What returns should you expect from markets?

Emma Wall  |  01/12/2016Text size  Decrease  Increase  |  
email_fwd

Emma Wall: Hello, and welcome to the Morningstar series, "Why Should I Invest With You?" I'm Emma Wall and I'm joined today by Freddie Lait, of Latitude Investment Management.

Hi, Freddie.

Freddie Lait: Hello.

Wall: So, I thought we could talk today about returns expectations and reality. We are facing incredibly challenging times at the moment, not least because of geopolitical risks, but also because market valuations are very high. And I think there's a bit of a disconnect between what investors should expect to get and what they would like to get.

Lait: Yes, I think, you are right. I think since cash rates have come down from sort of 5 per cent to nearly zero or less than that in some places in the world, investors haven't really recalibrated their expectations.

And so, a lot of businesses are still targeting returns that may have been achievable with a sort of 3 per cent, 4 per cent, 5 per cent carry underlying it with your risk premium on top, whereas now actually I think people will need to reset down their return expectations.

Sadly, I think, at the same sort of time when rates went down to zero, most markets seemed to have lost their investment compass. And so, you've seen increased volatility in FX markets and most markets around the world now including bond markets.

So, I think, you are into a lower return higher risk world and it's a very difficult one to navigate from here.

Wall: And you are now running a long-only portfolio. You used to be a hedge fund manager. Multi-asset and hedge funds tend to work towards the sort of target of cash plus a certain amount. But as you say, I think, people are still thinking about, cash 4 per cent, plus 2 per cent, equals 6 per cent. But that's just not the case anymore?

Lait: I think that's right and you've seen a lot of more leveraged funds, a lot of hedge funds striving to take more risk, thinking that the risk-return curve continues to be linear and I think that's been the danger.

I think the right thing to do is to plan your portfolios accordingly to take a little bit less risk than you're used to now, because risks are broadly higher, try and think about real-time correlations within your portfolio rather than the long-standing 20-year relationships because correlations are breaking down a lot at the moment.

And seeking to eke out that kind of equity risk premium, sort of, 3 per cent, 4 per cent, 5 per cent above inflation or cash which are both near zero at the moment and aiming a little bit lower.

Wall: And it's not all doom and gloom, before people get too depressed watching this video. There are opportunities out there. You just have to be a bit more clever about where you find them?

Lait: I think so. I think one way to decrease volatility in your portfolio, which is very commonsensical, is to invest in the sectors that everyone isn't talking about.

And it doesn't necessarily mean being hugely contrarian or taking a deep value call. I think you need to take a long-term call on all of your equity investments in particular.

But I think one example is the commodity space where everyone seems to be piling into, sort of the Trump infrastructural bill, things like this. Actually, if you look at what's been driving the commodity markets is mostly Chinese financial demand as opposed to real production demand.

If you work through what Trump's policies are going to mean in terms of the demand side for copper or iron ore, it's a couple of percent a year incremental demand and I look at that industry and say, well, the supply side is still terrible.

People are still bringing new mines on. There's excess capital employed going in. Margins are falling.

To me, for the next five years, commodity producers will run for cash and prices will stay very low. So, that's not a sector where I think one should be going towards and it's incredibly volatile. So, you cut out a lot of volatility by not investing in spaces like that.

Wall: And where are you looking then? Where do you find the opportunities?

Lait: So, I think, a great place to be investing has been the US financials, the US large-cap banks. We've had a large number of those in our portfolio at Latitude and they continue to seem to be very good value to me.

The returns are increasing. The competition has been decreasing.

They are all earning their--sort of, their return on capital is equal to their cost of capital at the moment broadly across the space at a zero interest rate environment.

So, in the worst possible world of heavy regulation and low underlying carry for them. They are much better businesses, they are much more leveraged and I think in any kind of rate cycle, I think they will take advantage of the fintech in the market and I think they are going to grow very, very rapidly and should re-rate 1.5 to 2 times book value depending on who you are looking at with some growth. So, that's a great space.

And I think ultimately in the US, the consumer is still the place to be investing. That's the cyclical sector of choice for me, not the commodity and the primary producers.

But if we get a little bit of wage inflation, the market is quite tight in terms of the output gap. So, I think, you will get some wage inflation and those consumers will spend more on everyday goods. So, consumer discretionary at the lower end is probably a very attractive place to be.

Wall: Freddie, thank you very much.

Lait: Excellent. Thank you very much.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

Video Archive...

Did lack of transparency cause the financial crisis?
19/09/2017  Ten years after the collapse of Northern Rock, Andy Agathangelou tells Emma Wall that greater transparency in financial services could ward off a second global financial crisis.
Are we facing another Global Financial Crisis?
19/09/2017  Ten years on from the collapse of Northern Rock, Dan Kemp tells Emma Wall how there are echoes of the crisis in markets today.
Wild ride in FY17 and more to come - part 2
13/09/2017  Morningstar's Peter Warnes discusses how you may want to position your portfolio in FY18, as geopolitical storms continue to rage and safe-haven assets feel the effects.
Wild ride in FY17 and more to come - part 1
12/09/2017  Cost-out remained a dominant theme for large-cap Australian companies in FY17, and looking ahead to FY18, they should be clearer on cap-ex, says Peter Warnes, Morningstar’s head of equities research – Australasia.
Deeper demand driving these pooled investments
31/08/2017  Listed investment trusts are beginning to take off in Australia, but exactly what are they and how do they differ from listed investment companies and managed funds?
Upbeat Woolies result tempered by Big W
30/08/2017  Woolworths' category-topping FY17 result driven by surprisingly strong sales, even as sector faces tougher times ahead, explains Morningstar's Johannes Faul.
Coke Amatil 1H17 result leaves margin of safety
28/08/2017  A challenged earnings announcement from Coca-Cola's Australian-listed business was largely expected, but downside is already priced in and improvements are expected in FY18.
How slashed Telstra dividend affects our outlook
23/08/2017  Brian Han remains reasonably positive on the telco giant even after some disappointments in the FY17 earnings announcement.
Earnings season FY17 mixed bag so far
18/08/2017  Aside from a few high-profile earnings guidance misses, large-cap stocks are doing okay as FY17 reporting season passes halfway, says AMP chief economist Shane Oliver.
Rio Tinto posts mixed result for 1H17
10/08/2017  An interim result of US$3.9 billion in net profits after tax for one of the world's largest mining companies was positive but slightly weaker than expected, even alongside a record dividend, explains Morningstar's Mat Hodge.
Kerr Neilson on why global investment exposure is key
07/08/2017  There are two types of investors, regardless of market noise, imputation credits, diversification approaches and market indices, says the managing director of Platinum Asset Management.
Finding fixed income opportunities in new paradigm
02/08/2017  Slowing economic growth in the US and parts of Europe emphasises the need to carefully select credit opportunities, says Vincent Reinhart, chief economist, Standish Mellon Asset Management.
Telstra won't be blown away by headwinds
17/07/2017  While it faces what Morningstar equity analyst Brian Han describes as a whirlwind of negatives, he suggests investors shouldn’t hang up on Telstra.
The home-truths of investing
12/07/2017  Look for companies that sit outside the cycle; heed the lessons of history; and remember the power of compounding, says Bennelong's Neale Goldston-Morris.
Self-managed super is not Do-it-yourself
03/07/2017  There are a few common pitfalls in running a self-managed super fund that mean trustees shouldn't go it alone entirely, says BT Financial Group's head of financial literacy, Bryan Ashenden.
Investing to protect on the downside
30/06/2017  There are investment strategies you can adopt to mitigate volatility-linked fear and uncertainty in markets, explains Roy Maslen, chief investment officer – Australian equities, AllianceBernstein.
Don’t overdo benchmark consideration
28/06/2017  Being benchmark agnostic is the most effective approach to fixed income investing, according to Anujeet Sareen, portfolio manager, Brandywine Global.
Factor-based investing using ETFs
26/06/2017  Investors should consider style-exposures--such as value, defensive or yield-- they would like in their portfolios, explains Jonathan Shead, head of portfolio strategists – Asia Pacific, State Street Global Advisors
Volatility plays to active manager strengths
--  The climate of political volatility in the US holds important implications for investors and the funds they invest in, particularly around Donald Trump's ability to pass legislation through Congress, says Pimco's Libby Cantrill.
Is the FTSE 100 Facing Another Market Crash?
16/06/2017  Ten years on from the pre-crisis FTSE 100 high, Morningstar UK's Emma Wall examines how UK stocks have fared