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Published 28 March 2013 00:50, Updated 28 March 2013 07:44
Let’s start with the bad news.
Your broker or personal banker or financial adviser may not admit it, but we have entered an era of low investment returns.
The London Business School (LBS) released in February its forecasts for real returns in the big asset classes over the next 30 years. They’re very long range, but they are also beyond bearish, and should encourage the trustees of self-managed superannuation funds to urgently review the way their investment portfolios are allocated.
Term deposits, for instance, will actually lose you about 0.5 per cent a year out to 2043, once inflation is taken into account. Inconvenient, when one considers that self-managed super funds (SMSFs) still held 28.6 per cent of their total $474 billion in cash and term deposits as at December 2012.
Government bonds, meanwhile, will make you zero in real terms according to LBS’ long-term analysis. So the Treasurer’s entreaties to buy them through a new sharemarket facility may do well to fall on deaf ears.
The LBS team is no more enthusiastic about listed shares, however, the Australian variety of which comprised 31.6 per cent of SMSF portfolios at the end of 2012.
The LBS academics – Elroy Dimson, Paul Marsh and Mike Staunton, whose 2002 tome Triumph Of The Optimists has had a big influence on investment analysis – mount a convincing argument that the “equity risk premium” is not as high as many people think. This “premium” refers to the bonus return above the risk-free rate that investors can expect as compensation for the risk of holding a portfolio of shares. The LBS trio contend it has been overestimated for many years.
“Until a decade ago, it was widely believed that the annualised equity premium relative to bills was over 6 per cent. This was strongly influenced by the [asset consultancy] Ibbotson Associates Yearbook. In early 2000, this showed a historical US equity premium of 6.25 per cent for the period 1926-99. Ibbotson’s US statistics appeared in numerous textbooks and were applied worldwide to the future as well as the past,” the LBS team relate in a Credit Suisse-sponsored study called The Low Return World.
“It is now clear that this figure is too high, as an estimate of the prospective equity return. First, it overstates the long-run premium for the USA. From 1900-2012, the premium was a percentage point lower at 5.3 per cent, as the early years of both the 20th and 21st centuries were relatively disappointing. Second, by focusing on the USA – the world’s most successful economy during the 20th century – even the 5.3 per cent figure is likely to be an upwardly biased estimate of the experience of equity investors worldwide.”
The academics go on to show that there is a strong association between low real interest rates, which they determine are here for a long time, and low subsequent equity returns. Their conclusion is that after inflation, shares (including the dividends they pay) will only deliver you between 3 and 3.5 per cent a year out to 2043. And that’s a long, long time.
The good news is that all of the doomsaying above is referring only to the return of benchmarks.
There are still plenty of sectors and one-off opportunities promising returns better than these low single digits, and BRW covers many of them in the following pages – everything from property (think the suburbs next door to the ones that did well in 2012) to pink diamonds (get in now, they’ve doubled in value in the past two years and Rio Tinto have almost run out).
We also cover Australian share opportunities, divided up between the Top 100 and the mid caps and small caps below.
The encouraging news for the self-managed super fund sector, which if anything has been adding to its collective Australian equity allocation since the ATO’s December 2012 figures were released, is that Australian shares are tipped to continue to do better than the global average.
Setting his forecasting aim a little lower than the LBS crew, AMP Capital head of investment strategy Shane Oliver has compiled projections for asset class returns over the next five years (see the table).
|Current yield #||+ Growth||= Return|
|World equities, local currencies||2.7||4.2||6.9|
|Asia ex-Japan, equities||2.6||8.0||10.6|
|Australian equities||4.3 (5.8*)||5.2||9.8 (11.0*)|
|Unlisted commercial property||6.5||2.5||9.0|
|Australian government bonds||3.0||0.0||3.0|
|Australian corporate debt||4.5||0.0||4.5|
|Diversified growth mix||7.7|
|Annual percentage, before fees and taxes. #Current dividend yield for shares, distribution/net rental yields for property and 5-year bond yield for bonds. ^Assumes forward points averaging 2 per cent points a year. *With franking credits added in. Source: AMP Capital|
He arrived at the numbers by combining current investment yields – dividend yields, rental yields and bond yields – with projections for nominal GDP growth and inflation where appropriate.
Remembering to subtract from his numbers whatever the inflation rate might be over the next five years, the medium-term picture looks a little brighter, particularly for Australian equities, once the impact of franking credits is priced in.
This is vindication for Andrew Hewison, a director and private client adviser with Hewison Private Wealth, who has counselled the 500-odd SMSFs his firm oversees to stick by their long-term asset allocations.
“So much of how your portfolio is doing today depends on whether you remained invested in equities during the doldrums of the financial crisis,” he says.
“If you [did], you’ve done extremely well just coming back to where we are. The blue chips are paying better dividends than they were before the GFC. If you think you’re smart because you cashed up during the GFC, and you’re still in cash, you couldn’t be too happy about what the sharemarket’s being doing for the past year.”
Individual frontier markets, such as Sri Lanka, can be volatile, but taken together such markets can be stable.Photo: Bloomberg
Nigeria? Sri Lanka? You can tell the search for high returns has become desperate when a respected Princetonian funds manager is invited to speak to Australian family offices about investing in countries such as these.
Individually, some of these “frontier” markets can seem “pretty flaky”, agrees Harding Loevner’s David Loevner, who already invests in these sub-emerging markets at the edges of the $5.5 billion in global equity mandates he runs for Australian superannuation funds.
“By themselves they are extremely risky, but taken together they are relatively unvolatile, because they are unrelated,” Loevner, who hails from Princeton, says.
“What does the election in Kenya have to do with the economy in Sri Lanka? Absolutely nothing. The holy grail is that as a group they are uncorrelated with developed markets, or even the ‘BRIC’ [Brazil, Russia, India, China] group. There’s a virtuous circle where they are improving their governance at a national and corporate level, there’s more influence from younger, Western-educated leaders who want access to global capital and know they have to be more transparent than their parents’ generation if they are going to get it.” Loevner says the frontier markets are cheap compared with their developed peers, with most of them trading at “high single digit” price to earnings ratios.
“These are markets that are going to return you in the low- to mid-teens annualised, but on a long view. A frontier markets fund is something you’d buy for your children,” he says.
Frontier markets funds accessible to retail investors already operate in the US, and if family offices are demanding it here, then it probably won’t be long before the asset class becomes accessible to SMSFs as well.
It’s important to remember that asset allocation is not the only setting to get right in maximising the returns from your SMSF, Hewison says.
“People go straight to the investment side of things, but you need to know your long-term goals and then get the long-term strategy in place,” he says.
“Have you got the contribution strategy right, have you maximised your tax-free benefits, do you have the right pension strategy?”
For instance, withdrawal-and-contribution strategies for SMSF members under 65 who have stopped work can, if timed right, add far more to the after-tax bottom line than a tweak of investment strategy.
“You can use the bring-forward rule to make withdrawals from the taxable portion of your fund and then put it back in as tax-free contributions,” Hewison explains.
Even after death, the rules governing your SMSF’s withdrawal policy can be more important than the strategy governing where contributions are invested.
“I often see wills that force all the assets out of the SMSF into a testamentary trust and then pay them to family members from there. This can be really tax and financially detrimental,” SuperIQ chief executive and SMSF administrator Andrew Bloore says.
“Why take something out of a nil tax entity and put it in the hands of a marginal tax payer unless you have no other choice?
“Show me in your will where it says you want the Tax Office to be a beneficiary under your estate?
“A little planning goes a long way here.”