November 2013 Review Comments
Written by Tony Gray   
Thursday, 21 November 2013 10:44

Portfolio Valuation & Comment

As suspected last month, on resolution (deferral) of the US debt ceiling and deficit battle, markets rallied higher – globally and in Australia.  This outcome was by no means assured – with a re-run of the whole saga a possibility in January or February.

Ten year Australian Government bond yields are now more than 50% higher than July 2012 and trending higher – with the circa 4.25% rate well above the 2.50% Reserve Bank overnight cash rate.  Business Confidence indicators, bond and share markets point to economic/profit growth.  This should see short-term interest rates rising in 2014 – providing some scope for higher income from the term deposit/fixed interest component of portfolios.

If interest rates rise too sharply – which is more in the hands of global bond investors than the Reserve Bank, then this could trigger a correction in share valuations.  This occurred to a significant degree in 1987 and to a lesser degree in 1994.  If interest rates rise at a slower rate, then rising earnings could see ‘ok’ returns from the broader sharemarket.

We are into a second year of strong returns and it is quite unusual to see two consecutive high total return years from any asset class.  There is no doubt that the higher valuations for growth assets has resulted in lower income yields and lower total return potential.  It also means risks are higher.

As I expect you are well aware by now, we don’t buy the market or link portfolios to the index.  We consider the individual return potential of the assets held.  Right now there have not been many new assets I have been happy to recommend that have a sufficient margin of safety.  For this reason there have not been a lot of new investment recommendations lately.

We only need to look at the 5% plus premiums to asset backing that the large Australian share listed investment companies are trading at (i.e. paying $1.05 to buy $1.00 worth of assets) and yields of circa 3.6% (~5% allowing for the value of the franking credit) to see the growth priced into the broader sharemarket.  Only a year ago these same listed investment companies were trading at 5% to 10% discounts to asset backing (i.e. paying 90 to 95 cents for $1.00 worth of assets) and yields were circa 5% (above 7% gross).

I have spoken to the managers of a number of well performing Australian equity managers recently – and they are running higher than normal cash reserves.  These are what may be termed ‘value’ managers and one risk is that they (and me) have become too cautious too early?  Momentum investors are buying now as the trend is up and they may well generate higher returns in the coming months?  It is now 6 years since the peak of the Australian share market (1 November 2007) and risk aversion is fading as time passes.  The purpose of these comments is to point out the higher risks/reduced return potential, but also the possibility that markets simply trend higher and that we may not be positioned to take full advantage of further rallies.

Specific Investment

The fund noted below may not be available or appropriate to your situation (depending upon your investment structure, goals etc) – but has been added to our small list of approved funds.

Acorn Capital Asia Small Cap Fund

I had the opportunity to speak at length with Douglas Loh, lead manager of this fund recently.  The Fund has only been running since November 2012 but has generated strong returns in that time frame.  The fund sits under the Australian Unity umbrella.

Douglas leads a team of 6 portfolio managers and has a very good track record with the Acorn Microcap fund, which focuses on smaller Australian stocks.  I like the fact that they use a stock picking approach and while they do benchmark to the Asian Small Cap Index they do not tie themselves to a country weighting.  For example, they see better value for Consumer Discretionary stocks in Taiwan and Indonesia in preference to China.

This fund provides exposure to between 60 and 80 smaller Asian stocks – generally with a market capitalisation measured in hundreds of millions, rather than billions.  The 1 year forward price-earnings multiple of the portfolio of 9.5 times appears cheap, return on equity of 18% is high and average gearing of ~12% is low.

I expect capital volatility to be higher (due to the nature of the markets and currency movements).  The smaller company effect, Asian growth exposure and a relatively high $A point to the potential for high returns from this fund.

Please contact me with any queries in relation to your portfolio.

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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