Investors are reasonably concerned as to where to invest when the Australian housing market is apparently over-valued and the share market seems captive to ongoing global risks. Many are gravitating towards cash. The post-global financial crisis (GFC) investment environment is certainly challenging yet there may be worthwhile strategies and investments to consider.
The pre-GFC period was notable not just for the high returns experienced by investors but also for the extremely low volatility of those returns. Between early 2003 and its peak in late 2007, the Australian share market delivered average annual total returns of 26 per cent with only one (slight) negative quarter of return out of 18 quarters in that entire period.
By stark contrast, excluding the GFC itself, in the period since the bottom of the share market in early 2009, returns have averaged only 12 per cent per annum with three of the 10 quarters (30 per cent) over this period experiencing negative returns, including the most recent June and September quarters. The past two quarters have been particularly difficult however, with -18 per cent recorded for the share market in aggregate over this period.
From 1980 to the current date, the Australian share market averaged total returns of 11.5 per cent per annum with 40 out of 127 quarters (31 per cent) providing negative returns. That’s amazingly close to what we have seen since early 2009. It seems then that we may have been spoilt by the apparently favourable investment period persisting prior to the GFC.
Not surprisingly, investors have become extremely risk adverse in the “new normal” environment evident since the GFC. One understandable reason for this is that a higher proportion than ever of Australians are already in or, are now approaching, retirement. A commonly voiced concern is that they can’t afford to lose more capital should shares continue their decline – the ramifications on their retirement lifestyles would be potentially too severe. It is a difficult choice they face – to capitulate and jump into cash may give them short term comfort but it isn’t likely to provide them with sufficient savings to last through retirement.
However, there are strategies which may provide lower risk choices for investors in this difficult environment.
Absolute return investing describes an approach which seeks to manage risk more efficiently to deliver higher returns for any amount of risk used. In the current market turbulence, absolute return approaches which seek to deliver similar or superior longer term returns to conventional investment approaches but with lower risk could be useful to many investors.
Equity income investing seeks to maximise income from relatively more stable dividend returns rather than focussing on volatile capital gains. The relatively high proportion of total share market returns earned from dividends in Australia (around 50 per cent of long term returns) and the tax effectiveness of this (due to dividend imputation), makes this a potentially attractive strategy. This income focussed approach may appeal to many retirees looking for ways to more effectively live off of the income generated by their retirement savings.
Portfolio diversification is a fundamental strategy by which the reliability of returns can be increased.
The investment choice is often viewed as being between investing in either shares or cash – two extremes of the investment risk spectrum. However, there are a number of other asset classes which many Australian investors have little or no exposure to which could add greater diversity to investment portfolios, potentially lowering overall portfolio risk.
Asset classes such as international shares, global listed or direct commercial property, infrastructure, insurance risk, private equity and hedged funds may, when combined appropriately with existing assets, can help deliver lower overall risk.
Structured products which provide capital guarantees may also be of interest, providing investors with “sleep at night” comfort. However, it should be remembered that the embedded cost of some of these products may dramatically undermine potential investment returns.
Unfortunately no investment strategy can provide the nirvana of high returns without risk. However, some of the approaches to investing I have discussed above may offer a third choice where investors can seek to achieve higher than cash returns with potentially materially lower risk to their portfolios compared with investing in the share market or traditional strategies.
Michael Karagianis is investment strategist at MLC.