Marked Up June 22nd

Tragic Events

This note is not a political note but an attempt to describe the events of the week and ask questions of the protagonists.

The recent tragic events in the United States and Britain reinforce the fact that although some rhetoric is viewed by the majority as extreme, for others it resonates as fact.

No one should lose their lives when pursuing peaceful activities whether it is social or political.

The point is who is providing the filter to the rhetoric? We are becoming accustomed to hyperbole as fact.

If we demand more fact less hyperbole, we might not have a better understanding of issues but we could see how truly complex the issues are.

White Noise

Inflamed rhetoric is not solely the domain of social, political commentary. Investment articles will easily move within asset classes and jurisdictions and eventually come to a conclusion which is either get out now or get in now, it’s a matter of life or death!

An example is the statement “The Brexit vote could cause a huge buying opportunity” by Wells Fargo[i]. The emphasis here I imagine is on could, but I assume just as easily it could be a huge sell?

It isn’t that the author, Mr Wren, has an obvious bias it is just that he is a senior global equities strategist and is writing about what he believes.

Readers of Mr Wren’s article need to assess what bias he may have, which is not to say he has a conflict but just that he is writing about his subject matter.

Mr Wren believes that retail investors should step in, stating that “I've argued over the past five years that the U.S. stock market has largely been a safe haven and I continue to believe that," Wren said. Investors "need to be stepping in there. They need to be assertive. They need to stay invested and they don't want to panic on this thing."

I have no idea if he is right and neither do investors. Investors need to decide if the rhetoric matches their goals.

As a retail investor do I want to position my portfolio to take advantage of one of the most significant political votes in recent times?

Or do I need to build protection?

The white noise offers an opinion; it doesn’t seek an opinion.

A picture paints a 1000 words

Last week I wrote about negative and zero rate environments. The following chart was sent to me by a customer.

Source Pension Partners

Australia isn’t recorded but our 10 year bonds are trading at 2.12%.

When I look at these charts I wonder how global sales teams are reacting. Are they trying to sell 10 year Swiss bonds at minus 49 basis points to customers or are they doing work explaining a country on the other side of the world.

How hard is it to sell the concept of investing in Australian bonds?

We have good political and legal systems, a stable economy growing around 3%, and a rule of law that is the equal of any modern society. Our currency is one of the most liquid in the world and our bond market is robust and large.

What happens if the Northern European and Japanese savers come to the conclusion their rates won’t go up for years and it might make sense to invest in the land down under.

Crowding Out

Mario Draghi is the ECB president and as part of their QE program has advised they will be buying corporate debt.

Bloomberg reported on June 8th the ECB had bought amongst others: Anheuser-Busch, Telefonica, Siemens and Renault. They were not the only corporates acquired. The goal is to stimulate the economy and move the inflation dial.

Mario Draghi is not a trader; the stated goals of the ECB have nothing to do with buying cheap assets to make money.

Investors and savers from Europe might have different goals such as make a return or return of capital?

How do investors react when the hold to maturity returns on government bonds is less than zero and now the possibility is that some corporate debt will fall below zero because central banks wants to buy them regardless of the profit?

My guess, and it is only a guess, is either the numbers of safes, mattresses and other means of storing cash will increase or efficient sales teams will develop sales strategies that know no boundaries.

Though decisions on where to invest are not binary, it looks like the options are:

1. Believe in an equity rally regardless of the global challenges; or
2. The low rate environment means you have to follow the credit story and find value in high quality credit.

REIT’s are boring, they are hot and boring.

A REIT is a Real Estate Investment Trust, a pass through vehicle that captures rents and passes the distribution to the unit holder.

Readers may think wake me up this is too boring.

The following chart tracks the performance of the ASX200 REITs in black versus the ASX200 accumulation in red.

The AREIT market has outperformed the equity market over the last year and to some extent has done so because it is so boring!

Boring is the new black. When sovereign bonds return less money than is invested, the conservative investor will look elsewhere.

In my view the world loves the “story” of equities but desires the performance of the conservative REITS.

It is about engagement, clients like to have coffee with friends and discuss the latest and greatest company; they never talk about a real estate trust that pays them 7%.

But they pay for the coffee with the 7% from the real estate trust.

Where to from here? I have no idea but if you have a margin for error then you can approach your balanced portfolio with some insurance premium in mind.

What does it mean for Australian Investors

The challenge for Australian investors is to build out portfolios that reflect today’s world.

Some investors start with a few metrics: what return is needed? How much capital can be risked? What am I experienced in and am I prepared to be a disciplined investor?

These metrics sound onerous; they will help provide a framework for the investment decision making process. The framework won’t guarantee performance; on the other hand it may result in a better educated investor.

Start with capital, whether it is $100 or millions of dollars and decide how much you are prepared to risk. If, for example, you’re prepared to risk 10% then 10% of your wealth can be invested in risky investments.

What return is needed on the balance perhaps 7%?

So with the cash rate at 1.75% how hard will it be to earn 4 times this to achieve around 7%?

Finding assets that could return 7% is possible, for example Japanese equities. What do you as an investor know about Japanese equities and if you know nothing what are you prepared to do to learn about them?

Hybrid’s with trading margins around 5% and bank dividends are over 7% both of which have a franking requirement.

REITs also come close. So what do you know about banks and property trusts and what you are prepared to do to learn about them impacts your capacity to invest in these assets.

These are not the only assets which will generate a perceived acceptable return.

Investors need to decide if four times the cash rate is acceptable and feasible.

If it is acceptable it now needs to be sustainable. The suggestion of return is not a guarantee and that is why investors look to build buffers.

A buffer is the return over the risk free rate that investors believe is acceptable for the risk incurred. The risk free rate is the government bond curve, risk free being the fact the government can issue bonds or cash as repayment. This assumes normal government behaviour of the non-Greek variety.

If you recognise you can’t always get it right you should recognise the need to build buffers for those days when inevitably you get it wrong.

The higher the margin, the higher the implied protection.

Investing is all about return and accountability. Work on the return and recognise who is accountable. Good advisors can be an important element in the investment process but at the end of the day it is your money.

It is important you decide how you want to invest your money; it’s all about the education.

Please remember this article is not investment advice. No one but you or your advisor knows (or hopes to know) what is best for you. We want you to understand the risks. If you’re unsure then don’t act.

Please read our disclaimers and terms of use.

Have a good one.

[i] CNBC The Brexit vote could cause a huge buying opportunity: Wells Fargo