10 investment lessons from 2015
Australian interest rates continued to fall, resource prices fell and the outlook for the Australian economy was weak, yet 2015, so far, was not all bad.
With technology, sustainable investments and global economies providing opportunities for some investors, here are 10 investment lessons we learned from 2015:
1.- Currency matters – falling Australian dollar
Falling Australian interest rates, uncertainty about the Australian economy and expectations of an increase in US interest rates saw the Australian dollar (AUD) fall in value. Great for investors with exposure to US dollar (USD) denominated investments but otherwise reducing 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 into market dips
Holding good levels of cash within your portfolio is an investment fundamental, but when cash rates are 2 per cent, even prudent investors can find it is difficult in practice, particularly when bank stocks may offer dividends of 6 to 8 per cent. Discipline paid off as investors with good cash levels were able to take 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.
Dixon Advisory generally takes an approach of 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 the 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. Bank investors, for example, have been tense since share prices started to come off, with some taking a 25 per cent hit. In those cases the 8 per cent dividend yield has not rewarded the investor enough.
Be cautious. Adjust your return expectations for risk. Income is important, but not at all costs.
4.- The opportunity of international equities
Part of the rush into international equities is driven by the outlook for a declining AUD and part is a longer-term trend to acknowledge there are opportunities not well represented in Australia. For example, healthcare and technology stocks are under represented on ASX and investors may need to go offshore to get that exposure.
5.- Issuance of LICs and ETFs grows and offers interesting opportunities
When building a portfolio, the approach at Dixon Advisory includes assessing a selection of Listed Investment Companies (LICs), but more recently we have seen an increase in the number of LICs and exchange-traded funds (ETFs) come to market. A variety of factors are driving this evolution. Tougher market conditions have seen the professional management offered by LICs become more highly valued. The interest in overseas exposure also helped with some internationally focused LICs listing on ASX.
ETFs have evolved from their traditional passive approach (i.e. index of the ASX 200) to offering a smart beta-style approach (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 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 has 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 around the world 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. Tesla’s massive Gigafactory, when complete in 2017, will have more lithium ion battery production capacity than all the current capacity around the world combined.
Emerging countries, particularly China, which in the past were reluctant to embrace clean energy solutions because of costs, are now embracing them out of necessity. For example, it is estimated that air pollution in China contributes to 4,000 deaths a day. VW’s admission that it cheated on emissions tests could be a huge boost to the electric car movement. Europeans are pushing back against pollution and diesel engines, and oil’s loss could be green’s gain.
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 life-long 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.
Review your risk levels and talk to a professional adviser about strategies and steps you can take to rebalance in a prudent way.
About the author
Nerida Cole is Managing Director, Financial Advisory, Dixon Advisory.
Nerida Cole is Managing Director, Financial Advisory, Dixon Advisory.