March 2013 Review Comments
Written by Tony Gray   
Thursday, 14 March 2013 10:45

Portfolio Valuation & Comment

Volatility has increased markedly for Australian shares in the past fortnight, with several daily falls or rises of more than 1%.  The market is now trading back at the higher end of the index as achieved in late 2009/early 2010 and late 2010/early 2011. 

The composition of the index is now markedly different though – we are now seeing small energy, mining and mining related businesses dropping out of the indices and industrial stocks added to indices.  The prices of large industrial companies (including the banks) are often at the highest levels since 2008, whereas miners are well below the 2009 to 2011 peaks.

Given virtually all portfolios we advise upon have been underweight mining and energy and overweight industrials, this has been a very positive outcome.  The contrast was brought home this week when a potential new client showed me their portfolio – formed with the assistance of a major broking house on the mainland.  Big overweights to gold, mining and mining service companies had resulted in a portfolio decline in the order of 25% over the past 2 years!

To tell it straight – I am finding now a difficult point to call the short-term direction of growth markets.  We might well see the market break higher and run on quite quickly, or equally give up some of the recent gains?  Our advice has consistently been to apply more funds to growth assets as interest rates have been falling – on the view that investors will redeem bonds and term deposits and buy shares and property for higher income yields – but this is now common ‘wisdom’ and my feeling is that interest rates have or are very close to bottoming.

I’m also aware that in previous cycles I have tended to take some gains too early in market recoveries – doing very well in the early stages but then having to buy back in as earnings growth and optimism drives share prices higher over multi-year periods.

On balance, while hoping that we see some pull-back in prices to present clearer individual buy opportunities, I also recommend holdings on to existing broad exposures for the longer-term potential.  This said, selling non-performing holding to either add to cash or re-deploy to some of the opportunities still available is probable.

One clearer opportunity remains smaller companies.  These stocks have typically lagged the rise in the large blue chip stocks, but in many cases it is possible to find stronger growth in earnings, cheaper pricing relative to earnings and higher dividend yields.  This is the sector of the market we are focusing on at present.  Smaller companies do tend to perform stronger when bull markets become established, but underperform during the earlier stages.

We remain positive on international shares and discussions with managers indicate they are readily finding decent 3 to 5 year investment opportunities – so we expect to continue to gradually increase international allocations for portfolios (less so for income focused investors).

With regard to term deposits, rates dropped slightly this week, despite no cut in the RBA overnight cash rate (remains 3.0%).  My expectation is that rates are unlikely to fall much further from these levels and that longer-dated deposit rates will begin to increase as the year unfolds – but for the meantime we are keeping terms short on new/maturing deposits.

Hybrid Income Notes – National Bank & Westpac Bank

National Bank and Westpac Bank have recently offered hybrid income securities to shareholders.  Our advice is to ignore these ‘opportunities’ for the following reasons:

  •  Institutions typically consider the income yield insufficient for the higher credit risk (i.e. retail investors are buying with too much of a focus on the income side and too little on the risk side) – I agree with this view;
  •  To elaborate, the newer hybrids are riskier than the older notes on issue, as they rate further down the security chain – with large enough falls in share prices triggering automatic conversion to stock (this mechanism allows the banks to treat the money raised from issuing the notes as capital).  In other words, investors take on equity style risk for income style returns;
  •  ANZ recently failed to pay out a New Zealand note – highlighting the right and the risk that the note issuer will not automatically pay out the note at the first opportunity – so what may be presented as (say) a 5 or 7 year term may in fact become long-term or even perpetual;
  •  The yields from owning shares in the issuer are in fact higher than that of the notes, with the potential for growth through rising earnings.  While the risk of moderate share price falls does not impact income note pricing, the risk of major falls equally impacts shareholders and note holders; and
  •  Income securities involve credit spread risk – should the risk premium for credit expand, then the price of newly issued notes will fall – they definitely cannot be compared to (say) term deposits in terms of security of capital.

Despite the above view, should you wish to participate in any of the hybrid income security offers, then please make me aware – otherwise we will generally continue to recommend ignoring the offers (but always subject to the individual terms offered).

Best wishes,

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

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


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