With the extreme market conditions that we are experiencing at the moment, it’s important to stay focussed and not lose sight of what you are looking to do in the longer term. We’ve recently spoken to a number of clients about what to do during this period of instability. Here are some of the key points to consider when assessing your portfolio

Ride Through Volatility
The recent fall in sharemarkets has been a timely reminder that there is greater risk associated with growth assets (shares and property) and this means that there are periods of volatility. It is also a time not to panic and sell assets that have recently been impacted by the market correction. Most of these investments have enjoyed stellar returns over the past few years and should continue to provide good returns over the long term.

If you entered the market recently you may not have personally experienced the longer term performances but you can look to the performance track records of the investments you hold to get a better understanding of this. Remember your long term strategy, and ensure your investment portfolio is of sufficient quality to ride through volatile investment markets.

The table below illustrates that particularly with growth assets – shares and listed property, volatility exists but the long term average performance of these asset classes rewards investors well.

 

Reduce Timing Risk
In current market conditions it is extremely difficult to predict the perfect time to invest a large amount of money into investment markets. In these type of market conditions, we prefer to reduce the risk of market timing by staggering the entry into investment markets over a period of several months.

This approach to investing is known as “Dollar Cost Averaging”. It averages out the purchase price of the investments thereby reducing the “timing risk” of investment purchases. Dollar Cost Averaging actually allows you to take advantage of the volatility of investment markets i.e. when the market falls, you’re able to buy more units.

Stay The Course
Crystallising losses after a market correction is a last resort. In most cases, investing for the long term requires discipline to ride through a market correction and volatility. By holding onto your quality assets, you will be able to enjoy the market recovery and long term growth.

In some cases it may be necessary to sell down assets which are expected to underperform in the short to medium term and reweight a portfolio towards investments offering better returns over these periods. Generally speaking these type of changes in the weightings of a portfolio are more ‘tweaking’ rather than seismic shifts.

Looking For Opportunities
Often after large market downturns, some investments are oversold, thereby providing an opportunity to purchase undervalued assets. Recognising that an investment market correction can provide this type of opportunity is important. This does not mean that investors should run out and buy shares simply because they have had large corrections but rather, having an understanding as to what caused the change in a given share price and how this relates to the true underlying value of the company.

Tactical Asset Allocation
Having an actively managed portfolio where tactical changes are made to the asset allocation can provide a better return to a portfolio. Reducing exposure to asset classes that are overvalued and increasing exposure to assets that are undervalued can increase the investment return that you are receiving. Listed Property trusts were overvalued for much of 2007, so an underweight position in this asset class would have reduced exposure to the correction that has occurred. Listed Property is now considered to be better value since the correction of December/January.

Diversification
An investment portfolio diversified across asset classes and various fund managers (and shares) provide a better platform to ride through market volatility as risk is spread across a number of investments.

Many of these ‘tips’ are familiar to many investors. While it is easy during a strong market to forget investment fundamentals and enjoy the ride, it is during market downturns that investors resolve is really tested. Have a plan and stick to it.

One final comment, if you are unsure whether your portfolio is well placed to deal with the current market conditions, give us a call.

Brendan Gallagher

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Investors in Listed Property Trusts (LPT’s) have recently had a strong reminder that their investment is starkly different from direct property investments. LPT’s have recently fallen sharply off the back of the collapse of Centro Properties Group

LPT’s have in the past been seen as a safe haven providing regular rental income compared to often less predictable dividend income from equities. But with the growth of stapled securities that bring debt and development risk into the equation LPT’s are no longer the safer haven of the past.

Compound this with complex structures where real levels of debt are not clearly visible and with significant exposure to the US and you have the Centro property group scenario. A high risk, highly geared structure vulnerable to the US led credit crunch.

This has led to a loss of confidence in the LPT sector which is down 25% since November. LPT balance sheets are being closely re-examined as investors try to avoid any further surprises.

Talk now is of the sector being at fair value, down from record highs, with LPT’s now yielding an average of 7.4%. However investors are entitled to ask whether this yield is sufficient given the current volatility and the fact that you can get close to that rate in term deposits.

A typical balanced investor will have approximately 10% exposure to the LPT sector in a super fund. At Financial Keys we have had active clients underweight in property for some time with a 7% exposure for balanced clients. In addition we have, where possible, weighted client’s property exposure towards income and away from development and debt risk.

This is in stark contrast to residential property investors. Residential property prices have risen by double digit figures in most major cities with the exception of Sydney. In 2007 house prices soared in Melbourne 18.1%, Brisbane 21.6%, Adelaide 20.2%, and Canberra 14.3%. In contrast Sydney prices grew by 8%. Different states are in different stages of the property cycle.

 

The outlook is for continued growth as demand outstrips supply. The demand is driven by record population growth due to high birth rates and immigration. This is set to continue with the government financial incentives for new born babies and the need for increased skilled migration to meet the nationwide skills shortage. Interest rate rises will clearly have a dampening effect keeping some investors on the sidelines but demand from first home buyers is expected to remain strong.

On the supply side there has been insufficient supply of land to meet demand. This became a hot issue in the lead up to the federal election with promises on both sides to increase land supply. But this problem is expected to continue for the foreseeable future.

While LPT’s have had their day of reckoning it’s important to remember that those who have held a quality portfolio of LPT’s have enjoyed a long period of high returns that far outweigh any recent correction. They also offer liquidity. You can’t sell the lounge room to pay for your next holiday but you can sell units in your LPT. They are also a passive asset, much easier to manage than an investment property.

There are many ways to invest in the property sector. LPT’s and residential property are two of the most popular but all have their place depending on your needs and objectives.

Andrew Condell

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The last quarter was characterised by a large slide in global share markets, with investors concerned about the possibility of a US recession and the potential for this to spread globally.

January in particular saw markets hit hard, with international equities falling 9.6% and Australian equities falling 11%.

The housing downturn in the US is now spreading to the broader economy leading to increased unemployment. Even though consumer spending grew in November and December it is feared that the weakness in the US housing market will reduce consumer confidence and that retail sales will fall during 2008. Unemployment in the US has now increased to 5% further dampening spending expectations. This is affecting the profitability of US companies, and international companies that are dependant on US imports.

The US Federal Reserve cut interest rates by 1.25 %, a massive reduction in such a short space of time. The size and speed of their actions says a lot about the level of concern for the state of the US economy and its ability to cope with current economic and market conditions. The US government also announced a large stimulus package delivering cash to consumers aimed at raising consumption levels. Share markets around the world responded favourably to these actions.

In Europe inflationary pressure continues to build, with food and energy prices increasing in late 2007. Interest rates appear to be on hold for the time being. Sharemarkets were spooked when Societe Generale unwound positions by a rogue trader, losing the bank €4.9billion.

China's economic growth remains strong. Although demand for consumer goods from the US appears to be slowing, demand from within China is increasing.

 

Australia on the other hand is at the other end of the spectrum to the US – an overheated economy with a tight labour market has pushed inflation above the Reserve Bank of Australia’s (RBA) target of 2 - 3%, forcing the hand of the Governor of the Reserve Bank to increase interest rates to 7%, the highest level since October 1996. The Australian economy will have to show signs of cooling, thereby easing inflationary pressure, before the RBA will be in a position to reduce interest rates.

Rising interest rates have also impacted the Australian Dollar in recent months, continuing to prop up the Australian Dollar as offshore cash seeks the high yield available in Australia. The RBA is expected to increase rates again during early 2008 in an effort to curb inflationary pressure.

The Listed Property Trust sector experienced a large correction, sparked by the near collapse of Centro Properties Group and Centro Retail group due to debt refinancing problems.

The Australian share market has enjoyed a long bull run that reached its peak on 1 November 2007. Since then investors have reacted to the bad news coming from the US and to the effects of the credit crisis on vulnerable Australian companies such as Centro, MFS and Allco Finance. On 22 January, the ASX 200 fell 7%, a fall not seen here in many years. Since then the Australian share market has regained some of the losses however volatility abounds as some highly geared companies struggle in the current environment of tight credit, and fears of a US recession.

The outlook for global share markets is for continued volatility. Credit concerns within the global financial sector and the slowdown in US growth will reduce investor confidence for companies with US earning exposure.

Brendan Gallagher

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While inconvenient for some, the latest Reserve Bank rate rise to 7.0% can be devastating for others. Interest rate rises are a blunt but effective instrument which take all in their sweep.

It’s not overburdened home owners that are the target of the latest rate rise. But they are the most vulnerable to its effects. Quite simply the Australian economy is running too hot and the tenacious Australian consumer just won’t stop spending and borrowing. The rate rises are meant to put a brake on spending and slow down inflation.

And there are more rate rises on the horizon. RBA Governor Glen Stevens predicts inflation will run above its 2 – 3 per cent target zone until mid 2010 and that further rises are needed reasonably quickly.

Our experience in Australia is in stark contrast to what is happening in many countries overseas where interest rates are on the decline. We currently have a historically low level of unemployment at 4%, some would argue that’s close to full employment, leading to labour shortages and wages pressure.

Then there is the China and India led resources boom pumping dollars into our economy, especially Qld and WA. This has lead to a skills shortage in the mining states and indirectly across Australia. Tried getting a tradesman lately? Not only are they impossible to find but they can virtually name their price with little argument from grateful consumers.

Add to all this, big tax cuts last July and another round to come this July and infrastructure spending announced by state and federal governments alike and it’s clear to see why inflation has taken off.

A large part of our consumption is coming from rising private debt which grew in December by its fastest annual rate in 19 years. This was mainly driven by business-sector borrowing, which increased by nearly 25% over the year. This money has been used to fund corporate takeover activity and capital spending as businesses seek to take advantage of a booming economy.

The recent Sub-Prime mortgage fallout in the US has led to a higher cost of debt across the globe. The Reserve Bank notes this has had only a ‘modest restraining influence” on the economy so far. It’s not enough to slow things down to the levels needed.

Importantly, interest rate rises take time to bite and on many occasions in the past the Reserve Bank has overplayed its hand leading to the hard landing. Also not all areas of the economy are booming and the interest rate cut can bite quickly in some quarters such as farming and manufacturing and take a lot longer to impact on others such as consumer spending. It remains to be seen how things play out.

Clients should take this time to monitor spending, repay personal debt, especially credit card debt and bunker down for the year ahead. It’s a good time to review personal budgets. It can also be a good time to invest as prices have come off the sharemarket considerably. However in these volatile times careful stock selection is very important. The same goes for property. The property experience has varied widely in different states and also within regions and cities.

We would also caution against fixing loan interest rates for considerable lengths. It may not be too long before rates start to turn downwards particularly if the RBA overplays its hand.

If you currently have a mortgage this could be a good opportunity to review your loans and lending strategy. Please call us to discuss.
Andrew Condell

Andrew Condell

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