Volatile Times Loom On The Horizon: Stop Spending And Start Saving

The Age

Saturday August 6, 2005

Peter Weekes

Investors must prepare for rocky times if they are to survive and prosper, writes Peter Weekes.

INVESTORS need to prepare for volatile times. This was one of the main themes to emerge from this week's annual Investment and Financial Services Association conference.

The heads of two of the country's largest fund managers, ING Investment Management Asia Pacific chief executive Chris Ryan and Vanguard Investments managing director Jeremy Duffield, say investors will survive and prosper only if they gear up now for "volatility, complexity and contingencies" ahead.

"The key conclusion is that while volatility and uncertainty have always been with us, what is different now is the complexity of the drivers of economics, business, investment and success . . . something well within our grasp, but we must reach for it or it will pass us by," Ryan says.

He says the investment environment is being reshaped by the economic and political rise of the developing world, in particular China and India, putting pressure on oil prices. Other factors include an ageing population and globalisation.

Access Economics director Chris Richardson says if households want to protect the wealth they have accumulated in the past 14 years of economic boom, they must start to save and invest outside of property.

He says they have relied on soaring house prices, not savings, to create wealth. This has funded an unprecedented shopping binge, which has driven the economy and reduced unemployment.

The problem, Richardson says, is that the process is unsustainable now that global long-term interest rates have started to rise after 20-odd years of historic lows.

With households highly indebted and spending about 4 per cent more than they earn, a pull-back in shopping could lead to a downturn, even recession, he warns.

Where does this leave investors? Can they use managed funds to chase the legendary alpha - that is, outperform the benchmark index? Is the answer higher voluntary and/or compulsory employer super contributions? And what role should tax play in investment decisions?

CHASING ALPHA

While acknowledging that some mainstream managed funds do outperform the market - which this year is predicted to generate high single-digit returns - Intech Investment Consultants chief executive Michael Monaghan says "a lot of the good-quality alpha is coming from boutique (fund managers)".

But he says investors must act early. "Taking time to window-shop doesn't work. There is alpha left in Australian equities, but it's becoming increasingly difficult to find with too many active managers looking for it."

Part of the reason to rush into boutiques is the very nature of the funds. Monaghan presented research showing that alpha returns halve after a fund has been operating for three years.

Boutique funds have emerged in a big way over the past five years. In the year to March they returned 43.2 per cent compared with 22.5 per cent from other large managed funds, according to Plan For Life.

There are now about 80 boutiques in the market.

"If investors get two or three of these (drivers), they should do well," Monaghan says.

SUPERANNUATION

The Government's decision in the May budget to scrap the 14.5 per cent superannuation surcharge for high-income earners and to raise the co-contribution for low and middle-income earners has encouraged people to save for retirement.

While it is too early to ascertain the amount of additional money flowing into super from high-income earners, about 500,000 low-income earners have taken advantage of the co-contribution scheme, which pays $1.50 for every $1 contributed by employees earning up to $58,000. About 60 per cent are women and 40 per cent are aged under 40.

Still, Richardson says more is needed. Access analysed a survey of 1000 employees commissioned by IFSA that asked people how much extra they would contribute to super if the 15 per cent contributions taxed was left unchanged, cut by 1 percentage point, and 5 percentage points.

It found that no additional contributions would be made if the tax was unchanged, an extra 1 per cent if the rate was cut to 14 per cent, and 4 per cent if the rate was cut to 10 per cent. This jumps to slightly more than 5 per cent for high-income earners.

TAX AND INVESTING

Tax should be a major consideration when deciding how to invest, says Duffield. Many online saving accounts offer an attractive headline rate of 5.25 per cent, but for those in the highest tax bracket, the real rate after tax is a mere 2.7 per cent while those on the 31.5 per cent tax rate receive 3.6 per cent.

"The most important thing for investors to do is to understand how different assets are taxed," he says.

"For example, property trusts are very good for income but not imputation (franking) credits, because LPT (listed property trusts) don't pay tax themselves, so they don't have imputation credits to pass on to investors.

"Depending on the investor, they may want to invest for growth and a mix of income and imputation credits or they may want a higher income from the property trusts."

Franking credits are important to many investors, as they can reduce their taxable income.

Duffield, who argues that managed funds should advertise their after-tax performance rather than pre-tax returns, cites a US study that found that of 71 active funds over the past 10 years, 15 outperformed the benchmark Dow Jones Industrial Average on a pre-tax basis but only five on an after-tax basis.

He says that while US funds now disclose their returns on an after-tax basis, Australian funds, apart from Vanguard, continue to "operate as though they are tax exempt".

© 2005 The Age

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