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Asset Allocation: A "reasonably defensive" portfolio picked for 1999

The asset allocation committee at the FPG Conference has opted for a reasonably defensive portfolio this year, favouring Australian and New Zealand markets.

Wednesday, March 3rd 1999, 12:00AM

by Philip Macalister

The asset allocation committee at the FPG Research conference is hoping that its portfolio for the next 12 months will perform better than last years.

The tactical asset allocation devised by the 1998 committee performed poorly, relative to its benchmark. The benchmark portfolio returned 24 per cent in the 12 months ended December 31, while the tactical portfolio returned 19 per cent.

"The reality is we screwed up last year," committee member and WestpacTrust Financial Services general manager Girol Karacaoglu told the conference.

Much of the blame for the performance was the committee's decision to significantly underweight international equities. This was primarily due to the uncertainty flowing from the Asian economic crisis.

Three quarters of the way through 1998 the allocation was looking good, because equities had performed relatively poorly, however the portfolio suffered when equity markets produced a huge rally in the final quarter.

The following table illustrates the allocations and each sector's returns in the 12 month period to December 31, 1998.

 

Asset allocations and returns for 12 months to December 31, 1998

Asset class

Benchmark %

Tactical allocation %

Returns

12 mth to Dec 31

NZ equities

5

5

0.32

NZ fixed interest

5

10

14.09

Cash

5

10

7.66

Property

5

5

2.90

Aust equities

10

5

15.76

Aust fixed interest

10

5

13.54

Intl equities

40

25

37.78

Intl fixed interest

20

30

13.63

Other

0

5

13.63

12 month returns

24%

19%

 

 

 

 

This year the benchmark has been revamped giving greater exposure to New Zealand assets.

Under the new benchmark 30 per cent of assets are allocated to New Zealand compared to 20 per cent last year.

Committee chairman, and Bank Credit Analyst Research Group managing editor Stephen Poloz says this change reflects investors' bias to the local market.

This year's tactical asset allocation is significantly different than last year.

Tactical asset allocation 1998 v 1999

Asset class

1998 asset allocation

1999 asset allocation

Difference

NZ equities

5

15

+10

NZ fixed interest

10

0

-10

Cash

10

10

0

Property

5

10

+5

Aust equities

5

10

+5

Aust fixed interest

5

10

+5

Intl equities

25

30

+5

Intl fixed interest

30

15

-15

Other (trading funds)

5

0

-5

 

Poloz describes this year's portfolio as being "modestly defensive" and tailored to producing a good yield.

With no big issues on the horizon, "there is no strong reason to go a long way from the benchmark," he says. "We are not looking for any disasters."

Poloz predicts that world economic growth will bottom in the second half of the year, and a slow, "saucer-shaped" recovery (as opposed to a quick, strong one) will follow. A recovery in commodity prices will follow.

A feature of the year will be further unsynchronised economic growth. In some areas it will be very strong others weak.

He says Europe and the US economies are slowing, there are problems in Latin America and Asia has stopped collapsing.

The key features of the committee's portfolio are that it is has more New Zealand assets than last year through both the benchmark changes and the tactical asset allocation decision. Locally the committee is overweight in property and cash and devoid of bonds.

Bank of New Zealand chief investment officer Anthony Thyne says despite a recent bout of euphoria about the local economy it is not yet clearly out of its recession.

"It's a bit too early to be too optimistic," he warns.

Likewise Poloz says, "people have got a little bit to enthusiastic (about NZ). We are a little skeptical."

He says the risks for the market are greater on the downside than the upside.

Thyne says the NZ sharemarket is at fair value and its yield is relatively high on a global basis and there are some negative factors.

The main one of those is the large current account deficit.

The asset allocation committee couldn't make a case for buying New Zealand bonds as "yields aren't going to fall," Thyne says.

Karacaoglu says NZ bond yields are already 1 per cent below the norm and a lot of the good news is already factored into the prices.

He says when you're nervous about the international bond market it is very hard to make an argument to buy NZ bonds.

The other major factor facing NZ markets is political volatility in the lead up the general election.

"One thing markets don't like is uncertainty," he says.

With bond yields so low, and little prospect of a rally, investors where better to favour cash where they can get similar returns with less risk.

For these reasons the committee reduced its NZ fixed interest weightings from 5 per cent to nil, and increased cash from 5 per cent to 10 per cent.

In keeping with the decision to take a defensive position and focus on yield, the committee opted to increase its exposure to property from 5 per cent to 10 per cent.

Australia was a highly favoured market, with double weight positions being taken in both equities and bonds. The committee also noted that it favoured Australia in the Australia/New Zealand mix.

It's reasoning was based around a number of factors including, a stable political environment, an expected upturn in commodity prices later this year, the sharemarket's high dividend yield and an expectation that companies will continue to post "good quality earnings".

The committee also took a "somewhat more cautious" approach to international equities this year, with most of the caution revolving around the valuation of the US market.

Rothschild Australia Asset Management's Jonathan Pain says it is hard to reconcile the US market's growth with the subdued outlook for earnings. He also said the US market had significant exposure to the troubled Brazilian market.

More than 400 of the top 500 US companies have Brazilian subsidiaries, he says.

The bright spot internationally is the European market.

Poloz says the four key risks facing investors this year are:

  1. International bond yields exceeding 6 per cent. If this happened there would be an "equity meltdown", which could be as much as a 30 per cent fall. He says if bond yields started to rise the case for buying bonds would be strengthened.
  2. The US/Yen rate raising to more than 140. Currently the cross-rate is about 120. Should it rise there would be a strong likelihood China would undertake a "competitive devaluation". This would also lead to an equity meltdown and a bond rally.
  3. Brazilian default. A Brazilian default could trigger a South American version of the Asian contagion. The United States would suffer under this scenario as a large number of US firms have Brazilian subsidiaries.
  4. Y2K. "There is the risk that the year 2000 never arrives," Poloz says.
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