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Investment commentary July 2016

Quick overview

  • The financial year ended 30 June 2016 was a difficult year for growth assets
  • Political instability has been on the rise globally
  • Future returns are likely to be lower than historic averages and some defensive assets are vulnerable if growth or inflation increase above expectations
  • Management of portfolios by professional fund managers can reduce risk and improve returns

A challenging year for growth assets

As financial year 2016 drew to a close there was yet another bout of volatility in markets, bringing the return on Australian shares back to just short of +1% for the year. The return for international shares was worse, saved only by a fall in the Australian dollar, which took an unhedged investor slightly into positive territory.

Defensive assets had a much better result, fixed interest delivering a +7% return locally and +9% internationally as bond yields made new lows around the world. One bright spot for growth assets was the performance of real assets such as property and infrastructure, both of which had returns around +12%.

From Grexit to Brexit and increased volatility

At the start of the financial year the markets were focused on the potential for Greece to leave the euro zone. Instead we finished the year with a referendum result supporting the departure of the United Kingdom from the European Union (Brexit).

Political risk is on the rise elsewhere in Europe but also notably in the United States. A backlash against establishment candidates there has seen Donald Trump seize the Republican nomination. It seems unlikely today that he will win the presidential election in November, but this has been a year of unexpected political results, including here in Australia. We think that political instability will continue, and this could drive bouts of volatility in markets in the year ahead.

A ‘goldilocks’ scenario of not too little and not too much inflation would be the best outcome

Now what?

Eight years after the Global Financial Crisis the global economy remains fragile, but there are reasons to be optimistic. Asset markets are priced for a period of continuing subdued growth and benign inflation. If this is what eventuates then we can expect returns to be lower than they have been over the long run.

If growth and/or inflation surprise to the upside then returns on traditional ‘defensive’ assets might turn out to be far less defensive. A ‘goldilocks’ scenario of not too little and not too much inflation would be the best outcome, where companies benefit from revenue growth and have the confidence to make investments in new capacity.

The silver lining

In a world with diverging monetary policies and growth potential, we think there’s greater ability for active fund managers to add value compared to the broader benchmarks. We’ve already been seeing this at StatePlus, where managers in our share portfolios have outperformed, but more importantly from our perspective have done so with less risk.