After false starts in both 2004 and 2005, the key question confronting Australian superannuation fund trustees in 2006 is: “Is a stronger position in international equities justified?”
When Super Review canvassed opinions on asset allocations at the beginning of both 2004 and 2005, there were plenty of suggestions that the time had come for funds to look offshore. The argument seemed logical enough — Australian share and property markets had out-performed and this was unlikely to be the case for another 12 months.
The problem, however, was that both domestic equities and property have not run out of steam — fuelled by compulsory superannuation fund inflows they’ve just continued to perform.
The conundrum confronting trustees has been made glaringly obvious by Mercer Investment Consulting’s latest sector survey, which looks back over 2005.
The Mercer analysis states quite baldly: “For the sixth year in succession overseas share markets were unable to match the returns from the Australian share market.”
And if trustees were in any doubt about what that statement might mean, the Mercer analysis went on to say: “An investment of $10,000 in the local share market in January 2000 will have now risen to over $19,000. A comparable investment in unhedged overseas shares would have dropped to $8,500.
The bottom line is that those managers urging superannuation funds to look offshore have not been entirely wrong in their assessments. The Mercer data shows that in 2004, overseas markets returned 9.9 per cent and performed even more strongly in 2005, returning 16.8 per cent.
But these returns look extremely modest when compared with the 22.5 per cent returned by domestic equities in calendar 2005.
Logic and history do suggest, however, that the time has come for funds to look offshore, and this is certainly a message being sold by Franklin Templeton Institutional.
The outgoing managing director of Franklin Templeton Investments Australia, John Gall, said that global equities were becoming more attractive to investors because local shares were currently more expensive than their global counterparts in nearly every sector.
Gall believes that Asian equities will attract growing investor interest over the coming year as population growth and the rise of more democratic governments create a favourable investment climate in the region.
He also believes that global property will also see increased allocations.
Perhaps it is significant that Mercer Investment Consulting Fearless Forecast survey, which reflects the views of investment managers around the world, does not point to Australian equities as being a sector likely to out-perform in 2005 but, rather, points to Japan, Brazil, Germany, Korea, China and the United States.
Indeed, the underlying message contained in Mercer’s Fearless Forecast is that Australian superannuation fund trustees should brace for more modest returns in 2006.
It said that investment managers were expecting the performance of equities in 2006 to lag the double-digit returns of last year.
According to the survey, global equity markets are expected to achieve a median return of 7.6 per cent this year, which compares to a 9.5 per cent return for the MSCI World IndexSM in 2005 and annualised historical returns for the past three years of 19.3 per cent.
Mercer principal Russell Mason said that, if anything, he believed that 2006 would be a year in which there was increasing pursuit of alternative assets such as infrastructure and private equity, with emerging markets likely to be to the fore.
Mason is loathe to suggest that international equities will be a key driver for returns through 2006 but points out that while there are still areas of volatility in the international environment, there is nothing obvious on the domestic front likely to significantly impact returns.
By comparison, Perennial Investment Partners senior portfolio manager Clay Carter believes that overseas markets are poised for another year of positive returns underpinned by solid economic growth and what he describes as “relatively undemanding valuations”.
This compares to his analysis that earnings growth for Australian equities is likely to be in single digits.
Perhaps more importantly, Carter suggests that currency is likely to present investors with less of a head wind in circumstances where the Australian dollar looks likely to be in a range of between the low to mid US 70 cents level.
At least a part of Carter’s relative optimism is driven by consensus estimates suggesting that global economies should expand by between 4 and 4.25 per cent this year, led in part by a recovering Japan and better macroeconomic conditions in the Eurozone.
“With the United States expected to expand at 3.5 per cent or more, this was likely to act as a stabilising factor as the Federal Reserve completed a series of rate rises.
“We note that global equity valuation remains extremely attractive given that markets in aggregate are currently trading at a 15 year low forward price/earnings ratio and on an earnings yield basis are still much more attractive than bonds or cash,” Carter said.
“Earnings growth, while decelerating somewhat from the heady levels of 2005, is still expected to be in the low double-digits. This should be contrasted with Australian equities where we expect earnings growth to trace back to single digits.”
Carter said that from a regional allocation perspective, the valuation anomalies that existed early last year were no longer so obvious given the strong performance of markets such as Japan and Europe in 2005.
“We would suggest that a more benchmark neutral approach be maintained with respect to the US, Eurozone and the UK,” he said.
“We believe Japan remains attractive given its recovery profile and the emerging world still only trades at some 12 times 2006 earnings while expected to grow in excess of 14 per cent,” Carter said.
He said that attractive emerging markets from Perennial’s point of view included Taiwan and China.
