May 2013 Review Comments
Written by Tony Gray   
Monday, 13 May 2013 17:06

Portfolio Valuation & Comment

We have now entered the difficult market circumstance feared last year – where lower interest rates have cut income as fixed interest assets mature and growth assets have been bid higher in a chase for yield (meaning yields for new investment have fallen).

This has worked out well for the capital value of portfolios (i.e. risen), but from an income perspective the increased cash generation for portfolios is modest at best – and for conservative portfolios will decline as fixed interest assets mature and are re-invested at lower rates!

It is now a challenge to find assets to purchase with an adequate margin of safety.  When referring to margin of safety, it is with the view that the original purchase valuation is well founded and the long-term total return potential reasonably achievable.  Buying assets simply because they are rising and without conviction as to the underlying value means that losses may well be realised should market sentiment suddenly turn negative.

Having seen a number of portfolios from new clients this year, it is apparent that a large number of investors sold out of yield assets last year and held on to mining and related stocks.  Those investors are now capitulating, selling out of cyclicals and chasing defensives and bank stocks at elevated valuations.

The challenge in this market is that the trend may well continue on for some time – as illustrated in the US – where share and listed property prices have risen for a very extended period as interest rates have fallen to record lows.  We’re not yet selling down the sectors that are trending higher as there are no obvious yield alternatives for investors at present.  It is also apparent that ‘fear’ of capital loss has now become ‘fear’ of income loss.

Defensive Assets

It now appears that the bull market in bonds is drawing to an end.  One sign is that it is now possible to buy Australian Government Bonds on the ASX – this will be a good long-term addition to the investment choices of investors – but right now the return potential is not justified by the risk.

For example, the current implied yield on a 3 year government bond is just 2.65%; whereas investing in (say) a 3 year Westpac term deposit presently pays 4.55% - and by keeping the total exposure under $250,000 the deposit is guaranteed by the federal government (with some conditions).  This is an example of where retail investors have an advantage over large institutions.

The bond risk is not of default, but that interest rates rise over time and lead to a fall in the value of bonds.

We have been very cautious of listed income securities, due to the apparent poor total return potential relative to the equity style risk of some notes.  However, floating rate notes pay a premium to bank bill rates and in a few instances the term to run and mandatory payout of the notes does mean that a modest exposure for many portfolios is now justified.  This is something I will canvass on an individual basis as we review portfolios.

Growth Assets

The big change in the last few days has been the strength of the $US and the relative weakness of the $A.  The $A peaked against the $US in 2011 and the trend appears to be gradually downward.  This reinforces our earlier position to accumulate international shares in portfolios – whether to add more exposure is a topic for our next discussion.

We favour emerging market and Asian share exposure as they remain cheaper than local or developed market stocks, with a stronger track record of growth.  The yield return is not particularly high and there will be volatility - but the dynamism and opportunity for ‘risk’ money to flow to those regions could see very strong capital returns generated.

While growth oriented investors or traders might contemplate some oversold opportunities in the mining and mining related sectors, generally we feel the down cycle risks remain and a bigger margin of safety (i.e. lower prices) will be needed to entice us into this space.

Planning Issues

The Federal Budget is tomorrow – so any comments now might be out of date very soon.

It is absolutely clear that around the world there is a move to lift taxation and attempt to reduce government spending to varying degrees.  I am assuming the Federal Government will continue to miss the budget target by ~$20 billion – that seems to have been the average deterioration of the last few years.  No need to worry though, it’s ‘only’ a deficit of ~$55 million per day and down from ~$135 million per day the previous year!  Good thing that individuals and the private sector have lifted the savings rate in recent years to fund sustainable national economic growth.

We are focused on end of financial year planning matters and this has interrupted the portfolio review cycle.  If you would like to discuss the investment positioning of your portfolio in the short-term, then 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 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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