Generations of Australians have been conditioned to believe that the stock market always bounces back.
However, after a 20 year bull run to 2007, largely driven by massive falls in interest rates, we may be in for a sustained period of lower returns and increased volatility. This is due to the deleveraging that has to take place globally and the increasing likelihood of interest rates and inflation rising.
This new environment, where the stock market return may not provide the tailwind that it has previously, is providing motivation for investors, including SMSFs, to rethink what their asset allocation should be.
Investors are increasingly looking to construct portfolios that are better at preserving or protecting their capital and that focus on generating a reasonable rate of return, rather than a return relative to a market index like the S & P/All Ordinaries Index.
Many astute institutional investors globally, including the large sovereign wealth funds, family offices and university endowment funds have adopted a non-traditional asset allocation approach for many years, where managing the absolute risk of capital loss is placed as a core objective and returns are then maximised within that constraint.
This approach to portfolio construction allows for a more diversified portfolio and a wider range of investments that seek capital preservation, lower volatility and low or no correlation to traditional asset classes like shares and property.
These new approaches are focused on generating more consistent returns, irrespective of the macro environment or equity market movements.
New investment vehicles and funds are being made available that have the investment processes and tools (many of which are not available to retail investors) that significantly reduce market risk and that are able to generate returns more consistently.
Some of the tools being utilised by these new funds include:
- An investment mandate that allows funds to allocate to cash until suitable investment opportunities can be found. This approach is very different to the traditional approach in investment management where funds have to be fully invested in shares even if suitable investments can’t be found or stocks are too expensive.
- A benchmark unaware approach. Many fund managers and investors benchmark their performance and the risk of their portfolios against the equity market indices (eg. the All Ordinaries Index). We believe that the true risk for investors is the risk of capital loss and that achieving a fair return with capital protection in mind is what investors actually want.
- An investment objective to outperform the risk free rate, which is the RBA cash rate in Australia, rather than a market index. Many investors have realised that if a fund manager is only focused on beating the market index, there will be many times when although they achieve that objective, the investor has still received a negative return and lost money.
- The ability to profit when share prices both increase and decrease provides a much better opportunity to make money in all market conditions.
- An alignment of interest between the fund manager and investors through fees that are directly related to the Fund’s performance over a more relevant benchmark like cash and through the fund managers having significant investments in their own funds.
- A limit of the amount of money, or capacity that will be managed in the fund. Too much money being managed in a fund is a significant inhibitor to generating strong performance.
Russel Pillemer co-founded Pengana in 2003 and has been Chief Executive Officer since inception. He is a member of the Institute of Chartered Accountants in Australia and has a Bachelor of Commerce (Hons) from the University of New South Wales.
