Archive for category: Industry Retirement Insights

How closely will the next 5 years resemble the last 5 years?

Many sharemarkets around the world have been pushed to records highs over the past 5 years, helped by a range of tailwinds. In this article, Anton and Hugh look at a range of factors that have helped lift global sharemarkets in the last 5 to 10 years, and what the outlook may be for the next 5 years.

March 2019 will mark 10 years since the sharemarket recovery started, following the lows of the Global Financial Crisis (GFC). From March 2009 to the end of August 2018 the US S&P500 has returned a cumulative +393%, the MSCI World Index +282% and the ASX300 Accumulation Index +201%. It is also interesting to note that these returns, specifically over the last 5 years, were generated against a backdrop of record low levels of volatility.

With many global sharemarkets now hitting record highs on a daily basis, it appears that many investors remain complacent and optimistic that the next 5 years can continue along the same lines as the last 5 years. This complacency is best demonstrated in chart 1 below which shows that there is currently a record number of speculative positions in the futures markets of the VIX and the traditional safe havens of Gold and US 10-year Treasuries. The recent
trajectory of this chart clearly demonstrates that current complacency amongst investors is at multi year highs despite the very strong rerating of stockmarkets over the last few years.

While it is nearly impossible to pick tops or bottoms in sharemarkets, with many global sharemarkets now at record highs, we believe it is prudent for investors to now ask the question: will the economic and liquidity conditions of the last
5 years continue for the next 5 years? In this paper we discuss 5 key areas which we believe are worth considering given the continued buoyancy and apparent complacency of many sections of the sharemarket.

1. The end of quantitative easing (QE) as Central Banks reign in the money supply

As financial markets teetered on the brink of collapse in 2008 and 2009, the US Federal Reserve responded with one of the largest and most unconventional forms of monetary policy. The Federal Reserve not only cut its key interest rate (the Fed Funds Rate) to virtually zero percent but the Fed also announced the buying of trillions of dollars in US denominated debt to flush the system with liquidity. By doing so the Fed significantly increased the supply of money to help stimulate economic activity. Quantitative easing quintupled the size of the Fed’s balance sheet to $4.4 trillion dollars and helped drive the 10-year bond yield from above 5% to 1.5%. Following the Fed’s lead, other major Central Banks around the world – such as the ECB, Bank of England and Bank of Japan – also followed suit with their own forms of unconventional monetary policy. The numbers across the globe are quite staggering: in total over US$12 trillion of new money supply was injected using quantitative easing which at one stage resulted in US$10 trillion of negative yielding global bonds, 654 interest rate cuts globally in aggregate since September 2008 and a period with the lowest interest rates on record around the globe. The chart below highlights the ballooning size of the US Fed’s balance sheet – with the normalisation process now in its nascent days as the unwind begins.

Chart 2: United States – All Federal Reserve Banks: Total Assets under increasing pressure – not small economies by any measure.

There is no doubt that QE and the record low interest rates of the last decade have assisted greatly in stabilising financial markets and saving the world from financial calamity – but they have also had the effect of significantly stimulating asset prices around the world, given the money that has been pumped into the system. This has helped to drive global equity markets to record highs. For companies, particularly in the US, share buybacks became increasingly attractive during this period, with the cost of debt moving significantly below the cost of equity, further supporting stock market returns.

This untested approach to monetary policy is now leading us to the current juncture – Quantitative Tightening (QT). The Fed, ECB and Bank of England have all expressed their desire to normalise monetary policy. The Fed has already ceased its quantitative easing programme and has increased US interest rates 7 times from 0.25 % to 2.0% in the last 18 months. The Bank of England has started increasing UK interest rates (albeit slowly) and the ECB is signalling an end to its quantitative easing programme some time in 2019. The Emerging Markets conundrum According to the Institute of International Finance, US$40 trillion was added to the debts of emerging market economies over the past decade. This debt has helped fund the growth in many of these economies. For many emerging countries, much of their debt is denominated in the US Dollar. As the US normalises its interest rates, the US dollar has pushed higher, leaving many emerging economies vulnerable to increasing US dollar debt obligations. Indeed, this year we have seen Turkey, Argentina, Brazil, South Africa, Mexico and Russia all come under increasing pressure – not small economies by any measure.

Chart 3: The emerging markets debt pile

We acknowledge that while Central Banks are mindful of disrupting the system after 10 years of growth, there is no doubt that the normalisation of interest rates and the reversal of quantitative easing is a significant change to what has occurred over the last 5-10 years. While the exact impact of these changes is difficult to forecast, we are surprised that it has not yet led to greater uncertainty in financial markets, as this change of policy may lead to some of the current imbalances in the global financial system being exposed.

2. The US economic expansion and low unemployment – is there further upside?

At a time when global economic growth, particularly in the US, continues apace, the passing of President Trump’s tax cuts comes at a time when the US economy appears in no need of further stimulus. From a high of over 10% in 2009, US
unemployment has reduced significantly so that it now sits at an 18 year low of 3.9%, as highlighted in chart 4. Remarkably, this record low unemployment has so far been achieved with little impact on inflation.

Chart 4: US unemployment levels close to two-decade lows

With the US consumer sector being such a large sector, equity markets have benefited greatly from the US led economic expansion and its declining trend of unemployment.

Continued robust growth and an extension of the business cycle may continue in the short to medium term. However, with the elevated base from which US growth must now be achieved it is hard to foresee the same rate of expansion
continuing over the next 5 years.

3. Australian housing – peak prices with a definite softening moving forward

The Australian housing sector has been a significant beneficiary of the current cycle as the combination of record low interest rates, readily available credit and strong population growth all played a hand in fuelling house prices to record levels. This significant price appreciation and commensurate increase in owner equity has had a large ‘wealth effect’ on Australian consumers and allowed many of them to continue to spend at a time of subdued wages growth.
The result of all this is that Australian household debt to GDP ratios are now amongst the highest in the developed world as evidenced in Chart 5. The strength of the housing market has helped directly support many areas of the economy such as construction and home improvement activity, while its positive impact on consumer sentiment has also indirectly helped sectors such as retail sales.

Chart 5: Australian household debt to GDP – significant elevation over the last 4 years

It seems fairly clear, for a variety of reasons such as record debt levels and the banks beginning to tighten their credit standards that in the next 5 years we will not see anything like the 40-50% cumulative house price appreciation of the past 5 years.

As global interest rates creep higher, the wholesale funding costs for Australia’s banks is rising which will need to be offset with higher mortgage rates. We have already seen the start of this with Westpac and Suncorp’s recent rate rises. With many Australian households already heavily indebted, higher interest rates will strain mortgage repayments and eat into disposable income, which may lead to lower property prices and higher defaults. The Banks’ lending books are also beginning to reflect the shift from promotional interest-only loans to principal and interest, which will lead to higher monthly mortgage repayments for many consumers.

The main point is to emphasise that many of the benefits to many sectors of the Australian economy that have resulted from the strength in Australian housing are unlikely to be repeated over
the next 5 years.

4. Chinese growth and fiscal stimulus – how long can it continue?

The Australian economy has benefited immensely from the industrialisation and urbanisation of modern day China with the strength of the Chinese economy over the last 5-10 years, and is one of the major reasons why Australia managed to avoid a recession through the GFC, in contrast to many other parts of the world.The Resource sector and our economy’s dependency on the Chinese economy was best displayed when in late 2015 and early 2016 commodity prices dropped sharply on concerns of oversupply and diminishing demand from China.

The Australian Resources sector fell approximately 35% in three months with many of Australia’s more leveraged companies in the sector facing the risk of bankruptcy. Thankfully for Australia, China embarked on a major round of both monetary and fiscal stimulus, and this helped commodity prices and Resource companies’ share prices recover from those sharp losses.

Chart 6: Commodity prices have become increasingly dependent on China stimulus

The Chinese economy remains difficult to forecast moving forward as their Government regularly intervenes to try and keep the economy growing steadily. However, as chart 7 below highlights, fixed asset investment (FAI) in China – a major driver of past growth – is falling at a considerable pace as the country matures and transitions into a more consumption driven economy. China appears vulnerable on many fronts – its debt pile stands at 300% of GDP, up from 171% at the end of 2008. While the trade war with the US will likely be resolved at some stage, the recent 20% drop in the Chinese domestic stock market and the plunge in the Yuan highlights the potential vulnerability of the Chinese economy and its reliance on global trade.

Chart 7: China Fixed Asset Investment continues to decline as their economy matures

China has accounted for a large portion of global economic growth over the past 5-10 years. As the Chinese economy matures and transitions into a consumption led economy, it is likely that the large tailwinds from China that helped the Australian economy grow may become less visible in the years ahead.

5. PE multiple expansion – can we go much higher?

With many global equity markets having risen sharply in the last few years, PE multiples are sitting well above their long-term averages. Whilst low interest rates can justify higher PE multiples, the rapid PE expansion over the last 5 years makes us cautious moving forward.

Chart 8: The growing divergence between the ASX 200’s PE multiples and EPS levels

Easy monetary policy and lower interest rates, economic expansion and China stimulus have been central to the performance of global equity markets. Elevated PE multiples reflect a confidence that current conditions can be extrapolated into the future, despite most companies’ earnings growth remaining relatively muted.

Concluding remarks:

While this is by no means a comprehensive list of the conditions that have helped lift global sharemarkets in the last 5 to 10 years, in our view it is indicative of the key issues which have helped lift investor confidence to very buoyant levels and the fair degree of complacency that has now set in. It appears to us that many the tailwinds of the past 5 years that have helped push many stockmarkets to record highs are now fading and in our view, it is a time to be very cautious when investing in the stockmarket.

IML remains disciplined and prudently positioned in our portfolios for any correction in equity markets. We continue to use any weakness to buy into good quality industrials trading at attractive valuations that we believe are well positioned in what seems to be an uncertain 3-5 years and whose earnings we believe will prove resilient through the cycle.

In our view, there are currently many signs of complacency in sharemarkets given the tailwinds that have buoyed the global economy over the past 5 to 10 years. As these tailwinds fade, it is more important than ever to invest prudently. We continue to believe that a research driven fundamental, bottom up approach to stock picking with a strong bias to quality and value remains best suited to the current environment, especially as we transition into what appears to be a fairly uncertain 5 years ahead.

Disclaimer

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to buy, sell or hold that stock.

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20 lessons from 20 years: #4 Dividends are key

I have learnt over my many years of investing that there are three reasons why dividends are key for investors:

1. Dividends are an important part of the return of an equity portfolio

2. The level of dividends is not impacted by the level of the sharemarket

3. The dividend yield on stocks can act as a ‘safety net’ in times of volatility

Dividends are an important part of the return

Over the long term, returns from an equity portfolio come from 2 sources – the capital appreciation from the shares held in the portfolio as well as the dividends received.
When one analyses the returns of these two components from the Australian sharemarket (the ASX 300) over the last 20 and 40 years the results are as follows:

Source: Calculated using IRESS data indices 31 December 1979 – 30 June 2018

As can be seen from the table above around half of the returns from the Australian sharemarket in the last 20 and 40 years have come from dividends – emphasising how important the dividends received from one’s portfolios are to the total return received from that an equity portfolio over time.

As can be seen from the table above around half of the returns from the Australian sharemarket in the last 20 and 40 years have come from dividends – emphasising how important the dividends received from one’s portfolios are to the total return received from that an equity portfolio over time.

The level of dividends received are not impacted by the level of the sharemarket

While the level of capital returns from an equity portfolio over any period depends on the movement in the share prices, the level of dividends received by an investor from an equity portfolio is dependent on the performance of the underlying companies’ earnings. The level of dividends and the dividend payout ratio of any company is set by the Board of the company and is generally a reflection of the overall profitability of a company – independent of its share price.

This is an important point to remember as it means that in negative periods in the sharemarket, an investor’s level of dividends from a diversified portfolio – if made up of quality companies with the right attributes – should not vary greatly from year to year and is largely irrelevant of what is happening on the overall sharemarket.

The chart below demonstrates this by comparing the volatility of the level of capital return to the level of dividend from the ASX 300 over the last 20 years.

Chart 1: volatility of returns of capital and income of the ASX 300 over 20 years

Source: IML, S&P ASX300 31/03/1998 – 30/06/2018

As can be seen from the chart above while the level of capital returns’ volatility has been quite high over the last 20 years – not surprisingly perhaps as it contains periods such as the tech boom and bust and the GFC and Eurozone crisis – the volatility of the dividends received by an investor from the ASX 300 has been very low – depicting the steadiness of dividends and this part of an investor’s returns.

The movement in the sharemarket particularly over shorter time periods of 6 to 12 months is more often than not dictated by the mood of investors. The mood of investors is impacted by things such as the predictions for future level of economic activity, inflation and interest rates as well as perceptions of geopolitical stability.

Often with hindsight what are quite minor events from an economic standpoint can cause the mood of investors to sour markedly and lead to large declines in the sharemarket. For example, Iraq’s invasion of Kuwait in 1991 led to all sorts of gloomy predictions about an impending global recession by many market analysts and economists.

Times of a perceived crisis can cause many investors to panic, and the prices of most shares can fall heavily initially as many investors/traders reduce their overall level of sharemarket exposure by rapidly selling shares indiscriminately and independent of their quality. What I have observed over the many years of investing is that once the panic subsides and some sort of normality is restored, those companies with sustainable earnings that can support a healthy dividend stream are often the shares that recover the quickest.

The reason for this is fairly obvious – rational long-term investors are always attracted to companies that pay a healthy dividend from a sustainable earnings stream as they understand that the level of returns from dividends is not dependent on future share price performance.

In other words, once shares in quality companies fall to a level where the dividend yield is attractive, this attracts long-term investors to start buying these shares as they ‘lock in’ the attractive dividend yield, despite a volatile sharemarket.

Concluding remarks
The lesson for investors is to always remember the importance of dividends when investing in the sharemarket. Dividends provide sharemarket investors not only with a consistent part of their total return but can also act as a ‘safety net’ in down trending markets. Dividends also provide investors with a relatively stable part of returns through the delivery of real cash flow, irrespective of the sharemarket cycle.

As a bottom-up value manager, fundamentals are crucial to deciding which companies are included in IML’s portfolios – mainly the quality and transparency of the earnings, cash flow generation, gearing levels or balance sheet strength – which ultimately is what is important in the level of dividends paid by companies to investors.

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to buy, sell or hold that stock.

 

Anton Tagliaferro, Investors Mutual Limited

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Natural or artificial? The choice for retirees on reducing portfolio volatility

When it comes to investment objectives, many retirees―quite understandably―want to have their cake and eat it: they want enough income to enjoy an adequate lifestyle for their remaining years, and they want to preserve enough capital so that they have some insurance against adversity.

From an investment perspective, the key to meeting these potentially conflicting demands lies in strategies that can reduce volatility in retirees’ portfolios and produce reasonably consistent total returns that would help meet both these income and capital objectives.

Financial-market turbulence or asset-price volatility work against nearly all investors, but particularly retirees, who―because they are drawing down capital to meet expenses―are less able to recoup losses when markets recover after downturns.

Broadly speaking, low-volatility strategies fall into two categories: those that use derivatives, and those that don’t. From an investment perspective, both have their advantages and disadvantages, and some investors will naturally prefer simplicity to the complexity implied by derivatives.

But how should retirees, given their special investment objectives, weigh these strategies’ relative merits? They should consider several factors, in our view, including volatility, price and performance. Just as importantly, they should also reflect on their own behavioural biases.

Avoiding Index Volatility

Let’s look, first, at how such strategies compare in terms of general characteristics. An equity-based strategy will typically rely heavily on its manager’s stock-picking ability, which will be essential to identifying shares which have relatively low correlation to the market’s ups and downs.

This is important, because it’s a well-attested fact that a portfolio of low-volatility stocks can outperform a broad index-based portfolio over time, on a risk-adjusted basis. It’s a phenomenon commonly known as the “low-volatility paradox”.

There are several types of derivatives-based low-volatility strategies, and one question that a retiree might want to ask in assessing them is: what role, if any, does stock selection play, and does it try to take advantage of the naturally-occurring low-volatility paradox?

Perhaps surprisingly, some derivative-based strategies have little if any concern about singling out low-volatility stocks for their equity portfolios. Instead, the portfolios replicate the broad market index while a derivative overlay attempts to smooth out the inherent volatility.

This need not be a bad thing, but there are two points to bear in mind. The first is that derivatives cost money, and the cost is likely to be reflected in the management fee. How does the fee charged by the derivatives-based strategy compare to its equity-based counterparts?

The second consideration is that the Australian share market, which is small and concentrated by world standards, is inherently volatile. The financials and materials sectors, which are both volatile, make up about 33% and 18% of the S&P/ASX 300 Accumulation Index respectively.

This means that some derivative overlay strategies―for example, put or call options on the S&P/ASX 300―need to offset broad market volatility to be effective.

One of the problems with this is that market volatility can take different forms―a short, sharp fall, for example, or a slow grind downwards―and some derivatives strategies are better able to deal with specific types of volatility than others.

A retiree looking at a derivatives-based strategy, therefore, needs to understand which kind of volatility the strategy is best equipped to handle. Strategies designed to offset many kinds of volatility tend to be expensive.

By contrast, an equities-based strategy using a portfolio of carefully selected low-volatility stocks starts off by being inherently less volatile than the market.

Managing the Upside and Downside

Relative performance is another point to bear in mind. The reason that low-volatility stocks can outperform the broad market over time is that they tend to lose less in a downturn but participate―not fully, but enough―in the upturn when markets recover.

Their limited exposure to downside risk means that they have less ground to make up when markets recover. This, combined with sufficient participation in the upside, explains how they can outperform over the medium to long term.

While the limitations in upside/downside behaviour of low-volatility stocks can be regarded as natural and inherent, however, the limitations on the upside and downside potential of derivatives-based strategies are essentially artificial.

For example, some derivatives-based strategies might attempt to limit downside risk by buying put options on their underlying stocks, and seek to offset the cost of this by selling a call option on the same trade.

The purchased put option would give the manager the right to sell the underlying stock at a predetermined price if the market price of the stock fell, while the sold call option would oblige the
manager to sell the stock at a pre-determined price if the stock’s market price rose.

In other words, the potential for this strategy to participate in market upside is limited by the sale of the call option. Some derivative strategies even target the income opportunity available from selling both calls and puts, thereby limiting both their upside potential and ability to limit downside risk.

Having weighed these pros and cons from a dispassionate investment perspective, what other factors should the retiree consider?

Behavioural Considerations for Retirees

Top of the list should be the retiree’s own risk appetite and financial circumstances―in respect of which there is no substitute for professional financial advice. The issue may not be “Which strategy should I choose?”, but how best to use both kinds as a form of portfolio diversification.

Either way, there are points that both the adviser and retiree may wish to consider, in our view.

One is that retirees tend to take a lot more interest in their investments than they did when they were in the accumulation phase and preoccupied with careers and raising families. Given their likely level of financial expertise, would they prefer to monitor complex or relatively simple investments?

As a general point, equities-based low-volatility strategies tend to be simpler and more transparent than their derivatives-based equivalents, and a lot easier to understand.

The other is the fact―well recognised in the literature of retirement planning―that our cognitive abilities tend to decline after the age of 75. Financially expert or not, it’s unlikely that most retirees would want to be grappling with the minutiae of derivatives strategies during their sunset years.

 

DISCLAIMER

This document is provided solely for informational purposes and is not an offer to buy or sell securities. The information, forecasts and opinions set out in this document have not been prepared for any recipient’s specific investment objectives, financial situation or particular needs. Neither this document nor the information contained in it are intended to take the place of professional advice. You should not take action on specific issues based on the information contained in the attached without first obtaining professional advice.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

INFORMATION ABOUT AB

AB is a leading global investment management and research firm. We bring together a wide range of insights, expertise and innovations to advance the interests of our institutional investors, individuals and private clients in major world markets.

AB offers a comprehensive range of research, portfolio management, wealth management and client-service offices around the world, reflecting our global capabilities and the needs of our clients. As at June 30, 2018, our firm managed US$540 billion in assets, including US$25 billion on behalf of institutions. These include pension plans, superannuation schemes, charities, insurance companies, central banks, and governments in more than 45 countries,

We’re truly global, but we’re not just portfolio managers and analysts in one location investing globally. We have an extensive global footprint that we’ve built over four decades. Our global teams collaborate across asset classes and investment strategies in order to spark new thinking and deliver superior outcomes for our clients. Every day brings a new set of investment challenges and opportunities. Through our unique combination of expertise, innovative offerings and global reach, we anticipate and advance what’s next—applying collective insights to help keep our clients at the forefront of change.

This document is released by AllianceBernstein Australia Limited (“ABAL”) ABN 53 095 022 718, AFSL 230 698. AllianceBernstein Australia Limited (ABAL) is a wholly owned subsidiary of the AllianceBernstein, L.P. Group (AB)

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Market dynamics: The case for value remains

In the world of haute couture, a famous designer once quipped – “In a world full of trends, I want to remain a classic”.

At Investors Mutual we would rephrase it as: “In a world full of trends, we want to remain a true-to-label value investor”.

The past 18 months has been a challenging and at times a frustrating environment for value investors. At IML we pride ourselves on our strict adherence to the IML investment mantra which has defined our approach to investing for the past 20 years – through all market cycles. That is to buy and own companies with a competitive advantage, with recurring earnings, run by capable management, that can grow, at a reasonable price.

This can be neatly described as an investment style of Value with a strong focus on Quality. However, over the past 18 months this proven approach has significantly lagged the styles of Growth and Momentum based investing.

A quick recap of the different styles

Value investors 

Seek companies whose share prices are trading below their intrinsic value as determined by bottom-up, fundamental analysis. This may include buying companies that are trading below their tangible book value, their net asset value, that have a long history of earnings and dividends and that trade at reasonable valuations.

Growth investors 

Seek companies that exhibit above average earnings growth and often are happy to buy when the share price looks expensive or trading well ahead of reasonable fundamentals. Growth investing is an act of faith, often buying earnings which have not yet materialised or where a company is expected to continue grow at a quick pace well into the future. Traditionally these companies trade on very high PE ratios as their earnings are expected to continue to accelerate for many years into the future.

Momentum strategies

Disregards much of the fundamental analysis that Value and Growth investors utilise. Momentum investors seek to capitalise on a continuation of short term existing trends. To put it simply this style – often used by quant investors and hedge funds – buys because the share price is trending higher or sells because it is trending lower. This style includes investing in whatever current market fads or concepts are capturing investors’ imagination. This style is self-fulfilling for a time as the more people believe the hype, the more the share price incites others to jump in.

So where are we today and why has it been a challenging 18 months for a Value investor?

As can be seen from figure 1: Momentum and Growth have outperformed Value and the ASX300 by a significant margin over the last 12 months. The scale of the out performance of the last 12-18 months has been so significant that it is now impacting the 3- to 5-year comparisons.

Figure 1: Annualised returns of ASX investment styles

There are a number of dynamics at play in the current market

We are now nine years into the current market phase which has been driven by a record breaking US market and by continued record low interest rates in many parts of the world – including Australia. Since Donald Trump was elected 18 months ago the US market has risen strongly and until recently volatility was at all-time lows. This renewed and unflinching sense of confidence in the sharemarket has made it difficult for Value investors such as IML to keep pace with the sharemarket, while the environment has favoured both Growth and Momentum strategies.

The majority of companies we visit continue to indicate that conditions remain very competitive in many industries and it remains a challenging environment to grow profits. As an experienced Value manager, it makes little sense in this environment to take on additional risk and pay excessive multiples for stocks which are attractive because they are growing faster than the average company.

However, over this same period many Growth and Momentum managers have shown a willingness to pay high multiples for companies such as; Treasury Wines, Bluescope Steel, Qantas, A2 Milk, NextDC, Cochlear, Macquarie Bank, Resmed and Aristocrat. While many of these are decent companies we challenge the thesis of buying these companies on such high valuations simply because of their short-term earnings outlook. It seems to us that some of the buying is being fuelled by hopes that current macro conditions will last forever.

As an example, a major theme has been the stellar performance of companies rising on exposure to the ‘daigou’ market into China, share prices continue to be based on the expectation that they can sell ever larger amounts of their products into China without any hitches.

We continue to ask ourselves when looking at many of these companies: is too much faith being baked into the future earnings projections of these companies? It seems to us that many companies are priced to perfection and any small slip or earnings downgrade will lead to a very rapid derating in many of these companies.

As demand for these Growth companies continue, we are now seeing Momentum strategies joining in and bidding these stocks up to vastly excessive valuations. The past 12 months has resulted in a very narrow universe of growth and momentum type stocks driving the market higher, whilst good quality industrial companies with modest yet sustainable earnings have lagged.

As Value managers, it is not our style to participate in this exuberance, we have a clear valuation framework around every company in our universe and one which we have always stuck to successfully since our inception.

Resources v Industrials – another growth v value conundrum

This brings us to the topic of the significant outperformance of Resources over Industrials since February 2016, which is also a major factor contributing to IML’s portfolios recent underperformance. Resource stocks by virtue of their nature fit the designation of chasing growth. IML always takes a cautious view on Resources given their high volatility and unpredictable earnings. Resource companies’ earnings and dividends remain beholden to the movement in underlying commodity prices, which remains totally unpredictable – as clearly seen in the last few years in the wild swings we have seen in the prices of commodities such as oil and iron ore.

In January 2016 commodity prices reached decade lows (yet still above longer-term averages), beset by global oversupply, tepid economic growth and significant concern for China’s financial markets. However, the Chinese Government responded with significant amounts of stimulus which helped many commodity prices to rapidly recover and in turn to a significant rally for Resource companies.

IML has always preferred to invest clients’ monies in a diversified portfolio of good quality Industrial companies. This method of investing in quality Industrial companies allows the prudent investor such as IML to model out the earnings streams of these companies into the future with some degree of certainty. Such a diversified portfolio of good quality Industrial companies will also provide investors with a predictable income stream in the form of dividends over time.

While at times a difficult market for value investors, we remain confident in our long-term approach and point to figure 2 below highlighting the long-term performance of the Industrials and Resources sectors. It is worth highlighting that the Resources sector returns are negative on a total return basis over 10 years.

Figure 2: ASX Industrials v Resources

What are we buying and why?

We have been buying the following companies on current share price weakness, companies which we believe have very resilient earnings, and strong management teams, yet whose share prices are all being impacted by factors which, in our view, are temporary in nature. We believe these investments will serve IMLs portfolios and their investors well in the longer term.

Amcor – a resilient global packaging company which is currently under pressure due to higher input prices and uncertainty around their emerging markets businesses. Amcor generates strong cash flows and has been relatively inactive on M&A for a while now as target businesses have been excessively priced. If reasonable acquisitions don’t eventuate, the focus will return to capital management which has been a key facet of Amcor’s strategy for capital deployment in the past.

Brambles – a global pallet pooling business, currently trading on 16.5x PE, with benefits still to come from productivity increases in its US pallet business. Brambles’ share price is currently trading lower because of fears that increases in lumber and transport costs will impact margins.

Pact Group – a rigid plastic packaging company which has diversified their business into contract manufacturing and materials handling. Concerns around organic growth from recent results have weighed on the share price, however we think Pact has a very strong management team, and is a durable business which can grow earnings over time via continued cost-outs and bolt-on acquisitions.

Caltex – a leading fuel distributor in Australia with a hard-to-replicate infrastructure network across the country. The share price has been weak of late due to slower near-term earnings growth as refining margins have declined and the company transitions from a franchise model to company operated.

Transurban – a toll road operator with a quality portfolio of roads spanning Sydney, Melbourne, Brisbane and the US, currently offering investors a 5.1% dividend yield with strong growth. Transurban’s share price is currently weighed down by uncertainty surrounding the WestConnex sale process.

Conclusion

The last 18 months has been a difficult market to perform in for value investors such as IML. Companies caught up in the latest theme, fad or concept are being rewarded despite, at times, questionable fundamentals and often a distinct lack of sustainable earnings.

We continue to remain disciplined in continuing to focus on the fundamentals of all the companies we invest in and we seek to not over pay for companies that are often over promising and on companies where the outcome
is often far from certain. With many companies’ valuations stretched, we continue to believe that portfolios underpinned by value and quality stocks remain the best place to be.

Referencing figure 3 below, IML’s proven and successful investment approach has guided investors through volatile and challenging times, notably the tech wreck of 2001-02, the GFC in 2008 and the Eurozone debt crisis of 2011. We remain prudently positioned for any possible correction.

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned
should not be interpreted as a recommendation to buy, sell or hold that stock. Investors Mutual Limited does not guarantee the performance of any Fund, repayment of capital or any particular rate of return. Performance returns are
calculated using the exit price, net of management fees and assuming the reinvestment of distributions. No allowance is made for tax. Past performance is not indicative of future performance. Returns can be volatile, reflecting rises and falls in the value of the underlying investments. Investors should seek independent advice as to the suitability of the Fund to their investment needs.

Investors Mutual Limited is the issuer of the Investors Mutual Australian Share Fund. Applications can only be made by reference to the current Product Disclosure Statement or through IDPS products that include these Funds. The Product Disclosure Statement can be obtained by contacting Investors Mutual or at http://www.iml.com.au/how-to-invest/pds-and-forms. Potential investors should consider the Product Disclosure Statement before deciding whether to
invest, or continue to invest in the Fund.

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Managing risks: Women and retirement

We are in the business of educating our clients on the importance of retirement planning. But research has shown that a one-size-fits-all approach to communication isn’t the most effective tactic. And while it’s impossible to customise messages person by person, it turns out that it’s quite easy to customise them by one big factor: gender. It’s widely accepted that there are differing preferences in communication styles and learning techniques between most men and most women. The question is: How can you adjust your message in a way that’s enlightening, not alienating for your female participants?

The risks of not being prepared

Before I answer that question, I want to reinforce why this topic is so important. Women have longer average lifespans than men, and retire earlier, with much less Superannuation than men, yet tend to underestimate how much they need to save for retirement.

Avoiding labels

At this point, you may be thinking that I’m going to suggest a series of women-branded workshops or educational flyers stamped in pink.

But I’m not.

When Invesco Consulting began the process of creating a workshop for women, we tested numerous options for titles with specific references to women, and one of the first things we heard from women is that they do not want to be singled out by their gender. In fact, any title that included a gender reference — such as “What Women Know About Money” or “The Female Financial Advantage” — consistently scored in the bottom 20% of engagement.

Why? Because women often view these approaches as carrying a subtle suggestion of inferiority, as if the “women’s version” was created for those who don’t qualify for the regular workshop. We found that a better approach is to create educational workshops and materials with the preferences of women in mind, but which doesn’t highlight them as “special” or “different.” In other words, simply work to meet the needs of your women participants — without labeling them.

Three key principles

This is the approach Invesco Consulting took when creating our investor education workshop “Your Prosperity Picture” (notice the lack of women-specific labels in the title). We found that there are three key principles that resonate with many women investors, and we incorporated these in our program:

Principle 1: Provide experience before explanation

Principle 2: Align life goals with financial goals

Principle 3: Be positive

Principle 1: Provide experience before explanation.

According to the Public Administration & Policy – APAC Journal, 3 women tend to be “Relational Learners” while men are usually more “Independent Learners.” We found that beginning a workshop with an interactive activity (instead of just launching into a presentation) can be a great way to tap into that learning preference for many women. But what kind of activity? In a column I wrote — “What will retirement look like?” — I discussed the power of visualisation exercises. Science has shown that if you visualise a particular goal that requires financial resources, such as traveling or pursing a hobby, it helps condition the brain to look for information and resources that might help in achieving that goal. Walking investors through a visualisation exercise that focuses on their goals can be a great way to begin a financial workshop.

Principle 2: Align life goals with financial goals.

One study has shown that women who feel their financial advisors have successfully helped them align their investment goals with their life goals are 41% more likely to be satisfied. In “Your Prosperity Picture” workshops, we do this by walking investors through the process of creating a visual financial plan that illustrates their short-term and long-term goals, and organises them by the amount of financial resources that will be necessary to make those goals happen.

Once investors are talking and thinking about their vision for their retirement, the next logical step is to connect that vision with your retirement plan benefits. You’ve set the stage to talk about practical strategies geared toward making their goals happen.

Principle 3: Be positive.

I started this column with some sobering statistics about women’s retirement age and retirement superannuation balance. I did that to set the stage for you, the Financial Advisor, but I would not include these in an investor workshop. Our research has clearly shown that negative spin doesn’t sit well with most women investors, and trying to scare them into action can backfire. In fact, the principle of being positive is so powerful that it transcends gender. It’s proven to be one of the most important and consistent language trends that Invesco Consulting has seen since we began doing our language research in 2009.

What does this mean for Financial Advisors? Rather than focusing on the possibility of negative outcomes and how to avoid them, focus on achieving what’s possible. Position your retirement plan as a way to help investors reach their goals, rather than taking a gloom-and-doom approach.

Bottom line

In general, women and men have different learning styles and communication preferences, but women don’t want to be singled out. A workshop designed for these needs won’t include “women” in the title, but will follow three key principles: providing experience before explanation, aligning life goals with financial goals, and maintaining a positive message.

 

Important information
This document has been prepared by Invesco Australia Ltd (Invesco) ABN 48 001 693 232, Australian Financial Services Licence number 239916, who can be contacted on freecall 1800 813 500, by email to info@au.invesco.com, or by writing to GPO Box 231, Melbourne, Victoria, 3001. You can also visit our website at www.invesco.com.au

This document contains general information only and does not take into account your individual objectives, taxation position, financial situation or needs. You should assess whether the information is appropriate for you
and consider obtaining independent taxation, legal, financial or other professional advice before making an investment decision. A Product Disclosure Statement (PDS) for any Invesco fund referred to in this document is available from Invesco. You should read the PDS and consider whether a fund is appropriate for you before making a decision to invest.

Invesco is authorised under its licence to provide financial product advice, deal in financial products and operate registered managed investment schemes. If you invest in an Invesco Fund, Invesco may receive fees in relation
to that investment. Details are in the PDS. Invesco’s employees and directors do not receive commissions but are remunerated on a salary basis. Neither Invesco nor any related corporation has any relationship with other product issuers that could influence us in providing the information contained in this document.

Investments in the Invesco funds are subject to investment risks including possible delays in repayment and loss of income and principal invested. Neither Invesco nor any other member of the Invesco Ltd Group guarantee the return of capital, distribution of income, or the performance of any of the Funds. Any investments in the Funds do not represent deposits in, or other liabilities of, any other member of the Invesco Ltd Group.

Invesco has taken all due care in the preparation of this document. To the maximum extent permitted by law, Invesco, its related bodies corporate, directors or employees are not liable and take no responsibility for the accuracy or completeness of this document and disclaim all liability for any loss or damage of any kind (whether foreseeable or not) that may arise from any person acting on any statements contained in this document. This document has been prepared only for those persons to whom Invesco has provided it. It should not be relied upon by anyone else.

©Copyright of this document is owned by Invesco. You may only reproduce, circulate and use this document (or any part of it) with the consent of Invesco.

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