Some Inconvenient Truths

Given the poor performance of Australian and world sharemarkets in the past few weeks, I thought it might be useful to put some thoughts down on paper, for both advisers and clients to consider at this time.

In short, investment returns, particularly in Australia, over the past few years have been way too high, and volatility has been way too low. That has led many investors to take way too much risk, and to expect returns that are simply not sustainable over the longer term. In presentations to clients over the past two years, I have stressed that nobody should do their financial planning assuming that the kind of returns from growth assets (again, particularly Australian growth assets) seen in recent years will be repeated. It is much better to be pleasantly surprised than bitterly disappointed – both in life and in investing!

Some historical perspective
The weakness we have seen in Australian shares follows five years of double-digit returns. For some time now, many investment managers, including MLC, have been warning that returns from the local sharemarket have been unsustainably high and that at some point, market conditions would be tougher, and returns would moderate. That is now happening.

Over short time periods, sharemarkets are inherently volatile places. What has been unusual has not been the volatility of recent times, but rather the lack of much volatility for the previous few years. Investors in shares need to be aware of this, and need to be invested for the long term. History has numerous examples of sharemarkets falling, and nervous investors bailing out, only to miss an eventual recovery.

The chart below shows the ASX300 index going back five years - a period which is probably the minimum time horizon that equity investors should work with. Even though the market has gone virtually one way over that period, there are still reasonably regular episodes where it takes a tumble.

 Let’s put that five year period in a longer term perspective. Each data point on the next chart shows the real (after inflation) per annum return from Australian shares over the previous five years. This is known as the rolling five year return. While we don’t have December quarter inflation figures as yet, it is likely that for the five years to the end of December, real returns from the Australian market, at better than 17% per annum, are the strongest we have seen since the mid-1980s. More precisely, they are the strongest we have seen since just prior to the 1987 stockmarket crash. These kind of returns were never going to last.

Over the past year, the strength of the Australian market has been driven by an ever smaller number of stocks. If we rank the stocks in the ASX300 index based on their performance in 2007, we find that the top five performers accounted for 73% of the market’s return. If we widen the universe somewhat, the top ten performers accounted for 95% of the market’s return!

Listed Property Trusts
The collapse in the Australian listed property market which began in the December quarter has been well documented, with the woes of the Centro Property Group featuring prominently. MLC and most of our investment managers have warned for some time (some years to be fair) that the local LPT market was becoming too heavily geared, too concentrated, too risky, and that the yields on offer in the sector were not compensating for that risk.

Yields in the sector are now considerably more attractive than they were prior to the crash. However, for the Horizon series property allocation, we continue to prefer global listed property as an asset class, and are happy to leave the decision to invest in Australian LPTs or not to our global managers. Thus far, those managers continue to prefer opportunities outside of Australia.

At MLC we continue to believe that trying to either forecast market returns in the short-run, or make short-term changes to asset allocation are both mugs’ games. Investors with a well-diversified investment strategy in place - a strategy that includes both Australian and global shares, among other asset classes - formulated as part of a long-term financial plan, should not be unduly concerned with the markets' recent moves. Probably the two biggest components of a financial plan are an assessment of long-term financial needs and goals, and an assessment of an individual’s appetite for risk. If either of those two components has changed, you may need to review your position. If they have not, then it is most unlikely that anything has happened in the past few weeks to trigger a change in your strategy.

Important Information:
Any advice in this communication has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on any advice in this communication, consider whether it is appropriate to your objectives, financial situation and needs. You should obtain a Product Disclosure Statement or other disclosure document relating to any financial product issued by MLC Investments Limited ABN 30 002 641 661 and MLC Limited ABN 90 000 000 402 and consider it before making any decision about whether to acquire or continue to hold the product. A copy of the Product Disclosure Statement or other disclosure document is available upon request by phoning the MLC call centre on 132 652 or on our website at www.mlc.com.au  
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