Mark LaMonica: Welcome to Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs. Welcome to Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs. 

Shani Jayamanne: I’m actually really excited for this episode today Mark. 

LaMonica: So you're not excited for all of them? 

Jayamanne: I mean, most of them I am, I mean I wasn't really excited for that half hour episode where you compared yourself to an income statement. 

LaMonica: I think that is stretching things a bit mate. But point taken – the next time I talk about a financial statement as an analogy I will be prepared for what, is it like 2 years of ridicule now? 

Jayamanne: Yeah

LaMonica: Okay, anyway, why don't you tell everyone why you're excited for this episode? 

Jayamanne: Okay so this is going to be one of my favourite episodes because one of our listeners favourite episode was when we talked about how to create a goals based portfolio. And today is a good extension of that episode. 

LaMonica: I think that was a good episode as well. 

Jayamanne: And it is one of my favourite episodes because we all believe that investing is about picking individual shares and ETFs. But in reality, that is only one component and not even really a necessary one. We invest to achieve goals and the largest influence on if we achieve our goals is knowing the return needed to get there and selecting an asset allocation that has a reasonable chance of achieving those returns. 

LaMonica: And asset allocation is a huge driver of returns. Far more than security selection. If you are trying to get a 8 percent return a year and you allocate 90% of your portfolio to cash you just aren’t going to get there – no matter how great of a stock picker you are. 

Jayamanne: And this is about framing risk appropriately. We are sold on the notion that risk is when your portfolio goes down in the short-term. But in reality risk is not achieving the return you need to reach your goal over the long-term.  

LaMonica: Which you’ve been quite vocal about and something that you've said you counsel a lot of your friends on. 

Jayamanne: I do. Many of my friends are so wary of the risk of investing in the share market that they keep the vast majority of their savings in cash. Which feels safe but makes it next to impossible to achieve long-term goals. 

LaMonica: Okay so today we have a guest episode Shani, another one , so this is our fourth maybe?

Jayamanne: Our third I think.

LaMonica: Okay, and we have Matt Wacher and so Matt is the CIO of Morningstar Investment Management for AsiaPacific. 

Jayamanne: Which makes him kind of a big deal. 

LaMonica: Yes it does. So among other things, Matt and his team are responsible for setting our long-term and shorter term expectations for the returns of different asset classes. So this should be a fascinating conversation about how investors should incorporate this into their financial plans. 

Jayamanne: And please go back and listen to our episode on goals based portfolio construction but the 10 second summary is that we encourage everyone to set goals and be specific about when you want to achieve it, how much you will need to achieve it and how much you would expect to save. That will allow you to calculate the return you need to achieve that goal which means you will have the basis for selecting the right mix of asset classes to get that return. 

LaMonica: Alright so with that background why don't we just jump into the interview Shani?  


LaMonica: So we are continuing our series of having guests on the podcast next guest and a really exciting one today so I’m really pleased to welcome Matt Wacher who is the Chief Investment Officer for Morningstar Investment Management in Asia Pacific. And Matt, so we have a lot of titles in this industry and I think we all know what they mean but a lot of listeners don't. So what is a Chief Investment Officer, what do you do day to day, what is your job? 

Matt Wacher: Well thanks for having me on Mark and um that's a very good question, I guess in principle I manage the investment team here in Sydney and I have some staff in Japan and India as well. And my day to day role is really helping that team make better investment decisions. So we spend a lot of time thinking about portfolios that we run, thinking about the research that we do. And I've got lots of very smart people in the team, way smarter than me in the team and its really about my experience and bringing back to bear and thinking about things, maybe in different ways, helping them make better decisions so that is kind of the key part of my role . I manage a portfolio myself, its quite an unconstrained portfolio so we get to do lots of interesting things there and I leverage all the research my team does as part of that. And of course supporting clients, doing webinars things like that, you know going out and meeting my clients, understanding what interests them and how they... how they're feeling about what we do as an investment team and making sure we're doing all the right things.

LaMonica: Okay great, and we'll get a little bit into the investment side of things in a bit, but Matt was actually recently featured in the AFR - we have it hanging in our kitchen. I don't know if that's embarrassing for you..

Wacher: It's very embarrassing 

LaMonica: But it goes through your background a little bit. But for everyone else who hasn't read that profile, how did you get to this role, what's been your career path so far?

Wacher: I think I said in that article and I'll say it again. I don't know how I ended up here, sitting here talking to you now Mark, as a Chief Investment Officer at Morningstar. It certainly was a, probably a non-traditional path to this type of role. I guess I started out my career in the financial markets. I was an options trader and that gave me a great introduction into asset pricing, albeit it of something complex, derivative that not many people really understand, but gave me a really good handle on risk and those sort of things, but it was also a really narrow type role. There's lots of maths and not very exciting things like that I had to engage with on a daily basis. And I managed kind of big portfolios with my team - obviously only the junior member of the team in those days, but you know for banks and other types of firms. And I did that in Sydney, London and Tokyo as well - I spent some time there. But really, I think they key part of my career, I pivoted for a while and left the financial markets. I went back to university and did lots of... I tell everyone I tried to use the other side of my brain for a while. I did a lot of philosophy and things like that. And that really set me up for kind of, to think differently and really deal much better with the grey areas. And you find that in investing, that everything is grey, I think there's often a false precision to what people do and actually there's much more grey abound the edges and so I think its sets me up for my role now having gone and spent some time out of the markets and done different things for a little while. And it all ties together in this role, I kind of navigated this path of doing a few different things, but when you think about well Matt managed risk in the past and he thinks about things a little bit differently, they're really all tied together. And I guess that's why Morningstar employed me.

LaMonica: Yeah, its hard to tell all these right.

Wacher: Yeah, that's right but yeah I mean everything I've done in my career I can kind of piece together say okay well I understand why I'm here right now.

LaMonica: Okay great so lets move a little bit into the investing side of things. In the intro to this episode and throughout the different episodes we've had on investing compass we always talk about the importance of a goals based approach. And we of course encourage listeners to define their goals, figure out what return they need to achieve them and then that goes into asset allocation which gives you the chance of achieving those goals. So sort of central to this and central to asset allocation is expected future returns for different asset classes - that mix you want to have in your portfolio. So that's something you guys do that Morningstar Investment Management does, so what is the process for estimating those future returns that we get from different asset classes. 

Wacher: Yeah so I mean it's fundamental to everything we do - is understanding, or getting a handle on what we think you know, the intrinsic value, the fair value as it were, of an asset is. And by an asset I'm talking about a stock or a group of stocks more likely for what we're doing - you know Australian equity asset class for example or bonds, or even a currency property, listed property for example. So when I talk about assets that's what I'm talking about here. And we want to get an understanding of well what do we think is fair return, a fair value that we can achieve, from this asset, you know Australian equities, over the long term, you know really ultra long term, the next 50 years. And if you look for example, at US equities, if you look back in history, they've delivered about a 9% return per annum, that includes inflation. And we'd say a fair return for US equities is about 9% and then we kind of peel back the layers and say okay well how do we get to that fair return and it really comes down to what I'm going to call fundamentals. And that's really the, you know the cash flows from a business. How a business returns capital to shareholders - and so you know you get dividends and you get buybacks. Buybacks are very prevalent in the US, less so here in Australia, but there are buybacks quite often in Australia, but dividends, what's the dividend and buyback - what's that cashflow yield that you're going to get from a company into the future. And how's the company, or the asset class able to grow those cash flows, grow those dividends and buybacks as it were for the equities - for equity markets. And so you come up with what we think is a fair rate of return into the long term and then we look okay at what is the starting point, so valuation comes into it, so if we say well, we think that actually Australian equities or US equities, whatever it might be, it either be over or underearning for a period of time against those fundamentals and the price has now gone up above where we think it should be or below where we think it should be and we'll come up with an expected return, so that might be, we think that the long term return for US equities including inflation is lets say 9% but at this point in time because its done x, y and z, we that actually now you're only going to get about a 2 or 3 or 6% return depending on the environment that we're in.

LaMonica: Okay so let's start long term and then we'll talk about right now and where you see opportunities. Okay so if we look long term, I think you guys put together a 20 year projection of returns. You've actually got a slightly higher return for Aussie equities than US equities over that period - what drives that?

Wacher: So for Aussie equities, as an Australian investor, there is a tailwind that you get from franking credits SO you would expect as an Australian based investor that you can pick up from the tax benefits effectively that you get from investing in Australian equities through franking credits, through the dividends that you receive - that you would get some tailwind above and beyond all other global equities.  That doesn't necessarily mean at any particular point in time its a better or worse opportunity, we factor that into all of our expected returns but that's why you've got a slightly higher long term return for Australian equities relative to US equities.

LaMonica: Okay great, and one sort of last question before we get into current opportunities. You know we have and one of the things we talk about is a strategic asset allocation. So that's really looking at sort of the, I guess the long term asset allocation that you guys are aiming for but then there's this tactical asset allocation right, and that's based on attractiveness right, at the current point in time. So I guess, you know what is attractive to you guys now, is there areas of the market whether that's an asset class or a country that you think is more attractive right now and things you don't think is attractive?

Wacher: Yeah and its very interesting because the portfolio I run doesn't actually have a strategic asset allocation. It's completely unconstrained. So really you're trying to, exactly as you say, find the best opportunities for the risk that you think you need to take. So you're really trying to think not necessary being tethered to a strategic asset allocation in that environment, you're thinking, okay well how am I going to be rewarded for the risk that I  take in any position. And you do that also with the strategic asset allocation but you have to keep that SAA as I'll call it in mind. And so where we think the opportunities are now, we think Australia is not a bad opportunity, like relative to recent past. You know we think there's about, not including inflation, above inflation, we think you're going to earn about 2 - 2.5% over the next 10 years per annum from Australian equities. And that's, looking back at this time last year, we thought you were going to have a negative expected return for Australian equities over the next 10 years so it's improved.

But there are other areas which we think are even better, and some of these areas you're not going to put your whole portfolio in. We think China equities, in particular Chinese tech stocks are very interesting at this point in time You know Brazilian banks and miners, or Brazilian aggregate we think is a good opportunity. Brazil's an opportunity because what we're think is well we'd rather, even taking in emerging market risks, and all those sort of things, we'd rather own Brazilian banks and miners at this point than potentially Australian banks and miners. Doesn't mean we won't own any Australian banks and miners, but you know, we want to have something there that we think we can generate a bit better reward for our risk owning some Brazilian banks and miners for example.

We also think, you know Europe's done very well just lately, but we did think at the start of this year that Europe was a good opportunity, and we think in the US we've got our highest weighting to the US that we've had for many years at this point in time, we think the US is a reasonable opportunity, similar to Australia, but there's parts of the US market that we think are very attractive and that would be areas like communications services and even some of their financial stocks as well we think are very attractive at this point in time and you're going to get a very very reasonable expected return out of those parts. Communication services I should add are you know, specifically stocks like Facebook and Google or Alphabet and Meta as they are called. 

LaMonica: Yeah, everybody gets very confused about communication services cos people consider those as tech stocks but they're not actually in the technology sector so.

Wacher: That's right, I think it's been about 5 years ago that they got shunted out of the IT sector. 

LaMonica: Just another thing to confused investors right?

Wacher: Exactly 

LaMonica: So you were one of the speakers at our conference, and I think this was sort of implied in what you were just talking about but you gave this really interesting presentation. You were talking about how valuation and talking about how valuation impacts future returns. And we do talk about that a lot on this podcast but many investors do the opposite right. So many investors chase returns and often times, if you have outsized returns, you know some of that may be from earnings growth, some of that may be from dividends, but a lot of is just from valuation increases and so can you talk a little bit about how valuation plays into that. Because we tried to make this point right that higher valuations could be lower future expected returns but how does that work and how does that inform your investing process?

Wacher: Yeah I mean I think it's actually central to everything we do. And I'd say  we see ourselves, because we have a fairly raised investment process, or fairly structured investment process, we think that we have a behavioural edge over other investors. I mean we don't think we can out analyse the stock or do anything along those lines we think we yo know we want to have a very systematic, or structured process, not systematic process there's discretion within it but we want to make sure we stick to that process and that gives us the behavioural edge. So fundamentally we believe you need to be different to the crowd you need to look at valuations and do fundamental analysis and really have a contrarian mindset. And that's going to help you earn much better investment returns over the long term if you're doing things different to the crowd.

And that's not just for the sake of being different, but think that we really want to be buying assets when others are selling them or selling them when others and buying because we think that that's where mispricings occur. And when everyone's doing the same thing, invariably you get this herding mentallity that you were kind of describing, and you know that then leads to these mispricings and we think okay well now would be a time to sell an asset into that, if you're holding it, or if on the other side of the fence if everyone is super risk averse, then you want to be buying assets. And so what we try to do in those sort of circumstances is go - are we wrong? Is everyone else right?

And so I'll give a simple example that people might understand - we haven't actually done this piece of work specifically but I thought it was a good example to give you. If we think about Apple as a stock and say it's currently priced at about $145 - so we think well is that appropriate, is it expensive is it cheap? We can do some work on that, but really what are the assumptions that people are making buying Apple at $145. What kind of sales does it need to generate to deliver those kind of returns? How many iPhones does it need to sell to deliver on that price into the future? And you think, well is that realistic or is that not realistic.

You know we had a similar example on the other side of the fence when we owned some energy stock after Covid. You know energy stocks were priced as though you know, no one was going to fly or drive or anything ever again and so we were thinking, well you know is that likely? And it could have been in Covid - there was a lot of uncertainty around back then, but we thought well lets assign a probability to that and we thought the probability was probably reasonably low, so we could buy some cheap assets on the other side of the fence not, again, doing the opposite of what the herd was doing. And then you lock in some pretty significant returns there and on the other side of that trade there was people buying Zoom and Peleton and things, thinking that they were going to be locked down forever and you know, no one was going to go back into offices. And we thought that got you know, stretched to your example.

So I guess we're not trying to be different for different's sake but we think that different, being different - you can taking advantage of mispricings, and we think that's not just a skillset that we should just have, others can do the same and when there's herding mentality, when there's these behavioural biases that appear in the market, we tend be, want to be on the other side of them.

LaMonica: Yeah and I think two of the really interesting things you said, you know we did an episode actually on edge and we went through the different pieces of edge that an investor can have. And the behavioural one I think it's great because it's something that anyone can do whether you are investing - doesn't make it easy, but whether you are investing on your own, you can have behavioural edge, you know whereas analytical edge is much harder right. So analytical edge means that if you're a mum and dad investor you have to be able to analyse all of the professionals that do this all day everyday that have all the training but year behavioural edge is a great one.

Wacher: Yeah and I think that, as I say, that's where our edge is. You know as I said at the start we've got lots of smart people in my team but I also said throughout this podcast, that there's lots of grey in investing so the right answer is sometimes not the right example in financial markets, you've got to be humble.

LaMonica: Yeah, and then the sort of second thing, and I think the Apple example was good and also the energy during Covid example was good, is you know people need to understand that of course the market's looking forward, meaning expectations are baked into a share price. And I think people lose sight of that right and the higher the valuation level, the higher the expectation and it isn't really how the company performs right, on an absolute basis, it's how it performs compared to those expectations.

Wacher: That's exactly right.

LaMonica: Well great Matt, this was great, thank you for coming on - very helpful. I'm sure everyone will appreciate listening to this, so thanks for that. 

Wacher: Thanks for having me on Mark, really appreciate it, hopefully it was useful.

LaMonica: Absolutely, yeah no, it definitely was and thank you all for listening. So as we always say, my email address is in the show notes. We would love any comments you want to leave on your podcast app or ratings and thank you very much for listening.