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Investors live in a more complex world than in the previous decade, when a set and forget equities strategy – while perhaps not the best way to manage a portfolio – seemed to work. But today, following five years of global market disruptions, investors need to know about equities, fixed interest and the macro-economic environment to have a chance of keeping up to date with latest investment strategies.
The macro-economic environment affects equities and fixed interest differently. If tomorrow we discover Italy is going to follow Spain in needing a banking bailout, then global equities will fall sharply while worried investors seeking to lower their risk profile will look for “havens” such as Australian bonds and the Australian dollar.
China’s move to lower but more sustainable growth, combined with its increased contribution to world growth is underpinning Australia’s “AAA” credit status and role as a haven, Altius Asset Management senior portfolio manager Chris Dickman says.
But if you buy government bonds in the current environment, you accept that at best you will get back your investment but more likely over the term of the issue you will actually lose some of the principal due to inflation.
Ten-year Australian bonds offer a 3.20 per cent yield that’s high compared with international alternatives. US bonds on the other hand essentially offer nothing except a guarantee to get your money back when the bond matures – and for some investors in the current volatile environment, that’s enough.
Australia high interest environment has been a honey pot to international investors with more than 80 per cent of government bonds now owned by overseas investors, compared with just 35 per cent in 2003.
But that does not mean there is no opportunity. In the United States, “BBB” rated corporate bonds are yielding about 3 per cent, while the Australian government’s five-year bond is about 2.5 per cent. However, the “A” or “BBB” rated Australia corporate bond market is still yielding more than 6 per cent and Dickman says that represents fantastic opportunity.
Aside from Australia’s high global interest rate environment, corporate bonds have become of greater interest and more accessible to mainstream investors only over the past couple of years, while new types of bonds such as bank-issued covered bonds are still gaining acceptance.
And so companies entering the corporate bond market have paid more to issue bonds than similarly rated companies in more mature corporate bond markets such as the US.
Dickman says quality companies such as Wesfarmers and Woolworths offer great security and a high yield for an investment portfolio.
And perhaps debt is a better option than their equities.
Platypus Asset Management chief investment officer Donald Williams does not have an optimistic view of 2013, although he does have better expectations for the following year and notes equity markets are 12 months ahead of the economic curve.
Williams says that despite the economy’s continued strength through the global financial crisis and its aftermath, the local equity market has underperformed its peers since the market bottomed in March 2009.
“The combination of an aggressive central bank and toxic political environment in Canberra have conspired to prevent any meaningful recovery in the domestic market,” he says
And as markets enter a new financial year, consensus earnings growth forecasts point to a double-digit increase this financial year. But Williams says that’s wildly optimistic and his expectation is closer to zero growth.
That dour outlook has pushed Williams to lean towards small to medium-sized corporations, where in-depth research in a space not as well covered by market research means there is more opportunity.
And although equity markets are largely being driven by macro-economic conditions, globally stocks are still responding to company-based news if the story is as good or better than expected.
Williams throws out a few examples from recent announcements to illustrate his point: a market update by Ainsworth Game Technology sent shares in the gaming machine company to a record high while St Barbara’s proposed purchase of fellow miner Allied Gold Mining caused a 50 per cent share price surge. Also, the announcement made by finance and telecommunications services provider FlexiGroup’s regarding an agreement with retail chain Ikea to provide interest free finance propelled its share price to a five-year high.
Acorn Capital chief operating officer Douglas Loh is another follower of smaller stocks and points out that from the 2009 bottom, share prices for the micro-cap sector – companies with market capitalisation of less than $250 million – increased by 84.4 per cent compared with 50.2 per cent for the All Ordinaries index.
The issue with micro-caps is liquidity. Loh says the sector is now at the lower end of its historical range and generally trades at about half the rate of the top 250 shares.
There also has been a significant drop in capital raised in the sector and Loh says this factor combined with squeezed margins may lead to consolidation opportunities.
He says there are pockets of opportunity in engineering and mining, such as Intrepid Mining and mature telcos such as iiNet.
Williams expects 2013 to be a transition year with flat earnings but with the lower interest rate environment showing positive effects on the local economy in the second half of the year. However, he does not expect this to flow through to increased capital expenditure.
Williams expects better global growth into 2014, a change of government and the full benefits of lower interest rates to improve both earnings and the performance of the equities market.
The movement of the dollar is important for equities and Williams expects it will continue to deflate. He says the boom is over for most of the resources sector. However, the dollar will not fall quickly as it is being bought up by international investors and sovereigns due to the nation’s “AAA” credit rating.
The impact of the high dollar is evident in quality global stocks like plasma specialist CSL, which despite expanding its business at a compound rate of 10 per cent for the past three years, has managed only flat earnings, says Williams.