SMSFundamentals: Investors Become Conservative After 2013 Rally

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SMSFundamentals is an ongoing feature series dedicated to providing SMSFs (smurfs) with valuable news, investment ideas and services, in line with SMSF requirements and obligations.

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This story was first published on March 12 for subscribers only but has now been opened to general readership.

By Greg Peel

The ASX 200 rallied 15% in 2013 in price terms and yielded handsomely for a stellar total shareholder return. Unless investors owned an index exchange traded fund (ETF) or invested in a managed index-tracking fund,  individual returns would have varied dependent on personal portfolio make-up, notwithstanding investment in other asset classes, but either way 2013 was a year in which post-GFC fear began to give way to a more “risk on” mentality. That said, solid and reliable dividend yields remained attractive.

As the end of the first quarter of the new year looms, it is clear 2014 has been a year to date of less exuberance, based largely on the fact 2013 priced in a big upswing in sentiment that now needs to be justified. Of that 15% rally, around 25% can be attributed to actual market earnings growth and 75% to increased price/earnings multiples. Or put another way, 25% reality and 75% hope. Hope, unfortunately in stock markets, does not spring eternal, so now investors are looking for earnings to catch up. The February reporting season just passed was a good start, but still there are plenty of analysts warning of “full” valuations.

Research from CoreData has shown a clear swing back to conservatism and an easing of risk tolerance among investors in the new year. In the following graph, CoreData asks the question “How likely are you to purchase a new investment product or invest in new equities within the next three months?” Responses are shown here overall and also split into three risk tolerance cohorts by the respondent’s own declaration – conservative, moderate and high risk.
 

There’s been a slight easing overall (16.9% from 17.3%) but on the split, it is the risk-tolerant investors who have reined in their exuberance while conservative investors have stepped up to the plate. As further CoreData probing implies, all cohorts are now dissatisfied with returns available in cash (term deposits) and our conservative cohort (such as SMSFs) have for some time been the biggest cash allocators.

The lack of return on cash has pushed conservative investors to allocate more funds to direct share investment, with residential property closely following as an asset class choice. CoreData’s findings corroborate with the recent investor-led run-up in house prices. High and moderate risk cohorts have chosen to reallocate their share portfolios more towards conservatism (defensive, high yield) and away from risk stocks (cyclicals, resources).

What we might deduce from the CoreData research is that risk-tolerant investors had a great 2013 and have locked in that success to some extent by shifting to a more defensive stance in 2014 while the local and global economic story plays out. Conservative investors already have less risky portfolios but they can’t go back into cash because the return is just not sufficient.

For those investors who either don’t feel confident in choosing their own stock portfolio preferences or who have better things to do (at the yacht club or nineteenth for example) than watch the market every minute of the day, the ever expanding range of ASX-listed ETFs is offering more and more one-trade portfolio choices.

The simplest way to invest in Australian stocks is to buy an ASX 200 ETF, which is an investment in “the market”, plus dividends. But the ASX 200 is a market capitalisation-weighted index which means a large chunk of your investment ends up in only a handful of mega-cap stocks. For example, about 41% of “the market” is represented by just six stocks – BHP Billiton ((BHP)), the Big Four banks and Telstra ((TLS)). Add in the two supermarkets, Rio Tinto ((RIO)) and CSL ((CSL)) and the Top 10 gives you a whopping 52% of 200.

Perhaps you, the investor, would rather not invest in resource stocks, or believe the banks to be fully valued, for example. Then there’s no point in buying the “market” ETF, and it’s back to choosing your own portfolio. But the variety of portfolio choice amongst ETFs is growing almost every month, as is the pool of investor funds finding its way into ETF investment. There are specific ETFs containing portfolios of large caps, small caps, high-yield stocks, sector-specific stocks (eg resources, financials), sub-sector specific (eg banks, REITs, emerging miners) and others in between.

This month, ETF sponsors have hit the boards with even more ETF diversity to offer.

In response to the market cap issue noted above, Market Vectors has issued an Australian Equal Weight ETF which has been developed “specifically with the intention of reducing the concentration of risk inherent in market capitalisation weighted indexes in Australia”.

The fund currently holds a portfolio of 77 listed securities equally weighted at around 1.3%. The portfolio still includes the big miners and big banks but they attract no more weighting than mid-cap inclusions such as Orica ((ORI)), Ramsay Healthcare ((RHC)) and Seek ((SEK)), the performance of which would otherwise be swamped by the big caps in a standard index fund.

“Many Australian share investors do not have exposure to mid and small-cap companies in their portfolios because traditional indices and broad based unlisted managed funds invariably focus on a few big companies, resulting in a large-cap bias and increased concentration risk,” suggests Market Vectors Australia MD Arian Neiron. “Investors will be attracted by the ease of diversifying their portfolios across many different companies, without having to pick the stocks themselves. We particularly expect strong demand from SMSFs, the fastest growing segment of the superannuation sector which has about $550 billion in assets, seeking diversified exposure to Australian securities”.

In another nod to ETF diversity, yesterday Lonsec launched a set of strategic ETF model portfolios designed to provide financial advisers and their clients access to a low-cost, diversified portfolio solution through a range of passive ETFs across traditional asset classes (Australian equities, international equities, property securities, fixed income and cash). The model portfolios range in risk profile from defensive to high risk.

In other words, rather than offering a balanced portfolio made up of a distribution into particular stocks, REITs, corporate and or government bonds and cash management trusts, Lonsec is recommending portfolios of ETFs that achieve the same risk/reward profile in a handful of positions rather than an array of positions (which reduces brokerage and simplifies tracking).

It won’t be long before we follow the US into ETFs of ETFs.

Indeed, the local ETF market has doubled to $10bn invested in just two years.
 

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