Play the long game
Equity markets plummeted in 2020. The swiftness with which the global pandemic escalated this year took economists by surprise, and on 8 March culminated in Australia’s worst day of trade since the global financial crisis. Investors selling into the market were panicking, which is never a good time to make investment decisions.
Not surprisingly, the following days and weeks saw the market rally as investors took advantage of what was perceived to be low share prices. Today, over six months later, markets have returned to pre-pandemic levels of high performance, meaning investors who did not panic and sell at the dip are better off. While it can be tempting to try and time the market, this is a risky strategy as no one knows for certain the best time to buy or sell.
The same lesson applies to cash. Since 2010, investors have held too much cash, always waiting for a “better time to invest” or for a “better entry point”. Citi analysts believe this behaviour is well worth avoiding in the next decade.
The graph below shows the returns on the S&P for a market timer who missed the 10 strongest up days between January 2000 and October 2020. Including reinvested dividends, such an investor would have achieved a return of 60.7 per cent for the entire period. By contrast, an investor who stayed fully invested in the S&P for the same period would have achieved a return of 250.7 per cent.
Over the long run, though, the clear lesson is that what matters most is not choosing the lowest entry point at which to invest, but having a fully invested core portfolio at all times. The cost of waiting could be even more painful.
Looking forward, investors should first determine the amount of strategic cash they need to hold for the next five to 10 years. This is to maintain liquid funds in times of unexpected personal circumstances. Next, consider how you will allocate your remaining capital in your core portfolio based on your risk and return preferences.
Don’t pay the lazy tax
Rates in 2020 hit record lows in Australia. In other countries like the US or Japan, where rates have hit zero or gone negative, they have stayed at low levels for long periods of time. This has negative implications for investors chasing yield, as savings accounts and term deposits are no longer generating a return. Term deposit rates are now lower than the inflation rate, and the Reserve Bank of Australia has made it clear its focus on unemployment means the cash rate won’t rise from its current level of just 0.1 per cent for at least three years.
As cash is now paying less than 1 per cent, it may be worth your while to look for other asset classes that pay higher income and defensive in nature. Fixed-income and dividend yield stocks are clear alternate options for a regular income stream.
Another way to avoid paying the lazy tax is to stay attuned to market events. For example, the news of a vaccine has positive implications for sectors set to benefit as a result – like healthcare or logistics companies likely to be tied to the distribution of a vaccine. Investing in these sectors with long-term growth potential will have benefits for your returns.
Searching for undervalued sectors after seeing a strong rally in 2020 will be the focus into the new year. With the positive vaccine news supported by huge waves of stimulus globally, rotation into COVID cyclicals sectors which were shunned during the pandemic will seemingly become “value” sectors to consider.
COVID defensives include “stay-at home” beneficiaries, such as digital entertainment, online retail, and consumer staples. COVID cyclicals include “leave-your-home” beneficiaries, such as hotels, restaurants or airlines.
Always maintain safe-haven assets
Safe-haven assets are not as exciting as equities, but where there is potential for a high return there usually comes higher risk. Individual investors decide their own risk appetite based on their personal situation, however, ensuring risky assets are balanced by defensive assets is key when markets are unpredictable.
Defensive assets include fixed income, “safe” currencies like yen, US dollars, Swiss francs, and gold. You can also package equities up into structures like market-linked investments, which allow you to build a hedge into the asset. These investments pay out a regular income for a fixed term.
At Citi, our high-net-worth clients have flocked into fixed income this year as one way to achieve yield while still opting for a more defensive asset class that can withstand market shocks.
In September, Citi hit a record number of fixed-income transactions, and fixed income assets under management increased approximately 32 per cent from September 2019. Investors who are willing and financially able to go up the risk curve can access other types of fixed income like high-yield, hybrids or capital notes that have offer higher yield, which commensurate with higher risk.
The optimal spread in fixed income would be across investment-grade bonds that have high credit ratings, along with some high yield bonds, which tend to perform in markets as they recover from a recession. Hybrids are also a popular addition to the fixed-income holdings, as they truly are “hybrids” between bonds and equity.
With these lessons in mind, investors are well placed to start investing now. Looking forward, the global economy will recover more quickly and robustly from the COVID recession than after a more typical large downturn. The virus was a shock, and the effects were far more unevenly spread than in other crises. Governments are providing the necessary fuel to support the recovery. In Australia, we have seen a huge rebound in economic data ranging from consumer and business sentiment, retail sales, housing data and GDP numbers.
In this environment, innovation will accelerate. So will the adoption of technology. The impact of this next industrial revolution will generate great value for investors and for society.
Mahjabeen Zaman, senior investment specialist, Citi
