International equities favoured

The preference for international equities over Australian equities continues, said panellists discussing asset allocation at the 2011 Morningstar Investment Conference held in Sydney on Friday.

Australian equities were overvalued, some significantly so, said Ibbotson Associates managing director and chief investment officer, Daniel Needham. He said currently profit margins were at levels of over 10 per cent, which was unsustainable.

Schroder Investment Management head of fixed income and multi-asset, Simon Doyle (pictured), said it was not so much an issue of valuations but rather fair value. He noted that there were a number of high risk issues across the world, which were of key concern to the Australian stock market. Structural problems across Europe and the US were a key challenge for economies and investors, and volatility would continue to place pressure on markets and risk assets, he said.

“Investors shouldn’t be complacent about the bigger picture risks,” said Doyle.

Michael Karagianis, MLC Investment Management investment strategist, said the attractiveness of international equities compared to Australian equities came down to future earnings potential. He said Australia was not growing as well as offshore, partly due to the high Australian dollar and rising interest rates.

“Unless things change, Australia will continue to lag relative to international performance,” said Karagianis.

Doyle said Schroders tended to have a bias towards Australian equities, but had recently decreased its asset allocation to Australian equities because the valuation advantage had closed down.

Currency valuations were also having an impact and the panellists agreed that global unhedged equities were the way to go.

“Looking forward I think the key swing factor for the Australian part of a portfolio is the issue of currency management,” said Karagianis, adding that currency risk should be a key part of the decision making process when it came to asset allocation.

The panellists also agreed that there was no argument between cash and bonds as the asset classes were doing different things and each has a place in a portfolio. Doyle said term deposits did look attractive, but term deposits did not circumvent the role of bonds.

There was, however, some disagreement when it came to property, with Needham stating that Ibbotson Associates was probably the only insto holding Australian real estate investment trusts (REITs). He noted that Australian REITs were being looked upon a bit more favourably despite the poor performance over the global financial crisis as there had been recapitalisation, payout ratios were now much more sustainable and they were trading at a discount to net tangible assets.

Karagianis, however, considered Australian REITs to be a “busted” asset class.

“I understand that there has been some restructuring, but it is an asset class dominated by only a few players,” he said. From a retail perspective the sector was under-diversified and MLC had therefore switched to global REITs that have a broader exposure, said Karagianis.

Doyle said Schroders came close to discarding REITs but the structural changes have meant that they have been “saved by the skin of their teeth”.