Earlier this year (January), we saw a pullback in markets which led to our article on the Titanic and Icebergs.
We are seeing a more serious adjustment recently and it can certainly be argued that the Icebergs
are getting a little bigger. Some might have names on them like ‘Trade Wars’ or ‘China’s Debt Bomb’
but the one they are all breaking off from is a pretty big one called ‘US Treasuries’.
Interest rates are going up in the US. This attracts the flood of money floating around the world
looking for yield and a safe haven. Sounds like a good thing but it is the ‘why’, the rates are going up
which is waking market volatility.
The US economy and a large portion of the companies that make up its share market have been
going gangbusters. The US share market to 30 September was pushing towards a 30% return for the
year. This booming economy has put real pressure on its employment base. In August 2018,
unemployment sat at 3.9%. The Republican infrastructure spend puts even more pressure on this
and we are finally seeing wage inflation. Things like fuel and food prices can go up and down quickly
but wage inflation is the big driver of interest rates and that is what central banks watch.
Wages go up, cost of production goes up, profitability declines, share prices that have been priced to
have spectacular growth are suddenly revised.
I could spend a lot more time on this but the really important thing for you, our clients, is not what
has happened and why, but what we were doing about it.
I will need you to bear with me because we have to talk about strategic asset allocation, index funds
and the cash alternatives. A couple of readers have just reached for the mouse (or alcohol) but hold
that thought, just for a few minutes…
Firstly Strategic Asset Allocation.
I have been around a long time and yes, I lived through ‘Black Monday’ and the October 19, 1987
crash. At the time of the crash, AMP and National Mutual were fighting for market share and it was
all about performance. National Mutual was advertising its balanced fund was at 20+percentage so
AMP was chasing as hard as it could.
How do you get performance? – more exposure to growth assets!
On the day of the crash all those years ago, ‘balanced’ fund investors in those institutions,
unbeknownst to them, had over 90% of their assets in growth assets. It wasn’t what they signed up
for and not how they were sold but by the end of October the Australian share market had dropped
by 41.8% and the US 22.68%. With over 90% of their money invested in growth assets (including
commercial property), many investors lost more than a quarter of their investments in 12 days.
Markets did recover (over 7 years) and there was some great opportunities in that period but it was
a very scary period.
What has that taught not just me, but all of us at RFS?
Strategic asset allocation counts and the ‘performance number’ always relates to how much risk you
are willing to take.
Some of you may have heard of ‘The Barefoot Investor’. There are some good common sense points
in his book though personally I prefer ‘Rich Dad, Poor Dad’ – probably showing my age here.
What disturbs me in his book and his web dialogue is his promotion of ‘Host Plus’s, Balanced fund’ as
the ‘best’ investment option for everyone across all age groups. Host Plus is not a bad option and is
designed for their average investor who is aged between 25 and 35. It has been performing well but
it is calling itself ‘balanced’ while holding 92% of investor funds in what we would call growth
assets. It uses terms like ‘defensive’ property investments to make this look less but we see
‘Property’ as growth and history would support us.
If you are 30, with 35 years to retirement this
may be entirely appropriate. You will see some big swings but you have a long time to recoup any
losses and historically growth assets will outperform in the medium to longer term.
If you are 55 or older and preparing for retirement or relying on your investments to fund your
lifestyle, you are in an entirely different position and a big loss of capital can have very significant
impacts on your prospects.
We, at RFS, are fundamentally conservative and this comes through in our portfolios. A balanced
investor in our funds would likely hold 65% of their assets in growth and 35% in defensive. This
may mean you miss out on some growth but when the market turns, which it inevitably will, the
impact is softened. If you want a Growth portfolio we have one that is 90% invested in growth and
yes it outperforms the Host Plus Balanced option (and is cheaper) but it is not for most investors.
Good, cheap access to market performance. We do not argue this and use index funds to decrease
the total cost to investor.
This sector has seen massive growth and is termed ‘passive’ investing. You basically get the market
return less some very small fees. So why not have all your money in this sort of option?
In a rapidly rising market, investors can be lulled into a false sense of security. More active
managers, start getting worried about valuations and increase their cash holdings. The active
analysts can’t see the value in certain stocks that are driving the markets and miss the lift the index
funds achieved by blindly investing with no qualitative overlay. Investors start questioning the value
of these active managers and put more and more into index until … we have a correction and
suddenly active managers show their value.
They still drop but not by as much as they are in less expensive shares. They can take advantage of
oversold stocks as they have been holding a large portion of their funds in cash, waiting for an
opportunity to buy.
At RFS we will use a combination of both as well as utilising different styles within the passive and
active options. This does mean we can lag in bull markets but not by much as we choose our
managers very carefully. When the market inevitably corrects we have designed your portfolios to
minimise the downside. This does not mean they don’t go backwards but it should be substantially
less and will normally recover more quickly.
Finally the cash alternative.
I wrote a piece in our Christmas message of 2012 on a real person, a well educated gent called
Graham who lives in Sydney. Graham is a ‘Fellow of the Society of Actuaries’ which means he knows
maths. Graham has been 92% invested in cash equivalents since 2012 waiting for disaster (8%
invested in gold stocks). He and I have had lots of conversations about investing and we catch up
most Christmas’s around a BBQ. Graham is very excited at the moment as he has finally been right
–Cash is king. Unfortunately, he has missed out on the longest bull market we have seen in recent
history and while sitting in cash has been very secure, his total return over the six years has been
Even if he had only been invested in Australian shares (international markets have performed far
better) he would have achieved a 99.98% return over the six years including this recent volatility.
Unfortunately, he was holding investments of about $1.8million which could be worth $3.55mil
today but is worth $2.09mil.
We would never advocate 100% holding in any sector but this reflects the importance of the ‘Hero
We build portfolios that benefit from growth asset exposure and also protect in volatile times.
Excluding yourself from any growth exposure leaves you at the mercy of cash and TD rates and with
cash at such low rates, it doesn’t take a lot to beat that as a benchmark.
Where to from here and back to those icebergs!
We are edging forward but not turning the ship around. As a good Irish friend of mine often used to
state, “we should make haste slowly”.
– The underlying managers were positioned conservatively. In many cases our managers have
little to no exposure to Australian banks who have been among the hardest hit in this last
– Don’t lose sight of what you are trying to achieve due to market noise.
– Retiree clients will be holding cash to fund their income needs so no assets are being sold to
meet cash requirements.
We expect to see more volatility, both up and down, and we see no great rush to buy into this
market but for the patient there are a lot of opportunities and what is currently cheap will be
expensive at some stage.
As always, we want you to be comfortable with your strategy so there are things we can do to
further de-risk your portfolios if this is causing sleepless nights. We would not be suggesting
abdication, just a tactical retreat while still staying in the field.
If you have any concerns please do not hesitate to contact us.