10 investment lessons from 2015
Australian interest rates continued to fall as did the price of resources amidst a weak outlook for the Australian economy, yet 2015 was not all bad news with technology, sustainable investments and global economies all providing great investment opportunities. So what are the key outtakes from 2015?
1. Currency matters – falling Australian dollar
Falling domestic interest rates, uncertainty about our economy and expectations of an increase in US rates saw the Australian dollar (AUD) fall in value. This was actually good news for investors with exposure to US dollar (USD) denominated investments but reduced the purchasing power of Australian investors on a global scale. Should long-term fundamentals for the US remain strong, this may indicate a longer-term continued decline for the AUD. If you see more downside risk in the AUD, looking offshore or at least diversification of currency risk in your portfolio may be worthwhile.
2. Importance of cash – buying in to market dips
Holding good levels of cash within your portfolio is an investment fundamental, but when cash rates are two per cent, even prudent investors can find it is difficult in practice, particularly when bank stocks may offer dividends of six to eight per cent. Discipline paid off for investors with good cash levels who took advantage of buying opportunities when markets dipped. If cash is too low and you need funds—particularly important to retirees—being forced to sell when markets are in a dip can shave valuable capital from your portfolio. We believe in keeping at least two to three years of expenses plus short-term lump sum requirements in cash.
3. In a low-growth environment investors can get hungry for yield and forget risk
With growth slowing and interest rates at record lows, the potential yield from equities drove many investors to reallocate money from defensive assets into Australian shares, where high dividends were on offer, particularly from big banks. In the process, some investors took on more risk than they realised. In making portfolio allocation decisions it is vital to focus on the total return, not just the potential yield. For example, bank investors have been tense since share prices started to come off, with some taking a 25 per cent hit. In those cases the eight per cent dividend yield has not rewarded the investor enough. We advise being cautious – adjust your return expectations for risk. Income is important, but not at all costs.
4. International equities provides opportunities
Part of the rush into international equities was driven by the outlook for a declining AUD and a longer-term trend to acknowledge there are opportunities not well represented in Australia. For example, healthcare and technology stocks are under represented on the Australian Stock Exchange (ASX) and investors may need to go offshore to get that exposure.
5. Issuance of LICs and ETFs grows and also offers interesting opportunities
When building a portfolio, we believe in assessing a selection of Listed Investment Companies (LICs), but there has been an increase in the number of LICs and Exchange Traded Funds (ETFs) come to market. A variety of factors are driving this evolution. Tougher conditions saw the professional management offered by LICs become more highly valued. The interest in overseas exposure also helped with some internationally focused LICs listing on the ASX. ETFs have evolved from their traditional passive approach to a smart beta-style that aims to enhance returns. For example, there are ETFs using rules-based formulas that target companies with a high dividend history or those that have traded with lower volatility.
6. Regulatory change can affect even blue-chip companies
With the goal of protecting the economy in the event of a property market correction, the Australian Prudential Regulation Authority (APRA) and the government asked banks to lift the capital reserves they hold for greater stability and to withstand an increase in bad debts. These changes forced the big banks to undertake equity raisings and created a few shockwaves in the market as expectations for return on equity were adjusted downward and dividend payout ratios were questioned.
7. Technology is changing the economics of many industries
The advancement of technology such as fracking made it cheaper to get unconventional oil and gas out of the ground. As old and new suppliers fought for market share, energy prices came down significantly with widespread impact across the industry. Bricks and mortar retailers have also faced pressure from the rise of online retail. Investors should consider if the business has a strategy to adapt to technology. Some companies have incubator teams focused on developing IT and artificial intelligence programs or might buy stakes in aligned disruptive technology companies. Good companies will already be thinking about how they can use these developments to improve their business.
8. Increasing demand for sustainable investments
Extending on the theme of changes in technology, several developments are coming together that are driving sustainable investing. Costs have come down dramatically and in many countries renewable energy is already cost-competitive with fossil fuels. Other developments in areas such as battery technology will further accelerate the growth of renewable energy while emerging countries, particularly China—that in the past were reluctant to embrace clean energy solutions because of costs—are now embracing them out of necessity. Although investment opportunities have been predominately offshore, the pace of development in this area is swift, so investors should be ready.
9. Volatility is not going away, but diversification helps
With global economic uncertainty continuing, diversification is key to managing the increased levels of volatility we have experienced. Making sure you have diversified enough to be protected is critical and this is expected to become even more important in 2016. Getting investments offshore that perform differently to the Australian market helps, as does reducing concentration within asset classes.
10. Investing is emotional, as seen in high volatility
2015 has been a reminder that people can overestimate the level of risk they can tolerate. News headlines can create a sense of fear and dread and the losses realised in the GFC have a lifelong impact. Investors who can sidestep getting caught up in day-to-day market noise and stay focused on the long term will do well. Understanding how and why your investment portfolio has been constructed can help manage times of stress.
We believe in regularly reviewing your risk levels and talking to a professional advisor about strategies and steps you can take to re-balance in a prudent way.
This insight contains general financial advice and was prepared without taking into account your objectives, financial situation or needs. Any forward looking statements in this insight are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct. As always, your personal circumstances are critical when considering any financial strategy and seeking professional personal advice is highly recommended.