Market Watch

At its meeting today, the Board decided to leave the cash rate unchanged at 1.50 per cent.

Conditions in the global economy are continuing to improve. Labour markets have tightened further and above-trend growth is expected in a number of advanced economies, although uncertainties remain. Growth in the Chinese economy has picked up a little and is being supported by increased spending on infrastructure and property construction, with the high level of debt continuing to present a medium-term risk. Commodity prices have generally risen recently, although Australia’s terms of trade are still expected to decline over the period ahead.

Wage growth remains subdued in most countries, as does core inflation. Headline inflation rates have declined recently, largely reflecting the earlier decline in oil prices. In the United States, the Federal Reserve expects to increase interest rates further and there is no longer an expectation of additional monetary easing in other major economies. Financial markets have been functioning effectively and volatility remains low.

The Bank’s forecasts for the Australian economy are largely unchanged. Over the next couple of years, the central forecast is for the economy to grow at an annual rate of around 3 per cent. The transition to lower levels of mining investment following the mining investment boom is almost complete, with some large LNG projects now close to completion. Business conditions have improved and capacity utilisation has increased. Some pick-up in non-mining business investment is expected. The current high level of residential construction is forecast to be maintained for some time, before gradually easing. One source of uncertainty for the domestic economy is the outlook for consumption. Retail sales have picked up recently, but slow growth in real wages and high levels of household debt are likely to constrain growth in spending.

Employment growth has been stronger over recent months, and has increased in all states. The various forward-looking indicators point to continued growth in employment over the period ahead. The unemployment rate is expected to decline a little over the next couple of years. Against this, however, wage growth remains low and this is likely to continue for a while yet.

The recent inflation data were broadly as the Bank expected. Both CPI inflation and measures of underlying inflation are running at a little under 2 per cent. Inflation is expected to pick up gradually as the economy strengthens. Higher prices for electricity and tobacco are expected to boost CPI inflation. A factor working in the other direction is increased competition from new entrants in the retail industry.

The Australian dollar has appreciated recently, partly reflecting a lower US dollar. The higher exchange rate is expected to contribute to subdued price pressures in the economy. It is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.

Conditions in the housing market vary considerably around the country. Housing prices have been rising briskly in some markets, although there are some signs that these conditions are starting to ease. In some other markets, prices are declining. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. Rent increases remain low in most cities. Investors in residential property are facing higher interest rates. There has also been some tightening of credit conditions following recent supervisory measures to address the risks associated with high and rising levels of household indebtedness. Growth in housing debt has been outpacing the slow growth in household incomes.

The low level of interest rates is continuing to support the Australian economy. Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Source: Reserve Bank of Australia August 1st, 2017

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Arguably, the most common fear holding an investor back from achieving a great return is a misunderstanding of what happens when markets fall (as they invariably do).

In order to use fear to our advantage, we would be well served to seek to understand the following three principles around shares and their value:

• A share is simply a small slice of company ownership;  

• A company’s value ultimately depends on its present and future potential cash flows;

• Value may not always equal price.

Multi-billionaire and world’s most successful investor, Warren Buffett, has defined investment as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.”

In other words, it requires patience. Buying a stock (or house, or managed fund) and simply hoping the price goes up soon is, most certainly, not investing. While we may naturally feel emotions based on what the price does over this shorter term, history has shown it is vital not to let these emotions steer our financial decisions.

Focus on quality and don’t speculate

A share is simply a slice of ownership in a business. For this reason, focus should be directed at the quality of the businesses and their prospects for the future, rather than a chart with a line that wiggles up and down as the price rises and falls.  

Unfortunately, in the financial media, there is a clear focus on explaining short-term fluctuations in share price. Commentators often try to attribute every little rise and fall to a particular event or issue. The risk is that an investor may start taking their cues from price movements – which is driven by short-term sentiment and emotion, rather than value – which is ultimately driven by the cash flows a business generates now and into the future.

Benjamin Graham, often known as the ‘father of value investing’, famously said that “Price is what you pay, value is what you get.” While the price of a share will certainly fluctuate, (sometimes multiple times per second, every day of the year!), the value of a company’s future cash flows is likely to be far less volatile. 

Speculation; i.e. buying and blindly hoping that a price will go up soon, might be considered the antithesis of investing, and shouldn’t ever be considered a safe strategy. Mark Twain once aptly mused that, “October is one of the most dangerous months to speculate in shares. The others are July, January, September, April, November, May, March, June, December, August and February.”

If a share price falls sharply, yet the value of the business’s future cash flow doesn’t change, this may provide a wonderful opportunity to purchase further shares at a discounted price, hence maximising the potential return and reducing the potential for loss. A skilled fund manager will take advantage of this by applying this principle to a portfolio of businesses in order to further reduce risk to the investor through diversification.

Paradoxically, as an investor, your hope should generally be that prices fall in the short term. Volatility is the friend of the long-term investor.

That is not to say asset price volatility doesn’t matter. For example, self-funded retirees being forced into selling units at a temporarily reduced price in order to fund their lifestyle isn’t an attractive proposition. For this reason, financial planners commonly emphasise the importance of maintaining an adequate cash reserve – particularly in retirement. 

Whether you are invested in a managed fund, direct shares or an investment property, price matters at precisely two times – when you buy and when you sell. The return on an investment depends on these prices and the distributions you receive over the investment period.  

For these reasons, most quality fund managers will tend to remain focused on the fundamental prospects of the underlying companies owned, and think as a business owner rather than a ‘stock picker’.

If you would like to discuss anything in this article, please call us on |PHONE|.

Source: AMP Capital 13 July 2017

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person without the express written consent of AMP Capital. © 2017 AMP Capital Investors Limited.

Many diversified funds appear similar on the surface, but when you lift the hood, they’re poles apart. Evaluating diversified fund performance can be like comparing the proverbial ‘apples’ with ‘oranges’.

But in this complex and volatile investment environment, choosing the right diversified fund has never been more important for investors and advisors. The wrong fund will not only be too risky, but its performance could mean failing to reach important financial goals.

Advisers and investors need a system to evaluate performance across diversified funds that is simple, consistent, and allows them to compare ‘oranges’ with ‘oranges’. The process particularly needs to consider not just return, but also risk.

We have identified 4 simple steps for effective evaluation of diversified fund performance. If advisers and investors follow these, they’ll increase the probability of choosing the right funds and reaching financial goals.

1. Pick a peer group 

The first step is to select a representative universe of funds for consideration. For example, you might choose a group of the largest diversified funds in Australia. Obviously, in a broad sense, the funds should correlate with a financial goal, such as income, or growth.

2. Measure risk 

Once you have a peer group, it is tempting to focus solely on performance when evaluating diversified funds. But performance is just one side of the coin: risk is the other. If Fund A delivers a higher return than Fund B is it a better fund? Not necessarily. An investigation of Fund A might reveal the manager took bold risks to achieve those higher returns. 

A simple comparison of fund returns, therefore, is not enough. There are four metrics that allow advisers and investors to determine how risky a fund is, which will help put performance numbers in context.

a) Growth asset exposure

Consider each fund’s allocations to growth assets. Growth assets, such as shares, property, infrastructure and growth alternatives (commodities, private equities and hedge funds) have high expected returns over time, but also higher volatility. Therefore, funds with higher allocations to growth assets are considered riskier than those with lower allocations.

The most common method of quantifying a diversified fund’s risk level is identifying what proportion is invested in growth assets.

b) Volatility

Next, consider the fund’s variability – or volatility — of returns during its history. Riskier funds tend to be more volatile – their value fluctuates more widely; lower risk funds tend to have more stable returns.

It is important to remember that volatility doesn’t measure how likely an investment is to permanently lose money, which is many investor’s understanding of what risk is. Yes, volatility and risk of permanent loss are correlated, but at times they can be very different things.

c) Scenario analysis

Thirdly, perform a scenario analysis. This analysis is also known as ‘stress testing’ because it measures portfolio performance during historical situations and simulated hypothetical events.

An easy scenario analysis is to see how different funds performed when markets fell historically. A ‘drawdown’ graph shows how much funds lost in market crises, which gives a good idea of a diversified fund’s risk profile. Fund A might have been more resilient than Fund B during the global financial crisis (GFC), an indication it is probably less risky than Fund B.

d) Illiquid assets

Finally, when assessing the riskiness of a diversified fund, consider its allocation to illiquid assets, such as unlisted property, unlisted infrastructure and private equity. They are a hidden risk factor in many diversified funds.

Illiquid assets are typically assets not traded on a centralised stock exchange and can’t be bought and sold easily. Investors might not be able to redeem (get their money back) for a long time, at times years. Sometimes, assets may need to be sold at big discounts to their true value.

Investors often ignore the risks posted by illiquid assets. But even moderate (around 20 per cent) allocations to illiquid assets can pose substantially increased risks to diversified fund investors. Those risks aren’t captured in standard risk measures. It’s advisable to separate out these funds with moderate and high allocations to illiquid assets in any risk/performance evaluation.

3. Consider tax and fees 

Once you have a group with similar risk exposures, you then need to consider the effect of tax and fees. To have a fair comparison, all returns must have the same fee and tax basis. 

Some funds report ‘before’ or ‘after’ fees, and ‘before’ or ‘after’ taxes. Superannuation can complicate the picture. Funds that only have super investors base their performance numbers on the lower concessional superannuation tax rates; other funds with a diverse investor base report performance numbers using higher non-superannuation tax rates.

Ultimately, the tax rate you pay depends if you’re inside or outside super; it’s not whether the fund is a super fund or not. It’s important to be mindful that, for those investing within super, post-tax super fund returns are likely to appear slightly inflated relative to other diversified funds.

4. Tally over time 

The next step is to take a long-term view of performance. When comparing funds with similar risk exposures, it’s tempting to evaluate each fund using a snapshot of a fund at a single point in time. But that fails to capture how funds perform over time. It’s like trying to judge how good a footballer is by looking at a photograph. 

Performance and risk, instead, should be compared on a chart which shows how the fund performed over time.

Diversified funds are managed as long-term savings vehicles and should be judged on that basis. Performance over one-month and three-month time horizons is typically irrelevant because managers aren’t making decisions with such short payoff periods in mind. Investors should focus on performance over periods of at least five years.

An additional comment: past performance is not an indicator of future performance

By following the four simple steps above, when evaluating diversified funds, advisers and investors will be able to compare ‘oranges’ with ‘oranges’. 

However, it’s important to emphasise (given that this article has solely focused on judging past performance) that: past performance is not a reliable indicator of future performance. Any historical performance analysis needs to be overlaid with two questions which focus on the future:

1. Why has the fund outperformed/underperformed?

2. Are the drivers of the outperformance/underperformance sustainable and likely to be repeatable into the future?

Without answers to these questions evaluating historical performance is not only pointless; it can be dangerously misleading and shouldn’t be relied on for decision-making.

If you would like to discuss anything in this article, please call us on |PHONE|.

Author: Stephen Flegg, Portfolio Manager at AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person without the express written consent of AMP Capital. © 2017 AMP Capital Investors Limited.

Dr Bernard Meyerson, IBM’s chief innovation officer, was in the room in 2011 when his company’s powerful artificial intelligence (AI) computer, Watson, famously won Jeopardy, defeating the game show’s two most successful contestants. “There was an incredible euphoria,” Meyerson said in a presentation at AMP’s recent Amplify program. “Watching the system do that was mind blowing.”

Watson’s historic win was victory of “machine” over “man”, and showed the amazing ability for computers to think, learn and act. It was science fiction becoming reality.

AI is viewed as a threat, particularly to jobs, yet Meyerson, who is at the cutting edge of developments, has good news for people: the greatest benefit from AI will come when humans and machines work together in a new ‘cognitive’ era.

While the human investor and adviser won’t die, they must adapt and learn to work with machines to harness the power of AI and survive in this new era. “It isn’t going to stop,” Meyerson says. “The challenge is to know it’s coming and stay ahead of it.”

Beyond our abilities

Meyerson says AI has actually been around for long time. He notes that Alan Turing – the Nazi Enigma code breaker and the ‘father’ of computer science and artificial intelligence – was doing computing in World War II.

But AI is now being driven by our need to understand, through analytics, a torrent of data and information unleashed by digitisation. Consumers send 500 million tweets and make 55 million Facebook posts a day alone.

Matthew Hopkins, Senior Portfolio Manager of AMP Capital’s Multi Asset Group, says AI is a “whole bunch of things coming together”, including an explosion in the amount and breadth of data, the technical capacity to store and transport it, and progress in analysing it through advances in machine learning and pattern recognition.

“The velocity of business today is almost unimaginable,” Meyerson says, adding that feedback on new products is now near-instantaneous. The success of a new sneaker launch in the past was judged in months. Now, a launch to a few thousand buyers triggers immediate comment. “The complexity of what we have developed simply outruns the human ability to deal with it.”

This stream of information – ‘big data’ – is useless unless it is transformed into knowledge. Meyerson agrees with the notion that data is the ‘new oil’. “If you don’t refine it, it has no value,” he says. “It’s just muck that hangs around. But if you refine it, it runs the world.”

No different

Meyerson says financial services is no different. “Financial services are data driven,” he says. “We’re in this emergent era where you need to rethink how you do this because it’s going to have the same profound impact [in financial services] as it’s been having in all other fields.”

Investors and advisers must survive and thrive in this digital disruption. AMP Capital’s Matthew Hopkins says that more ‘efficient’ markets will be one of the biggest impacts of AI on investors. AI will generate, access and analyse market information more quickly and this will be instantly reflected in prices. The ability to produce ‘Alpha’ – or excess returns above a market – will be harder to come by.

Man + machine

AI won’t make human advisers and investors redundant, according to Meyerson.

Computers may surpass humans in deep learning, large-scale maths and fact checking, but most importantly they’re better at discovery: finding the factors critical to success when there are multiple variances in a process.

Watson took 17 seconds to analyse 3500 text books and 400,000 pieces of data to diagnose a non-smoking, young, Asian woman with lung cancer. It found a very rare genetic mutation in her cancer and recommended a new drug for treatment.

Does that mean we don’t need doctors? We still do, Meyerson says, noting it was the doctors that performed the 100,000 or so trials to build the data for Watson to analyse.

Humans offer qualities that computers cannot – things such as intuition, design, value judgement, compassion and common sense.

The power lies in combining the two in Meyerson’s simple equation: a human + machine = a value far greater than the sum of its parts.

Industry 4.0

But while they’re not redundant, investors and advisers will need to adapt to what Meyerson calls the new ‘cognitive’ era, or Industry 4.0, which is characterised by:
 

• Collaboration between man and machine becoming the norm

• The storage of knowledge not data

• Businesses using data and AI to expand, not by trial and error, but by intent

• Velocity, with clients and providers gaining near instant insights into what is needed and what is possible

• A move to a pervasive engagement model where people – particularly Millennials and the next generation – expect to be able to access what they want when they want it and get the right answer now

Integrating man and machine

Advisers particularly have been impacted by the growth of robo-advice where advice and investments are automated. But Meyerson’s man + machine vision aligns with predictions of the ‘bionic’ adviser and investor where humans work alongside machines.

IBM is already working to integrate man with machine. One leading Asian financial services group is analysing clients’ behavioural attributes based on history,investments and social media (if public), and giving that information to advisers. “Suddenly they become a much more trusted entity because they know enough to give advice in the context of the person,” Meyerson says.

AI is also being used by insurers to improve claims decisions, pricing, and in some instances to cut processing times by more than 90 per cent.

Hopkins says advisers absolutely have a role, but they need to adapt by providing solutions that are “more than just a set of numbers”. They will be focused on helping shape and frame client goals, and then provide solutions that are tailored to the client’s personal circumstances. AI and technology will be the enablers that help provide a better solution.

Hopkins notes that after chess grandmaster Garry Kasparov was defeated by the computer ‘Deep Blue’ in 1997, it didn’t signal the end of human players. Kasparov went on to show a chess player working with a computer was far superior to just a computer alone. Hopkins feels that investment and financial advice should be the same.

Meyerson has a simple message for investors and advisers grappling with AI. He says either ignore it or lead it. “Usually leading it is a way better example than getting run over by it.”

If you would like to discuss anything in this article, please call us on |PHONE|.

Source: AMP Capital 13 July 2017

Infrastructure offers a range of investment characteristics that can be particularly attractive in the low interest rate and volatile market conditions we have seen in recent times. Clients tell us they like its attractive, consistent returns and yield; defensive characteristics; and diversification benefits. Infrastructure is also becoming more accessible to retail investors. In the past, high quality unlisted infrastructure assets were usually only available to large institutional investors but now mums and dads can own their own piece of Melbourne Airport or UK rolling stock company Angel Trains.

Below are five reasons why investors should consider infrastructure.

Attractive, consistent returns

Infrastructure offers the potential for attractive, consistent returns through market cycles. This is because infrastructure assets are often essential to the day-to-day operation of our society such as the provision of water or electricity and gas. Due to the nature of the essential services they provide, these types of assets are often less influenced by economic factors than many other businesses. In addition, infrastructure assets often enjoy the protection of monopolies, or operate in markets where the barriers to entry are high, meaning they are often free from the competitive pressures faced by many more traditional companies.

It can help investors meet their income goals

Infrastructure assets can provide consistent, long-term income yields because their revenues are often underpinned by regulation or by long-term contracts with highly creditworthy counterparties (which can often include governments). Consequently, infrastructure assets may offer a high level of security with regards their future revenues. Infrastructure asset revenues are also often linked to inflation, which can help investors protect against erosion of the value of their investment by inflation over time.

It’s a defensive play

Infrastructure generally, and unlisted infrastructure particularly, can play an important role for long-term investors due to the stability it can provide within a diversified investment portfolio and the visibility of the income streams it generates. In a low interest rate environment where the outlook for total return appears compressed, asset classes that exhibit defensive characteristics with an attractive and stable income profile are obvious candidates for a long-term investment strategy.

The world needs more and updated infrastructure

Infrastructure is an investment thematic that will continue to play out because the need for infrastructure is a never-ending cycle. Growing populations need to be supported by additional infrastructure while ageing infrastructure needs to be periodically upgraded or replaced. Investment in infrastructure helps stimulate sustainable, long-term economic growth, which then creates a further need for infrastructure. Ultimately, infrastructure promotes higher living standards as it fosters economic growth and creates jobs. A McKinsey report estimates that US$57 trillion of global investment in infrastructure will be required by 2030.

Active management of infrastructure assets

AMP Capital has an active asset management philosophy when it comes to the management of the unlisted infrastructure assets it invests in. AMP Capital employs asset managers who have had extensive senior level industry experience. In addition, AMP Capital seeks to ensure that the overall stake under its control is sufficient to allow for significant influence over the future direction of the business. This would typically involve representation on the boards of the businesses. AMP Capital has a high level of involvement in these businesses, with a view to driving returns and managing risk for the benefit of investors.

If you would like to discuss anything in this article, please call us on |PHONE|.

Source: AMP Capital 16 June 2017

Author:  John Julian, Portfolio Manager, Core Infrastructure Fund, AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Key points

• It is clear that the forces from the regulatory and physical environment will shape the future of global real estate.

• Developers and landlords with quality management teams and the expertise to prepare for these challenges will be at an increasing advantage during volatile weather patterns.

An age-old assumption is that carefully selected real estate will be a safe harbour in the face of market volatility. In the face of extreme weather events like flooding, cyclones, sea level rises, sustained heat waves and hail storms, this assumption may not hold. Extreme weather patterns can fundamentally change the value of real estate. In the most severe cases, volatile weather patterns can destroy real estate.

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Climate change and this new age of weather volatility presents a challenge for global real estate investors. There are the physical impacts of climate change relating to the damage that occurs when extreme weather hits, as well as the indirect impacts of climate change relating to the change in rental demand and the value of assets.

Regulatory risks from governments all over the world targeting carbon emission reductions and the availability of capital are also important considerations. Institutional investors are increasingly expected to disclose the carbon footprint of their portfolios, recognising that what gets measured gets managed.

Implications for global property investors

As investment managers, we review the environmental credentials of every real estate entity before we invest. From an earnings and valuation perspective, it makes financial sense: new buildings need to be energy and water efficient to attract and retain premium tenants and existing buildings need to be retrofitted to minimise stranded asset risk. In Australia, 81% of office buildings are over 10-years old.

Final thoughts

• Climate change and this new age of extreme weather patterns present a challenge for global real estate investors. There are the physical impacts of climate change to consider, as well as the indirect impacts on valuation, including tenant demand for resilient buildings and the cost of retrofitting existing building stock.

• There are the regulatory risks arising from governments all over the world targeting carbon emission reductions and the investment risks arising from the availability of capital.

• Listed real estate managers with a track record of deeply integrating these issues in their investment process will be the best placed to construct a portfolio that will deliver an attractive, resilient, long term exposure to this asset class.

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Source: AMP Capital 16 June 2017

Author: Kristen Le Mesurier, Senior ESG Analyst, Investment Research AMP Capital