Building portfolios in times of uncertainty

With $6.4 trillion wrapped up in Aussie residential real estate, and $993 billion in commercial real estate, the property market remains the darling of investors. 

And with the Sydney and Melbourne property markets rebounding strongly after recent dips in both capital cities, La Trobe Financial senior account manager, Andrew Evans, says the fundamentals for Australian property as an asset class remains strong.

Speaking at the IMAP Investment Forum in Melbourne and Sydney in September, Evans said investor demand in property remained strong and resilient, despite recent drops in real estate, which saw Sydney come off its peak by -14.7 per cent, Melbourne by -10.8 per cent and Brisbane by -2.7 per cent.

“There was no housing crash, as some commentators predicted, but instead, we saw an orderly correction of the market,” Evans said. “We are now seeing significant auction clearance rates in both Sydney and Melbourne, which have rebounded strongly.” 

Supported by the Federal election result in April, Evans says the return to month-over-month house price growth is a continuation of a trend that has been in play since the start of 2019.

He added that the fundamentals for this asset class remain strong, with the housing market having bottomed and credit quality improving across the industry. 

“The Australian population is growing annually at about 400,000 people per year. This means there is strong and continued demand for more dwellings to accomodate this growth,” Evans said. 

“And with record low interest rates, which is a stabilising factor for the housing market, property remains a solution for investors as they hunt for yield.”

Macro outlook

Building portfolios that are more resilient to market movements during challenging times, is in itself a challenge. And despite global trade tensions continuing to add to macro uncertainty, Chris Baker – Director, Fixed Income and Product Strategist at BlackRock – doesn’t think a local recession is imminent.

“But the current U.S./China trade war will reduce market growth, which will remain mute to benign going forward,” he said. “It’s hard to see this changing anytime soon, with global interest rates likely to drop further or remain where they are.

“However, given the prospect of a weaker U.S. dollar, BlackRock favours local currency Emerging Market Debt as a way of generating yield.”

Yet, despite a U.S. led protectionist push that has increased downside risks to the global economy, Baker remains cautious in his macro outlook for the Australian market.

According to Baker, BlackRock believes that as a ‘base case’ for Australia, consumers will remain cautious, credit growth will remain weak, and rising unemployment will see additional RBA rate cuts.

“We expect the household saving rate to continue to increase, as households repair their balance sheets; we believe ongoing moderation in dwelling construction will have a drag on GDP; we believe the unemployment rate has bottomed with a gradual rise expected, although underemployment remains a challenge for the RBA; consumer confidence to remain weak as house price growth stagnates into 2020; and inflation remains weak with falling rents, dwelling construction, and very low wage growth,” Baker said.

“However, despite this cautious assessment, we still don’t believe a recession is imminent.”

Table 1: Australian macro outlook

Source: BlackRock

Alternatives: Looking outside the mainstream

The first mistake many advisers make when thinking about ‘alternatives’ as part of an investment porfolio, is treating them as an asset class, which they are not, according to Michael Karagianis - a senior consultant at JANA. 

Speaking at the IMAP Investment Forum on 31 October – along with Longreach Alternatives CEO, Samuel Mann and Pengana Capital CEO, Russel Pillemer – Stephen said ‘alternatives’ should be teated as a class of investments and not an asset class. 

And with traditional ‘go to’ asset classes, like Australian equities, already fully valued, he believes alternatives make a compelling case for investors wanting to defend their positions in increasingly volatile markets.

Alternatives fall outside the traditional asset classes, like equities, bonds and cash. They typically include the like of private equity, hedge funds, managed futures, commodities, art and collectibles.

Making the case for alternatives, Stephen said the two common characteristics of alternatives are:  a return premium for illiquidity and diversification of returns away from traditional asset classes.

However, he added that investors required “open-minded scepticism” when investing in alternatives.

“It’s critical that investors consider the fees when investing in alternatives, as the alpha benefit can be eroded by the fees,” Stephen said. “Advisers also need to fully understand the strategy they are invested in, so if you can’t explain it to the client, then you need to reconsider the strategy.”

And while Stephen viewed alternatives as providing true diversification to an investment portfolio, he also believed they were often mis-used by advisers, cautioning that diversifying into alternatives, at a time when traditional asset classes are outperforming, generally don’t do as well.

It was a view supported by Longreach Alternatives’ Samuel Mann, who agreed it was important to have an allocation of alternatives in a portfolio for diversification purposes.

“There has been a long held misconception that alternatives are highly volatile, when in fact, it’s the opposite. Their volatility is extremely low. So, an allocation to alternatives does help reduce sequencing risk. That’s why the Future Fund in Australia has allocated nearly half of its portfolio to alternatives,” Samuel said. 

However, he added that while the quality and quantity of alternative opportunities had been slim in the past, this was changing for Australian investors, particularly in respect to private equity.

According to Pengana Capital’s Russel Pillemer, private equity is experiencing considerable growth as an investment opportunity.

“When it comes to investing, public companies represent just the tip of the iceberg, with the majority of companies – about 98 per cent – being privately owned. Private companies tend not to be listed because of all the regulation involved,” Russel said.

Private equity firms generally raise their funds from institutions and wealthy individuals, with those funds invested in buying and selling businesses. After raising a specified amount, a private equity fund will close to new investors; each fund is then liquidated, selling all its businesses within a preset time frame, which is usually no more than 10 years.

While private equity funds tend to outperform public offer funds, Russel added there were a couple of key considerations advisers and investors needed to be aware of.

“There are definitely liquidity issues,” he said. “By investing in a private equity fund, your investment is likely to be locked up for about 10 years.”

He also added that private equity was still an opaque market, where it was difficult for advisers and investors to get quality information on this type of investment in order to make an informed decision.

“To help address these issues, particularly around liquidity, Pengana has launched a listed private equity fund, allowing investors to take advantage of this alternatives opportunity,” Russel said. 

The IMAP Investment Forum is a community of interest for dealer group researchers, investment teams and independent researchers, where they can hear and learn from specialist portfolio managers and chief investment officers of advisory businesses. These experts and advisory professionals provide their insights on the practical issues involved in implementing managed accounts in an advice business.