Major global events have changed financial markets forever, yet planners are still building portfolios the same way they did 20 years ago. Krystine Lumanta reports.
One of the enduring beliefs about emerging markets is that they are volatile and high risk. An allocation to emerging markets in a typical diversified portfolio rarely exceeds the five per cent mark.
In contrast, the typical allocation to Australian equities can be as high as 30 to 40 per cent.
Jonathan Wu, associate director and head of distribution and operations at Premium China Funds Management, says the excuses for avoiding emerging markets are inconsistent.
“I’m not going to hide behind this model of asset allocation that we’ve done for the last 20 years and accept that this is the way forward,” he says.
Wu says a commonsense approach to investing is key and the new investment world requires “diversifying away from Australian equities” as “the same rules no longer apply today”.
“That’s a really big reality check that financial planners need to accept because if they keep putting money in developed markets, especially allocating 40 per cent to Australian equities, you’re going to strike a problem at some point in time,” he says.
Wu says advisers are allocating 40 per cent to Australian equities for two reasons: because they know what they’re investing into, and because of the franking credits.
“But, through all the analysis I’ve done, both of them are completely flawed,” he says.
“If advisers say they want to know what they’re investing in exactly, what do you hire fund managers for?
“If you go to 12 Aussie equity fund manager briefings in Australia, they will all tell you why BHP is fantastic, why Fortescue is great. It’s nothing you didn’t know before.
“So how can you justify to yourself that you’re paying them a lot of fees to generate one per cent in excess of the index return, when emerging markets are providing a lot better return profile, especially for the risk level?”
The net tax gain from franking credits received from Australian equity funds isn’t a compelling argument either.
“I can tell you that it’s insignificant, because if you’re getting five per cent per annum for the last five years and you get your franking credit advantage, you add a per cent onto that. So at most, you get six per cent per annum,” Wu says.
“If you as an adviser are going to continue to give them mediocre return – and in most cases they are, because they’re sticking with fund managers that they used 10 years ago – they’re not adapting to change and [they are] setting themselves up for ultimate failure.”
Wu says the advantage of emerging markets – and what he believes will still be their advantage overall in the next 10 to 15 years – is that investments are made in markets that are severely inefficient.
“What I mean by inefficient is that if you were to plot down on a chart risk versus return and you put the ASX 200 dot smack bang in the middle of that chart, and then subsequently you plot every single Australian equity fund – active, long, short, whatever – onto that same chart, you’ll find a very interesting phenomenon.
“Everyone’s really close to the index because it’s very difficult to outperform an index in the developed market or in an efficient market like Australia,” he says.
“But if you map out the same thing in emerging markets – whether it be MSCI emerging markets, a UBS index or a FTSE index – a lot of managers will actually skew very far away from that.
“They’ll either do really poorly or really good,” Wu says.
“There’s actually not many managers that are sitting on the index of emerging markets because most of them are active management and the smart ones will go in and out as they see fit.
“That will disappear in 15 years’ time.”
Wu says that ultimately, the job of re-evaluating portfolio allocations has been snubbed because “no one’s willing to put their neck on the line to make a call [and] there is no killer instinct”.
“The thing about killer instinct in making a call is that you will make mistakes,” he says.
“But your sole aim is to ensure that the gains and the benefits that you get out of your killer instinct outweigh those losses.”
However, Wu predicts that this way of thinking will remain in the next decade.
“I think it will take us at least until when markets move over again before people start to make a call,” he says.
“We are trying to get advisers to change their mode of thinking to invest for a new world and a new decade, as opposed to doing what they were 10 years ago.”
Wu questions why there isn’t just one equities section in portfolios, part of which should include Australia, but reflecting its two per cent representation of the world, in terms of market capitalisation.
“For anyone that thinks allocating 30 per cent into Australian and New Zealand equities is a safe bet, they are setting themselves up for failure,” he says.
The problem comes down to a herd mentality issue.
“Everyone’s trying to make the safe bet and the safe bet is: if I don’t make a call, I won’t be seen as doing anything wrong.”
