What your portfolio is really missing

While this article is written for Australians it raises a number of relevant points for New Zealanders including the point; investors should be paying more attention to infrastructure offerings given the low rates of return available in the equity market and defensive nature of the infrastructure.

Australians are a diverse bunch. We enjoy a variety of food, sport and cultural activities. But when it comes to investing, our tastes are a little bland.

With the exception of some token hybrid shares or a handful of capital notes, the average Australian investor is holding just three asset classes: local shares, property and cash.

Chris Morcom of Hewison Private Wealth knows this only too well. As a private client adviser he is frequently presented with the portfolios of clients that are a little, shall we say, lopsided.

"Most investors tend to start with assets they know and understand, such as term deposits and then residential property, then they move onto Australian shares," he says.

This can cause investors significant heartburn when markets take a leg down.

Few realise, for instance, that property is in fact a growth asset and when times are bad the capital values of property can correlate with other growth assets, such as shares. That means prices can fall, and sometimes fall swiftly.

The way to solve this problem is to diversify into other asset classes.

Craig Keary is the Australian and New Zealand director at fund manager AMP Capital. Like other traditional fund managers, AMP Capital runs a number of strategies including equities, fixed income and so-called alternatives.

Keary says, however, that it is the company's infrastructure offerings that investors should be paying more attention to, given the low rates of return available in the equity market and the defensive nature of the infrastructure sector.

"Investors are getting wise to the benefits," says Keary, highlighting the steady nature of income that flows from multibillion-dollar assets such as toll roads, airports and railways.

In the past, the problem has been getting access to such gems, which are typically owned outright by industry superannuation and global pension funds, or conglomerates such as Warren Buffett's Berkshire-Hathaway.

But as rates dipped lower, fund managers such as AMP have spotted an opportunity to launch retail products offering access to the wider market, opening up a whole new world for investors.

"The need for infrastructure is never-ending," Keary says.

"For investors, it offers predictable, regular and sustainable income as well as portfolio diversification as is lowly correlated to other asset classes such as bonds. Infrastructure is a good defensive play when markets are volatile."

Which brings us to another asset class that Australian investors have largely dodged: fixed income or bonds.

Where shares are equity – an actual portion of the company which may or may not pay dividends and are prone to wild swings in valuation – bonds are debt.

Bonds are also more stable. The price you pay for a bond at issue is the face value and the interest payment the company makes to you is called the coupon.

The face value of the bond rarely changes very much and the coupon should never change unless the company (or country) that issued it goes broke.

A nice, boring, stable asset class that should be in the portfolio of every investor.

Or should it?

Dr Doug Turek is the managing director of advice firm Professional Wealth and has a keen interest in asset allocation and investor psychology.

He says that the typical Australian investor is under-exposed to bonds but says right now, that's actually a good thing. 

"Bond prices have never been so high. For instance, the benchmark 10-year Commonwealth Government Bond is yielding 2.2 per cent and so is trading on a price-to-earnings ratio of 45 times. You might justify paying that for Google but not a nil growth bond," Turek says.

Expectations of low rates for longer have weighed on the coupons for bonds and the only way for investors to get a higher yield is to drift up the risk curve, which means swapping the safety of a bond backed by a government to one backed by a company the specialises in lending to commercial kitchens. 

Turek says most investors will get much better value by hunting down a high-yielding bank account offering around the 3 per cent mark or by heading offshore.

"If you must buy bonds consider buying global bonds, which enjoy an about 2 per cent lift in yield from currency hedging or buy local inflation bonds, which nowadays give you free protection from surprise inflation."

But if you're shopping overseas for bonds, then why not shares? Over the past few years there has been a growing acceptance among local investors that having a massive bias to Australian banks and mining stocks makes very little sense.

Nick Ryder, an investment strategist with JB Were, says that over the past five years, annual total returns from international shares have averaged at around 16 per cent, against 6 per cent from Australian shares.

"By value, Australia represents only about 2 per cent of global equity markets, yet the ATO [Australian Tax Office] statistics show that self-managed superannuation funds hold 31 per cent of assets in Australian listed shares," he said.

Andrew Moir, managing director of private wealth at Evans & Partners, says that if you assume that the majority of an SMSF's managed fund exposure is to overseas shares then the overall allocation could be as high as 10 per cent.

"It's hard to generalise, but for growth investors looking at wealth accumulation over the long term this should be two to three times higher," Moir says.

He points to the asset allocation of the Future Fund, a benchmark for investors with long term horizons as an example. The Future Fund had a 22.5 per cent portfolio allocation to international equities as of March 31, 2016.

Of course that's before we even get into such investments as private equity and alternative assets such as hedge funds. All of which the Future Fund has meaningful exposure to.

But those in the early stages of diversifying, it might pay to knock over the big ticket items first.

Australian Financial Review, Smart Investor 8 June 2016