There is a school of thought that investment returns have very little to do with individual investments and are most affected by asset allocation. One of the major advantages of managed investment products is that they give investors the opportunity to allocate money into a wide range of areas, some of which would be difficult to access directly.

Diversification of investments, geographically and by way of asset allocation, has also traditionally been seen to be a defensive action, protecting investment portfolios from losing money. The rational being that if values in one asset class or location decline, then money will move away from these investments to assets in other geographic areas or asset classes.  During 2008 no amount of diversification by geography was effective in protecting investment capital, nor did diversifying amongst any sector of the stock market. Alternative asset classes such as infrastructure, private equity, hedge funds and property all performed particularly poorly. The only asset classes to give positive returns were cash and Government bonds.  

The Australian share market during 2008

No asset class in the Australian share market performed well during 2008. The performance of various asset classes is listed below: 

Source: CommSec, Iress                      

WINNERS AND LOSERSTotal returns, since 1986

Source: CommSec                                  

However, not all asset classes showed negative returns. The latest data from the Real Estate Institute shows that residential property returns posted modest growth during 2008. Across the eight capital cities, returns on 3 bedroom houses grew by 5.4% in the year to September. Best returns were in Adelaide (up 15.4% while worst was Perth (down 3.4%. Over the past five years, returns on 3 bedroom houses have grown on average by 14.1 per cent. 

This does not mean that everyone should sell there other investments and invest in residential property. But it is worth noting that this asset class has remained strong, particularly given the very bad publicity real estate has received and given that falls in housing prices, in the US and UK in particular, are major factors in the current economic malaise.

Is diversification a defunct strategy?

Definitely not! Diversification will remain a key to most people and institutions investment approach. However, the nature of diversification strategies will need to change, to cater for the vastly different environment that all investors now face. It has been common for investors, particularly institutional investors, to maintain a rigid asset allocation strategy, but it is unlikely that this approach will be successful moving forward, as the world economy changes in response to the current turmoil. An example of a significant change in asset allocation strategy can be found in the actions of the Federal Governments Future Fund, which has recently made very large investments in Debt securities, taking advantage of the premiums Australia’s banks have been prepared to pay for access to funding. 

What does this mean to Investors?

Investors need to take more note of what is happening in the wider economy and act on the information obtained. Alternatively advice should be obtained from professionals. There is a lot of conjecture as to what is going to happen in both the short and longer terms, with regard to the performance of different asset classes. There are many who look at historical stock market fluctuations, which show significant declines have traditionally been followed by strong recoveries. Those who consider that the same will occur this time will likely invest heavily in the stock market during the next 12 months. But there are others who believe that the current crisis has highlighted inherent weaknesses in the way the world economy operates and that the necessary changes will cause prolonged pain in financial markets, and continued poor performance by all asset classes.  To make an informed decision on asset allocation during the coming years, investors should consider which areas have strong fundamentals supporting growth, as these will likely be the first to recover.  

Some ideas for 2009

Different combinations of fundamentals affect various investments differently. To predict which asset classes will perform the best, investors need to make informed judgments as to which areas of the economy will recover first. Some ideas are listed below:  

1. There is a general consensus amongst economists that the performance of the Australian share market will improve during 2009, particularly during the second half of the year. Fundamentals support a recovery like that seen in 1975 and 1983, but it is also clear t hat there is a long way to go before investors regain confidence in financial markets.
2. The Australian housing market is well positioned for stronger construction, increased purchases of established dwellings and modestly firmer prices in 2009. Unlike other parts of the globe, Australia has an under-supply of housing. This has not been helped by the current economic climate, which has lead banks to tighten up significantly on development lending. This will lead to a further tightening in supply during future years.
3. It is widely expected that there will be a global economic recovery during the second half of 2009, lead by Asia. Combined with Australia’s relatively high interest rates this will lead to a firmer Aussie dollar over 2009. CommSec have stated they expect the Aussie dollar to lift to US73 cents by midyear and US77 cents by end 2009.

If the above analysis is correct you would expect businesses that have strong exposure to the share market, such as ASX Ltd, fund managers and insurers to perform well. Similarly companies that rely on a strong housing market, such as builders, developers and those selling products or services to these businesses should see improved business conditions during 2009. Meanwhile a strengthening Australian dollar will be good for importers but bad for exporters and businesses that rely on international tourists. This is a simplistic view, but is a starting point for those who wish to test their skill in predicting which areas will recover first. The current environment will likely prove to be a time of great opportunity for those who accurately predict economic trends and act on those predictions.  

A fantastic tool for investors is the fund selector at Morningstar which lists most of the funds available, and enables you to search by different criteria, such as by fund manager and sector, along with a number of other criteria. Morningstar also provides star ratings on individual funds. Morningstar also offers information such as historical performance and fees. 

A simple way to improve the returns on your current and future investments, with no additional risk, is to reduce the fees you are paying for management of your investments. This process is simple and free, it involves filling out details of existing investments on this form. For new investments send your application to us for lodgment, we will waive any upfront fees and rebate you 100% of any upfront commissions received further, if your combined investments with us generates trailing income in excess of $20 we will make cash rebates to you equal to 50% of the amount received (excl GST). Payments are made 3 times per year. 

Who do you believe?

Making a decision on what will happen during the next 12 months and betting your investment capital on that decision, is exactly that, betting. If we have learned anything from the current malaise it is the inability of anyone, including the most highly thought of professionals, to accurately predict when such events will happen. Equally there is no way to accurately predict an end, without a large dose of luck. This does not mean that investors should sit on their hands and do nothing? Not at all, but investors will have to be smarter in assessing the relative risk and reward of different investments. This is a time where superior money managers, both professional fund managers and individuals, have an opportunity show their prowess and significantly outperform the rest of the market. There are sure to be plenty of individual companies that will benefit greatly from the current conditions in the long term. Equally prices of some assets, outside of the stock market, will prove to be particularly cheap at current prices, in the future. The problem is not lack of investment opportunities, it is the difficulty in recognizing them.  

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