No one in the Australian superannuation industry doubts that the primary driver for double digit returns in 2004-05 was the performance of Australian equities, but the big question confronting superannuation funds, asset consultants and fund managers is: What will be the driver in 2005-06?
The reality is, however, that the strength of Australian equities through the past financial year caught many people by surprise, leading to a good deal of caution about the outlook over the next 12 months. That said, the broad consensus is that the good times with respect to Australian equities are probably over.
That, at least, is the view of Michael Wysch, senior consultant at Frontier Investment Consulting.
“It’s not as though domestic equities are ridiculously overvalued at the moment, but the reality is that they simply can’t continue doing what they’ve done over the past two years,” he said. “There have been a number of factors fueling equity strength, not least of which has been the high value of the Australian dollar against the US dollar. But if resource prices drop off, and the Australian dollar weakens, the impact will mean lower returns.”
Wysch isn’t alone in his assessment of the short-term future of domestic equity performance. Michael Coop, head of capital markets research at Intech Investment Consultants, said although Intech’s forecasts are generally restricted to the long-term, he would have to agree.
“Over the last two years, returns have been very high by historical standards. But this has followed weaker returns previously. I would say that over the five year period, returns have been slightly higher than expected for the long-term, but the strength of returns in the past two years has simply been unsustainably high,” he said.
Interestingly, Wysch and Coop’s view is one not shared by Ken Atchison, managing director of Atchison Consultants, who believes that while Australian equities may experience a much lower rate of growth in the next few years, there will not be a declining trend.
“We are reasonably positive about Australian equities, and do not feel they are excessively priced,” he said. “What we are looking for is high single-digit returns, probably around 9 per cent, and this would include imputation credits.”
Like it or not, most pundits believe that Australian equities have reached their peak, and there is now a good deal of speculation about what, ultimately, will trigger the decline.
Aside from the strong performance of the Australian dollar, Wysch identifies the cyclical nature of the share market at home and abroad as reason for a slow-down. But looking at purely domestic issues, he states that with inflation as high as 2.5 per cent, it would be hard to expect double-digit returns.
Atchison, however, sees severe impact risk from another quarter entirely.
“We see the greatest risk in the market at the moment as coming from interest rates in the United States. Until recently they have been excessively low, but if they were to suddenly spike, there would be a serious impact on both domestic and international equities,” he said.
According to Atchison, if such a spike in US interest rates did occur, super funds should look at the sudden change as an opportunity and not a crisis.
“If a US interest rate spike does occur, a savvy super fund with strong cash flows could look to move away from their benchmark asset allocation weightings,” he said. “There would be opportunity to increase exposure to both Australian and international equities. This would definitely be a buying opportunity.”
Wysch looks to the future with anticipation.
“It will be interesting to see how trends for asset allocations shape up,” he said. “It’s a tough one, because nothing seems cheap at the moment.”
Asked if changes were on the horizon for Unisuper’s asset allocations, David St. John, its chief investment officer, said that after the completion of their latest three year review of fund asset allocations, Unisuper would look to make changes to benchmarks in response to internal modeling.
“In the past, Australian shares have held quite a high weighting for us when compared to international shares, but following our recent review, that trend is likely to reverse. Exposure to international equities will increase,” he said.
Coop too, sees international equities growing in popularity for superannuation funds.
“There is definitely a developing trend towards international equities and international listed property securities as well,” he said. “There is a lot of money out there to be invested, and only limited room in domestic equities. The other options have got to gain favour.”
With domestic equities apparently losing the popularity they previously enjoyed, the favoured successor is clearly their international counterparts. But it is a belief held by both Wysch and Atchison that investors will also look to the steady favourable returns provided by some of the less volatile options.
“At the moment, there are great returns to be had in the energy sector,” said Wysch. “They might not last, but they could go on for many years. People are also looking outside of bonds at property, infrastructure and private equity, to wherever risk prices well.”
Atchison identifies income stream as the key to determining the investment options with the best risk-to-reward relationships.
“Good income streams provide stability and low volatility,” he said. “That is why direct property and infrastructure are such good options. I wouldn’t look at hedge funds because, depending on the strategy, they can be too susceptible to commercial risks.”
Wysch said that the trick was being patient:
“Chasing the latest fad may pay off, and it may not. Looking to the longer term, it is better to save the dollars and to wait for the right option with the right risk-to-reward balance.”
