Investors are wildly more optimistic than financial professionals

Investors are wildly more optimistic than financial professionals

The average investor across the world has wildly more optimistic return expectations than the average financial adviser.

Boston-based Natixis Investment Managers conducted its eighth annual survey of investors, spread across 24 countries over March and April, and found the average expected long term return among the 8,550 respondents was 14.5 per cent per year. In a striking contrast, the global average amongst the financial professionals they surveyed was only 5.3 per cent per year. For the record, Australian investors expected a return of 14.4 per cent, compared to 6 per cent for the financial professionals.

The difference between investor expectations and those of financial professionals is something Natixis calls the ‘expectation gap’. For 2021 it is 174 per cent, but tellingly, it has jumped by almost half from the 2020 gap, after investors’ return expectations leaped by 25 per cent but financial professionals’ were unchanged.

Conspicuously, as financial markets have continued to rise since the surveys started in 2014, investors’ expectations have gone up hand in hand. In 2014, real returns, that is, after inflation, were expected to be 8.9 per cent, and for 2021 it’s 13 per cent.

The branch of economics that studies human behaviour refers to ‘recency bias’, which is where peoples’ expectations, and not just about financial returns, are heavily influenced by their most recent experiences, whether they be good or bad.

It’s easy to theorise that after seeing share markets rebound spectacularly from the fastest ever 30 per cent sell off, to the second fastest ever 100 per cent gain in the US, that it’s recency bias more than common sense that’s leading investors to expect the good times to keep on rolling.

By contrast, financial advisers keep getting told by highly rated, and highly paid, investment consultants, that successive years of strong, above average market returns will almost inevitably be followed by years of below average returns due to the inexorable force of mean reversion. Trees don’t grow to the sky, after all.

According to Vanguard, over the past 50 years Australian shares have averaged a return of 9.7 per cent per year and for international shares it was 9.9 per cent. However, if we change the horizon to 20 years, the return for Australian shares was 8.4 per cent, and for international it was a far less impressive 4.7 per cent. In other words, the point at which you invest makes an enormous difference.

It’s an argument that makes sense and is backed up by compelling data: the likelihood of strong future share market returns declines the higher are valuation multiples. With global share markets hitting new all-time highs, the noise around valuations grows by the day. The challenge for a smart investor is, of course, which valuation multiple do you use and why?

One of the most commonly used multiples is the Cyclically Adjusted Price to Earnings (CAPE) ratio, which is the brainchild of Nobel economics laureate Bob Shiller. For the US it’s currently above 38, and the only time it’s been higher was in the period leading up to the dotcom bust. Australia’s is a far more modest 24.

Advocates of the CAPE ratio point to its ability to predict future share market returns over the next 10 years, based entirely on what’s happened in the past. For the US, at current levels, it’s about 1 per cent per year, and for Australia, it’s about 9 per cent.

However, critics of the CAPE ratio point out it’s all but useless as a timing tool, given the US has been above its long-term average now for almost the whole of this century. Also, critically, trying to compare today’s macro environment, characterised by record low interest rates and bond yields, super accommodative monetary policy and record fiscal stimulus, to past periods that were almost the opposite, is like comparing the proverbial apples and oranges.

The same argument applies to comparing a normal PE ratio to historical averages: how do you account for vastly different inflation, bond yields and policy settings?

Unfortunately, there is no crystal ball that will tell you accurately and consistently what future returns will be. Investors may end up being right for the wrong reasons, or the conservatism of the average financial professional could prove prescient.

Guide to superannuation threshold changes

Guide to superannuation threshold changes

Changes to superannuation thresholds from 1 July 2021 to 30 June 2022

Transfer Balance Cap

The transfer balance cap rules commenced on 1 July 2017. It is a limit on the amount of superannuation a member may use to commence a tax free pension in retirement phase. It is also the level at which you may not make any further non-concessional superannuation contributions. From 1 July 2021, this transfer balance cap will increase from $1.6 million to $1.7 million.

Non-Concessional Contribution Cap

The non-concessional superannuation contribution cap will also be indexed up from $100,000pa to $110,000pa and so the 3 year bring forward rules will enable you to make a $330,000 non-concessional contribution.

Concessional Contribution Cap

The concessional superannuation contribution cap will also be index up from $25,000pa to $27,500pa. Concessional contributions include employer SG (super guarantee), salary sacrifice or deductible super contributions.

Superannuation Guarantee (SG)

The contributions you will receive from your employer will rise to 10%pa from 1 July 2021. Employers will need to pay this on salaries of up to $58,920 per quarter.

The increase in contribution limits is always a noteworthy event, given it tends to only occur every 4-5 years. For those considering utilising the 3 year bring forward provisions, it may be worth considering deferring these payments for 6 weeks. This also applies to those who were considering using their superannuation to purchase a retirement income stream prior to 1 July 2021. If you would like to discuss these changes and how to best take advantage of them, please feel free to contact us. We will be more than happy to assist.

How a hedge can counter currency fluctuations in your portfolio

How a hedge can counter currency fluctuations in your portfolio

In the darkest hours of the 2020 Virus Crisis the Australian dollar collapsed to 55 cents against the US dollar as the Little Aussie Battler was dumped in the rush to secure the safety of the default global currency. Once the panic was over, the Australian dollar began a revaluation journey that has seen it rise back to 78 cents.

Over that same period of revaluation, overseas share markets also staged a spectacular recovery, led by the US, but many Australian investors were left wondering why the returns from their international shares failed to keep up. The answer lies in what is referred to as ‘the currency effect’ due to the rising Australian dollar (AUD).

There’s no question the diversification offered by investing in international assets provides enormous benefits to a portfolio, as well as opportunities that are simply not available in the Australian market. However, on top of the challenge of finding attractive investments, there’s the added obstacle that fluctuations in the currency can have a sizeable impact on returns.

Just like shares, a currency can be cheap or expensive. When the Australian dollar is cheap, it takes more to buy the equivalent amount of a foreign currency, and vice versa. It’s a matter for debate as to what level the AUD needs to fall to in order to be considered ‘cheap’, but over the past 20 years anywhere below 65 cents is a decent rule of thumb, and around 88 it’s getting expensive.

The problem comes when cheap Australian dollars are used to buy an international asset and then the dollar rises strongly, as happened last year.

For instance, buying US$20,000 worth of a US stock when the AUD is at 65 cents, will cost A$30,769 (20,000/0.65). If the share price rises by 10 percent over the next year and the currency remains unchanged, the investment will be worth A$33,846 (22,000/0.65).

However, if instead the AUD had appreciated by 20 per cent, to 78 cents, the investment would only be worth A$28,205 (22,000/0.78). The currency effect has more than wiped out the benefits of the higher share price.

The way to overcome this potential problem is to ‘hedge’ the currency, which eliminates the impact of currency fluctuations. A hedge acts like a form of insurance, so the return will only reflect the change in value of the underlying investment.

To illustrate with an example, VanEck has an ETF listed in Australia that is based on the MSCI World Quality Index (‘quality’ is a filter that targets higher growth), which comes in a hedged and unhedged version.

Between the bottoming of global share markets in March 2020 to the end of April this year, the hedged version, QHAL, went up by more than 73 per cent. The unhedged version of the exact same portfolio went up by only 32 per cent. The difference was entirely due to the impact of the rising Australian dollar.

The impact of currency fluctuations on your portfolio graph

Indeed, any Australian-bought, unhedged international investment will have underperformed a hedged version by the same amount over that same period. The opposite can happen too. In 2011, taking advantage of the AUD trading at US$1.10 to buy unhedged international investments,  provided a multi-year tailwind as the currency gradually fell back toward its long-term trading range.

There are three solutions to address the currency effect on a portfolio. First, if the AUD appears cheap, it is possible to buy some international investments in a hedged version.

Second, there are ETFs that can act as a kind of insurance overlay for a whole portfolio. For example, the BetaShares Strong Australian Dollar Fund (AUDS) is designed to increase by more than 2 per cent if the Australian dollar rises against the US dollar by 1 per cent. Their Strong US Dollar Fund does the opposite.

Third, do nothing. There is research that argues the long-term effects of currency fluctuations are negligible because it tends to gyrate around the average. So those times the Aussie dollar appears cheap simply offset those that it appears expensive

What you need to know from the 2021-22 Federal Budget

What you need to know from the 2021-22 Federal Budget

As Scott Morrison kept reminding us this morning, ‘we are fighting the pandemic’ and so the Federal Budget focuses on key spending to drive Australia’s economic recovery.

This is a Budget promoting economic growth and employment. While you will have those who continue to have major concerns over government debt and the continued spending, could it be that we are seeing a ‘new’ way of thinking when it comes to debt? My colleague, James Weir, wrote a paper explaining this with Modern Monetary Theory (“MMT”), suggesting maybe the focus on debt is unwarranted?

So here are the simply the main features of the 2021-2022 Budget;

Personal Income Tax

Low and middle income tax offset

This will be extended to 2021-2022 providing a reduction in tax of up to $1,080 to low and middle income earners.

Superannuation

Federal Budget - Superannuation

Removing the work test

This is actually a significant change. Individuals aged 67 to 74 years will be able to make non-concessional super contributions, or salary sacrifice super contributions without meeting the work test.

However, in order to make personal deductible contributions, you will still need to meet the work test.

Downsizer contributions

The charges announced in the Budget from that article include reducing the eligibility age for 65 to 60 years of age. This scheme allows a one-off contribution of $300,000 per person from the proceeds of the sale of their home.

To learn more about downsizer contributions and how it can work for you check out my blog here.

SMSF residency restrictions

From 1 July 2022, the Government will extend the central control test from 2 years to 5 years and remove the active member test.

Super guarantee threshold

The $450 per month minimum income threshold under which employers are not required to make a super contribution for employees will be removed 1 July 2022.

First Home Buyer Scheme (FHBS)

From 1 July 2022, the Government will increase the amount of voluntary contributions to $50,000 which may be released for the purchase of a first home.

Family Support

Family Home Guarantee

The Government has introduced the Family Home Guarantee to support single parents with dependants buying a home. This is regardless of whether they are a first home buyer or a previous owner-occupier. From 1 July 2021, 10,000 guarantees will be made available over four years to eligible single parents with a deposit of as little as 2%, subject to an individual’s ability to service a loan.

The Government is also providing a further 10,000 places under the New Home Guarantee in 2021/22. This is specifically for first home buyers seeking to build a new home or purchase a newly built home with a deposit of as little as 5%.

Increasing childcare subsidy (CCS)

To ease the cost of childcare and encourage a return to the workforce, from 1 July 2022 the Government proposes to provide a higher level of CCS to families with more than one child under age 6 in childcare. The level of subsidy will increase by an extra 30% to a maximum subsidy of 95% for the second and subsequent children. For example, currently a family may receive a 50% subsidy on childcare costs for each child if family income is between $174,390 and $253,680. Under the proposal, the family would receive a CCS of 50% of costs for their first child and 80% for their second and subsequent children. The annual CCS cap of $10,560 for families earning between $189,390 and $353,660 will also be removed.

Social Security

Pension Loan Scheme

The Government has announced added flexibility by allowing up to two lump sum advances in any 12 month period up to 50% of the annual pension.

The Government will also not claim back any more than the sale price of the house used to guarantee the payment.

Aged Care

The Government has announced a $17.7b investment in aged care reform over the next 5 years which will cover:

  • Additional Home Care Packages
  • Greater access to respite care services
  • A new funding model for residential aged care
  • A new Refundable Accommodation Deposit (RAD) support loan program.

Business Support

COVID Package

The Government will extend until 30 June 2023 the instant write-off of depreciable assets as well as the ability for qualifying companies to claim back tax paid in prior years from 2018-2019 where tax losses occur until the end of the 2022-2023 financial year.

Still time to get on board for value stocks

Still time to get on board for value stocks

September 2020 marked what could be one of the most significant changes in the stock market for the past 12 years: value stocks started to outperform growth stocks. Importantly, this rotation could go on for a long time to come, offering opportunities for substantial gains.

What is meant by ‘growth’ and ‘value’ stocks?

Growth companies are those whose earnings can grow independently of the broader economy, the classic example being tech companies, or some health care stocks. Value companies are those whose earnings go up and down with the economic cycle, thus they are also called ‘cyclical’ stocks.

Since the GFC ended, value stocks have underperformed growth by the greatest margin ever. Why did that happen?

Cyclical stocks are dependent on what you might call ‘organic’ GDP growth. On one side of the economy, the GFC caused a massive slowdown in private sector growth as companies tried to get their balance sheets back in order by reducing borrowing, and on the other side, governments all over the world tried to reduce their spending to avoid blowing out national debt levels, a policy also known as austerity.

The consequence was the post-GFC economic recovery was the slowest and weakest on record, so it followed that cyclical companies’ earnings growth was also weak. Naturally, investors backed growth companies instead.

Why are value stocks back in favour?

Governments around the world have responded to the COVID crisis with massive amounts of fiscal support, which has ignited organic economic growth. Here in Australia the federal government has injected the equivalent of 13 per cent of GDP in brand new money, plus another 2 per cent came from early superannuation withdrawals. In the US it’s been a mind boggling 25 per cent, and even Europe has joined in.

The upshot is, after most economies reported record falls in GDP in June of last year, we’ve seen a sharp reversal. Australia recorded back to back quarterly GDP growth above 3 per cent for the first time in the 60 year history of the National Accounts. And in the US, Goldman Sachs is forecasting 2021 will see 8 per cent growth for the first time in 70 years.

As usual, the share market has anticipated the reversal of economic fortunes and value stocks have already enjoyed a sizeable rally. From its bottom last year, the Australian bank sector has bounced 39 per cent, energy by 34 per cent (after oil famously traded below zero last year) and materials 17 per cent.

Why value stocks could rally for a while yet

While they are sizeable moves already, it’s possible the rotation toward value stocks will continue for some time yet. The sheer size of the government stimulus packages saw the Australian household savings rate peak at 20 per cent, and it’s still at 12 per cent, which represents a lot of potential spending still to come. In the US, households are estimated to be sitting on more than US$1.6 trillion in savings, or about 9 per cent of GDP.

Another reason is shown in the chart. In the 12 years since the GFC global value stocks gave up almost 30 years of outperformance against growth stocks and appear to have only just started to claw some of that back. There have been other attempts to turn the tide that were short lived, but none have been backed by such a compelling change in macro support. Indeed, Richard Bernstein of Bernstein Advisors, formerly the Chief Investment Strategist at Merrill Lynch and one of only 57 inductees to Institutional Investor magazine’s Hall of Fame, said “the difference in performance (between value and growth stocks) could be startling to investors over the next couple of years”.

Still time to get on board for value stocks graph

How to position your portfolio

There are plenty of value-oriented fund managers you can invest with, like Perpetual and Platinum. I’ve also written previously that I think the resources sector faces a strong outlook. There are unlisted managed funds that specialise in that area, like Ausbil’s Global Resources Fund, or a listed one is the Tribeca Global Natural Resources LIC (TGF.ASX). BetaShares has an Australian resources ETF, but 53 per cent is invested in BHP, RIO and Fortescue, so it’s heavily influenced by the iron ore price.

For global exposure, VanEck’s new VLUE ETF uses a proprietary ‘Value Enhanced’ algorithm to invest in a basket of 250 value stocks from across the developed markets ex-Australia. And finally, Europe, the UK and Japan also offer a value-oriented bias.

Call us today if you’d like to discuss how to gain exposure to value stocks in your portfolio.

How to pay off your mortgage sooner and accelerate building your wealth

How to pay off your mortgage sooner and accelerate building your wealth

For most people, their mortgage will be the largest debt they will have in their lifetime. Because there are no tax benefits on this type of debt, it’s worth considering paying it off (or at least partially down) quickly so can make the most of the opportunity to accumulate wealth outside the home.

So, here are a few tips which can help you get that mortgage down.

1. Get the right loan from the start

There are so many factors to consider when deciding which is the most appropriate loan. And the loan your friend has may not be the best loan for you. Just like the loan with the lowest advertised interest rate could cost you more in the long term.

2. Understand how to use your loan

Once you have gone to the effort of structuring your loan correctly, it’s important that you know how to get the most benefit out of it. For example, an ‘offset’ account may not help you pay your home loan quicker unless you have the discipline to use it as it should be used.

3. Increase your repayments – every dollar helps!

Whether it be a lump sum payment or increasing your monthly repayments, every extra dollar will result in a saving to your interest cost and thus will reduce the time to repay your mortgage. At a 2.5%pa interest rate, an additional $200 per month repayment on the average mortgage will save approx. $30,000 in interest costs. At a 4.5% interest rate, this increases to approximately $60,000 in interest costs

4. Work on your loan early

During the early years, a higher proportion of your loan repayments are going towards paying the interest expense, with a smaller portion reducing your principal owed. So, commiting to make larger additional/lump sum repayments during the initial years of your loan will repay a larger amount of the principal and so will save on the interest costs.

5. Ask your bank for a discount

You’ll be surprised with the reduction you may get on your interest rate if you just ask.

6. Better still use a pro-active mortgage broker

A great mortgage broker is invaluable. From recommending the best loan specifically for you, to explaining how to best utilize it to getting on the front foot and asking the financial institution for a discount. Our lending manager, Cameron Purdy was able to secure our client a further discount 18 months into her loan by simply getting on the front foot and negotiating with bank. It resulted in a saving of over $900 per month!

7. Build Wealth while accelerating your mortgage repayments

A ‘debt recycling’ strategy enables you to simultaneously pay off your home loan sooner, while building an investment portfolio.

So rather than wait until you pay off your loan before commencing the build up of your wealth/investments, you can start doing it now!

And while the investment portfolio is growing, the income it generates is directed towards the home loan acting as another source of repayments and accelerating the time taken to be mortgage free!

Debt recycling is an extremely effective strategy and while popular among many professionals, it is something all who have a mortgage should consider.