PDF.jpg Download as PDF

2012 01 investor.jpg

On 1 January 2002, the 10 year government bond yield was 6.8%. Ten years later, 1 January 2012, it was down to 3.8% (i.e. 3.0% lower). This means that NZ government bonds have proven to be a good investment over recent times. Not only have investors picked up the yield, they have benefited from the capital gain arising from the fall in yields. The investment rule is that as interest rates fall, the capital value of a bond goes up. Good bond returns were not a New Zealand phenomena, investors investing in overseas government bonds have done slightly better.

In contrast, investors who have invested in the share markets have not faired as well. While NZ shares have been positive at 6.3% p.a., overseas shares have gone down -3.4% p.a. But overseas shares have not been negative because of the value of the shares, but because the strength of the NZ dollar. When the NZ dollar goes up, the value of overseas investments, in NZ dollar terms, goes down.

But the last ten years was significantly influenced by the last four years, which was particularly poor for shares. During this period, the contrast in returns from bonds and from shares was more dramatic.

 

Average returns (% p.a.) to 1 January 2012


Ten years Four years
NZ bonds 7.3% p.a. 9.3% p.a.
Overseas bonds 8.0% p.a 7.3% p.a.
NZ shares 6.3% p.a -6.0% p.a.
Overseas shares (before the currency impact) 2.2% p.a. -4.8% p.a.
Overseas shares (after the currency impact) -3.4% p.a. -7.0% p.a.
Inflation (NZ CPI) 2.7% p.a. 2.8% p.a.

 

 

The overseas share market chart below plots the movement of the global share markets since October 2007 (the start of the sub-prime mortgage debacle and the global financial crisis). Since October 2007, global share markets are still down 18% (but up 77% from the low in March 2009).

Overseas share market (gross, local currency)

Overseas sharemarket Jan 2012


18% remains a significant fall over a prolonged period and naturally creates a high level of uncertainty and concern. It is not known when the markets will return to their level in October 2007. However, any investor who switched out of shares in 2009, after the initial fall, will have missed the partial recovery. But with shares, it must be remembered:

  • market down-turns have happened before and will happen in the future on a regular basis. This should not be a problem provided that shares were not bought with the intention of spending the money in the next few years.
  • In the past when fall have happened, the share market has ultimately recovered, but the recovery can take several years. It is a test of an investor’s patience and willingness to take on volatility

As the last 10 years have been good for bonds and poor for shares, the temptation is always to move to bonds. However, the next 10 years is unlikely to be as good for bonds as the last ten years. In the next ten years, the returns from bonds will reflect the current yields (3.8%) plus or minus the impact of any fall or rise in the yields. To repeat the last ten years, interest rates will now have to fall to 0%. In contrast, the returns from shares will reflect the profits of companies and the balance between buyers and sellers.

 

The next ten years

Historically there has been a correlation between the ten year bond yield and the future average level of economic growth. With NZ 10 year bond yields now at 3.8%, if this relationship continues (and allowing for some inflation), it means that we are for a decade of low economic growth.

With a likely low economic growth outlook, the price of shares of companies that require growth and expansion to do well, will probably not do so well. This is unless they can increase their market share, or operate in a sector where the demographics trends give them an. It is therefore probably a time to focus more on companies where the profits do not rely on growth and where a higher portion of their profits is sourced from current revenue. Receiving higher dividends will also be beneficial. Therefore, companies with lower price earnings ratios (PEs), more certainty of revenue and higher dividends, will probably have an advantage.

So for a long-term investor, we would continue to invest in shares but with a bias to local (NZ and Australian) shares and emerging markets. Local shares for the dividends and emerging market shares for their exposure to the areas of the world that will likely experience higher growth.

For investors with immediate expenditure needs or wanting a short-term focus, the emphasis should continue to be the certainty of cash and bonds and accept that returns will be lower. While overseas bonds will probably still continue to have an advantage overtime, because of the uncertainties around the debt levels of Europe and the US, local bonds probably represent lower risk.

 

What would I do?

If I was looking to retire within 10 years and I had 60% of my money in shares today  If I was not planning to retire for 10+ years, and I had 60% of my money in shares
Given that the share markets have recently declined, my starting point would be to leave my current money invested as it is, and wait for the share markets to recover. I would not automatically realise the loss.
I would allocate my future savings to cash (or cash and bonds) if retirement was 5 years off. My goal would be to build up my cash and bonds to cover my retirement expenditure needs in the first 10 years of my retirement and therefore give the current shares plenty of time to recover, before I realised them.
I would also monitor the markets and review my strategy in 12 months. If the global situation has not shown signs of improvement, I might then start to realise some of the shares to reduce my exposure.

Given that the share markets have recently declined, my starting point would be to leave my current money invested as it is, and wait for the share markets to recover. I would not automatically realise the loss.

I would allocate my future savings to cash (or cash and bonds) if retirement was 5 years off. My goal would be to build up my cash and bonds to cover my retirement expenditure needs in the first 10 years of my retirement and therefore give the current shares plenty of time to recover, before I realised them.

I would also monitor the markets and review my strategy in 12 months. If the global situation has not shown signs of improvement, I might then start to realise some of the shares to reduce my exposure.

Given that the share markets have declined, my starting point would be to continue to invest in accordance with my current strategy. My new money will buy more shares today than it did 6 months ago and therefore boost my future average return. I see no reason to change my strategy because of recent events. This assumes that when I set my original long-term strategy, my strategy was right for my situation. 

At the same time, I would review whether having 60% in shares and the volatility that goes with this, was right for me. I am confident that the recent market downturn is not a one-off and will happen again. If this makes me feel too uncomfortable, I would change my future strategy to reduce my exposure to shares overtime.

 

Legal stuff

This article is a general investment commentary. It should not be considered as being personalised financial advice. Members should obtain appropriate financial advice from a suitably experienced Authorised Financial Advisor, before making any investment decisions. Only an Authorised Financial Advisor can legally take into account the person’s personal circumstances. SuperLife does not give personalised financial advice.