A client has sent through a link to another article following up the discussion in my previouse blog - How long might a recovery take?

This article was published in the New York Times last Saturday 21st March - Lowered Expectations for the Bulls' Return

The article highlighted the risk in expecting that the equity markets will rebound to their historical highs any time soon:

"it took 7.2 years after the start of the bear market in 2000 for stocks to reach a bottom and then to climb back to the 2000 peak. After the bear started growling in 1973, it took 7.5 years to return to the high. And after the 1929 crash, equities didn't return to their previous peak for another quarter of a century."

To paint a brighter side to the analysus Dimson (author referred to in my previous blog entry) was quoted as saying:

"Here's another way to think about it: Even if it takes 10 years for the Dow to claw back to its old highs, at an annual rate of nearly 7 percent, "you would have still done very well ? certainly better than in T-bills,"

More food for thought.

Regards,
Scott Keefer

In reading through The Australian wealth section this morning I came across an article written by Time Blue - Boomer to Busted.  The article as a whole was an interesting discussion of the impact of the current investment climate on those close to or in retirement.  However, the part of the article that drew my attention was the discussion of an academic paper written by Elroy Dimson, Paul Marsh & Mike Staunton - Irrational Optimism.

This paper looked at annual returns from the US and other international share markets from 1900 to the end of 2002.  Reading the article can provide a somewhat bleak view of future prospects from investing in equity markets with the authors suggesting you are an irrational optimist if you think it is totally safe to invest in equities even over a 20 year period.

Tim Blue's insights from the article was that the researchers found 7 occasions when it took at least 10 years for a full recovery in the value of equities in real terms (after taking out the impact of inflation).

Our firm's approach is that for investors who intend to draw down on their investments in the short to medium term, (e.g. retirees, those using transition to retirement strategies, those accessing income from the portfolio before retirement) we suggest that they hold 7 years of draw down requirements within their portfolio in lower volatility cash and fixed interest investments.  We base this suggestion on positioning clients so that they are protected from being forced to sell growth assets at values less than previous high points (currently November 2007 for Australian and international equities).

Why 7 years and not 10 years?  Those 7 years of cash and fixed interest will be supplemented by interest and dividend payments will push this window out past 10 years.

So what does this all mean?

If it takes 10 years from November 2007 to regain the high point, this means that an investor's asset allocation should be placed so that they are not forced to sell growth assets before the end of October 2017.  What real return would be required from equity investments to get back to this high point? - approximately 6.4% (i.e. if inflation averages 3%, the return from equities would need to be 9.4%)

This sits fairly nicely with Siegel's long term returns from equity markets

Alternatively though, according to Dimson et al, who see the real return from equities more likely to be 4% going forward this 10 year window pushes out to a 16 year window.  Based on this insight, for those with less tolerance to risk it might be that a portfolio is positioned with 10 years of cash and fixed interest to help protect against this eventuality.

For our firm, we think it is important for clients to be fully aware of these parameters and together with us make prudent decisions about asset allocation and investment decisions.

A final consideration that is often forgotten is defining what is the timeframe for the investment portfolio?  For most, an investment portfolio (don't forget superannuation) is required to last until death.  For many, the goal is to pass on assets to others at death whether it is to family or for philanthropic causes.  This pushes the time frame even further out.  Once you get out past a 20 year time frame, the certainty of having a positive outcome from investing in equities, although not certain, is definitely high.

In conclusion, our firm believes that investing in equities is a prudent approach over the long term.  However, expectations about these investments need to be based on realistic parameters and in relation to each individual client's preferences.

Regards,
Scott Keefer

For those interested in loooking into Dimson's research in more detail, through my CFA studies I have come across a webcast presented by Dimson in 2005 - Irrational Optimism.

I have come across an interesting analysis conducted in the US by The Market Analysis, Research and Education (MARE) group, a unit of Fidelity Management & Research Company (FMRCo), which looked at four possible investor strategies:

The Stay-the-Course Investor - Maintains dollar-cost averaging throughout a bear market.

The Bear Market Dodger - Effectively avoids the bear market by shifting 100% of new contributions to cash before incurring any losses, and shifts 100% of new contributions back into stocks as the market resumes a long-term uptrend.

The Bear Market Refugee - Shifts all new contributions to cash at the onset of a bear market (20% drop), and shifts 100% of new contributions back into stocks as the market resumes a long-term uptrend.

The Doomsday Capitulator - Shifts 100% of new contributions to cash at the bear market's cyclical low point, and shifts 100% of new contributions back into stocks as the market resumes a long-term uptrend.

The analysis looks at the previous tough bear market in the US of 2000-02 where the S&P 500 fell by 47%.

The analysis assumed that each investor had a starting balance of $10,000 entirely invested in equities, and was making monthly contributions of $500 per month to stocks prior to the arrival of a bear market. These investment parameters reflect the situation of an investor using dollar-cost averaging to accumulate wealth or save for a long term goal.

For the three market-timing investor scenarios that chose to shift their future contributions to cash (Bear Market Dodger, Bear Market Refugee and Doomsday Capitulator), MARE chose a common date on which all three investors resumed their contributions back to stocks: January 2004. This date was chosen based on historical analysis on how long it typically takes investors to feel comfortable buying stocks again after a bear market.

The results were:

This analysis shows the benefit of implementing a dollar cost averaging strategy.  By buying more shares at lower prices throughout the equity market downturn, the Stay-the-Course Investor was able to reap bigger portfolio gains when the market recovered.

Care needs to be taken in anlysing these results as they are taken from one particular time period and have some underlying assumptions that may be questioned by readers - e.g. What if the bear market dodgers returned to the market earlier than January 2004?

That being said, it does provide some further anecdotal evidence supporting the use of a dollar cost averaging strategy.  This is the strategy being employed by nearly everyone who is making regular contributions to superannuation.  Since June 2007, our firm has been suggesting this strategy for any clients coming to us with new money or new clients coming with cash.

This approach does not appeal to those with market timing instincts, but as academic and scientific research continues to show us, market timing rarely provides stronger levels of performance over the long term.

If you would like to read the full article discussing the study conducted by MARE please go to the article: Dollar-cost averaging: The bear market solution investment strategy

Regards,
Scott Keefer

Over the past week I have come across two interesting resources that may be of interest to readers of this blog:
 
The Credit of Crisis visualised - a simple summary of how the credit crisis eventuated.
 
Interview with Gus Sauter - Chief Investment Officer and Managing Director of the Vanguard group - Mr Sauter answers 15 questions about the current market conditions and the lessons for investors.

Regards,
Scott Keefer

In his latest article written for Alan Kohler's Eureka Report, Scott calculates an index which takes into account the benefit provided by franking credits for Australian investors investing in the ASX200.  Investors have enjoyed an increase in returns after frankingcredits of 1.3% per year on average since July 1, 2000.  A total return of 18% in ten years.

As part of our financial planning process, we have a tool that reports on the returns from asset classes over the past 30 years on a rolling 12 month period basis, quarter by quarter.

Recently I was asked under what conditions could you access some or all of your superannuation funds before reaching your preservation age.
 
First a quick reminder, the preservation age is currently 55 but will be increased to 60 on a phased in basis:
 
For a person ...
Before 1 July 1960                     55
1 July 1960 - 30 June 1961         56
1 July 1961 - 30 June 1962         57
1 July 1962 - 30 June 1963         58
1 July 1963 - 30 June 1964         59
After 30 June 1964                    60
 
Before reaching your relevant preservation age you may be able to access your superannuation under one of the following conditions of release:

In his latest article written for Alan Kohler's Eureka Report, Scott looks at the murmurs from the Henry Tax Review threatening to cut franking credits.  Scott outlines some posible outcomes if the current franking credit system were to change and encourages individual investors and superannuants to take the time to get involved, to put forward their thoughts on what is in their best interests

One of the fears before entering the latest company reporting season was how much dividends would be impacted by the current climate.  This firm sees the dividend story as a key aspect of the decision to invest in Australian shares especially given the dividend imputation system which has been in effect here since the 1980s.

A report I read yesterday provided some interesting details about the most recent reporting season - Feb profits season avoids disaster, but harder times ahead The key points for me were:

• Company results for the fiscal 2009 first half reporting season in February were "no worse than mixed", Citigroup analysts said in a report.
• Companies delivering surprisingly positive results outnumbered those with disappointing results by 10 to nine, with the balance performing broadly in line.
• Nevertheless, median net profit growth was down four per cent on the prior corresponding period, the investment bank added.
• CommSec's analysis of the results of more than 270 companies showed average first half earnings per share (EPS) was down 6.1 per cent on the prior corresponding period, excluding the diversified financial and real estate sectors which were dominated by asset writedowns.
• CommSec's profit season analysis also found, surprisingly, that many companies maintained or increased interim dividend payments despite difficult markets.
• Of 273 companies in CommSec's sample, 47 lifted dividends, 125 maintained them at the same level, and 101 reduced them.
• Goldman Sachs JBWere analysts said that of the companies they covered, 51 per cent reduced dividends, 20 per cent held them steady, and 29 per cent increased them, leaving total dividends paid to fall by 2.3 per cent.  Full year dividends for fiscal 2009 are expected to fall by 18 per cent on the prior year, and then rebound in 2010.

You would have to be blind Freddy not to see that the current climate for companies is tough.  However the actual income that is being passed on by these companies to their investors is not slit your throat stuff.  Back last month I suggested that we would have to see cuts in dividends in the order of 50-60% across the board for the yield from these investments to be beaten by the yield from cash.

Unfortunately, as is always the case with investing otherwise it would be a free lunch for everyone, there are other factors including the risk of a long term financial downturn.  This suggests to me that investors should be continuing to take a prudent and careful approach to investing in growth assets but for those with a long investment timeframe, investments in shares are worthy of consideration. If you would like to see our approach to this decision please take a look at our Building Portfolios page.

Regards,
Scott Keefer

A common fallacy thrown out there by those supporting an active investment approach is that this approach can protect you better from bear markets.

Today I share some more practical evidence that this is just not the case. It has been published by The Inteliigent Investor newsletter.  This is one of many investment newsletters that provides stock selection suggestions for its readership.  I have to applaude them because each year they have their stock picking record audited to show just how much they have helped their readers.  Unfortunately for them this has provided a lot of transparency to how they have performed.  The following is an extract from the latest report of their results: