Low interest rates and falling bond yields have been a feature of investment markets over the past few years, but they each reached record levels in May, with the yield on 10-year Australian Government Bonds hitting a record low of 2.2% after the Reserve Bank cut its cash rate to its lowest ever level of 1.75%.
The sharemarket lapped it all up, with the All Ordinaries Index duly delivering a 3.1%return for the month. Our Equity Income Portfolio was slightly ahead of this figure, with a return of 3.7%. Since it started accepting real money for investment last July it has returned 18.1%, compared to 4.4% for the index; since inception in 2001 it has returned 13.7% a year, compared to 7.9% for the index.
The most obvious beneficiaries of the low yields are so-called ‘income’ stocks, whose dividend yields are flattered by comparison. But ‘growth’ stocks also benefit, with analysts plugging lower discount rates into their valuation models.
That’s fair enough – valuation is a relative matter since you have to put your money somewhere – but it raises a couple of issues. The first is that the reason bond yields are low is that bond investors expect growth to be low in coming years. At the moment share investors seem to be soaking up the lower discount rate without acknowledging a lower growth rate, which is to try to have their cake and eat it too.
The lower growth rate will also affect income stocks, because more companies will find their earnings going backwards and ultimately have to cut their payouts. ANZ, BHP and Woolworths have all cut their dividends this year, and they will not be the last.
Ultimately, the theory tells us that if yield and growth assumptions are adjusted by the same amount, then it should have no net effect on valuation – but at the moment investors clearly see the glass as half-full.
The other big question is whether interest rates will stay low or return to a more normal level – and what indeed is a more normal level? Since the 1980s, the 10-year bond yield has fallen steadily from around 14%. But looking back at developed economies over centuries (ie the US and the UK), the 1980s look like the outlier, with yields closer to 4% over the long term.
Even 4% would mean a near-doubling from current levels, which would likely cause a lot of pain for shares. The bond market is telling us, though, that this is a long way off and we’re not ones to argue. We are, though, ones to be cautious – and we feel that the Equity Income Portfolio owns a good balance of attractively priced stocks with plenty of pricing power. Ultimately, we’d expect these to be the ones to perform best in most conditions.
Macquarie Group was the portfolio’s best performer in May, returning 22% thanks to increased calm in financial markets. GBST Holdings and Hotel Property Investments were also strong performers, rising 15% and 13% respectively, while OzForex recovered 10% as it finally started advertising its new brand OFX.
The biggest losers were miners BHP Billiton and South32, which lost 8% and 6% respectively, and IOOF Holdings, which fell 8% after warning that earnings would be flat in the current financial year.The portfolio didn’t conduct any trades in the month.
GROWTH OF $10,000
PEFORMANCE SUMMARY TO 31 MAY 2016
Source: Praemium, RBA. Returns are before expenses and fees. Returns are shown as annualised if the period is over 1 year. * Since Inception (SI) date is 1 July 2015.
|PERFORMANCE TO 31 MAY 2016||1 MONTH||3 MONTH||6 MONTH||SI* (P.A.)|
|Intelligent Investor Equity Income Portfolio||3.65%||12.85%||10.24%||17.02%|
|ASX All Ordinaries Accumulation Index||3.09%||11.47%||6.67%||4.39%|
|Excess to Benchmark||0.56%||1.38%||3.57%||12.63%|
While every care has been taken in preparation of this document, InvestSMART Financial Services Limited (ABN 70 089 038 531, AFSL 226435) (“InvestSMART”) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and see professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided. This document has been prepared for InvestSMART by InvestSense Pty Ltd ABN 31 601 876 528, Authorised Representative of Sentry Asset Management Pty Ltd AFSL 408 800. Financial commentary contained within this report is provided by InvestSense Pty Ltd. The information contained in this document is not intended to be a definitive statement on the subject matter nor an endorsement that this model portfolio is appropriate for you and should not be relied upon in making a decision to invest in this product. The information in this report is general information only and does not take into account your individual objectives, financial situation, needs or circumstances. No representations or warranties express or implied, are made as to the accuracy or completeness of the information, opinions and conclusions contained in this report. In preparing this report, InvestSMART and InvestSense Pty Ltd has relied upon and assumed, without independent verification, the accuracy and completeness of all information available to us. To the maximum extent permitted by law, neither InvestSMART, InvestSense Pty Ltd or their directors, employees or agents accept any liability for any loss arising in relation to this report. The suitability of the investment product to your needs depends on your individual circumstances and objectives and should be discussed with your Adviser. Potential investors must read the PDS, Approved Product List and FSG along with any accompanying materials. Investment in securities and other financial products involves risk. An investment in a financial product may have the potential for capital growth and income, but may also carry the risk that the total return on the investment may be less than the amount contributed directly by the investor. Past performance of financial products is not a reliable indicator of future performance. InvestSense Pty Ltd does not assure nor guarantee the performance of any financial products offered. Information, opinions, historical performance, calculations or assessments of performance of financial products or markets rely on assumptions about tax, reinvestment, market performance, liquidity and other factors that will be important and may fluctuate over time. InvestSense Pty Ltd, InvestSMART Financial Services Limited, its associates and their respective directors and other staff each declare that they may, from time to time, hold interests in Securities that are contained in this investment product.