What we liked and disliked – September 2018

What we Liked?

  • The S&P 500, a good proxy for the US economy, rose by 7.5% in the quarter, the largest such increase since the March of 2013. This was largely driven by an increase in Apple shares, which were up 22%. Similarly, the Dow Jones was up 9.1% for the quarter. As much as the press might have us believe, the US (and most) global sharemarkets don’t really care who is the president (or Prime Minister).

 

  • The performance of Scott Morrison in his first month as our new Prime Minister has been a strong one. We still can’t see how he wins the next election, but saying that the Shorten team has had some trouble pivoting their game to keep up! If we have learned anything over the last few years, it is that there is no such thing as the unwinnable or unlosable election.

 

  • We have loved the fall in the Aussie Dollar, even though it has made travelling overseas a lot more expensive of late. A lot of our recommended investments have had a powerful tail wind over the past 5 years with the dollar falling from over $1.00 to $0.72 today. Having your money exposed to such a change would have resulted in an extra 4% per annum. We love a tail wind!

 

What we Disliked?

  • The Melbourne Institute and Westpac Bank Consumer Sentiment Index for Australia declined by 3 percent month-over-month to 100.5 in September 2018. It was the weakest reading since November last year, amid increases in mortgage interest rates; political instability and household budget pressures.

 

  • The ever-reducing availability of good valued investment opportunities in Australia. It seems to be hard to find any real investment opportunities in many investments at all, from bonds to equities, all looking priced to perfection.  The tell-tale sign we are very late in this economic cycle.

 

  • We didn’t like CSL giving up all the gains made this financial year slipping back from a all time high of $232 to $203. (see later in the report for a review of CSL).

 

  • As much as Wattle Partners applauded the Royal Commission, we didn’t like the lack of detail and action points found in the interim report. The issues have been clear for a long time, what we need now is actions to clear the conflicted mess up.

 

  • The egotistical mess that Tim Haywood and Daniel Sheard got themselves into, causing the $7bn dollar fund (GAM Absolute Return Bond fund) to be shutdown. The good news is the sell down process is running smoothly and the portfolio continues to perform well.

 

Franking Credits – Facts & Fallacies

To say franking credits have been a talking point in recent months, would be an understatement. It seems everyone we speak with is growing increasingly concerned about the potential implications of this policy, even though it is a proposal from opposition with some 8 months before another election.

Given the publicity and borderline hysteria around the subject, we thought it worth outlining our views and understanding for our readers.

What are the facts?

According to Shadow Treasurer Chris Bowen website, the proposals are as follows:

  1. To cut the cash refund of excess franking credits for most investors from 30 June 2019;
  2. To exclude those receiving a Government Pension from this change;
  3. To also exclude charities and the politician’s own superannuation scheme, the Future Fund, from this proposal;
  4. To exempt members of self-managed super funds (SMSFs) if they were receiving a pension on the 28th of March, being the date of the announcement.

As you can see, the original proposal was quite straightforward, however, the backpedalling and exemptions began almost immediately which complicated matters. Before delving into our analysis, we believe it is important to address a few common misconceptions regarding the proposal.

  1. It is apparent that the cost savings proposed by this policy (which refers to some SMSF’s receiving refunds of $2.5m) are likely to be substantially lower following the implementation of the individual $1.6m cap on exempt pension balances;
  2. The proposal applies to all investors and superannuation funds identically, it is the exemptions that discriminate against SMSF investors;
  3. All investors will still be able to utilise their franking credits to offset any tax payable, including those with over $1.6m in an SMSF; meaning the number of people impacted is not as wide as initially thought;

What are the fallacies?

As is generally the case with such a hot issue, every journalist, adviser and investor has an opinion on the implications. Unfortunately, many of these people either don’t understand the inner workings of the superannuation or franking systems, which leads to less than useful advice. With this in mind, we have attempted to address what we believe to be the major fallacies around this proposal.

Fallacy No. 1 – The cancellation of refunds will only affect SMSF’s

As is seemingly always the case, the financial media sells this story as a war against wealth SMSF trustees, suggesting they are more heavily impacted than the alternatives. This proposal will impact every person in Australia that invests in shares and is not receiving an Age Pension. Yes, it will have a substantial impact on those with between $800k and $1.6m in the pension phase of superannuation, however, it is more widespread than that.

One little considered issue with this proposal, is that fact that many of Australia’s small businesses, who employ close to 50% of the population, operate their businesses either through a family trust or a company structure. If that company makes a profit and pays tax, it will receive franking credits, which can then be distributed with a dividend to shareholders. This proposal means it isn’t just those buying ASX shares, or the $2.6 trillion in superannuation but anyone running a business that will be impacted in the long-term.

Fallacy No. 2: The richest will be the hardest hit

The core sales pitch of this policy has been that it targets the fat cats, the 1% or the ultra-wealthy; those receiving $2.5m franking credit refunds. Again, unfortunately this is not the case. Such is the complexity and poorly considered nature of the policy, that it actually those people who have sought to fund their own retirement that will be hardest hit.

For example, those with over $1.6m in superannuation will still be able to offset any tax payable on the accumulation component that exceeds $1.6m with the franking credits they receive. The introduction of this cap essentially made franking credits valuable to these people once again. On the other hand, two retired families with less than $1.0m in superannuation will be put in vastly different positions according to an analysis provided by the SMSF Association, available here.

The SMSF Association’s analysis looks at two different couples, one with $700,000 in an SMSF, who receive a part Age Pension and another with $900,000 in an SMSF who do not. It assumes they both invest 40% of their portfolio in ASX-listed shares and receive a 5% dividend income plus franking credits. The results of the proposed policy are stark:

 

Owns home and SMSF worth $700k

Owns home and SMSF worth $900k (before)

Owns home and SMSF worth $900k (after)

SMSF Income

$35,000 $45,000 $45,000

Franking Credits

$6,000

$7,700

$0

Age Pension

$9,900

$0

$0

Total $50,900 $52,700

$45,000

Under the proposal, the couple who have saved $200,000 more over their lifetimes end up with less income than the couple of who saved $700,000. In our view, Government policy that results in one family who have saved more being in a worse position to one that has saved less is inefficient and poorly planned. This is likely to significantly reduce the incentive to save in superannuation and place increasing pressure on the Age Pension.

Fallacy No. 3: The member-direct loop hole

There is a growing misconception, in both the media and DIY investor circles, that you may be able to get around the proposal by moving your superannuation balance to an industry super fund. They suggest that even if you are not receiving an Age Pension, if you buy shares through an industry super ‘member direct’ option (that allows you to invest in ASX shares directly, the trustee is required to allocate the associated franking credits to your account regardless. Interestingly, before this proposal was announced, very few superannuants investing in an industry fund actually understood that any franking credits they received were actually used to offset the tax payable on the other millions of members within their fund in accumulation phase.

It was only last week that I was reviewing the comments of a similar article to this, to which an industry super fund representative was responding. The most enlightening point was that he could not expressly confirm that it was or wasn’t possible. It seems he wanted to keep the issue as grey as possible in the hope that the inflows to industry continued.

To our understanding, and according to the trust deed of most industry super funds, we do not believe there is a rule, or clause that specifically allows this refund to happen. Of course, it is the trust deed that governs each of these funds. If such a clause did exist, we are confident that it would be quickly removed, or the legislation amended accordingly. In this event, the decision to rollover to an industry fund would effectively be handing your franking credits over to the accumulation members in your fund whilst going through the hassle and cost of having to close your own SMSF.

Fallacy No. 4: High yield stocks will fall

One of the most worrying reactions to the proposal that we have seen, is the idea that investors should sell of their high yielding stocks because they are likely to fall. If anything, the slightly reduced value of franking credits may lead to some of Australia’s business making the long-needed decision to reinvest in their own business rather than paying out all their profits as dividends.

We are confident that this proposal will have a limited impact on the Australian sharemarket. For one, some 60-70% of ASX companies is owned by foreign investors or institutions, who have no use for franking credits. Secondly, the largest portion of the $2.6 trillion invested in superannuation is held in accumulation phase, which will continue to receive the full benefit of franking credits given they are taxed at a rate of 15%. In addition, anyone with an income exceeding the tax-free threshold, or with over $1.6m in super, will continue to benefit.

In the long-term, it may mean Australian companies are starved of stable capital from domestic investors, as they seek yield elsewhere; however, we hope this is not the case. In the short term, we may see an increase in off-market buy-backs, such as that announced by Rio Tinto this week, in an effort to distribute excess franking credits and effectively bring forward future years dividends for investors.

Fallacy No. 5: You are better off rolling back to accumulation

One of the more concerning strategies that has been raised, is the idea that investors should roll their superannuation back to the taxable accumulation phase. These experts were of the view that moving back into a taxable position would mean your franking credits can be used to offset any tax that would be payable; hence their value isn’t completely lost. This really only applies to those with less than $1.6m in pension phase.

In the case where you don’t require the regular pension income from your super fund and where you are currently receiving a substantial refund, this may make sense. Particularly so if you have taxable income in your own name. However, in general the idea is counterintuitive and will likely be difficult to implement. One issue we see with this strategy is the impact of realising substantial capital gains in any given year. These gains would be included in your funds assessable income and taxable at the standard superannuation rates of 15% (and 10% for assets held for over 12 months). What happens if the realised gains exceed the franking credits available within your fund? Or if you decide to change your investment strategy? In these cases you will likely end up paying additional tax for no reason.

To conclude

Whilst those with $3.2m in their super fund will be impacted by these proposals, it will be those with less than $1.6m and generally less than $1.0m that will be the most heavily hit. The aim of this article was to increase our readers understanding of the changes, so they can both be prepared in advance but also to understand the long-term implications of this proposal. As with any change to superannuation law, it will affect millions of people in different ways, across the entire $2.6 trillion in assets held in all types of funds; this will not be a simple process.

In my personal view, I do not believe this policy, once understood by voters in its entirety will have sufficient support to be passed in its present form. I believe the most appropriate solution will likely involve placing a cap on franking credit refunds, say $5,000 per person, rather than simply exempting those who are on the Age Pension. The policy will simply have too much of an impact on people seeking access to the Age Pension and a disincentive for future generations to save for their own retirement.

In terms of our advice, we do not recommend taking any action until a real proposal is put to Parliament. In the event the legislation passes, and you feel your portfolio is overweight to ASX-listed shares (which many are), then you should seek global diversification using many of the world class managers that now exist in Australia. Alternatively, you may wish to ask your children to become members of your SMSF, which would allow your franking credits to offset any tax on their taxable balances. This may represent a better option than the interest rate sensitive assets that represent a large portion of industry fund balances today.

To summarise, we believe all investment decisions should be based on their merit as an investment, not on the potential tax benefits that they provide. If you are concerned about the implications for your portfolio, don’t hesitate to contact us for a review.

The Wattle Watch

In any given month, Wattle Partners meets with many different professionals offering a new investment product, idea or scheme. Most are a pass from us, but now and again some pique our interest.  The following is an outline of the opportunities that we think deserve a second look.

Growth Farms – Australian Agriculture Lease Fund

We met with David Sackett, the Managing Director of Growth Farms. David’s group has recently launched a new fund called the Australian Agriculture Lease fund. The fund plans to raise $100million to invest in farmland across Australia. Growth Farms has a long track record of managing livestock, irrigated and row cropping assets, with about $430 million being managed already.

Most readers would know that Wattle Partners has been a big supporter of the agricultural industry with strong recommendations of Rural Funds Group (RFF) and Arrow Funds Management, both have proven to be very impressive investments,  showing an annualized return of over 30% per annum over the past 3 years.

We do still recommend both investments, however David had some very succinct points that made us consider his fund as an alternative.

Farm leasing is a well-established strategy in the US and Europe but not so much in Australia. It’s seems to work very well for investors and tenants (farmers) as there are mutual benefits.  The size of the farms they target are commercial and well run but typically farmers wanting to expand, however the farms are too small for institutional investors like pension funds and as such provides a return benefit to the investors.

The idea is that leasing provides a stable cash flow based on rental yield and avoids much of the volatility that comes with direct exposure to agricultural markets. David commented that the “the leasing model gives farmers opportunities to expand their businesses without having to find the capital to buy more land” and noted “many existing farms are sub-scale and capital constrained. Leasing overcomes this”.

“On the flip side from an investor’s point of view, leasing provides a stable cash flow based on rental yield and avoids much of the volatility that comes with direct exposure to agricultural markets.”

Australian Agricultural Lease Fund’s investor support base and earnings will be assessed after five years, but the intention is to give it a 10-year life span David did make the point that many agriculture funds are charging uneconomical rates to the farmer, he commented “that funds charging 6-7% rental will send the farmer broke eventually”.

He said while the new fund’s 4.5pc rental rate may be considered a “bit of a stretch” for some aspiring lessees in the livestock sector, in the wake of recent jumps in grazing land values, it was “certainly not at the top” of the leasing market’s range.

“If somebody with an existing family operation sees a place next door, we may well be interested to partner with them”. “We’ve been in this game, looking after other people’s investments, for a quite a while and we know the sort of discipline required.”

Acquisition opportunities would likely range from sugar cane country to irrigated grain and dairy properties, with the fund paying attention to areas where current seasonal or commodity market trends may make land valuations more attractive.

Growth Farms expected the yield after fees to be about 4%, and then farmland values to appreciate over the long term at 2% to 3% more than the consumer price index, thanks to rising commodity prices and productivity gains.  So, a total return over time of low double digits with very limited volatility.

 

Should you consider investing?

The short answer is yes. With low to negative correlation to other assets, the fund seems to have found a submarket (direct to farmer) that offers a low risk way to get exposure to a diversified portfolio of Australian agriculture.  Wholesale investors are invited to invest a minimum of $100,000 to join the fund.

Aoris Funds Management

During the week we met with Stephen Arnold, the Chief Investment Officer and Portfolio Manager of a new global share fund. Aoris is reasonably new to the market, however, Stephen was previously managing close to $1bn with Evans and Partners under a similar strategy and consistently delivered returns in the top 10% of similar managers. As independent investment advisers, and investors ourselves, we are regularly approached by managers seeking investors for their new products as they know we are not tied to major institutions and are willing to consider new managers or strategies.

We will provide a more detailed review of this fund as we undertake more extensive due diligence, however, we must say we were impressed by our initial meeting. In our view, this is a manager who knows what they are good at and understands the issues with a great deal of the industry. The fund is high conviction, holding only 10 to 15 companies, seeks a return of 10-12% and gives no consideration to any index when constructing its portfolios. At its most simple level, the fund is focused on avoiding businesses with key risk characteristics of high financial leverage, low profitability, rapid asset growth and expensive valuations. Readers will likely expect most people would avoid these companies, however, that is unfortunately not the case, and in fact it drastically reduces Aoris’ investment universe to just a few core sectors.

In terms of the investments they seek, it is businesses who are increasing their real earnings, not accounting for adjustments, and dividends year after year and reinvesting a portion of their profits back into their business. They are not seeking to identify the next Amazon, Apple or Google, but rather invest in the solid, profitable businesses that we use every day.  This fact alone means they will complement well with higher growth managers and provide valuable diversification.

Should you consider investing?

Not yet, Wattle Partners is doing a lot more work on this one but see the fund as a potential investment in the Wattle Partners Value Bucket. We will provide more information once we have completed our due diligence on this investment.

The Impact of Electric Vehicles on oil demand

During the month we come across an article from Stephen Anness, who is a global manager at INVESCO.  Given Wattle Partners recommends some oil and energy exposure in our core portfolio, along with indirect exposure to the electric car market we thought readers would also find it of interest.

Oil consumption is currently 95 million barrels per day (mb/d), an increase of 11% from 86 million barrels in 2008, despite the anaemic economic recovery from the worst financial crisis since the 1930s. However the widely held view is that demand is peaking and will start to fall imminently.

A large part of this thesis is based on the increasing availability of electric vehicles (EVs). The basic argument is that increasing EV adoption will lead to demand for gasoline/oil/diesel products (‘oil’) inevitably falling sharply, leading to a collapse in the oil price. However, we do not believe this to be the case and the claim is undermined by the data. We accept that the future of the car is evolving rapidly, that the proportion of EVs will grow substantially over the coming years, but it appears to us that the likely speed of adoption is overstated. Furthermore, even if the take up of EVs was to rise more quickly than we believe, the impact on total oil demand is likely to be limited.

In this article we seek to challenge consensus and highlight significant issues we have with the expectation of immediate, wide-scale adoption of electric vehicles and its impact on oil demand. We will address four key areas:

  • Oil demand derived from passenger cars
  • Impact from government subsidies on EVs
  • Effect of rapid EV adoption on the battery supply chain
  • Requirement for infrastructure

Oil demand derived from passenger cars

We believe many investors under-appreciate the dynamics of global oil demand. Out of the 95mb/d of global demand for oil, only 19mb/d, or c.20%, is actually for passenger cars (see Figure 1).

For the purposes of this article we have assumed that heavy duty trucks and other transport (e.g. ships and planes) cannot be electrified given the power-to-weight requirements. Therefore, our ‘at risk’ portion of oil demand is only 20% of global demand which to some extent debunks the myth that demand is all about cars as we’ve known them, or ‘ICE’ cars (internal combustion engine).

Fig 2. Forecast new cars sold (net) and global car park (bn)

Source: Invesco Perpetual as at 05 September 2017. EV = Electric vehicle; ICE = Internal combustion engine.

The other key element is a stock versus flow argument when it comes to the future of the car fleet. The global car fleet consists of around 1bn cars and virtually none of these are electric. Every year, around 85mn new cars are sold and 40mn are scrapped leading to an increase of around 45mn cars per year in the global fleet. Unless all cars sold move to be electric vehicles very quickly indeed, the fleet of ICE cars will continue to grow, (at least in the medium term) even if adoption of EVs increases rapidly.

Fig 2 shows the impact of rising EV adoption on the global car fleet. Assuming a very rapid adoption to 40% of global car sales being EV by 2024 the global car fleet should still grow by around 30% by 2024. It is therefore hard to see reduced demand for oil even in an aggressive adoption cycle for EV. Moreover, the prospect of peak demand for oil — an end to growth in global consumption — has been discussed in the energy industry for many years, without apparently coming much closer.

Fig 3. Failed forecasts of energy transition

Year of Forecast Forecast
1971 100% US electricity from nuclear generation
1976 33% of all US energy from renewable
1977 36% of US industrial process heat from solar power
1978 20% of all US energy from solar
1978 50% of Swedish energy from biomass
1980 49% of US energy from renewables
2006 Create rst oil-free economy
2007 CO2 emissions 40% below 1990 levels
2008 Cut US fossil fuel-based capacity by 88%
2008 100% of US electricity from renewables is achievable
2008 To replace natural gas – red power generation in the

US

2008 To use saved gas in cars and wean US off oil imports

Source: CLSA as at 2017.

Impact of government subsidies

The world of vehicles is changing, yet how the consumer responds remains uncertain. The shift towards electric has been supported by significant government incentives. Norway, for example, owes its success to the hundreds of millions of dollars in tax revenues diverted towards subsidies making it almost free to drive an electric car. Today it is normal for a Norwegian to buy an electric car in addition to a petrol vehicle for daily use to save money. Yet in countries such as Denmark and Hong Kong, where subsidies have been removed, sales of EVs have dropped dramatically. When the incentive was dropped in Denmark in January 2016, EV sales plunged 80% from the previous year (source: FT, as at 21 March 2017).

There are other considerations too, such as the impact on government coffers from lost revenue of vehicle duty and fuel tax. In the UK around 67% of the petrol price is tax. If the government abolished the UK gasoline market, that would cost $17bn per annum. It should also be noted, even in Norway which has seen rapid EV adoption, that oil demand is still rising.

Impact on the battery supply chain

As we stand today, the battery supply chain is a critical but little discussed constraint to rapid EV adoption. Modern battery technology requires a number of rare materials, for example lithium and cobalt, which are essential ingredients. We do not yet see a robust-enough supply chain for these products for the scale that would be required; cobalt in particular appears to us to be a considerable bottleneck for rapid EV adoption. There is currently enough cobalt mined globally to produce circa 5m EVs, assuming we don’t use cobalt for anything else such as phone and tablet batteries. It is not a matter of just price, production of cobalt simply cannot be ramped up quickly.

Furthermore, some 60% of cobalt production comes from the Democratic Republic of Congo (DRC), which has had issues with political instability and child labour. We are clearly wary of basing a thesis on one rare earth metal; however, there are currently no battery technologies which can produce the energy density required for pure EV which do not use cobalt in the cathode.

Infrastructure requirement

Different parts of the world are at different stages of developing the necessary infrastructure for the adoption of EVs. However the questions raised are broadly consistent: where can I charge my battery? How long will it take and how often? And how much will it cost? While none of these issues are insurmountable, the ease of filling up with fuel at your local petrol station is hard to replicate on a mass scale. For consumers with no off street parking, they have to find public charging points. How long they need to wait and how convenient that is, is debateable. Moreover investment is required (public or private) to pay for the infrastructure and it remains unclear who is prepared to do this and what rate of return they will require.

Conclusion

EVs are hugely topical and it is easy (and lazy) to directly extrapolate their impact on the global demand for oil. There are a number of other factors that we must consider: global GDP growth, industrial usage of oil, and how emerging market growth will offset OECD demand falls. By 2040 it is expected that the global population will grow by 23% and GDP will double. While per capita consumption of oil peaked 30 years ago in the US, Germany, France and the UK, it has grown at over 4% in China and India in the last three years. It is also worth considering that the average American currently consumes 25 times more oil than the average Indian. Meanwhile there is currently no readily available technology or alternatives to replace the oil required for shipping, aviation and chemical production.

As with all emerging technologies, the exact impact on consumer behaviour from EVs is difficult to anticipate. A new technology could emerge which can accelerate the pace of adoption. All we can say, with everything we know at this point, it that it is hard to see rapid mass adoption of EV and very difficult to see any dramatic shift in the demand for oil from passenger cars.

Real lessons from the GFC

You have no doubt seen all the ‘what we learned from the GFC’ articles in recent weeks. Interestingly, most journalists have decided to publish these on the anniversary of the pre-GFC sharemarket peak, rather than its bottom. We think it is far more relevant and useful to remember the bottom, as this where the real pain was felt, with plenty of tears, difficult conversations and most importantly, lessons learnt for the future.

It seems many financial market ‘experts’ have learned little from the pain of the GFC. Most articles spouted the standard lessons of diversification, avoiding leveraged companies and being sceptical of financial engineering. Whilst these may be right, in many cases they can be difficult to identify, or in the case of diversification, misunderstood or poorly implemented.

We always like to look back at what today’s heroes had to say in 2007, which for some reason is very difficult to find even in the days the google. The widely respected and lauded economist, Shane Oliver, had this to say in 2007:

“There is no sign of any impending crash on my calculations . . . the economic backdrop looks pretty good with pretty solid profit growth, relatively low interest rates, all at a time when the demand for shares is quite high,’

I’m not sure about you, but this comment doesn’t give us much confidence to follow his advice today. So rather than provide you with the same templated list of ‘Avoiding a Crisis’ lessons, we have put together a number of real action points for all investors:

1. Don’t invest in the index:

We know exchange traded funds, or ETF’s, are incredibly popular, that or they have substantial marketing budgets. Yet it was the sharemarket indices, which most ETF’s replicate, that were the core of the pain felt by investors during the GFC. For instance, the ASX All Ordinaries dropped from a high of 6,873 in November 2007 to just 3,090 points in March 2009. That’s a 55% fall. Most importantly, it still hasn’t returned to previous levels. Our advice to investors is this: if you like volatility, invest in an index fund or ETF.

2. Always hold some real cash in your portfolio:

This seems to be one of the more difficult things for investors, particularly with interest rates at just 1.5%. Yet, if the GFC taught us anything it is the need to have cash, or truly low-risk Capital Stable assets in your portfolio that can be used to buy shares when they fall. As many learned during the GFC, there is no benefit of simply shuffling your capital from one share that has fallen to another, you need to be able to draw on cash at the appropriate time. Our advice: hold an 5% in cash over and above your usual pension or drawdown requirements.

3. Avoid illiquid assets held through liquid structures:

The best real-life example of this point is the property and mortgage funds that were frozen during the GFC. Unfortunately, most of these investments would have performed particularly well over the next 10 years, yet the actions of a few investors in rushing for the door, resulted in poor returns for everyone else. Anyone who truly understands investment markets knows that the problem with these funds wasn’t the underlying assets, but the fact that the managers were offering daily liquidity or redemption’s, on those assets. The areas we are particularly worried about today are listed investment companies (or LICs), ETFs or managed funds that invest into corporate bonds, high yield ‘junk’ bonds or direct loans. Even more worrying has been the new ‘fractional’ property investment platforms allowing you to buy a few ‘bricks’ in an investment property. These options have been increasingly popular, with many listings over the last few months, as investors sought to diversify their income. We are also wary of exchange traded bonds, particularly where the market maker is also helping to issue the bonds, and synthetic ETF’s like the volatility, short, commodity and currency. If you like these assets, make sure you aren’t investing through a structure that offers daily liquidity, or be prepared for your LIC or ETF to potentially traded a discount to the value of your investment.

4. Make sure you can make money when the market falls:

In 2007 long-short or absolute return funds were primarily the domain of the ultra-wealthy and institutional investors. They were neither well understood, or readily available to Australian investors, who were primarily invested in top 50 ASX-listed shares. We learned during the GFC that there are only two ways to make money when the market falls; don’t have anything invested when it happens (which is nearly impossible) or make sure you have access to a manager who has success in and the flexibility to short the market. The ability to short companies means you can bet on those companies falling in price. It also means that should a major event occur, your long-short manager can change the direction of the portfolio immediately. Today, Australians are spoilt for choice of active, long-short managed funds which don’t have the requirement to remain 100% invested in equity markets in all conditions. One example is Platinum’s International Brands Fund, which has a flexible, long-short approach. The fund’s value peaked in May 2007, hit a bottom some 30% lower in March 2009, but had recovered all of this ground by April 2010; it took the index another three years before achieving this feat.

5.A fixed asset allocation strategy doesn’t work:

The majority of financial advisers and investors operate on a fixed or strategic asset allocation basis. This means your portfolio is set once and forgotten unless you decide to request a change. The GFC exposed this strategy for what it was, lazy, and frankly dangerous, financial advice. What happened was first time investors who walked into a financial adviser’s office in 2007, when most sharemarkets were at all-time highs, were told to invest 70% of their wealth in sharemarkets, and sometimes borrow to do so. The result was the worst sharemarket crash in 50 years and most investors remaining below their original investment value for up to a decade. You would probably expect something like this would change the way they provided advice, unfortunately it did not. Interestingly, it seems many of the industry super funds today are still using the SAA approach, but taking it to a more aggressive level with up to 90% of many balanced funds in risky investments as sharemarkets once again approach all-time highs.

6.Don’t try to pick the top or bottom of the market:

We are all prone to this belief that we can time the market and do better than everyone else. Few people have been successful in repeatedly doing so in history and many people have lost their capital whilst waiting to be proven right. The problem with being too early, as we have seen since 2015 when the market ‘peaked’ according to experts, is missing out on substantial, compounding returns. On the other hand, we can admit that we called the bottom of the market at least 10 times between 2008 and 2009; by the time it eventually happened, we were exhausted. What we know about investing is this: it is businesses (and shares in them) that have been the most successful and consistent providers of growth over the long-term. Even more importantly, we know that the best returns come from compounding, i.e. by staying invested and benefitting from the reinvestment of your capital. Our advice to survive the next GFC, ensure you get your allocation between Capital Stable and Risk assets right today, and have an extra 5% cash on the sidelines to give you comfort.

7. Hold more alternative assets:

In hindsight, the one thing that stood out between the best and worst investors during the GFC, was their exposure to alternative assets. The sole reason industry funds performed well was their combination of alternative assets. These included real assets like property and infrastructure, as well as a diverse range of absolute return, hedge, venture capital, private equity and distressed debt funds. Unfortunately, these weren’t freely available to most investors and advisers 10 years ago, or if they were they were limited to as little as 5% of the recommended portfolios. In a period where most investment returns will be lower than the last decade, with interest rates increasing and the debt problems having not disappeared, alternatives offer the only way to protect and grow your portfolio. Property and infrastructure will be impacted by higher rates reducing their valuations, but data-driven, opportunistic, non-correlated investment strategies are set for success. This is why the likes of Yale Endowment and the Future Fund etc. are investing as much as 30% in these sectors. They know they will not be getting any more capital, so they need to make their current dollars last longer.