Investment market update - August 2012

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UniSuper's Chief Investment Officer, John Pearce, provides a market update for UniSuper members.

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Returns are for periods to 31 July 2012. Past performance is not an indicator of future performance.

The financial year is off to a solid start, particularly for any Australian investor with exposure to the local share market. Since the onset of the financial crisis the Australian market has been a perennial underperformer. While the US share market (S&P 500) is trading about 12% below all-time highs, the ASX 300 is a massive 37% below its all-time high. This is despite the fact that the Australian economy has been far stronger than the US, demonstrating the disconnect we often see between economic growth and equity market performance (note that the Chinese share market has also been a perennial underperformer).

While various reasons have been suggested to explain the underperformance, my personal view is that the main driver has been the much higher interest rate and exchange rate environment prevailing in Australia. The flood of liquidity provided by the US central bank has found its way into risk assets in that country. Foreign investors awash with liquidity have tended to favour our bonds rather than equities, and hence the reason why over 80% of our government bonds are held by foreigners.

Given that Australia has the highest real official interest rates in the developed world, and short term bank deposits are still yielding well over 4%, it’s not hard to see why the domestic share market has not attracted large inflows. However, the market movements in August may be the early signs of the Australian market catching up, as the impact of the latest easing of interest rates works through the system. On the other hand, the strength of the currency will continue to create a headwind, particularly with respect to attracting foreign investors (referring of course to portfolio investors, as distinct from direct investors).

Can the share market rally continue?

Over the recent past we have seen spurts in the share market in response to the comforting rhetoric of politicians and central bankers, only to be met by waves of selling when reality sets in.

David Einhorn is a highly respected fund manager, who rose to fame when he short sold Lehman shares not long before the company collapsed. The diagram below illustrates his view on markets.

Diagram

While Einhorn clearly has a cynical take on events, it looks like a reasonable representation of what has happened over the past year or so. The latest rally in stocks is largely a result of the bold announcement from the President of the European Central Bank (ECB), Mario Draghi, who recently declared:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”

So in Einhorn’s parlance this is the 'announcement' to solve the problems. However, the ECB is effectively controlled by Germany, so if the Germans decide that they are not happy to support its actions, the bold announcement by Draghi will have no substance.

News from other parts of the world remain mixed, and it is easy to build a positive or negative case to support a bullish or bearish view. The USA continues to grow at sub-trend levels with employment growth now in the vicinity of about 100,000 per month compared to the 230,000 per month we were seeing in the first quarter. Chinese policymakers now appear to be far more unequivocal in their determination to get the economy growing faster, though being the second largest economy in the world, it is unrealistic to expect immediate results.

If, however, the Europeans manage to muddle through, the USA continues to grow (albeit at sub-trend levels), and China is successful in steering economic growth to desired levels, then the answer is yes, we can sustain a further rally. 

Financial Year 2011/12: UniSuper posts strong performance versus peers

Members will soon be receiving their annual statements and the bulk of our members, who are in the Balanced option, may be underwhelmed with the return of +1.7% for the 2011/12 financial year. The return over three years is 6.6%, which equates to a respectable real return after inflation of about 4% (with core CPI averaging 2.6%). Please refer to the Investments section of our website for further information on investment option returns. (Past performance is not an indicator of future performance.)

While the short term returns may be underwhelming in an absolute sense, when assessing investment performance it’s important to look at relative returns because an investor has no control over the direction and magnitude of market movements. For example, when the stock market is very weak (as it was in 2008 when the ASX 200 fell 41.29%) it is effectively impossible for a typical Balanced fund to record a positive outcome (unless it was run by Bernie Madoff). 

UniSuper’s Balanced option has a strategic allocation of 70% to growth assets (such as property and shares), and 30% to defensive assets (such as bonds and cash). Given these parameters, a return for the year of +1.7% looks reasonable given that the Australian share market was down -7% and Cash returned +4.7%. Hence, if one were to simply invest in a balanced “index” fund with 70% Australian equities / 30% Cash, the return for 2011/12 would have been about -3%. Therefore, we can say that UniSuper has outperformed this (theoretical) index portfolio. 

Relative performance is typically measured against a market based index (as per the above example), and/or against industry peers. Various agencies publish statistics on investment manager performance and the one we prefer (due to its comprehensiveness) is SuperRatings.

SuperRatings recently published their fund performance rankings for the financial year ending June 2012, and the following table summarises UniSuper’s rankings across the main investment options over various periods.

Quartile Ranking of UniSuper’s Accumulation Option Performance*

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* SuperRatings Crediting Rate Survey – as published on 26 July 2012 for the financial year ended 30 June 2012. Does not take into account any subsequent revisions or corrections made by SuperRatings. Past performance is not an indicator of future performance.

UniSuper’s core value proposition is the delivery of competitive returns at low cost. We have consistently been one of the lowest cost providers of superannuation funds in the industry. Furthermore, the above table indicates that our low cost structure has not compromised our overall ability to deliver competitive returns.

Although the above table only shows the rankings of our Accumulation options, in the same SuperRatings survey, UniSuper’s High Growth, Balanced, Conservative Balanced and Capital Stable investment options for both our Accumulation and Pension members were all in the first quartile (top 25%) of competitor funds over one and seven-year periods.

It should also be noted that our Defined Benefit Division returned 3.3% for the year (after expenses and fund taxes). The Defined Benefit Division’s portfolio has its own strategy tailored to its particular requirements, as its primary objective is to meet defined benefit commitments. For this reason, the Defined Benefit Division is not typically included in surveys. If it were, its performance would have ranked within the top decile (10%) of comparable diversified options in the SuperRatings survey.

A number of factors have contributed to our performance over the past year. The Australian share portfolios have benefited from an overweight position to small industrial companies, whose earnings growth has outperformed the broader market. Overall, our external managers added value with one in particular (Lazards) significantly outperforming the broader market, largely due to an underweight position in underperforming resource companies. The global portfolios benefited from an overweight position to the technology sector, and we also tended to hedge a higher proportion of our currency exposure than the industry average. Various unlisted assets (particularly property) also recorded very solid returns.

On the negative side, we have maintained an overweight position to the Asian markets, although the quantum of the overweight has been steadily reduced over the year. The Asian markets, despite their favourable fundamentals, have been negatively impacted by foreign outflows. Small changes in foreign capital flows tend to have a disproportionately large impact on Asian markets due to their relatively small size and lack of liquidity. Given the strong possibility that a “risk aversion” mood could prevail for some time, we are unlikely to add to our Asian exposure in the short term. Our preference for new allocations will continue to favour high yielding equities. 

Past performance is not an indicator of future performance. This information is of a general nature only and may include general advice. It has been prepared without taking into account your individual objectives, financial situation or needs. UniSuper’s investment strategies will not necessarily be appropriate for other investors. Before making any decision in relation to your UniSuper membership, you should consider your personal circumstances, the relevant product disclosure statement for your membership category and whether to consult a licensed financial adviser. This information is current as at 7 August 2012.