Westscheme's Chief Executive Talks about Investment Volatility
After four years of strong gains in global equity markets, concerns about the US economy have resulted in a noticeable change in the investment environment. Global investors have become increasingly risk averse and very sensitive to new information which has resulted in a significant increase in market volatility.
The sharp contraction in the US housing market has been the catalyst for the recent change in the global investment environment. The US economy slowed noticeably in the December quarter 2007, with GDP growing by 0.6% (annualised). The US Federal Reserve and other central banks have responded to the slowing US economy and the problems in credit markets by cutting interest rates and providing liquidity to money markets. Since September 2007, the US Federal Reserve has aggressively cut interest rates from 5.25% to 3.0% currently. These cuts should provide a boost to global growth and help relieve some of the pressures currently in the global financial markets.
So far the slower growth in the US economy over recent months has had limited impact on other parts of the global economy. While growth in Europe and Japan is slowing, it is not weak. Importantly, China has continued to grow at a rapid pace which has helped underpin moderate global growth. Over the year to the December quarter 2007, Chinese GDP grew by 11.2%.
While the Australian economy continues to grow at a strong pace, concerns about the US housing market have put downward pressure on the Australian share market. While the Reserve Bank of Australia (RBA) is conscious of the problems in the US economy and credit markets, it has been concerned about building inflation pressures in the Australian economy, raising interest rates to 6.75% during 2007. The inflation data for the December quarter 2007 (released in January) show that underlying inflation is around 3.5%, which is outside the RBA’s 2% to 3% target range. Given this and signs that the Australian economy remains strong, the market is expecting that the RBA will raise interest rates again by 0.25% following its February meeting.
Looking ahead, there is considerable uncertainty about the outlook for financial markets. It appears likely that issues related to the US housing market and global credit markets will continue to be key factors over the shorter term. The key downside risk is that the problems in the US are larger than envisaged, resulting in a protracted period of weak US growth. On the positive side, developing nations, particularly China, continue to grow at a rapid pace.
While the current volatility in global share markets and the associated uncertainty about the short-term outlook is disconcerting, superannuation should be considered from a long-term perspective. The current investment environment is a reminder that share markets can have strong and weak phases. While it may appear tempting to try and predict such phases, this is very difficult to do. It is better to focus on the long term when considering superannuation. Over the long term, share markets have tended to rise in a relatively consistent manner. For example, the pre-tax return from the Australian share market over the past 20 years has been more than 10% per annum.
It should be noted that Westscheme’s default option, the Trustee’s Selection, has been designed to be less sensitive to equity market developments than the majority of superannuation funds. The Trustee’s Selection has a more diversified approach through a lower allocation to shares and a higher allocation to alternative assets (e.g. infrastructure and direct property). Movements in the returns from alternative assets do not tend to be closely aligned with the returns of the share market. This means that the Trustee’s Selection tends to be less affected by weak share markets than the majority of superannuation funds. For example, the Trustee’s Selection significantly outperformed the average return from other superannuation funds in the 2001/02 and 2002/03 financial years. This is the last period when global equity markets fell sharply. However, I am sure you will all know by now that past performance is not a guarantee of future net investment performance.
Overall, it’s important to remember that superannuation remains a secure long-term investment choice, and is one of the most important, and generally one of the simplest, ways for Australians to prepare for their retirement.
For full details on Westscheme’s investment strategy click here.
My thanks to Access Capital Advisers for their assistance with preparing this document.
Howard Rosario
Chief Executive
1 February 2008