February 2012 Review Comments
Written by Tony Gray   
Tuesday, 07 February 2012 00:00

Portfolio Valuation & Comment

Australian and international sharemarkets, including listed property, advanced through January and early February as investors became accustomed to the ‘bad’ news from Europe.

Whether this is sustainable or the market gains are reversed we do not yet know.

What then to do from an investment perspective?

Re-reading Benjamin Graham’s Intelligent Investor (first written in 1949, but worth reading the 1973 revised edition also), at the most basic level the main choice is between shares and bonds.  For our purposes we can consider listed property, international shares and Australian shares in one basket.  In the bond basket, we can include at-call and term deposit money. Benjamin Graham was Warren Buffet’s mentor – although he and other students of Graham all developed their own individual approaches to funds management.

Graham’s thesis is that when bonds are yielding well above share dividend yields that you move to a maximum allocation of 75%, retaining 25% in shares.  When dividend yields are well above bond yields the reverse applies.  Otherwise the base case is a 50/50 allocation. 

This is somewhat contrary to the approach that was applied by most investors and their advisers (including TG Financial) until the last couple of years - of having a relatively low maximum weighting to cash and fixed interest assets for Growth or High Growth Investors on the basis that long-term returns from growth assets justify always having a relatively high allocation to shares and international shares and property to varying degrees. 

As the Investment Strategy specific to each portfolio has been reviewed and updated, we have tended to reduce the minimum allocation to growth assets and increase the maximum allocation to cash and fixed interest assets. 

There has been a significant change since April 2011, with bond yields in Australia falling sharply – to levels not seen since the late 1940’s/early 1950’s.  At the same time share prices are
weaker and dividend yields higher.  A 10 year Commonwealth Government bond is currently yielding ~3.9% p.a. whereas the typical gross dividend yield from an Australian share portfolio is ~6.9%.  Based on Graham’s approach, now is the time to be 75% invested in shares and 25% in bonds.  This of course will vary depending upon your risk/return profile.

Why then have we not (yet) recommended big increases in share allocations for portfolios?  For the same reason that most of the rest of the world have not – the fear that the debt and deficit issues in Europe and the US will result in a Japanese style outcome for economies and shares over an extended period.  This might also include a second global financial crisis.

Going back to the 1929 share market crash, it was not until mid 1931, when countries were being progressively forced off the gold standard by investors chasing safe havens (much the way foreign investors are piling into Australian bonds for safety), that a second major bear market occurred.  In the US the sharemarket, which had already fallen almost 60% by mid 1931 then fell by more than 60% again by the first quarter of 1932 – a total fall of ~85% from the 1929 peak.

So returning to the original question – what to do from an investment perspective?

Graham made an interesting observation – that if you had invested the same amount each month from 1929 through to 1939, then the average return per annum would have been 8% - pretty remarkable given the falls outlined above and that share prices were still 68% off their 1929 peak at the end of 1939.  This return was achieved since progressively more and more shares were purchased for the same dollar outlay as markets fell.

Right now we’re nowhere close to the elevated prices of 1929 (or 2007) and I am cautiously optimistic that markets will range sideways and eventually rally higher, much as occurred in the 1970’s.  However, since the risk of being wrong could be quite significant, rather than applying significant new cash to markets (local and international) I advocate a staged entry – where regular top-ups to existing stock or through the introduction of new stock occurs – regardless of short-term market rises or falls.

The same approach applies for international investment in light of (1) low prices relative to bonds and (2) the high Australian dollar.

First half reporting season is just getting underway, so there may be some stock specific opportunities or action required.  As always, if there is a material change in your position or goals, or if you have any investment or planning queries or concerns, please contact me. 

Best wishes,

A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin
Principal, TG Financial

Please treat the above comments as General Advice, with no action to occur until we have considered with reference to your financial position, needs and goals.

Last Updated on Thursday, 22 March 2012 13:00

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