06 June 2013

 Dear Investor,

Financial Year 2013: Taking stock

At La Trobe Financial, we are sometimes accused of being excessively conservative – old-fashioned, even. In many ways, we wear this badge with pride. While we are always ready to acknowledge that financial market innovation can be beneficial, we believe that most investors are best served by remembering a few timeless investment principles. That is why we so frequently return to these principles in Investor Insight.

One of our most enduring investment themes is that getting rich slowly never goes out of fashion. In some ways this 'goes against the grain. After all, it is human nature to dream of sudden wealth. That is why Tattslotto has such appeal – “life could be a dream”, goes the promotional jingle.

Now the chasing of a dream via the occasional purchase of a Tatts ticket is an eminently human thing to do. But it would be a mistake to regard it as a rational investment decision – in investment terms, the risk of losing your money is simply far too high to justify the outlay. Similarly, so many financial disasters are caused by investors chasing extraordinary returns and doing so by embracing excessive risk. In many cases, they spend the rest of their lives regretting their mistakes. For example, in recent years we have seen people at or near retirement choosing:

  • to use debt (‘leverage’) in their portfolios to produce higher returns. Whilst leverage is a legitimate financial tool, it magnifies losses as well as returns. This means that utilising leverage is inherently a high risk investment strategy.
  • to remain over-invested in equities (shares). Again, investing in equities is absolutely legitimate, but over-exposure to the asset class puts investors at risk in the event of a market crash.

We are reminded of the importance of this insight as we survey the markets near the end of the 2013 financial year. In our February Investor Outlook video report (click here to view), we queried whether investors were ‘sleep-walking back out the risk curve’. In other words, the hunt for yield had moved investors from cash to bonds, from bonds to hybrids and then to equities. This meant that investors were investing in riskier and riskier assets. And increased risk, of course, raises the prospects of increased losses.

As the chart below shows, the ‘risking up’ trend has been pronounced over the financial year. At 2 July 2012, the S&P/ASX 200 index was at 4,133. It then went on a long ‘bull run’, increasing steadily over the year with two periods of consolidation (November 2012 and March – April 2013). By the middle of May 2013, it was as high as 5,221.

Source: Yahoo!7Finance

It is important to remember that a share purchase is simply the purchase of a share in a business. So the amount that is paid for a share should reflect the profitability of the business. But aggregate corporate earnings have not been growing much over the last twelve months. In fact, after trading at a 20 year trailing P/E low of 12 last year, the share market is now trading at an above-average trailing P/E of 18. In other words, investors in May 2013 have been prepared to pay 18 times historical earnings that they were only willing to pay 12 times for just one year ago.

Whilst this increase does not mean that the share market is about to experience another crash, it is one indication that risks for investors could be building. These risks could manifest in the short term – as we write the market has lost over 250 points (5%) in just over a week, dropping from 5,209 on 20 May to 4,956. But a near-term crash is not an investor’s only concern. Detailed work by one of the world’s most influential finance and investment academics, Robert Schiller, indicates that an investor who invests when P/E ratios are high risks earning lower future returns.

Whilst Schiller’s statistical analysis was complex and detailed, the conclusion can be more simply visualised by the use of a graph. The graph below shows the distribution of historical 20 year annualised returns (the vertical axis) against P/E ratios at time of investment (horizontal axis). As can be seen, the distribution slopes downwards, left to right. This indicates that investments made at low P/E levels tend to achieve significantly higher returns over twenty-year period than investments made at high P/E levels.

Price-Earnings Ratios as a Predictor of Twenty-Year Returns

The run up in the Australian share market has not gone unnoticed in the broker community either. On 22 May 2012, Citigroup advised its global clients to reduce their exposure to Australian stocks. It argued that P/E valuations are 10% higher than the two decade average and that dividend yields have dropped from 5.1% to 4.1%, with limited scope for higher payout ratios or growth in earnings per share.

We emphasise that this does not mean that investors should avoid share markets. It simply means that they need to be very careful about choosing their investments and their level of exposure to those investments. Given the volatility of share markets (more detail here), it is doubly important that investors at or near retirement consider carefully whether they are over-exposed to shares. After all, six years after the GFC, the All Ordinaries remains around 38% below its peak in real terms. Can you afford to wear that sort of loss to your portfolio?

That, of course, raises the question as to where investors should invest, if not the share market. The obvious answer is that investors could/should consider different investments such as fixed interest investments, like La Trobe Financial’s offerings. In next month’s edition of Investor Insight, we will consider this issue further.

 Best regards,
Chris Andrews
Head of Funds Management

The following awards and ratings were given to the Pooled Mortgage Option within the La Trobe Financial Mortgage Fund


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Randal Williams
Chief Wealth Management Officer

t  +61 3 8610 2831
e  rwilliams@latrobefinancial.com.au

Chris Andrews
03 8610 2811
Vice President, Head of Funds Management
Daryl Hill
0408 566 524
Vice President, Head of Major Clients

Michael Watson
0409 419 039
Senior Manager Client Partnerships
Megan Pfab
0408 126 664
Senior Manager Client Partnerships
Jason Gidman
03 8610 2818
Cheree Cain
03 8610 2810
Funds Operations
Richard Anstey
03 8610 2809

Freddy Gong
03 8610 2858
Assistant Portfolio Manager
Helmuth Ewinger
03 8610 2833
Senior Manager Client Partnerships
Stacey Hynes
03 8610 2805
Senior Manager Client Partnerships
Peter Polemikos
03 8610 2834
Senior Manager Client Partnerships
Terrie Simpson
02 9238 2065
Senior Manager Client Partnerships
Jo Ni
03 8610 2803
Investor Administration Officer
Ada Yeung
03 8610 2865
Investor Administration Officer

La Trobe Financial is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 145 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.

Copyright 2013 La Trobe Financial. All rights reserved. No portion of this may be reproduced, copied, or in any way reused without written permission from La Trobe Financial. Disclaimer


La Trobe Financial Asset Management Limited ABN: 27 007 332 363 and AFSL No: 222213 is the issuer and manager of the La Trobe Australian Mortgage Fund. It is important for you to read the Product Disclosure Statement for the Fund before you make any investment decision. The PDS is available on our website www.latrobefinancial.com.au or by calling 1800 818 818. You should consider carefully whether or not investing in the Fund is appropriate for you.
- The rates of return from the Fund are not guaranteed and are determined by future revenue of the Fund and may be lower than expected. Investors risk losing some or all of their principal investment. The investment is not a bank deposit.
- Past performance is no guarantee of future performance.
- Withdrawal rights are subject to liquidity and may be delayed or suspended.
- The award and ratings were given to the Pooled Mortgages Option within the La Trobe Australian Mortgage Fund.
- The rating is only one factor to be taken into account in deciding to invest.
1. Zenith's "recommended" rating indicates that it has high confidence in the manager meeting its objectives. The Zenith Investment Partners ("Zenith") ABN 60 332 047 314 rating referred to in this document is limited to "General Advice" (as defined by section 766B of Corporations Act 2001) and based solely on the assessment of the investment merits of the financial product on this basis. It is not a specific recommendation to purchase, sell or hold the relevant product(s), and Zenith advises that individual investors should seek their own independent financial advice before investing in this product. To view the relevant research information, please visit www.latrobefinancial.com.au The rating is subject to change without notice and Zenith has no obligation to update this document following publication. Zenith usually receives a fee for rating the fund manager and product against accepted criteria considered comprehensive and objective.
2. SQM Research - 4 stars to 4.25 stars - superior, suitable for inclusion on most Approved Product Lists. To view the relevant research information, please visit www.latrobefinancial.com.au This rating will not take into account your, or your clients' objectives, financial situation or needs. It is up to investors to consider whether specific financial products are suitable for your objectives, financial situation or needs. Research houses receive a fee from La Trobe Financial for rating the product.
3. Lipper Leaders Rating Total Return (Score – 5) Lipper Ratings for Total Return reflect funds’ historical return performance relative to peers. The ratings are subject to change every month. The highest 20% of funds in each peer group are named Lipper Leader or a score of 5 for Total Return. Lipper Leader ratings are not intended to predict future results and does not guarantee the accuracy of this information. More information is available at www.lipperweb.com. Thomson Reuters Copyright, All Rights Reserved.