Market Watch

We all know that market volatility can affect investment performance over the short-term. However, to change your entire investment strategy in response to short-term market movements can have devastating effects on the generation of your long-term wealth. Successful investment strategies that use a dynamic asset allocation approach enable investors to retain a long-term vision while capitalising on the ‘ups and downs’ of short-term market movements.

Market volatility and risk are not always the same thing

There is no denying that market volatility can present a risk to achieving investment objectives. It is therefore important that this risk is mitigated effectively to achieve long-term success. To fully understand this, it’s important to understand the difference between volatility and risk:

The contribution technology makes to a company’s value is no longer driven purely by access to data but rather by how efficiently a company captures, manages, understands, leverages and protects that data.

• Risk – the probability of not reaching the destination (failing to achieve the investment objective). Risks are often hidden in places where not many people are looking for them. The best place to look for risk is within the ‘crowd’. Crowded positions; crowded investment strategies or investment styles all entail a significant risk of failure.

• Volatility – an unexpected deviation in the path to a destination (the investment goal). Volatility is often triggered in response to a wider recognition of risks. That is, volatility is a backward-looking measure of risk.

In essence, volatility is like losing some pieces in a game of chess where the aim is to win the game. An investor’s ultimate goal should be greater exposure to the upside of a rising market than to the downside of a falling market.

Managing volatility

There are various ways to manage volatility in a low return world. These include:

• Being concerned about the downside risk, while paying little attention to the upside potential and holding a large cash/defensive position at all times in the expectation of another GFC. This will be a low volatility strategy but most likely a low return strategy as well. Investors who take this approach often opt for a managed/capped or low volatility investment strategy – in other words, selling when volatility rises and buying when volatility falls. This approach can lead to lower volatility, but introduces a significant risk of falling short of return objectives. More often than not, the time to buy is when volatility is high and risk premium is elevated, not when volatility is low

• Relying on diversification based on historical correlations. The shortcomings of this strategy are;

• Relying on historical correlations is dangerous; and

• Given that each percentage fall requires a larger percentage gain to break even, (e.g. a 20% fall requires a 25% rebound to break even), without the scope to increase exposure on rebounds, recoveries can take a long time. The more volatile and steep market corrections are, the longer a full recovery will take.

• Our choice – dynamically and objectively assessing upside versus downside risk – this means cushioning the downside risk while benefiting from the upside. It entails objective analysis, a fine balance between conviction and flexibility, and paying more attention to risk than volatility. The ultimate aim is to be exposed more to the upside in a rising market than to the downside in a falling market.

Is market volatility likely to continue?

There are certain factors that suggest market volatility is likely to continue.

These factors include:

• Global equity valuations (ex US) remain cheap however, the current weakness in US equities is taking place at a time when absolute valuations are rich, earnings growth is slowing and inflation expectations are falling. The valuation ceiling on US shares is likely to exert ongoing volatility to other markets.

• Ongoing dynamics relating to US rate hike expectations, the rising USD, falling EM currencies and tightening financial conditions should lead to ongoing volatility, as investor expectations with regard to the US Fed’s rate lift-off wax and wane.

We have been of the view that the global equity bull market (particularly in the US) is likely to have reached its mature phase. However, a lack of broad-based overvaluation, few signs of global overheating, low recession risk and a gradual global economic recovery all point to a low likelihood of a global equity bear market, but increased likelihood of frequent volatility spikes.

When it comes to managing the ups and downs of the investment cycle, the key is to engage in active diversification through an objective-based investment process, while resisting external influence from other investors.

By Nader Naeimi

Nader Naeimi is Head of Dynamic Asset Allocation and Portfolio Manager for the AMP Capital Dynamic Markets Fund. With over 19 years of experience in financial markets, including 15 years as part of AMP Capital’s Investment Strategy and Economics team, Nader’s responsibilities include analysis of key economic and market factors influencing global markets.

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) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) 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.

Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

The global economy is expanding at a moderate pace, with some further softening in conditions in China and east Asia of late, but stronger US growth. Key commodity prices are much lower than a year ago, in part reflecting increased supply, including from Australia. Australia’s terms of trade are falling.

The Federal Reserve is expected to start increasing its policy rate over the period ahead, but some other major central banks are continuing to ease policy. Equity market volatility has continued, but the functioning of financial markets generally has not, to date, been impaired. Long-term borrowing rates for most sovereigns and creditworthy private borrowers remain remarkably low. Overall, global financial conditions remain very accommodative.

In Australia, the available information suggests that moderate expansion in the economy continues. While growth has been somewhat below longer-term averages for some time, it has been accompanied with somewhat stronger growth of employment and a steady rate of unemployment over the past year. Overall, the economy is likely to be operating with a degree of spare capacity for some time yet, with domestic inflationary pressures contained. Inflation is thus forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate.

In such circumstances, monetary policy needs to be accommodative. Low interest rates are acting to support borrowing and spending. Credit is recording moderate growth overall, with growth in lending to the housing market broadly steady over recent months. Dwelling prices continue to rise strongly in Sydney and Melbourne, though trends have been more varied in a number of other cities. Regulatory measures are helping to contain risks that may arise from the housing market. In other asset markets, prices for commercial property have been supported by lower long-term interest rates, while equity prices have moved lower and been more volatile recently, in parallel with developments in global markets. The Australian dollar is adjusting to the significant declines in key commodity prices.

The Board today judged that leaving the cash rate unchanged was appropriate at this meeting. Further information on economic and financial conditions to be received over the period ahead will inform the Board’s ongoing assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target.

Enquiries:

Media Office
Information Department
Reserve Bank of Australia
SYDNEY
Phone: +61 2 9551 9720
Fax: +61 2 9551 8033
E-mail: rbainfo@rba.gov.au

Regional spending requirements

Infrastructure requirements in North America, Europe and Asia vary, with spending planned to meet the needs of projects relevant to the particular region.

• North America – an additional US$2 trillion between now and 2020

  US public infrastructure spending is at a 20-year low, even with the American Society of Civil Engineers (ASCE) rating the nation’s infrastructure on average as ‘poor’.² An additional US$1.6 trillion of funding compared to what has currently been committed is required to reach an adequate standard.

• Europe –EUR300 billion over the next three years

  During the Financial Crisis, investment fell sharply and has remained weak since. The European Commission is currently proposing the creation of these funds, with the aim of boosting long-term investment in Europe.³

• Asia –US$730 billion per annum over the next decade

  McKinsey forecasts that 70% of this figure needs to be invested in transport and energy assets.⁴ For example, India will require more than US$1 trillion of investment in infrastructure over the next five years, as their current inadequate transport, energy and water infrastructure is preventing their economy from growing at a greater pace.⁵

Governments can’t do it all

Historically, Governments were the exclusive providers of a nation’s infrastructure. Over time, and as a consequence of the global financial crisis, lower tax revenues and higher expenditure has meant that governments are increasingly relying on the private sector to help fund these investments. With governments around the world at various stages of the continuum when it comes to engaging the private sector, Australia and the UK are the most advanced. They have recognised that the private sector infrastructure companies value transparency, certainty and the ability to manage risks in the regulatory frameworks or contracts.

In addition, some governments have recognised that for new capital to undertake the required investment an attractive return framework needs to be provided. Indeed, it’s not been uncommon for regulators to offer incentives above a base level return, either implicitly or explicitly, in order for specific strategic investments to be undertaken.

Benefiting from a structural growth story

These conditions are the basis for a structural growth story for global listed infrastructure companies. The infrastructure requirement is massive, and with attractive returns and supportive frameworks we expect continued stable, reliable, cash flow growth from global listed infrastructure companies of 7-9% over the medium to long-term.

These conditions are the basis for a structural growth story for global listed infrastructure companies. The infrastructure requirement is massive, and with attractive returns and supportive frameworks we expect continued stable, reliable, cash flow growth from global listed infrastructure companies.

The stable regulation provides for reliable dividend yields of 3-4%, while returns on ongoing investment is driving growth in cash flows of 7-9% (with which companies can re-invest or return to shareholders).

This means that investors may be able to benefit by diversifying into this new asset class which stands to become the greatest investment theme of our lives.

Find out more about investing in global listed infrastructure securities here

¹ PwC, 2014. Capital Project and Infrastructure Spending.
² The Economist, 2014. The Trillion-Dollar Gap.
www.economist.com/news/leaders/21599358-how-get-more-worlds-savings-pay-new-roads-airports-and-electricity.
³ European Commission, 2014. European Economy: Infrastructure in the EU: Development and Impact on Growth.
⁴ McKinsey, 2012. Asia’s $1 Trillion Infrastructure Opportunity.
www.mckinsey.com/insight/financial_services/asias_1_trillion_infrastructure_opportunity.
⁵ Council on Foreign Relations, 2014. Governance in India: Infrastructure.
www.cfr.org/india/governance-india-infrastructure/p32638.

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) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) 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.

Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

The global economy is expanding at a moderate pace, with some further softening in conditions in China and east Asia of late, but stronger US growth. Key commodity prices are much lower than a year ago, in part reflecting increased supply, including from Australia. Australia’s terms of trade are falling. 

The Federal Reserve is expected to start increasing its policy rate over the period ahead, but some other major central banks are continuing to ease policy. Equity markets have been considerably more volatile of late, associated with developments in China, though other financial markets have been relatively stable. Long-term borrowing rates for most sovereigns and creditworthy private borrowers remain remarkably low. Overall, global financial conditions remain very accommodative.

In Australia, most of the available information suggests that moderate expansion in the economy continues. While growth has been somewhat below longer-term averages for some time, it has been accompanied with somewhat stronger growth of employment and a steady rate of unemployment over the past year. Overall, the economy is likely to be operating with a degree of spare capacity for some time yet, with domestic inflationary pressures contained. Inflation is thus forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate.

In such circumstances, monetary policy needs to be accommodative. Low interest rates are acting to support borrowing and spending. Credit is recording moderate growth overall, with growth in lending to the housing market broadly steady over recent months. Dwelling prices continue to rise strongly in Sydney, though trends have been more varied in a number of other cities. The Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for commercial property have been supported by lower long-term interest rates, while equity prices have moved lower and been more volatile recently, in parallel with developments in global markets. The Australian dollar is adjusting to the significant declines in key commodity prices.

The Board today judged that leaving the cash rate unchanged was appropriate at this meeting. Further information on economic and financial conditions to be received over the period ahead will inform the Board’s ongoing assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target.

Enquiries:

Media Office
Information Department
Reserve Bank of Australia
SYDNEY
Phone: +61 2 9551 9720
Fax: +61 2 9551 8033
E-mail: rbainfo@rba.gov.au

Statement by Glenn Stevens, Governor: Monetary Policy Decision

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

The global economy is expanding at a moderate pace, but some key commodity prices are much lower than a year ago. Much of this trend appears to reflect increased supply, including from Australia. Australia’s terms of trade are falling nonetheless.

The Federal Reserve is expected to start increasing its policy rate later this year, but some other major central banks are continuing to ease policy. Hence, global financial conditions remain very accommodative. Despite fluctuations in markets associated with the respective developments in China and Greece, long-term borrowing rates for most sovereigns and creditworthy private borrowers remain remarkably low.

In Australia, the available information suggests that the economy has continued to grow. While the rate of growth has been somewhat below longer-term averages, it has been associated with somewhat stronger growth of employment and a steady rate of unemployment over the past year. Overall, the economy is likely to be operating with a degree of spare capacity for some time yet. Recent information confirms that domestic inflationary pressures have been contained. That should remain the case for some time, given the very slow growth in labour costs. Inflation is thus forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate.

In such circumstances, monetary policy needs to be accommodative. Low interest rates are acting to support borrowing and spending. Credit is recording moderate growth overall, with growth in lending to the housing market broadly steady over recent months. Dwelling prices continue to rise strongly in Sydney, though trends have been more varied in a number of other cities. The Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for equities and commercial property have been supported by lower long-term interest rates. The Australian dollar is adjusting to the significant declines in key commodity prices.

The Board today judged that leaving the cash rate unchanged was appropriate at this meeting. Further information on economic and financial conditions to be received over the period ahead will inform the Board’s ongoing assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target.

Enquiries:

Media Office
Information Department
Reserve Bank of Australia
SYDNEY
Phone: +61 2 9551 9720
Fax: +61 2 9551 8033
E-mail: rbainfo@rba.gov.au

Communication infrastructure has rapidly advanced over recent decades. While many countries have upgraded their infrastructure to keep up with these changes, the rapid pace in which technology is advancing means countries will continually need to invest to remain globally competitive. For example, multinational consulting firm McKinsey, forecasts a telecom infrastructure investment of US$9.5 trillion between 2013 and 2030.¹

A large portion of this investment will be used for communication towers, as they facilitate the global transition of mobile communications, from voice and basic data to high-speed broadband. The chart below demonstrates the huge rise in global mobile data traffic – expected to increase nearly 10-fold between 2014 and 2019.

Source: CISCO, 2015

Emerging trend for private investors

One impact from this growth has been the emergence of independent tower operators, as governments and telecommunication companies have been selling tower assets that no longer meet their strategic goals.

Historically, owning an extensive tower network presented a competitive advantage in terms of coverage and service. However with increased capital expenditure requirements from new technologies and increased data needs, telecommunication companies are finding it more efficient to sell-off assets and take 10-15 year leases on the towers. This is a very attractive business model for independent tower companies, as not only do they secure stable, inflation protected cash flow streams, but they are also able to add other carrier’s equipment to towers that have historically only had one tenant. This could potentially result in doubling revenue for very limited additional capital expenditure.

What does this mean for infrastructure investing?

We are beginning to see an increase in interest for infrastructure investing and in the number of investors making discrete allocations to this asset class. As allocations rise, we expect to see a significant amount of new capital enter the space. Investors need to ask themselves whether they want to invest now and benefit from the expected growth in this asset class – or whether they want to wait for the investment trend to become increasingly recognised.

Through an active approach to portfolio management, investors can seek to take advantage of the emerging communication theme, with fund managers increasing exposure to sectors that are most likely to benefit and reducing exposure to sectors that are expected to underperform.

To find out  more about investing in global listed infrastructure securities, please click here.

¹ McKinsey Global Institute, 2013. Infrastructure Productivity: How to save $1 trillion a year. www.mckinsey.com/insights/engineering_construction/infrastructure_productivity

Joseph Titmus, BEc, SA Fin Portfolio Manager / Analyst Joseph Titmus is based in AMP Capital’s London office and is responsible for the analysis of infrastructure companies in Europe and Latin America. He has nine years’ experience in the financial industry and was involved in the development of AMP Capital Brookfield’s listed infrastructure capability. Joseph joined AMP Capital’s Sydney office in February 2006 as an investment adviser within the Global Real Estate Securities Team. He moved over to the Global Listed Infrastructure Team in October 2008 and relocated to London in April 2010.