Q&A: Investing in an uncertain market
Inflation, recession risks and geopolitical challenges have kept investors on the edge. In this Q&A, Professor Jerry Parwada of UNSW Business School, an investment and financial markets specialist, shares his thoughts on the market, what it means for retirees and high net worth individuals (HNIs), and the role of portfolio diversification.
How will the market likely impact retirees and HNIs?
Jerry Parwada (JP): With the current general trend being towards rising interest rates, this means that assets whose values are linked to interest rates have become cheaper relative to equities, making them more attractive.
However, it also means that retirees and HNIs who have exposure to investments such as annuities, bonds, CDs etc whose return is fixed are seeing reduced purchasing power as inflation rises.
Are Australian markets being impacted less than other countries?
JP: It is not possible to directly compare Australia with other markets because of the timing of us moving towards higher interest rates. Australia has lagged that of comparable economies such as the UK and US.
It is notable, though, that other markets (such as in the US) have experienced more pronounced drops in stock valuations.
This is because the core signal of imminent increases in interest rates – inflation – started rising in countries such as the UK and the US well ahead of and at a much bigger pace than Australia. For example, while inflation in Australia in the period 2020-2022 remained below 5 per cent, the US and the UK raced ahead towards their current near-double digit rate.
The US Federal Reserve (the Fed) signalled in statements that there would be rising interest rates in the near future, while the RBA was promising a hold until at least 2024.
How could investors lessen the inflation impact on their portfolios?
JP: For an investor holding a portfolio of investments, rising inflation may result in the value of some of the assets rising relative to others, for example. This means a previously well-balanced portfolio becomes skewed.
The best way to lessen the impact of inflation on portfolios is to be vigilant about either consulting one’s adviser regarding such an imbalance or using one’s own knowledge to periodically rebalance the portfolio.
With regards to fixed income exposures, there are some inflation-protected products to consider. However, such products may also charge high fees for such protection because of heightened demand, thus diminishing their value. A good financial adviser will be able to steer clients in the right direction in this regard.
Which sectors are worth considering in the current market?
JP: I choose to be a bit of a spoiler here and caution against the practice of ‘industry timing’ in response to short term volatility. This is because, in the first instance, individual investors tend to do well when exposed to low-fee, index type products.
Numerous academic and industry papers show that there is very little ‘alpha’ obtained from active management and if it is achieved, it is whittled away by transaction and management fees. A good financial adviser should be able to match an investor’s financial circumstances and risk appetite, with appropriate, low fee, exposures.
What is the role of diversification in uncertain times?
JP: The role of diversification has never been more important for novice and seasoned investors alike as at this moment. ASIC “Retail Investor Research” report contains very troubling statistics about the behaviour of Australian retail investors. To quote directly from the report:
“The majority of investors (82%) held fewer than five product types overall (e.g. Australian shares, cryptocurrencies, international shares). Over one-third (36%) of investors held one product type only (e.g. Australian shares only), 24% held two different product types, 22% held three or four product types, and 18% held five or more product types. Of those investors who held only one product type, most were invested in either Australian shares only (53%) or cryptocurrencies only (31%).”
It is particularly concerning that the most concentrated portfolios are comprised of speculative assets such as cryptos. Even with traditional asset classes, there has been a long trend in the community of overweighting on assets based on what friends happen to be investing in. Even SMSFs are not spared, with regulators historically expressing concern about their concentration in real estate.
What are your three portfolio diversification tips?
- When thinking about diversification focus on your whole portfolio, including superannuation. For example, an individual whose superannuation is overwhelmingly in equities may focus their conversation with a trusted financial adviser on alternative assets.
- Take advice from qualified professionals or if you are a seasoned investor, do not follow the crowd into risky asset types.
- Understand the role of fees in your overall portfolio returns.
For more market-related insights from Professor Jerry Parwada, please read this article - Stock market: Should I buy stocks now - or hold off?