When thinking about what events, two key events come to mind; the federal election, which we know will happen sometime before 18 May, and the other, less certain, is the potential for a more significant correction as trade wars between the US and China escalate and the US Fed continues to increase interest rates.
While neither event is new, I think it’s very important to be comfortable with your asset allocation at this point in the final stages of the current long bull market. The turning point, which you could argue has already arrived, will see investors chasing yield by investing in risk assets lose capital, with negative capital values destroying overall returns. The focus should shift to preserving capital and using it at the low point to take advantage of cheap assets.
So take time now to review your portfolio and prepare, I think 2019 is going to be a bumpy ride for investors.
1. Australia will have an election next year
I’m not a gambler but after the recent Wentworth by-election and shock Liberal loss I thought I would check the odds of Labor winning the next election. According to Sportsbet, Labor is currently 1.25:1, while the Libs are 3.50:1.
If Labor get in with a decent majority they’ll be able to legislate current proposed changes to franking credit, negative gearing and capital gains tax and that’s going to change the way people view markets and invest.
Some assets are going to be less attractive, forcing asset revaluations and prompting investors to rethink asset allocations.
Loss of negative gearing on existing properties and an adjustment to capital gains tax will take some of the shine off property, although tighter bank lending standards in the wake of the banking royal commission already seems to be making an impact.
The proposed franking credit legislation is significant and will harm investors who are not paying tax but are reliant on those refunds. Removal makes hybrids and shares relatively less attractive than lower risk corporate and government bonds and deposits – assets that receive no beneficial tax treatment. Most hybrids distributions assume investors can claim franking credits but if not, returns then are very similar to bank subordinated bonds, a far superior, lower risk investment than the hybrids.
2. Potential for a more severe correction
Last month saw geopolitical and sovereign risks come to the fore, and global share markets adjust downwards, meaning that as we roll into 2019 I’m thinking about positioning portfolios for a significant correction that many feel is coming. What we don’t know is when.
I have always encouraged investors to think for themselves and stress test their own portfolios. How would a further 10, 20 or 50 per cent correction impact your portfolio and lifestyle?
Do you have an appropriate defensive position to meet lifestyle and other long-term goals and aspirations? Here I don’t mean having three years living expenses sitting in cash.
Asset allocation for SMSFs and even for large Australian pension funds is skewed towards shares and cash. In most cases they hold too much in one or the other – either taking too much risk, or not enough. Ask yourself what’s most important?
- A minimum cashflow to meet ongoing expenses?
- A high yield, so you don’t have to touch the capital?
- Preserving capital to leave some for the kids or perhaps a worthwhile charity?
What’s your number one priority? Has it changed? Does your asset allocation need a rethink? As you approach retirement you need to be more conservative as you simply don’t have the time to recover from a major GFC type event.
So, in light of a potentially shaky outlook for 2019, what features of corporate bonds be useful in a portfolio?
- Cashflow. Corporate bonds usually pay quarterly or semi-annual interest, a great way to boost cashflow and meet minimum withdrawals from a super fund.
- Maturity date and capital. Most bonds are issued with a face value of $100. Then they start trading in the secondary market, where prices can go up and down but do not change the fact that you can expect the $100 face value to be returned to you at maturity.
- Range. From lowest risk government bonds paying around 2 per cent p.a. to high yield foreign currency bonds paying over 10 per cent p.a. and everything in between. FIIG Securities makes over 400 bonds available typically from $10,000 per bond.
- Tradability. Corporate bonds are tradeable on a T+2 day basis, the same as shares.
Elizabeth Moran, FIIG Securities director education and research