Holding an investment for the suggested timeframe gives investors a good chance of achieving the result they were after, but as Nathan Bode explains, it does not guarantee it.
The GFC has raised questions regarding conventional portfolio construction theory. Conventional wisdom states that the best risk-adjusted returns are achieved through a balanced approach to portfolio construction. Indeed, diversifying across asset classes worked during the GFC – where Australian large-cap equities were down 40 per cent (peak 12-month drawdown), the Australian bond market was up almost 15 per cent, and Australian cash was up more than 7 per cent.
However, this may provide cold comfort for investors who have been forced to delay their retirement due to a significant decline in the value of their nest egg.
For many of these, it was not the GFC alone that affected their retirement savings, but also the lack of adequate investment and retirement planning. Asset class suitability is becoming an increasingly critical issue, particularly with rising numbers of Australians moving closer to retirement. In the wake of the GFC, we believe it’s timely to examine the historical performance of the major asset classes – cash, fixed interest, property, and equities – to determine the most appropriate minimum holding period for each.
While our analysis largely supports conventional investment horizons, investors should remember that holding an investment for the suggested timeframe gives an increased likelihood of generating a positive return, but does not guarantee it.
Cash meets short-term savings needs
Conventional investment horizon theory suggests that an appropriate holding period for cash is typically less than one year. Cash is seen as, and has proven to be, a safe haven in times of crisis. The benchmark UBS Bank Bill Index has, without fail, provided positive returns month-on-month since its inception in March 1987.
‘For many of these, it was not the GFC alone that affected their retirement savings’
The liquidity and predictability of cash provides comfort when it comes to meeting a short-term savings need, such as the settlement of a house purchase, or short-term retirement funding. With a benchmark duration less than 60 days and a low risk of capital loss, a suitable time horizon for a cash investment can be very low (that is, days, ignoring a product’s redemption policy if investing indirectly). As a long-term investment strategy, however, the low returns on offer and limited protection against inflation relative to more “growth-style” assets may mean that cash plays a secondary role in a long-term balanced investment portfolio.
Fixed interest is at least a medium-term investment
The historical analysis we’ve conducted on this asset class supports the view that, all things being equal:
• Traditional fixed interest is a two- to three-year proposition;
• Credit is at least a three-year proposition; and
• High-yield fixed interest is at least a five-year proposition.
However, it is important to note that products offered within the fixed interest sector will vary significantly. It is important to understand these differences when determining a suitable investment horizon.
While traditional fixed interest is a relatively low-risk asset class, capital loss is still possible. Over the past 20 years, there have been two occasions where the international fixed interest sector (using the Barclays Capital Global Aggregate Index (A$ hedged) as a proxy) has experienced negative annual returns.
The index experienced rolling negative 12-month annual returns, from August 1994 to January 1995. And it experienced a negative return between February 1, 1999, and January 31, 2000.
The sector has, however, produced positive returns over rolling two-year periods since 1990 (index inception). This supports current wisdom that fixed interest funds that are invested in investment-grade government, government-related, corporate, and securitised securities are best suited to investors with two- to three-year investment horizons. It is important to note that this will vary across products, reflecting differences in product architecture.
Within the international fixed interest sector are the niche credit and high-yield sub-sectors. Credit funds predominantly invest in investment-grade corporate debt, whereas high-yield funds invest in lower-credit-quality/sub-investment-grade securities. Credit exposure tends to be more volatile than government and government-related exposure, and the allocation to lower-credit-quality securities in high-yield products often translates into less liquidity and more equity-like returns. This typically results in a longer investment horizon for credit and high-yield fixed interest products relative to conventional fixed interest counterparts.
Historical index returns, albeit limited within these sub-sectors, support the conventional belief that credit is at least a three-year proposition and that high-yield fixed interest is at least a five-year proposition, again ignoring product architecture.
Investment in property should be at least a five-year proposition
Property is the asset class where we believe the conventional investment horizon theory is most problematic. Australian real estate investment trusts (A-REITs) have historically been considered a low beta/volatility play. As such, many viewed the investment horizon for REIT products as being shorter than for other equities asset classes, albeit longer than most fixed interest sub-sectors. In recent years, this has been seriously called into question. Risk/volatility, as measured by standard deviation, has increased three-fold. Drawdown has also been significant, and higher than that experienced in broader equities sectors.
For a sector which had consistently delivered positive two-year rolling returns since September 1989 (2004 in the case of global REITs), the extent of recent negative performance – which bottomed at almost minus-70 per cent over rolling two-year periods to February 2009 – challenges the view of REITs as a low beta, low volatility asset class.
