Investment and Market Update
Justin McLaughlin, ClearView’s Chief Investment Officer, gives us his views on what’s happening in the market and the potential impact on investing for the future.
Market Update
As regular readers of this Viewpoint know, we see most equity markets as fairly valued with the risks being a series of global economic and political problems that we have described in some detail previously.
We have talked about the big picture risks a lot in past editions. We also have made the point in previous additions that valuations in equity markets are generally cheap, and in the last Viewpoint we showed a chart of Australian shares and our estimates of fair value. In this update we will continue to discuss the positive story which is the valuation picture, with a focus on emerging markets.
When we look at valuations we try to “normalise” earnings to avoid the problems of markets that only look cheap because corporate earnings are unusually elevated, or which look expensive because such earnings are unusually depressed.
For example the Australian share market is trading on a headline P/E ratio of 15.59 with a dividend yield of 4.43% (source Bloomberg). We can observe that Australian corporate earnings are somewhat depressed relative to their longer them trend. If we look at the P/E ratio on longer term trend earnings the ratio falls to 12.4 times. While 12.4 times is inexpensive even the headline P/E ratio of 15.59 times is not overly demanding in terms of historical values.
Most global markets, with the sole exception of the US share market, also look cheap. The US market looks cheap when valued on current earnings, however these earnings seem predicated on very wide and sustained profit margins being maintained, which seems unlikely over the longer term.
Fund reforms will improve diversification potential
Earlier this year we embarked on a program of changes to the ClearView funds. As the process nears completion we take a deeper look at how these changes can have a positive impact on your portfolio diversification.
You may recall in the previous issue of Viewpoint we announced some reforms to our funds to better position them to take advantage of a broader spectrum of opportunities. One of the principle steps was to add new investments into the funds, including:
- Listed International Infrastructure equities;
- Emerging Market equities; and
- International Property.
This increase in breadth was then to be supported by improving the ability for our funds to adjust their investments to match current investment opportunities. Effectively this means revising the asset allocation ranges that govern the spread of investments in which the funds can invest.
Our reform process is now well down the track, with many of the changes being completed and in operation. Specifically, this includes:
- Introducing Listed InternationalInfrastructure;
- Rebalancing funds using the new asset allocation ranges;
- Making a significant reduction in the allocation to international bonds in favour of higher yielding Australian fixed interest investments;
- Changing the mix of fund managers used in the Australian share fund to diversify the fund away from being too exposed to Australian banks and materials; and
- Restructuring the cash fund to ensure that it is largely invested in deposits with the largest and most creditworthy banks in Australia.
We are still in the process of introducing Emerging Markets investments into the funds, but expect this to be completed soon to round off the review.
Improved ability to smooth out returns
As we explained in the November 2010 issue of Viewpoint, we are making these changes to improve the diversification within the funds. The guiding principle in diversification is to spread funds into various classes that offer positive returns over time, but which don’t move in lockstep at all points in time. By blending these investments it is possible to “smooth out” the returns. If one asset class is experiencing a dip in performance, this can be counterbalanced by other asset classes that may be on an upswing.
Diversifying more intelligently
Our fund reforms, however, take the process of diversification to a deeper level than this. We recognise that diversification can be diluted if relationships between specific investments in different classes are not properly taken into account. Let’s look at an example to illustrate the point. A share fund manager may decide to spread investments into Chinese equities as well as domestic resource companies. On face value it may seem like this achieves diversification across international and domestic equity asset classes. On closer inspection, however, the relationship between the actual investments choices made could be limiting the benefit of diversification. Resource companies sell much of their product into China so any slowdown in the Chinese economy could well result in both the Chinese share values and the domestic resource share values falling.
Our approach with the ClearView funds is not only to widen the range of investments but also to manage the selection process to ensure that the mix of investments is truly diverse and complementary. This will better achieve our goal of giving you a more resilient and effective investment potential.
“We recognise that diversification can be diluted if relationships between specific investments in different classes are not properly taken into account.”
