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Investment Planning: What a “Back to Basics” Investment Strategy Could Mean for You

Debbie Alliston is the Head of Multi-Asset Portfolio Management for our parent company, AMP Capital. Her leadership is one of the many investment planning resources provided to us by AMP Capital.

In December 2015, Ms Alliston contributed an article to the AMP Capital blog called “Is it time to go back to basics?” We would like to provide you with some of the information from that article.*

Cash interest rates are low, not only in Australia but around the world. US rates are rising but the projected growth is slow. Consequently, investors may wonder how to make money in the financial markets. Bond yields are low, as are the yields in other asset classes.*

When the numbers for 2015 come in, it is expected that the equity markets will show positive performance for four consecutive years. However, the low-growth environment in financial markets has many investors unsure of future growth in the equity markets. Australian equities have produced negative earnings growth for the last three years. Ms Alliston doesn’t see it turning around until at least 2017.*

Ms Alliston is of the opinion that a “back to basics” approach may be appropriate.*

Back To Baiscs Investment Planning Strategy

Equity Risk Premium (ERP)

According to Ms Alliston, investing in equities provides a premium over investing in bonds and cash. Since 1900, what she calls the “realised ERP” has provided an average of close to 6.0% for Australia and 4.5% for the US. For the present, she predicts a 3.5-4.0% ERP in Australia and between 4.5-5.0% ERP in Asia and emerging markets.*

She sees the US market as “fully valued” while Japan, Europe and Asia “offer attractive value.” While the yields from cash rates and bonds are projected to remain low, she sees the equities market as one that will reward investors for their risk, making equities “an asset of choice.”*

However, she cautions that the valuation buffer has gone down while risk in the equities market has risen. Before the Global Financial Crisis (GFC), Australian equity shares had outperformed global shares. For the last five years, though, global markets have outperformed Australian markets.*

She believes Australian shares will continue to lag behind global markets due to subpar growth, pressure on banks to improve the strength of their balance sheets and the commodities sector still seeing slow growth.*

Diversification

Diversification is a technique designed to mitigate equity risk. In most portfolios, equities represent the largest risk. Diversification means finding strategies and assets that are not associated with equity risk.*

Ms Alliston sees investing in Government bonds as “the most obvious diversifier.” When the economy fails to grow, cash rates are typically lowered. This increases capital value and lowers bond yields. Bonds become more sensitive to changes in their yields as the duration or maturity of those bonds becomes longer.*

While current yields are low, Ms Alliston feels that if there is a significant market correction, bonds will outperform equities, which can provide offset and mitigate a portion of one’s losses. Currency can also play a role because the Australian dollar can often underperform when equity markets are falling.*

Infrastructure and property have a connection to economic growth factors but they are also tied into factors such as supply and demand, cash rates and inflation. This can give them different performance dynamics than equities.*

Private equity provides diversity because while economic factors affect them, management can make a great difference in performance.*

What it All Means

Ms Alliston believes that investors should examine their portfolios closely to evaluate their level of diversification. She cites portfolio construction as a skill that is specialised and can help maximise returns for investors. In the quarter ending September 2015, diversified funds only suffered between 25-33% of the drawdown in equities markets.*

There are numerous multi-asset vehicles on the market for investors which are professionally managed to provide varying degrees of risk/reward. Ms Alliston sees a “professionally managed solution” as an investment that “makes sense.”

If you would like to learn more or would like an obligation-free consult, call Approved Financial Planners today: 08 6462 0888.

*AMP Capital, Debbie Alliston. “Is it time to go back to basics?” 09 December 2015.