Property versus shares: A question of timing

After the end of the housing boom in Sydney and Melbourne, have stocks gained the upper hand or is bricks and mortar a better option?

Morningstar’s head of equities research, Peter Warnes says it is a question of timing.

“If you go back post-GFC, the Australian investor chose property as his or her risk asset of choice, while US investors chose equities. And both were correct,” he says.

Warnes cites figures showing that Australian residential property outperformed local shares over the past decade. As a result, housing loans doubled to $580 billion in 2017 from $290 billion in late 2007, while investor loans surged, peaking at 39 per cent of all housing loans in 2015, up from 32 per cent in 2007.

Residential property investment post-GFC was a no-brainer for gun-shy investors

Meanwhile, margin lending in Australia peaked at $41.5 billion in December 2007 but had shrunk to $10.6 billion by December 2016. In contrast, US margin lending hit record levels in response to a surging stockmarket, while Australian stocks lagged.

“Over time, housing prices keep rising over the long term, but so do equities. I don’t think it’s a race to the top,” Warnes says, suggesting that a diversified portfolio should have “a bit in each camp”.

The latest research shows Australian residential property investors have enjoyed a prosperous past decade.

Australian residential investment property posted an 8 per cent annual gain (before tax) in the 10 years to December 2017, while Australian shares grew by 4 per cent a year, according to the 2018 Russell Investments/ASX Long Term Investing Report.

Among other asset classes, global shares (hedged) posted a 7.2 per cent annual gain, followed closely by global fixed income (hedged) (up 7.1 per cent), Australian fixed income (up 6.2 per cent) and global shares (unhedged) (up 6.1 per cent).

Global listed property (unhedged) advanced by 5.4 per cent a year, comfortably outpacing the worst performer, Australian listed property, which posted a 1.8 per cent annual gain.

However, the report reveals some lessons for investors seeking to maximise future returns. While Australian residential property took the top spot in 2001 and 2002, it came last (below cash and Australian bonds) in 2004 and 2005. Global and Australian shares have also been volatile compared to fixed income returns.

Overall though, the most consistent performer has been a multi-asset portfolio, as represented by the 70 per cent sample growth fund, which has posted positive returns in 19 of 20 years.

Don’t chase last year’s winner

The report has a warning for investors: past performance is no guarantee of future returns.

“Russell Investments’ research and analysis shows investors generally tend to reduce their likelihood of achieving higher return outcomes by chasing last year’s winners or adopting other strategies based on their predictions,” it says.

If an Australian investor switched to follow the previous year’s winner each year, he or she would be 29 per cent worse off, compared to staying in the sample balanced fund. For US investors, such bias would have underperformed the Russell 3000 index by 1.8 per cent a year in the 34-year period from 1984 to 2017.

Common "behavioural biases" cited by the report include overconfidence (trading too often); herding (buying high, selling low); familiarity (being overweight the domestic market); and mental accounting (“naïve” diversification).

Instead, the report suggests investors diversify across multiple asset classes and rely on different types of return drivers, being careful to manage “sequencing risk,” or the risk of experiencing poor investment performance at the wrong time, such as pre-retirement.

However, Morningstar’s Warnes suggests investors consider the impact of rising interest rates on the returns from “risk assets” such as shares and property.

Westpac Banking Corporation (ASX:WBC) was the first among the big four to announce an “out of cycle” 14 basis point interest rate hike. ANZ Bank (ASX: ANZ) and Commonwealth Bank (ASX: CBA) last week followed suit.

“The interest rate cycle is now going back up, and that means risk asset valuations will fall,” Warnes says.

“This is because the 10-year bond yield is the risk-free rate used to value both shares and property. The housing market has come back and I think equity markets within a year will be 20 per cent lower than they are now – pockets of property have already done that”.

For Australian investors, Warnes suggested holding more cash would be prudent.

“You’ve seen what investors like [Magellan founder] Hamish Douglass are doing – he’s now holding 18 per cent cash in his international portfolio, the highest level since 2009,” he says.

“Cash gives you optionality when asset values come back. It’s no use being fully invested in the down cycle, because when bargains emerge you’ve got no firepower.”

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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