According to the latest ATO statistics, listed Australian shares are still by far the biggest asset allocation for SMSFs, with real property, both residential and non-residential, running a very distant second.
While this has worked out well for SMSFs in recent times, the key question now is whether this performance will continue.
Australian market outlook
In our view, market conditions in Australia look reasonably benign over the next six months, barring any geopolitical shock. In particular, we continue to like sectors that are able to grow organically with strong cash flows. These mainly include healthcare, resources and some gaming and technology businesses.
However, investors need to be mindful that most of these companies have high earnings exposure to the US dollar. Hence, a strengthening Australian dollar would put some pressure on their earnings growth outlook. While we don’t believe the current rally in the Aussie dollar will be sustained with the clear divergence in the economic outlook between the US and our own, it is nonetheless a potential issue that needs to be monitored closely.
Looking at specific sectors, the banking sector seems to have passed APRA’s capital requirement adjustments in reasonably good shape. From here the sector should deliver on-trend growth with stable dividend yield over the next 12 months. However, the medium-term outlook is more challenging.
In the consumer discretionary end of the market there is now some value emerging. Even so, we remain cautious on that front as there is significant structural pressure faced by the sector with the imminent entry of Amazon which could drive further price deflation and margin compression.
Warning signs
SMSFs tend to be heavily invested in sectors such as banks, resources and property, and these are currently showing some warning signs that investors should be aware of.
As mentioned previously, the domestic banking sector currently offers decent yields for income-conscious investors and it seems to have passed the worst of the prudential tightening measures in recent weeks.
However, over the medium term, investors need to be mindful of a sector with substantial financial leverage in a low growth environment. There is increasing evidence that our housing market has peaked, and we are just at the beginning of the household deleveraging cycle. Without a strong housing sector, banks’ earnings and dividend growth will be challenged in the medium term despite a more benign regulatory environment.
Looking at resources, the sector went through a roller-coaster ride over the past 15 years driven almost entirely by China’s explosive economic growth and its insatiable demand for raw materials.
This growth is now clearly on the wane. China has shifted its priority from generating high economic growth to financial stability and sustainability of industry sectors. This means we have passed the peak demand for the broader commodities, and companies are now more susceptible to China’s shorter-term policy changes which will affect commodity prices.
Both the banking and resources sectors have been a very crowded trade for retail investors, including SMSFs, which means taking on the aforementioned risks will not be appropriately rewarded. Investors should become more active and seek to diversify their investments. Investing in companies exposed to new industries with higher organic growth will generate much higher risk-adjusted return in the medium term.
We would also caution exposure in bond yield sensitive sectors such as listed properties and utilities as global central banks are now moving to unwind the excess liquidity generated over the past five years and it is likely we will see those sectors underperform.
Caution ahead
Caution is definitely warranted by investors in the year ahead. The Australian domestic growth outlook is deteriorating. There is mounting evidence that the housing cycle has peaked and this is likely to be further depressed by APRA’s efforts to reduce aggressive mortgage lending. Household debt levels are high at a time when they are also experiencing flat to negative real wage growth.
The immediate risk to the economy is that excessive tightening of the lending standards could further drive down house prices, creating a negative equity effect. It is difficult to predict when this might happen, as we remain in an accommodative monetary policy environment with rates at all time low, which should support house prices. Plus improving terms of trade with higher commodity prices are helping governments pour more funding into infrastructure which should drive economic activities.
But overall we see a slightly challenging lower growth period ahead with notable risks embedded in the household sector.
Challenges for investors
A key challenge for investors over the next 12 months will be the outlook for central bank policies. The equity market has performed solidly over the past financial year largely driven by accommodative policy conditions and excess liquidity.
Going forward, the best days of the yield trade may be behind us as central banks’ accommodative monetary policy peaks out. The US Federal Reserve has already had several rate hikes and is ready to start shrinking its balance sheet by September. The European Central Bank has only just started to shift its stance from an easing bias to potentially wind back its bond purchase after seeing clear evidence of a broad-based economic recovery in the eurozone.
However, these policies remain extremely accommodative with the real cash rate across most regions still firmly in the negative territory. We are unsure at which point the shift in policy will start to impact asset prices, therefore we expect increased volatility in asset prices and currencies during this transition period.
Over the longer term, should this unwinding of policy drag on, it would inherently impact productivity and future growth which we see as a real negative for the economy and equity markets.
Being active and diversified
Our overall view, therefore, is that while the short-term outlook is relatively benign, there are warning signs over the medium and longer term, and investors would be well served by reviewing their investment approach and ensuring they are getting appropriate risk adjusted return.
To us, this means actively managing portfolios, and having adequate diversification.
We also take a long-short investment approach. The most obvious benefit of long-short investing is that it offers investors the ability to benefit from both rising and falling prices.
Traditional long-only managers are generally skewed towards identifying opportunities to buy, whereas long-short managers can take advantage of their insights across a much wider spectrum of investment opportunities through both buying and short-selling. A long-short approach also enables portfolio efficiency to better capture alpha insights while diversifying away unintended risk exposures.
But whichever approach investors take, one thing they can be sure of is that nothing stays the same for long in investment markets.
Jun Bei Liu, deputy portfolio manager, Tribeca Investment Partners
Given the view that equities might struggle to perform, and all the empirical evidence that asset allocation is the most important decision (because beta is more important than alpha), moving money from long-only equities to a long-short equities doesn’t make sense for investors.