October 2013 Review Comments
Written by Tony Gray   
Friday, 18 October 2013 13:59

Portfolio Valuation & Comment

Attached is your portfolio as at the end of September.  You are able to access your portfolio on-line at any time and Ferne can arrange this if you require assistance.

It may well be that by the time you read this note that the US government have resolved the shut-down of some federal services and negotiated a higher debt ceiling – in that event markets will initially rally higher and the need for portfolio changes delayed.  The debt and deficit issue will have been deferred and the music will keep playing for a while longer.

If, on the other hand, there is in fact a default – where the US misses interest or capital payments due on bonds, then we don’t really know how that will pan out this time around.  The heads of major global banks describe that outcome as ‘unimaginable’ or ‘catastrophic’ – which is unhelpful.  In fact the US government has missed debt interest payments before – the last occasion was in the in 1970’s and even though the interest was paid a few weeks later, the outcome was that US bond yields rose and remained higher – even after payment.  This was in recognition that US government debt was not as risk free as had been supposed (the US does not, for example, have to pay any interest for the period of default!).  This time around the global financial system is a whole lot more complex – with all sorts of derivatives priced off bonds and using US Treasuries as the settlement mechanism.

How is any of this relevant to your portfolio positioning?

Even the risk of default should result in all bond yields being re-priced higher over time to reflect the reality that they are not risk free assets.  This results in losses or reduced returns for existing bond holders and should also theoretically result in lower valuations for growth assets.  This really only leaves cash (at-call) and term deposits as true defensive assets – at the cost of low income returns.

We already advise no exposure to bonds for direct portfolios.  For fund of fund type exposures this is simply not possible as managers use bonds as a defensive asset class.  In that circumstance it may pay to move some funds to cash and term deposits to reduce exposure.  Unfortunately adjusting a fund of fund approach to a more conservative setting results in a higher exposure to bonds!

For direct portfolios, key considerations will be the quality of asset earnings and cash-flow and the strength of the balance sheet.  We already take this into account when reviewing and discussing portfolios.  The area most at risk in portfolios is via banking stocks – initially in terms of falling share prices, but then with earnings and dividend consequences from rising funding costs and bad debts.

The yield from bank stocks remains attractive at this time – circa 7%+ allowing for the value of franking credits – so to sell down banks stocks is unappealing I realise – especially as we are talking about a risk that may not eventuate.

The point of writing about the current situation is not to panic you into a wholesale exit of growth assets to cash.  It is to highlight that real risks exist and that we should discuss what, if any, changes to your portfolio are warranted.  This very much depends upon your risk tolerance, the impact of capital gains tax, goals and so on.

Thus far markets globally have barely adjusted lower to reflect the risk of default.  To that degree at least we have not seen opportunities emerge to buy assets cheaply.  This also means there is not a pricing penalty when lightening or quitting non-performing assets to hold extra at-call monies.

I have ceased accepting new clients in the short-term to review portfolios and be available to answer questions and consider adjustments; so please make contact if we have not spoken in recent weeks.

 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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