Investment Matters

Financial year: it’s a wrap

We have just wrapped another strong financial year for the Australian market, +13.7% (All Ordinaries Accumulation Index, XAOAI).  In fact it has been on quite a run post the GFC, with only one year of negative performance (FY-12, -7%) and six years with performance greater than 12%. 

[Your Australian shares meaningfully outperformed the market.  More information on this will be provided in your Annual Investment Review, and subsequent reports.]

 market performance

 Source: IRESS, First Samuel

 

Digging deeper

This year it is particularly interesting to look at the market on a sector basis.

The sectors of note are Financials: impacted by the share price movements of the Big-4 banks (which comprise a significant weight of both the Financials index, and the All Ordinaries and ASX200), with ANZ -1.7%, CBA -12.0%, NAB -7.4% and WBC -4.0%.  And Telecoms: impacted by Telstra -39.1%.                        

 

Source: IRESS, First Samuel

Investing in the banks?

As most clients have probably noted, we do not currently investment in the big-4 banks – and haven’t done so since before the GFC.  For any timeframes of a year or greater, this has not been to the detriment to clients (average client Australian shares portfolios have outperformed by 3.7% annualised subsequent to the GFC, 6-Mar-09 to 30-Jun-18).  This is notable given the yield chase that propelled the banks to record share prices in the post GFC / low interest rate world.

 

Source: IRESS, First Samuel

We currently do not assess the Big-4 to be a sound investment, even at their lower share prices. 

Downside risks (everything from regulatory / Royal Commission, credit contraction, capital requirements, residential housing market exposure, increasing global interest rates) are looming large.  Additionally, the companies themselves need to fix systemic structural issues / poor culture, etc.  We believe there is significant water to still pass under the bridge re the latter.

At least some of these risks have been built into the share prices – it is the reason they have fallen over FY-18.  But, as investors, in our mind two questions remain:

  1. what do the normalised earnings profiles and capital structure look like for the banks in 2 or 3 years' time? – we are struggling to get a handle on this, and 
  2. is there adequate earnings' growth over the coming 3 years to warrant investing?

For these reasons, we do not assess making an investment in one or more of the Big-4 as currently sensible.

However, there is a chance there will be a bounce-back in the share prices of the sector.  Share price recoveries – some of which can be sustained and some not – are not unusual.  Given the index weight of the banks, this could result in a period of relative underperformance for your equity portfolio.

We believe that sticking with our investment approach will, over time (we note our 3-year investment horizon), result in a better outcome for your wealth.  Thus, we will not be driven to invest in the banks because of a fear that your equity portfolio might underperform the market index over a shorter time frame.

Conclusion

The market had a strong FY-18 (and your equity investments outperformed).  The ‘market’ showed significant variation in performance at a sector level, notably Financials and Telecoms.

We are cognisant that there may be a short term underperformance of your (non-Big-4 bank owning) equity portfolio if, for instance, there is a recovery in the share prices of the Big-4 banks.  However, we believe it is important to maintain our investment approach, which focuses on long-term outperformance.