SuperLife investor update
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March 2011
One of the most important decisions an investor makes is
the portfolio’s mix of cash, bonds, property and shares.
These are the four different types of assets and the mix of
them is the overall investment strategy of the investor.
The mix is important because it ultimately explains the return
that the investor receives. So investors need to decide how
much of each asset type they should “normally” have and
whether, because of the current environment, they should
have more or less of one than normal.
Each of these decisions are not easy to make.
________________________________________
Currently, the price paid for
the future profits of a
company is lower than what
historically has been paid.
This implies that shares are
either “cheaper” than
normal or the profits of
companies are about to fall.
________________________________________
Normal mix
The normal mix of cash, bonds, property and shares for an investor, is a combination of what will
“theoretically” achieve the investor’s return requirements and what risks the investor then chooses to
take. While determining the theoretical mix can be straightforward, understanding an investor’s
emotional drivers (hope, fear, greed and regret) for risk is a lot harder.
The theoretical decision will depend on the investor’s personal situation:
-
the level of their savings
when will they spend their savings i.e. their need for regular income and extra lump sums
the importance of the expenditure and the level of certainty required i.e. making sure it is there
when needed.
The above will affect how much the investor should have in each type of asset. They may then be
willing to have more volatility with the potential for a higher return, or more certainty and accept that
they will likely get a lower average return. This part of the investment strategy decision will be based on
the investor’s personality, beliefs and emotions, as well as the current environment and recent
experience.
Current environment
Despite what some people say, no one knows what will happen in the investment markets in the
immediate future. The comments below are therefore general observations about the current market
based on our current views and guesses.
Cash rates are now low and lower than they have been over the last 20 years (see
chart 1). They are lower than where we think they will be long-term. At these
levels they provide little margin for inflation. Therefore, either there will be nil
or low inflation over the next 3 to 5 years, or we are in a sustained period where
holding cash is more important than the possibility that inflation will erode the
value of an investor’s savings. Investors need to look at other types of assets to
protect their savings against the potential for inflation.
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Chart 1
Also relevant are the interest rates on longer dated bonds (see chart 2). Like cash rates, these are lower
than normal and therefore the risk of a poor return over the short-term, is higher than normal. Investors
can manage that risk by holding bonds to maturity.
At the same time, the gap between 10 year bond rates and cash rates is significantly higher than normal
(see chart 3). Combined, these factors imply that bonds are riskier than normal but currently better value
than cash, from a return perspective. So unless an investor is only interested in very short-term returns,
the current cash rate suggests that investors should have less cash than normal and more invested in
bonds.
Chart 2
Chart 3
SuperLife investor update March 2011
2
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www.SuperLifeKiwiSaver.co.nz
www.myFutureFund.co.nz
Our general advice is that investors should have, as a normal level of cash assets, an amount equal to
what they will spend (from their investments) over the next three years. However, because of the low
cash rates, if an investor was looking to improve their return for moderate additional risk, they may
prefer to hold less cash and more bonds than normal. We expect this to be the better one year strategy.
The price of a share reflects a multiple of the profit of the company and the normal supply and demand
considerations. The multiple of profits is referred to as the PE (price/earnings) ratio. Sometimes,
investors will pay more than average, and sometimes less than average for the future profits of a
company. Buying shares when PEs are low is often best (a lower price for a given level of earnings). But
no one knows with any certainty what the profits will be in 3, 5, or 10 years, yet alone in 1 year from
now, and therefore whether the PE is truly low. What might be a low PE multiple today of past profits,
may be a high PE of the future profits; we do not know. The profits will reflect the general economy,
the type of company it is and the quality of the company’s management.
Currently (see chart 4), the market suggests that the PE multiple of the average company is lower than
what it has historically been, not as low as it has been at times, but definitely less than normal. This
implies that shares are “cheaper” than normal (and should be bought), or that the profits of companies
are about to fall, or at least will not grow as much as normal.
Chart 4
There is a lot of speculation on whether the NZ economy will grow and whether the prices of our dairy
products and other exports will stay high. This places an element of doubt on the immediate profit
levels of companies. The implication therefore, given the current lower than average PE multiple, is that
it is a better than average time to buy shares but not guaranteed short-term. Remember however, that
buying shares should be done only with money that you do not intend to spend in the next 10 to 12
years, unless you wish to speculate. If investors have reduced their share holdings in recent years,
continuing to rebuild them to the normal level may make sense.
Invest well for a SuperLife
SuperLife investor update March 2011
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