Portfolio update 7 March 2023

Market Update

The strong start to the calendar year for Australian and US markets fizzled somewhat in February as investors came to the realization that interest rates are likely to keep going up for longer than originally anticipated.
Late last year the hope was that rates both here and in the US would peak by the end of March, and whilst the general view is that inflation has peaked, it has remained stubbornly high meaning the rate hiking cycle is not over yet.
We continue to see volatility in global markets, with investors clinging to the words of central bankers for any positive or negative tones, while conversely economic reports that show continued strength in the economy are viewed as evidence that further rate hikes are needed.

Recession Concerns

What these returns show is the importance of diversification, as not all markets will behave the same way at the same time, and also the importance of not taking knee jerk reactions when certain markets and investments perform poorly, as often they are the ones that have the strongest recovery when conditions improve.

The equities exposure in your portfolio remains well diversified across different regions and economies (both developed markets and emerging markets around the world) and also between larger, well established companies with well known brand names, and smaller, lesser known companies which display strong quality characteristics. We continue to believe that this is the best way to position the portfolio in these uncertain times.
 
While central banks are doing all they can to combat inflation, they are also wary of a ‘hard landing’, that is when an economy enters a recession after an interest rate hiking cycle.  Historically, it has been the most common scenario, 75 percent of US monetary policy tightening cycles since 1955 have resulted in a recession, so it is understandable why many investors see this as the likely scenario for this cycle.

US Federal Fund effective rate versus recession periods

Source: Board of Governors of the Federal Reserve System (US), February 2023.
We believe that this concern about a recession will continue to cause volatility in markets in coming months.

How we have positioned the portfolio for the current climate

The issues facing markets outlined above have been present for some time and we have structured the portfolio with these issues in mind.  First and foremost, we continue to believe that being well diversified is the most effective way to manage portfolio in all conditions, but the benefits are typically most pronounced in times of volatility where individual investments or asset classes can move quite sharply.  In our model portfolios the ETFs and managed funds provide exposure to thousands of underlying investments.

An example of some of the holdings in the portfolio and how they are positioned for an economic slowdown include:

• QUAL and QSML – Should a hard landing eventuate, quality is the ‘go-to’ factor during a slowdown and the corresponding recovery- namely strong balance sheets, higher return on equity and stable earnings.
• VVLU – Value shares have tended to outperform growth shares during period of economic slowdowns and many value stocks are in industries such as health care, financials, industrials and energy which don’t see their sales and earnings fall as much as growth stocks during recessions.
• A200 – Companies that have strong balance sheets and sustainable dividends will continue to be viewed favourably.  The biggest dividend payers over the next eight weeks are BHP Group, Woodside Energy, Commonwealth Bank, Fortescue Metals Group and Rio Tinto, all of which are held in A200.
• Realm and Arculus – Floating rate or low duration bonds have substantially outperformed fixed rate or longer duration bonds since the start of 2022 and with interest rates expected to continue rising, the yields on these funds are increasing whilst capital values are much less volatile than those of fixed rate bonds.
• GDX and PMGold – Gold has delivered positive returns in five out of the last seven recessions and is a good diversifier for the portfolio.
• IFRA and ClearBridge – Infrastructure revenue is inelastic – toll roads and utilities are essential for a functioning society. Infrastructure assets often have inflation-linked annual increases in rents written into the contract.  Infrastructure generally outperforms when economic growth slows as these companies are rewarded for their ability to generate sustainable earnings.

Collins House will continue to monitor market conditions closely and make changes if and when necessary.

Proposed Superannuation Cap of $3,000,000

There has been quite a lot of media hysteria regarding the recent announcement that the government will tax earnings on superannuation balances over $3 million at 30% rather than 15%.

While there is still much to play out, the below represents what we know so far:

• The change is not due to start until 2025/26 and with an election before then, may not even be introduced.
• It will only affect individuals with balances in excess of $3 million, which is estimated to be 0.5% of all superannuants.
• For the 99.5% of superannuants not expected to be affected, the following will still apply:
  • Whilst in accumulation (pre-retirement) phase, superannuation investment earnings will continue to be taxed at a maximum rate of 15% p.a.
  • Once retired over age 60 and drawing a pension:
    • Individuals with up to $1.7 million (increasing to $1.9 million from 1 July 2023) in pension phase will have superannuation investment earnings taxed at ZERO.
    • For individuals with balances above $1.7 million (or $1.9 million from 1 July 2023) and below $3m, earnings above these thresholds will be taxed at up to 15% p.a.
• Once over age 60 and retired, the vast majority of superannuants regardless of the size of their superannuation balance, will continue to be able to take money out of their superannuation accounts, tax free.

As the above shows, for those people not affected, superannuation will remain the most tax effective investment vehicle for retirement.  Even those who will be affected, will still enjoy the above concessional tax treatment on their balances up to $3 million.

If you have any questions about the above or would like to discuss your portfolio in more detail, please don’t hesitate to contact your advisor.