Baillieu's asset allocation
This week's fund manager interview is with Malcolm Wood, the Chief Investment Officer of Baillieu.
Baillieu is a broker investment bank and they’re financial advisers and they also have some funds management capabilities and Malcolm does that. It's difficult to get precisely what they're on about in terms of their fees and so on with their funds management business because they're a pretty bespoke outfit.
The other thing worth noting is that they focus mainly on asset allocation. But it's interesting and Malcolm has got some worthwhile views on where you and he and everybody should be positioned at the moment and his views about the market are worth hearing.
Here's Malcolm Wood, the Chief Investment Officer of Baillieu.
Malcolm, you're Chief Investment Officer, you run the wealth management business, right or at least you run the fund?
That's right.
Just paint us a picture of what your business is. Have you got one fund or do you run portfolios as SMAs or individually managed accounts?
Yeah, we do all of the above, Alan. Part of my role is to assist our financial advisers in providing all their services to clients. Whether it be asset allocation, dynamic asset allocation, equity portfolio construction, so we're doing all of that whether it be in individual portfolios or something like SMAs as you describe it.
Right, do you have a fund or not?
We've got model portfolios at the moment, we're in the process of setting up a couple of SMAs which will soon be coming out.
Can you tell us how much you've got under management or advice?
Yeah, the firm’s got somewhere around $15 billion in funds under advice.
Can you give us a sense of what your fees are?
Well, it really depends on the advice that the client is looking for. We're obviously not a cookie-cutter model, we're one where we want to consider the client’s circumstances and work out what's most appropriate and best for them. If it includes a financial plan that would obviously entail one group of services, if it's just a brokerage only account that's quite different. It really depends, Alan, and something that depends on the client’s circumstances and objectives.
Right, because the thing about Baillieu, I guess, is you're a whole lot of different things. You're a broker, as you say, you're a financial adviser and you're a wealth manager.
That’s right.
I suppose it's difficult to break them out into one thing. When we talk to wealth managers or investment managers, we always ask what the fees are just to get some comparison, right? Is it possible to tell us what your investment management fee is if someone just wants that?
Well at the moment that really depends on the arrangement that the client makes with the adviser and that's very much part and parcel of the level of advice and work that we do for the client, so it's quite bespoke. What I would say, having worked in a couple of firms, Alan, that from a price perspective we're extremely competitive.
Right, okay. Is it possible to tell us what your performance is? Do you have a single number as to how you've been going?
Yeah, we've run some asset allocation models for, I guess, one and a half years and the performance there has been above the benchmark, that's for a balanced asset allocation model. The reason we've performed above benchmark is we've had a high exposure to offshore and we've benefitted from the recent rebound in international markets but primarily from the lower Australian dollar.
What's your benchmark?
That's the Morningstar balanced asset allocation model.
Right, okay. The latest thing I've read by you on your website was something in October which was headed ‘A Bull Market Health Check’.
Right.
Which was fairly apt considering the market kept falling until Christmas Day basically, so you were a little bit ahead of the game. What's your view now?
Look, we've had a very good recovery in markets. Equity markets are up double-digit in many instances or around double-digit year to date and as you say, up even more from around Christmas, from the Christmas trough. I think we'd have to expect the rate of recovery to moderate but we're still of the view that equity markets, particularly international equity markets, are going to provide higher returns, risk adjusted, than other asset classes.
Do you think we're in a bull market still or is it a new bull market or what?
Yeah, from an international perspective, if you sort of say the US is the key measure of whether we're in a bull market or not, yes, we still are in the same bull market. Obviously, that was a pretty healthy correction in the fourth quarter as you point out, one that we think helped re-establish good value in the market. We still think the US economy will continue to grow and we've got a very supportive central bank in the US, but elsewhere as well.
You said in that note in October, ‘Bull markets do not die of old age but from recessions.’ Do you think that there is recession on the horizon or not?
I'd probably differentiate between the international environment there and the domestic environment, Alan. I think that internationally, if you look at the US the household sector fundamentals are extremely good by historic standards, good income growth whether it be through job creation or real wage growth. The benefit of the tax cuts still coming through in our view and what I think is pretty accommodative central bank policy. The corporate sector in the US is in very good health, obviously helped by the cut in the corporate tax rate but also if you extrapolate from that, you're still looking at underlying profits at record levels and balance sheets are around average in terms of leverage.
That looks pretty constructive to us as well. The usual signs of lead indicators of a recession, such as major imbalances in the economy, inflation, these sorts of indicators are generally absent. We think the US is okay, but domestically we're a lot more concerned, not forecasting a recession but we think that recession downturn risks here are unusually high primarily because of the housing downturn.
Right, so do you think that the RBA will cut interest rates this year, and if so, do you think that would prevent a recession?
Well I think the Reserve Bank has been very, very bullish on growth and with the recent post-meeting comments from the Governor, they’ve moved to a neutral bias. They've certainly trimmed their forecast but there's still pretty healthy levels so I think if the Reserve Bank was looking at things today, they would say they're not going to cut rates. However, in our view if we move forward 6 or 9 months, if the housing downturn continues as we expect and there is a negative wealth effect, i.e. consumers spend more slowly than their income growth, then we think that the Reserve Bank would cut its growth forecast again and move towards rate cuts. Will that prevent a downturn? I think it would help trim the downside but I do think we will need fiscal stimulus at some point to prevent a more serious downturn.
Well we've got an election on so fiscal stimulus is probably guaranteed in an election year.
Yeah, well I think there'll be a little bit of spending. The government in its mid-year Economic Update indicated that it had policies that are decided on but not yet announced. Which I think amounted to about $9 billion over 3 years, I think we need that and more on our economic outlook.
Tell us where that leaves your asset allocation at the moment? How are you positioned?
We think the logical place for Australians to put their assets, given that international backdrop, our domestic backdrop, the political risks here, is to be offshore. We think that the Aussie dollar will act as a shock absorber for the economy as it has in the past, so investors can take advantage or hedge against that risk by being overweight international and unhedged; being able to take advantage of a lower currency. That's our key asset allocation move.
We actually think that, whilst we've talked about the US and we're constructive on the US, we do think there are better opportunities in markets outside the US. Japan, emerging markets, even Europe, to our mind, offer decent upside from here. International equity is our key overweight, we’re underweight domestic equities, fixed income and cash as well.
Give us a sense of the proportions, what does overweight mean to you?
To give you some numbers on that, obviously the benchmark is an important consideration there but we're about 6 percentage points overweight international equities.
What's the benchmark that you're overweight? What's the percentage benchmark?
We talk about that in a strategic asset allocation sense, so that's against what we think will be the medium-term best place to be and so we're overweight 6 percentage points against that, but even more so against the benchmark.
I'm just trying to get a sense of if you look at a particular portfolio that you're running, what percentage of it is in international equities?
At the moment 40% is in a balanced international equity fund.
Right, okay and what proportion in domestic equities?
Just under 20%. From an asset allocation perspective, we are overweight growth assets, with about 65% of our portfolio in growth assets at this point.
And the rest in fixed interest and cash?
Yes correct, defensive assets, that's right.
Do you, in your international asset allocation, include ASX listed international companies?
No, so within Australian equities, if we like international or multinationals, such as say a Brambles or a QBE, we'd include that in our Australian equity exposure. International, when we look at it, is really international, so it's exposure to companies listed in other jurisdictions.
Doesn't that mean your actual exposure to international is greater than 40% or 45, whatever it is, because you probably do own CSL and Brambles and maybe Boral and all these companies. I mean they're international companies.
I think that you could look at it that way, Alan, I guess the way we look at it is to say, let's look at each of these as asset classes and project returns for them and we treat them separately. We look at international equities as one basket, Australian equities as another and within the Australian equities basket we've got companies that are domestic focused, others that are more commodity focused, others that are more global as you point out. But you can say the same thing about other markets as well. The US market has companies which have exposure to Australia, so does the European index, but we treat them as listed in, and our exposure is to them in their international, where they're listed.
But the Australian business are immaterial, they’re tiny by comparison to the main businesses. I suppose there's no point arguing with you. I'm just interested in this topic in the sense that, I suppose to some extent you talked about it as being a hedge in the sense that the Australian dollar is likely to act as a shock absorber by which you mean I guess, that it'll fall. But that, I suppose, also improves the profits of internationally exposed Australian companies, doesn’t it?
That's right, obviously most significant for exporters because they have revenues that may be denominated in international currency, principally the US dollar and a lot of Australian dollar costs. Whereas the CSLs and the Brambles of the world aren't really involved in export so it's a translation effect there. They're earning 'x' dollars in the US and when we translate that back into Australian dollar terms, it's more valuable if the currency is lower, absolutely right.
Yes, that's right. It sounds like your whole approach is all about asset allocation and that you don't do stock picking, that is to say you invest via balanced funds or possibly even ETFs, I don't know, but your service is asset allocation. Is that right?
Yeah. That's one part of our service. Asset allocation is important, we think it's a key driver of long term returns for clients. Tactical or dynamic asset allocation which we've been talking about, are we over weight or underweight particular asset classes, we think that's important as well. But that's not to diminish the importance of security selection, that obviously can add value as well. That's thinking about whether I should be overweight, BHP or Woolworths or Commonwealth Bank in an Australian equity context or not. We think that here's room to add value in all three levels, Alan.
You do do stock picking, particularly domestically?
That's right, we've got a close relationship with Credit Suisse where we get our international research as well as research the top securities in Australia and then we've got our own research team that focuses on small and midsized Australian listed companies as well. We're utilising their investment insights and ideas to help come up with Australian equity portfolios.
Right, and you mentioned the question of whether you're overweight, BHP, Woolworths or Commonwealth Bank, what's the answer?
Yeah, so it really comes back to reflecting on some of the similar themes that we've already talked about Alan, we think that there are good opportunities in Australian businesses that have significant businesses offshore, some of the names that we've already chatted about briefly would be included in that, Macquarie Group would be one that we're particularly positive on in that context. The likes of Brambles, Amcor, James Hardy, these are companies that we have in our portfolios that give us exposure to what we think will be stronger lower risk growth offshore. On the banks, to talk about Commonwealth Bank, we think that the banks are really going to struggle for growth domestically and we think that their provisioning against bad debts will have to rise over the next few years as well as the regulatory and compliance imposts that they'll face as well. We're underweight the banks.
On the consumer names like Woolworths, we struggle with the valuation of some of those names and we think that in an environment of sluggish consumer spending and intensifying competition that they'll struggle to justify those valuations, so we're underweight a lot of those consumer names. BHP we're more constructive on, it sort of fits with our view that international looks better than domestically, lower currency would obviously help BHP as well. Out of those big three, if you will, we'd be underweight CBA and Woolworths, and overweight BHP.
You really only like Australian companies that don't have their business in Australia?
Yeah, I think that that's probably the environment that we're facing. Australian companies that have the ability to export, and BHP and so on are classic examples of that, with substantial businesses in Australia. But yeah, they're exporters and will benefit from lower currency, yeah.
A bit further on retailers, so you feel that not just the grocers like Woolworths and Coles but the other retailers are challenged as well?
Yeah, I think to a greater or lesser extent, in that consumer spending is under pressure, so if you think about it Australian consumer spending over the past 5 or 6 years has been substantially assisted by the tailwind of a huge housing boom. The saving rate, the difference between income and spending, has declined from about 9% to 2.5% over that period. Now, you know some of your columns eloquently put it, Alan, there's problems in the housing market and we're thinking along similar lines that as capital gain and wealth in the property market deteriorates that people aren't going to spend faster than income anymore.
That means consumer spending is going to be sluggish, and on top of that a lot of these companies are facing the headwinds of online competition so you've got this sort of cyclical and secular headwinds facing a lot of Australian retailers, so we think it's a tricky space to have a lot of exposure to.
Yeah, great to talk to you, Malcolm, thanks.
No trouble at all, thank you for your time.
That was Malcolm Wood the Chief Investment Officer of Baillieu.