Home / Australia looking good in both equities and bonds

Australia looks like being at or near the top of the charts for long-term performance for both equities and bonds, according to work by Research Affiliates. Rob Arnott, the firm’s founder, told seminars in Sydney and Melbourne last week that most mainstream asset classes in most developed countries, however, offered less than investors expected.

Australia offered the prospect of the top performance in equities compared with Europe, Japan and the US, and with less volatility than Europe and Japan (but not the US). Research Affiliates, the manager which has done most for the development of smart beta strategies since its inception in 2002, says the long-term return for US equities will only be about 1.5 per cent.

An Australian 60:40 portfolio of equities and bonds can be expected to return 5.6 per cent versus the average for global securities (unhedged) of 2.7 per cent.

For investments outside Australia – and perhaps within Australia too – Arnott said investors should consider other asset classes because traditional asset class definitions were not the only option. He added that non-AUD exposures could be defensive. Two other strategies were:

. Unlock excess returns within asset classes. Traditionally this has been done by using active managers but smart beta strategies such as the RAFI (Research Affiliates Fundamental Index) could add value in a simple, transparent and low-cost way.

. Rebalance across asset classes. A buy-and-hold approach leads to over-weighting of recent winners. Tactical “over-rebalancing” can profit from extremes of valuation.

Considering other asset classes was the first path to improving return potential, he said. These included emerging markets equities, emerging markets local debt and currencies, high yield securities and bank loans, commodities and REITs. He said unhedged equity returns for Australian investors were more diversified.

Arnott said tradition indexing could not deliver excess returns in inefficient markets and assume that prices reflect intrinsic value. RAFI, on the other hand, assumes prices deviate from intrinsic value. RAFI could not win in certain market conditions, though, such as when momentum or growth are dominating.Active management as a collective has been shown to be unable to beat the market and is utterly reliant on manager skill.

Research Affiliates partners with other managers for the implementation of its strategies. In Australia the two main partners are Colonial First States Real Index joint venture and the implementation specialist manager Parametric.

Research Affiliates opened an Australian office early this year, staffed by Mike Aked, an Australian who had worked for the firm in the US. He is a partner and director of research for Australia.

Aked told the seminars that there had been a proliferation of smart beta strategies around the world since Research Affiliates had its major paper on “Fundamental Indexing” published in the Financial Analysts Journal in 2005. Plus, some strategies had dozens of underlying indices, covering geographies and size, for instance. RAFI had more than 100 indices associated with it.

The three main points to consider in selecting a smart beta strategy were: do “robust” research on the factors; invest in well-crafted strategies because implementation mattered, and; rely on impactful investor support – don’t chase performance.

– G.B.