This note puts the recent share market performance in a longer-run perspective. It highlights the fact that equity returns over the short-run can be uncomfortably volatile. The note also suggests, however, that based on some longer-run valuation measures, the market is not especially expensive at current levels. Together with recent modest returns, this suggests scope for above average returns at some stage over the next few years.
The Volatility of Annual Equity Returns
The Australian share market is off to a bad start this year. As at the close on 18 January, the market was already down by 8.3% for the year – the worst start this far into January in history. Meanwhile, the past two years have also produced relatively sub-par equity returns. On an GDP-inflation adjusted basis, the total return from the Australian All Ordinaries index was 5.0% in 2014, and is estimated to have been just 3.8% in 2015. That compares with an average annual real return of 13.6% since 1960, and a compound annualised real return of 11.3% over this period.
As seen in the chart below, however, the data since 1960 suggests a return of between zero to 10% is not that unusual – it has happened almost once every 5 years. Indeed, the spread of annual outcomes is relatively wide, with 14 of the past 56 years producing a negative total annual return – or once every 4 years. There was even a year in which real returns declined by more than 40% – in 2008 – and 7 years in which total return returns declined by more than 20%. Of course, as also evident the upside gains can also occasionally be spectacular – annual returns exceeded more than 20% in 19 years, or one third of the time.
Longer-run Valuations are Favourable
Investment Implications: Setting the right risk exposure
The correct investment strategy for an investor naturally depends on market conditions and an investor’s own preferred risk exposure.
For investors either in or approaching retirement, an important consideration is that fact that although equity market returns appear relatively less volatile when viewed from a longer-run perspective they remain highly volatile over the short-run. That means major market downturns can seriously cripple a retirees’ investment nest-egg due to their ongoing need to draw down capital even when market values are low. This limits their ability to participate in eventual market rebounds.
For investors concerned with such market volatility, BetaShares has introduced a suite of ‘risk managed’ Funds, which aim to provide exposure to a broadly diversified portfolio of Australian shares, while reducing the volatility of the equity investment returns and cushioning downside risk. As seen in the chart below, for example, BetaShares Managed Risk Australian Share Fund (managed fund) (ASX Code: AUST) has since its inception late last year to 18 January 2016 produced less volatile returns and has also helped cushion investors from the recent decline in share values. While the S&P/ASX 200 Index has declined by 4.6% in this period, AUST has declined by only 2.8%. In addition, since inception annualised volatility of AUST has been ~45% less than the Index. While this time period is admittedly very short and readers are cautioned not to place reliance on it, it does illustrate generally the “smoother ride” the risk management strategy seeks to provide.
Source: Bloomberg, BetaShares. Past performance is not an indication of future performance.
Investors also have the option of effectively setting their own net-exposure to the equity market through full or partial hedging their portfolio using the BetaShares Australian Equities Bear Hedge Fund (ASX Code: BEAR) or the BetaShares Australian Equities Strong Bear Hedge Fund (ASX Code: BBOZ). The Bear Fund seeks to generate returns that are negatively correlated to the returns of the Australian share market (as measured by the S&P/ASX 200 index), while the Strong Bear Fund seeks to generate magnified returns that are negatively correlated with the market.
By contrast, investors with a higher risk preference and who perceive recent share market weakness as a buying opportunity may find interest in the range of BetaShares Geared Funds. The BetaShares Geared Australian Equity Fund (hedge fund) (ASX Code: GEAR), for example, provides investors with a simple way to obtain a cost-effective geared exposure to the returns of the Australian share market. The Fund is ‘internally geared’, meaning all gearing obligations are met by the Fund. The Fund’s gearing ratio (the total amount borrowed expressed as a percentage of the total assets of the Fund) is managed between 50-65%.
Please note: BEAR and BBOZ’s strategy of seeking returns that are negatively correlated to market returns is the opposite of most managed funds. Also, BBOZ and GEAR use gearing, which magnifies gains and losses, involves significantly higher risk than non-geared investments, and may not be a suitable strategy for all investors. Investors should seek professional financial advice before investing, and monitor their investment actively.