By Martyn Wild.
What's got our attention?
It surely has been a good year for investors in Australian fixed interest, with the 1 year return to the end of June 2019 having been 9.6%. As fixed interest goes, that's pretty solid. But can it continue?
Well, no surprise, we are not going to make that call here! Nevertheless, what we will point out is that 9.6% is very much toward the upper range of expected returns in any given year for this asset class. Given the average 1 year return over the past few decades is something like 5.7%, one might convincingly argue that things are too good. In fact we estimate that, all else being equal, there is an 85% probability that returns will be lower going forward.
Knee-deep in statistics
One of the services we provide to our clients is monitoring market valuations, not least versus expectations. Referring to the blue & orange curves in chart below, we see a non-parametric and a normal distribution (respectively) for Australian fixed interest. They are derived from the historical returns of the asset class over the past few decades. In layman's terms, the curves illustrate the range of possible returns (and their likelihood) for this asset in ascending order.
Now, we would never use anything less sophisticated than a non-parametric distribution to construct portfolios and the chart below shows a few reasons reasons why. Notice how the normal distribution (orange curve) over-estimates the likelihood of the current rate of return? When compared to the blue curve, it also just looks unrealistic, doesn't it? It certainly doesn't look 'normal' to us.
Nevertheless, just because recent returns have been really good doesn't mean they won't continue to be good (or better) going forward; that's not what a distribution of returns tells us. What we can say, however, is that its not particularly likely that they will. That should give you pause...
Tactical asset allocation (TAA) - to be or not to be? If you are unfamiliar with our investment philosophy, we always prioritise the strategic asset allocation (SAA) as the primary driver of investment outcomes over any given time horizon. That being said, there may be instances where taking a short term tilt toward or away from one or more assets could make sense. We think that as long as there are appropriate checks and balances in place and you (or your investment manager) have proven skill, TAA can complement your SAA.
Now, please don't take this blog as investment advice! You should always get a professional opinion on such things and one tailored to your particular investment needs. As with all things in life, balance is key.
For more information or to talk to a member of the MARQAM team, please click here. MARQAM is a privately-owned, boutique consulting company focused on providing superior investment outcomes for clients and greater profitability for businesses. We are not affiliated with any other financial institution
Disclaimer: The information provided here is for interest purposes only and does not constitute investment advice or a recommendation of any kind.