Since the emergence of “Modern Portfolio Theory” and the “Capital Asset Pricing Model” in the late 1960s, institutional investors have taken a quantitatively driven approach to portfolio construction, looking to create portfolio diversification and obtain better risk-adjusted returns by balancing their asset-class exposures. This journey has seen several important advancements in thinking about how to optimally achieve desired results.
Funds that want to take the total portfolio approach first need to get the total portfolio view. To do that they not only need data – and lots of it – but a rock-solid understanding of exactly how they’re going to use it.
Order restored, for now, in asset class behaviours
One of the comforting factors about the annual Russell Investments/ASX “Long-Term Investing Report” is the regularity with which the lead changes for what is the best-performing asset class over even very long timeframes. Investment professionals know how difficult it is to predict a winner.
The latest report books Australian shares as the top performer over 10 and 20 years before and after tax. The year before, residential investment property, more surprisingly, was the top performer in gross terms over 20 years. The study tends to validate the high exposure to growth assets employed by Australian super funds compared with many of their overseas peers – another comforting factor about the report.
Now in its 15th year, the Russell/ASX study illustrates the impact of broad economic factors. The two key themes of the past 20 years have been falling bond yields and strong economic growth in Australia thanks largely to the resources boom. The next 20 years may be very different.
Scott Fletcher, Russell’s director of client investment strategies for Asia Pacific, said there were various factors investors needed to consider when looking forward rather than back. The “triple treat” of returns from domestic shares, currency movements and residential property, were unlikely to be sustained.
“The two-speed domestic economy driven by mining activities has slowed to a single pedestrian-speed growth outlook and this will impact returns from multiple domestic assets in the future,” he said.
“Although the Australian dollar has fallen more than 12 per cent in Q2 of 2013, it is still overvalued relative to history. Looking to the next 10-20 years it is unlikely that the currency will appreciate much further, and boost hedged returns by the same amount as in the past.
“Another trend that is very unlikely to continue is the multi-decade trend of falling government bond yields. While these have contributed to very strong performance in domestic and global bond markets for the last 20 years, especially providing investors with safe havens in volatile times, more realistic expectations for bond market returns for the next 10-20 years are in order.”
Over the 20 years to December 2012, gross return for Australian shares was 9.8 per cent, compared with 9.5 per cent for residential investment property, 8.5 per cent for hedged global fixed interest and 8.1 per cent for unhedged global listed property. Unhedged global shares beat only cash for that 20-year period, with a return of 5.3 per cent.
The impact of tax can be significant. On average, the tax rates paid by top marginal tax payers in the different asset classes were: 19 per cent for Australian shares, 28 per cent for both listed and residential property, 29 per cent for unhedged global shares and 36 per cent for hedged global shares, 46 per cent for global listed property, 48 per cent for Australian bonds and cash and 49 per cent for global bonds.
