November Quarterly Asset Allocation

November Quarterly Asset Allocation

Quarterly Asset Allocation Update

November 2012

The Asset Allocation and Investment Committee met in November in the aftermath of the US elections, and whilst the once in a decade leadership transition was being completed in Beijing. We have elected to maintain the current settings with respect to the active asset allocation stance in each of the asset classes, comfortable with our long held preference for both Australian Equities and Emerging Markets. As can be seen in the table of our long term return forecasts below, we expect significantly better returns over the next ten years from these favoured asset classes than we do for either Developed Markets within International Equities or for Listed Property Trusts in Australia.

We devoted a significant portion of our discussion to the level of interest rates around the world, and to the impact to portfolio decisions of rates staying at historically low levels in Developed Markets for at least the next several years. From historical analysis we observe that when interest rates remain low we are likely to see higher valuations applied to other asset classes including equities. The United States currently provides a good example of the tendency for investors to be prepared to pay higher prices for shares, particularly those with higher dividends, as opposed to receiving very little or no return from traditional defensive investments such as money market funds and bonds.

As a result, we have slightly adjusted our view on where we see P/E Ratios in 2022, which is reflected in the Valuation Effect row below. You will note also below that we have split the International Equities asset class forecast into Developed and Emerging markets, and will continue to report these separately from now on. This now makes much clearer the themes that we have consistently written about, that is a higher income return (yield of 3.7% vs 2.8%), significantly higher earnings growth for Emerging Markets (3.6% vs 1.0%), and more upside from the Valuation Effect, reflecting relatively higher current prices in Developed Markets than for Emerging Markets.


In the October Monthly Commentary we wrote at some length about the stress testing that was applied to the Australian banking sector, and of course the conclusion that our major banks had the capacity to deal with a quite severe downturn scenario, without requiring a bailout. As portfolio managers it is useful to spend time understanding what the potential consequences of such an extreme scenario might mean, though our forecast remains that the outlook for the Australian banking sector will be low growth, but still providing attractive returns by virtue of the steady tax advantaged dividend payments.

Within Australian Equities we continue to favour the banking sector with an overweight exposure of 15% compared to the ASX200 index weight. The effect of this decision for an investor in the No. 4 program is that their target exposure to Financials is 21.5% of the overall portfolio, compared with 15.7% if this asset class was invested at the index weights. The natural consequence is to be underweight the remaining sectors, though this is spread proportionately with the largest underweights being to Industrials and Consumer Staples, both of which are approximately 4% under the index weight.

We have mentioned previously a somewhat cautious approach to the Resources sector, though recent signs of the Chinese economy stabilising and recovering into 2013 are encouraging. We have an essentially neutral exposure here, with our target portfolio including a 1% overweight to the Energy and Materials sectors. By their nature companies in this space tend to be more volatile, and hence we think that patient buying up to this neutral exposure continues to be the right approach. Since late July the ETF we own that tracks the Resources index gained more than 18% to its peak in mid October, before retracing by half that amount over about the next month. We will be prudent in adding exposure and expect that buying in the Resources ETF will continue to be focused on newer portfolios.

Australian Equities No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 10.0% 15.0% 20.0% 27.0% 40.0%
Target 14.0% 21.0% 28.0% 37.8% 56.0%



A little over a year ago we included a 30% drop in earnings for Europe over our ten year forecast period, and in the time elapsed since then we have seen remarkably close to that decline already eventuate. Whilst we think the short term economic outlook continues to be poor for the next few years at least, with a longer term perspective and given depressed prices and low current earnings, the forecast returns start to look more attractive from these levels. We have not made any decision to add exposure to Europe at this point but will continue to monitor developments closely and may begin to add exposure to portfolios carefully at some stage in 2013.

We are approaching the end of the staged sell down from the Developed Markets ETFs, namely the Global 100 (IOO), Global Consumer Staples (IXI) and Global Healthcare (IXJ) ETFs, which we started in February of this year. As the holdings in these ETFs becomes progressively smaller we will accelerate the rate of selling to ensure we don’t leave inconsequential positions in your portfolio, and expect that this activity will be finalised in either late 2012 or early 2013.

On both the forecast returns and the relative valuations we monitor we remain very comfortable with the exposure in this part of your portfolio being directed to Asia and Emerging Markets. The transition of leadership has completed in China and we believe that they will continue to grow in the order of 7% to 8% per annum for at least the medium term, an enviable result for the world’s second largest economy. It is widely expected that the new government leaders will continue to embrace the objectives of the current Five Year Plan to rebalance the Chinese economy towards domestic consumption.

With around five weeks until the end of the year which brings the beginnings of the contractionary effects of the fiscal cliff in the United States, there seems to be some optimism that Washington will come together to find a compromise. Those with a more sanguine outlook are even suggesting that the cliff will come and go in early January without much immediate impact, likening it to the Y2K bug that occupied everyone’s attention when the calendar rolled over from 1999 to 2000. What is inescapable is that over the long term there needs to be significant reforms that will curtail growth in order to reverse the growth in debt levels, and this will be a drag on economic growth in the US economy.

International Equities No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 5.0% 10.0% 15.0% 23.0% 35.0%
Target 3.0% 6.0% 9.0% 13.8% 21.0%



The ASX200 Property index recorded a low at 709 in August last year and has since rallied to within sight of 1,000, representing a 38% gain to the high in late October. However as we have stated many times before, the timeframe over which performance is viewed is critical, and the index is still down by more than 60% from the all-time high of early 2007 even after this recent rally.

Of course the decision we need to make is one that looks forward not backwards, and on that basis we continue to remain at 0% exposure to this asset class. As outlined in our forecast returns, whilst the yield and expected earnings growth are in line with long term expectations, we believe current prices look expensive and as a result we have the Valuation Effect detracting from performance by 1.6% per annum. As a result the overall return does not compare favourably to other asset classes and hence we will continue to monitor the sector but remain uninvested until our forecast improves.

Listed Property No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 5.0% 5.0% 10.0% 10.0% 10.0%
Target 0.0% 0.0% 0.0% 0.0% 0.0%



Over the last quarter we have made adjustments to accommodate new securities within this asset class model, which provides more diversification in this part of your portfolio. Importantly, we have also elected not to participate in some of the new investments that have come to market where they did not meet our investment criteria. Overall we maintain a slight underweight to this asset class of 25%, with expected returns at current prices lower than we forecast for both Australian Equities and Emerging Markets.

In recent times, our ability to access new investments prior to their initial listing has been a successful strategy and one we will continue with whilst the range of ETF options in this sector does not meet our requirements. We continue to maintain good relationships with both the investment banks to ensure continued access to new investments, and also with ETF managers that we expect will expand the range of ETF options in 2013.

If the current environment continues it is likely that there will be some divergence in the holdings of this asset class between portfolios, depending on their inception date with Implemented Portfolios. We apply valuation tests to new investments before adding them to the portfolios, and will also continue to be buyers of currently listed investments, but only at attractive prices.

HY Income Secs No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 10.0% 15.0% 15.0% 15.0% 10.0%
Target 7.5% 11.25% 11.25% 11.25% 7.5%



Like High Yield Income Securities above, we have avoided the range of ETF options that contain what are considered to be traditional defensive assets, mainly government bonds. This really is one of the key investment decisions that will impact the performance of your portfolio over the next several years. Pleasingly the performance of this asset class within your portfolio has been quite strong in recent months, notably via the good price increases in the recent Subordinated Note issues (ANZHA, NABHB and WBCHA). We are starting to see some moderation from recent highs and will resume buying for new portfolios when good value is again on offer.

The model investments sourced from the major Australian banks and listed on the ASX are providing an expected return of a little over 5% at current prices. By comparison the current rate on ETFs that invest in Australian Government Bonds is about 3%, and we believe there are significant risks of capital loss over our forecast period should interest rates rise to historical norms.

Expected returns across the whole range of defensive investments are lower than has been available in the past few years, and our investments which pay floating rate returns have moved in line with official interest rates. One of the key reference rates is the 90 Day Bank Bill Rate, which over the last year or so has fallen from around 5% to just above 3%. We do also monitor the term deposit rates available from the major banks and compare them to our model investments over similar maturities to ensure we are obtaining an acceptable return. Of primary importance however is that this part of your portfolio provides stability when market volatility is elevated, and we believe the combination of model Income Securities investments will meet that objective.

Income Securities No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 40.0% 40.0% 30.0% 20.0% 0.0%
Target 55.5% 49.4% 41.4% 29.72% 12.4%


Cash No. 1 No. 2 No. 3 No. 4 No. 5
Neutral 30.0% 15.0% 10.0% 5.0% 5.0%
Target 20.0% 12.35% 10.35% 7.43% 3.1%


As you would expect from an approach that is based on a long term forecast, the monthly reviews and quarterly adjustments undertaken by the Asset Allocation and Investment Committee represent minor adjustments to our long term views, more often reflecting changes in price levels than significant alterations to our core assumptions. We expect that the themes we have been discussing in all the forms of our communication with you will continue into 2013, and we will continue to evaluate the best options to reflect those themes in your portfolio.

DISCLAIMER: The information in this commentary has been provided for publication by Implemented Portfolios (ABN 36 141 881 147. AFSL Number 345143). The information has not been verified by Implemented Portfolios or Adapt Wealth Management Pty Ltd (ABN 76 821 231 362 Corporate Authorised Representative of CHPW Financial Pty Ltd AFSL 280201) but is believed to have come from reliable sources as noted in the acknowledgements. No Liability is accepted by Implemented Portfolios, or Adapt Wealth Management Pty Ltd, its Directors, officers, employees or contractors for any inaccurate or incorrect information. The information is a broad commentary and there is no intention that a client should act on the information without seeking professional assistance from their own advisers (legal, tax, accounting, financial planning) for suitability in respect of their unique circumstances.

About Reuben Zelwer


Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.