt laden economies (both government and private sector debt) will impede growth for quite some time to come and a strong Australian Dollar is impacting on the value of assets held offshore.
Let’s recap – portfolio growth will generally be lower for the foreseeable future due to lower consumption and the burden of debt around the world. Generally, income yields are being affected by lower dividend yields from shares and reduced yields in the property trust sector. So in these changed conditions retirees need to think about deriving more of their portfolio income through fixed interest investments. Structuring some term deposits with a range of maturity dates into a nicely diversified portfolio can provide improved capital stability and regular income. In addition staggered maturity dates allow the investor to access higher rates (if they rise) as deposits mature. You should note that the reverse is true if interest rates were to have declined at the maturity dates – maturing deposits would be reinvested at lower rates. That said, for the time being at least, we are not in a falling interest rate environment.
It’s important to note that this is not a time to remove share or property trust investments from portfolios entirely. They remain very valid components of all long term investment portfolios and the income streams from these investments often have taxation benefits which are not available in interest bearing investments.
Rather, the changed conditions dictate that portfolio weightings to the major sectors – cash, fixed interest, shares and property – should be reviewed. Generally speaking, holding more cash in portfolios at the moment is not such a bad thing. If the world economy were to slow again – particularly the US economy – it would impact on Australian markets which might allow you to invest into some markets at lower prices. That said, do not try to ‘time’ markets – it’s fraught with risk and requires ‘hair trigger’ buying decisions to get it right. It’s sometimes better to stagger your placement to sharemarkets over extended periods of time – months. In other words as the old saying goes – ‘don’t fire all of your guns at once’.
Instead of running 5% or 10% cash in a portfolio, up to 20% cash now would not be inappropriate for the shorter term outlook. Similarly, the fixed interest (sometimes called ‘interest bearing’) allocation can now play a larger part in portfolios, particularly for retirees whose day to day needs hinge on portfolio income.
With reduced global economic growth a given, it’s very difficult to justify high allocations to international markets and by high I mean above 10% to 15%. Better to have much more of your portfolio onshore than offshore at the moment. Within your international allocation, you might want to consider a ‘tilt’ to Asian markets as a long term deployment.
Younger investors with decades to retirement do not have the pressing income needs of retirees and many would assume that an ‘all growth’ allocation remains appropriate. However, such investors could do worse than to accumulate portfolio income – boosted by the re-weightings discussed above – for later re-investment into their portfolios. When portfolio growth deserts you, at least income can be reinvested.
Investing is never a set and forget thing. You need to keep in touch with the way markets and economies are changing and apply your findings to your portfolio decisions. Getting those decisions mostly right is the desired outcome.
Next edition we’ll look more closely at portfolio asset allocation. Sign up to Positive Interest.
Professional advice is recommended for all financial and strategic decisions. However, this information is not professional advice and has been prepared without taking account of an individual's objectives, financial situation or needs. Because of this, an individual should first consider the appropriateness of this information, having regard to their objectives, financial situation and needs.
The persons involved in its preparation and distribution and their related persons disclaim all liability for any loss or damage suffered due to the use or otherwise of the information. The views and opinions expressed in this presentation are those of the author and do not necessarily represent the views and opinion of Rabobank Australia Limited.
