Investors to pay a heavy price for sticking with cash

Staying out of growth assets is the biggest mistake clients make at the moment, according to David Bryant from Australian Unity Investments, who argues recent experience proves the need for clients to take their portfolios back to pre-GFC levels.

Advisers currently undertaking annual client reviews are likely to be having one of two discussions with their clients.

Some are likely to be saying, 'You have missed out on some major market growth because you were too obsessed with the safety of cash'.

Others, hopefully the majority, are saying, 'You have seen really meaningful capital growth because you maintained a balanced portfolio'.

It is easy to be wise after the event, and it’s also understandable why many investors wanted to sit on the fence over the last few years, but recent market and interest rate moves re-emphasise the need for diversification, particularly back to growth assets.

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At the beginning of last year – as is the case at the start of 2013 – many commentators were optimistic that 2012 would be the year the sharemarket made significant strides, and that the interest rate cuts would improve business and consumer confidence.

Yet there were many ups and downs in financial markets around the world during 2012, although by and large the ‘worst case’ scenarios – for example, the possibility of a collapse of the Euro zone, or the US economy falling over the ‘fiscal cliff’ – were avoided.

Despite the volatility, by the end of the year the sharemarket had made some good gains – up from 4100 to 4600, which mostly came right at the end of the year.

However, the ongoing rises and falls during the year, including a significant drop in June and another scare in November, meant many investors still found it a nerve-wracking ride.

Most professionals are now seeing the beginning of 2013 as a symbolic ‘fresh start’ for investors who can hope the next 12 months will deliver more substantial performance to their portfolios.

But what of those investors who have stayed on the sidelines, including those who still have most of their savings tied up in term deposits that are yet to mature?  

At the time of writing, these investors have already missed out on 20 per cent equity growth in the last few months – and there is still confidence in the air.

It is not too late for them to switch into growth assets and expect to see some capital gains.

Advisers should be able to take advantage of this greater confidence to convince risk-adverse clients that a balanced approach is still the best risk management strategy.  

In many ways we are at the point now where we at least know what the unknowns are, even if we aren’t exactly sure how they will play out, and this is contributing to investor confidence.

It’s a position that compares favourably with two years ago, when we couldn’t even hazard a guess at all the things we didn’t know, such as where the Eurozone would find itself.  

While natural disasters are, of course, still a wild card, the political and economic situation, by and large, is much more stable and predictable than it has been over the last couple of years.

Nevertheless, advisers may still have difficulties in convincing some clients they should be getting their portfolio back to pre-GFC levels in terms of balancing and investing in growth assets.

This does not include taking on excessive gearing or looking at complex financial instruments that few people understand. But it does mean moving out of cash and into growth assets.

While it may be understandable if investors who saw their savings fall alarmingly after the GFC are still scared of making a mistake, the biggest mistake at the moment is to stay out of growth assets.

Both the equity and property markets are at their most forgiving point in the cycle – growth over time covers up most investment mistakes made at the early stages of a recovery.

The other major mistake investors can make at the moment is at the other extreme – taking on extra risk to try to catch up on the market growth they have already missed out on.

It is not surprising all the evidence points to the fact that investors with advisers have done best in recent difficult markets.

This is because they have been encouraged to take a balanced approach in every sense of the word, and manage their risk to avoid the pitfalls that confront the less well-informed.

But what of those who have insisted on staying on the sidelines?

They need to understand the risks involved – both in getting back into markets, as well as the risks involved in not doing so.

 Investors have generally become too risk-adverse and it is a habit that needs to be broken.

They need to understand some capital risk is essential if they are to preserve and grow capital over time.

Investors in term deposits are unlikely to do much better than break even at present rates, and they now need to start looking at options that give net yields of 6-8 per cent, not 2-3 per cent.

For some, equities may still be a step too far, and for these investors diversified property trusts could be more attractive.

While the focus has been on equity, the opportunities in property have been largely overlooked due to too much emphasis on liquidity. 

Indeed, looking at some of the growth options for investors it’s nearly all good news.

Property

Property represents great value at the moment.

Yields between 7.5 per cent and 8.5 per cent are very achievable and, with some of the income tax deferred, this is very good for investors.

With interest rates at historically low levels, the opportunity to lock in conservative but very favourably priced levels of debt will only add to yields and amplify capital growth.

Australian shares

I believe the Australian share-market is still undervalued and those who pick the right stocks could see more solid gains during the year.

While there could still be ups and downs, the overall market trend will continue to be up.

The year 2013 is likely to be a year when growth managers should start to deliver valuable alpha to investors. On the other hand, index investors will find it increasingly difficult to gain traction.

International shares

The high Australian dollar has made it difficult for investors to see value in international equities, but during the course of the year this should adjust.  

Investors should keep in mind international markets provide substantial diversification that the Australian sharemarket simply doesn’t allow, due to the dominance of resource and banking stocks here.

Sectors such as IT and biotechnology, which offer major investment upside, are extremely small domestically compared to overseas markets.

Overall, we can feel fairly comfortable that the drivers for growth or contraction over the next six months will be China, the US, and Europe.

We can also have a certain level of confidence that whatever problems remain in those areas are now recognised, and are being dealt with, even though the success of managing the issues still remains to be seen.

Asian equities in particular should start to perform better in 2013, following unexpected underperformance in recent years.

The outlook for the USA is also pretty healthy. Overall, the US economy is on a slow grind upwards. It is the US that continues to lead the world in innovation and creativity, and this will eventually pull it out of its economic doldrums.  

Unfortunately Europe remains a problem area. Perhaps the best outcome for the year ahead here is an absence of disasters.

But overall there seems to be little scope for growth, and perhaps still some downwards momentum to work through before things can start to get better.

Bonds and fixed income

Reasonable yields are still achievable in bonds but investors will need to be adept. This is an asset class where the benefit of using experts is substantial.

As currency pressure comes off, bond yields should improve. However, the capital volatility which goes with this needs to be considered. Timing will be very important.

Australian investors continue to be worryingly underweight in bonds compared to investors in other countries and, particularly for those seeking an income in retirement, this needs to be addressed.

There remain good opportunities in specific sectors of the bond market, for example corporate bonds, which investors should not ignore.

Cash

Cash stands a good chance of being the worst-performing asset class of 2013.  

Achieving a return that barely covers the cost of inflation will be an outstanding result, and investors still need to take into account tax and other costs.  

The best that can be said of cash is it provides liquidity, so investors who believe they will need quick access to funds will find it useful to hold some capital in cash.

Otherwise, they should be looking for other opportunities for their investments.

Overall outlook

Overall, 2013 should be a better year for investors. Those who have their money in the right place should achieve steady and stable returns of between 7 and 8 per cent, but this means starting to move out of the perceived safety of cash and into investment options that provide greater scope for returns.

Hopefully advisers will find their clients accept the logic of this and move to a more diversified portfolio that contains a balance of growth options such as domestic and international equities, property and infrastructure assets.

David Bryant is chief executive officer and chief investment officer of Australian Unity Investments.