Christine St. Anne: Today I'm joined by Westpac's David Simon to talk to us about navigating your portfolio amid volatility. David, lovely to see you again.
David Simon: Thanks, Christine. Good to be here.
St Anne: Now, David, just to begin with, what are the big risks to your portfolio, and particularly the issue of deflation which seems to be a theme this year?
Simon: Yeah, look, I've heard the issue around deflation quite often, certainly in the last six to 12 months. I mean, generally speaking for people that don't know what deflation is, it's basically negative inflation. So it's a period where an economy generally has price falls -- a period of price fall.
Now, effectively, it's not a bad thing when you're buying white goods and flatscreen TVs because they tend to sort of fall in price. So that's a pretty positive thing. But, generally speaking, more broadly deflation isn't good for economies.
Effectively, deflation means that existing debt has an effectively increased real value, which isn't a good thing, and that certainly drives the other characteristics sort of very similar through a deflationary environment, which includes rising unemployment, reduction in wages and just general lackluster economic growth.
And companies, shares and property don't really like periods like that, especially companies that have higher fixed costs and higher debt levels. Those companies, in particular, are not very favourable in periods of deflation.
Some of the alternatives in these periods include infrastructure assets, such as roads and toll ways. They're quite monopolistic in nature and have a link to price rises. So they generally do well in periods of deflation as well as government bonds and cash.
St Anne: Now, looking at some of these asset classes, David, of course, interest rates have fallen further and that has only peaked up the demand for income-producing equities. I mean Commonwealth Bank is even touted to go up to the $100 mark. What other sources of yield are available to investors?
Simon: Yeah, sure. I mean, look, there are certainly other alternatives, but they are certainly not going to be risk-free. So some of the alternatives include bonds and there is a whole wide range of bonds that investors can look at as an alternative to investing in cash -- obviously, cognisant of the fact that there is a high level of risk associated with bonds than investing in cash or fixed interest.
So you can invest in a range from government bonds to semi-government bonds to corporate debt, all the way through to emerging market debt and you'll find that certainly there can be high levels of yield and certainly high levels of income. However, the problem is that there is certainly going to risk associated with that.
Other assets include infrastructure, which as I mentioned that they are typically inflation-linked and there is a predictability in terms of income because of their characteristics, and some of those include energy plants, railways, tolls, airports as well as boat ports. You'll find that these are quite well income-producing.
Real estate investment trusts are also an alternative, particularly those trusts that focus on rental income rather than developmental profits. And income equity funds are also an option as well. They include a buy-write strategy using call options and they generally provide a more consistent high level of income. However, again, not without risk.
St Anne: Now in terms of navigating your portfolio amid these sorts of risks, when is the right time to rebalance. I mean how can investors get that right, David?
Simon: Yeah, look, I mean, it's impossible to time a market. So we're always in the belief that regularly rebalancing is a very, very important part of any style of traditional portfolio management.
So as long as the investor has got that core strategic asset allocation, that encompasses a portfolio that really represents and resonates their risk profile, circumstances and investment objectives and then they have got that tactical overlay, which is often referred to as a tactical asset allocation. And that's the more short-term opportunistic movements where you are using you know that tactical overlay to take advantage of market opportunities, more of a short-term focus, but also rebalancing around the edges.
So, typically when portfolios haven't been moved for a period of time, they become tilted towards some asset classes that have outperformed others. And that's generally a time where rebalancing is prudent to ensure that you're really reducing that component, taking the profits and banking in areas where you are either conserving profits but also taking advantage opportunities in other markets which may be undervalued.
So rebalancing should be a consistent, constant periodical process, regardless of where you see it in the market, whilst making sure you always retain that strategic asset allocation, that core component of a portfolio.
St Anne: Now, finally, David. We've been talking for ages about global investing, so is that becoming increasingly important now for investors to really look at that?
Simon: Yeah, international investing has always been a crucial and critical part of anyone's portfolio. I mean, if you look at the Aussie market, it's dominated by only a few companies across even less sectors. So there is stock-specific risk associated with just investing in the Australian share market, which is quite extraordinary, but it is also a testament to the fact that we're still relatively small in the global scheme of things.
So, having exposure to international equities is quite important because it really reduces the correlation of a portfolio and that's an important thing to think about. Because if you look at the Australian share market, if you invest in one of the banks, if that goes up in value, generally the other banks will go up in value as well. So there is a very high level of correlation, which means that there is not a sound or really prudent approach to managing risk.
So really using international equities not only enables lower levels of correlation, which means that if the Australian market goes up, it doesn't necessarily mean international market is going to go up, but certainly vice versa as well. So it really should smooth out returns, offer opportunities for sectors and companies that are not available within just the Australian share market and also reduce that volatility by providing more consistent returns.
St Anne: David, thank you so much for sharing your insights on how we can take a better control of our portfolio and our investments. Thank you.
Simon: Thank you.