|Summary: Australian investors have been handsomely rewarded from Australian property and Australian-based listed companies. This faith has been built up with more than two decades of prosperity and population growth without any annual contractions in the economy. But this trend is maturing … and investors must recognise the dangers in extrapolating the recent past to their future decisions.|
|Key take-out: After years of great domestic returns in property and local shares, Australian investors should now ask whether things have changed and they have enough exposure to overseas shares.|
|Key beneficiaries: General investors. Category: International Shares.|
Platinum Asset Management’s Kerr Neilson is one of Australia’s best known international investors. Kerr has often been interviewed by Eureka but today he debuts as a guest writer. His article kicks off our ‘Around The World In 80 Days’ series on overseas investing that Eureka has been designing to help our subscribers navigate towards profitable investment outside of our domestic market.
The series (held in partnership with Platinum Asset Management) will involve a range of webcasts, events and published research delivered to you over the next...don’t you know it... 80 days!
Watch out for our upcoming webcasts on the USA (September 30) and Europe and the UK (October 28) and live events in Sydney Sheraton on the Park on November 25 and Melbourne Sofitel on Collins on November 27.
The more you travel, the more your perspective changes; you discover locally generated myths that to an outsider are clearly aberrant and yet locals treat them as a certainty. When discussing investments with Australians, how often do you hear about the benefits of owning property or the dangers of investing abroad on account of exchange rate movements?
Fortunately, there are periodic reality checks and importantly, following the GFC, there is now greater circumspection as to the merits of negative gearing.
Once upon a time it was all about the positive attributes of leveraging an investment but now the cost of the bet going the other way is better understood.
So often it has been my experience that imperfections in the pricing of share investments arise from two human behavioural biases. They are interlinked and relate to over-emphasising the recent experience and extrapolating the current into the distant future. These short cuts are a way many of us try to deal with the overload of information and they give us a simple method for dealing with seemingly complex systems.
Why they are so damaging is that the narrative can carry huge conviction but if not married to the appropriate price, it has no worth. So when it comes to assessing risk you are actually evaluating potential gain/loss weighted against its likelihood.
To put it another way is that sometimes a low probability of an event encourages us to either ignore it or to see it as being cancelled out by the potential gain. Remember, though, that a total wipe out is just that, and to define outcomes without a view of the very worst case will be to underestimate risk. This leads us to the essence of this article.
Putting it in an Australian context
Australian investors seem to have a predilection for Australian property and Australian-based listed companies. This faith has built over the years on account of a protracted period of population growth and prosperity: 21 years without any annual contractions of the economy.
This faith in local markets has been further reinforced by the falling cost and freer access to borrowings. A relatively strong labour market which has contributed to annual rises in real wages has enhanced this feeling of well-being and Australians have responded by taking on progressively more debt.
In the late 1970s, debt to personal income was 40%; by 2013 it had risen to 150%.
As billionaire trader George Soros will tell you, the notion of reflexivity is built on participants mutually reinforcing a trend, until they don’t. The disturbance can be triggered by a surprise event that invariably seems trivial in relation to the damage done.
Identifying a maturing trend
Far from gaining comfort from a long-established trend, it is wise to progressively become more sceptical as the trend ages and matures. How do you spot that a trend is ageing? Simply by observing crowd behaviour: To note when the crowd no longer expresses doubt about it despite changing momentum of the underlying drivers.
In the residential property market the experience has been delightful for those well-entrenched. We all know the case for property but seldom are the gains expressed in compound returns and seldom are holding costs and repairs/embellishments fully accounted for. Most point to the gains in tens of thousands of dollars, which in most cases has been augmented by considerable mortgage leverage which they would never dream of applying to a long-term portfolio of shares.
This same comfort seems to apply to Australian-based listed companies. It is well-founded and perhaps a lot more justifiable than placing faith in residential property. However, the listed sector has become increasingly skewed to the major banks/insurers and the big two miners. These now account respectively for 45% and 17% of the entire market’s capitalisation.
When we look at valuations on the cyclical adjusted profits, the case is perhaps justifiable but against similar opportunities abroad, in most cases, valuations here look uninteresting.
Looking at the Australian banks separately, relative valuations are at a 30-year high and typically 80% more expensive than a portfolio of world banks! What would happen to their profitability if the government asked them to hold more capital?
After a great innings that has been driven by the Chinese miracle, surely now is the time to be questioning the underlying drivers of the Australian dollar. The terms of trade have in all probability completed a huge bull market and in a world with less reserve intervention, there are perhaps fewer central banks looking to place their surplus funds in the Australian currency.
How the smart money acts
It is a fact that the function of markets is to ration the allocation of money. For the majority of participants, precedent rules their thinking but the smart money systematically analyses what is changing rather than simply relying on the historic trend.
Over the last 20 years to December 2013 Australian equities have been superb, giving an aggregate compound gross return of 8.7% per annum, according to the 2014 long-term investment report (ASX, Russell Investments). Residential property across the country has averaged 9.9% per annum over the same period while international shares have delivered 8% per annum. The Platinum International Fund has outperformed all these markers… but that is not the message.
The key take-away is that after years of great domestic returns, Australian investors should surely now be asking whether things have changed and they have enough foreign share exposure.
Kerr Neilson is managing director and chief executive officer of Platinum Asset Management.