As we continue to see significant market volatility, we thought we would provide you with an update on what the Committee has been implementing in the Investment models as we move through this investment cycle.
Portfolios Reweighted
As always, at the end of the quarter (31 March) the portfolios were re-weighted back to the original holdings at the start of the quarter. This disciplined process meant we took risk ‘off the table’ at the end of December, right before the markets started the current drop, and more recently, at the end of March, we topped up some of the exposure to growth assets at the lower prices the market is currently presenting. We also took the opportunity at the end of March to adjust a few underlying components in the models, with the aim of reducing some of the volatility we are experiencing.
Added exposure to ASX Top 20
In the Australian share component of the AAN Core, AAN Growth and AAN Australian models, we reduced the exposure to the current 3 Australian share managers and added in an exposure to the top 20 shares on the Australian share market. In the industry this is known as the ASX top 20. As we move through these cycles, there tends to be a ‘flight to safety’ by investors, with the larger companies usually perceived as somewhat safe havens over smaller, more growth focused companies. By adding in an exposure to the top 20, we are aiming to capture some of this ‘flight to safety’ which will hopefully reduce the volatility we have been experiencing in the models. As an added benefit, we expect that the above will improve dividend flows within each model. In reviewing the models since the change just over 1 month ago, we have seen a reduction in the total volatility of the models, although in general, market volatility has increased which is still impacting investments.
Australia versus the world
We have noted that the Australian market, up until recently, was holding up well during this period, especially compared to international markets. Due to our models holding an equal weighting to Australian and International shares, this has meant that any comparisons of the models to Australian shares have seen some under-performance which was largely due to the performance of the international sector. However longer term, the international sector has been considerably outperforming the Australian share sector for quite some time, which has meant that by equal weighting these sectors within the models, we have benefitted from performance of both sectors at different parts in the cycle.
The graph below shows the comparison between the Australian and International markets, and the AAN Core model, from 1 January 2022 – 31 March 2022 (grey line is the AAN Core model returns). As you can see, there has been quite a discrepancy between Australian Shares and the ‘Rest of the World’ for this start of 2022.
The graph below shows this difference is even more pronounced when comparing the Australian market to the US Midcap Growth market (This being the sector our Active International manager invests in).
In the below graph the period 1 April 2022 to 9 May 2022 is displayed so you can see the outperformance that was evident at the start of the year is now less pronounced, with the relationship between the Australian market and the ‘Rest of the World’ more in sync. This was also the period when fixed income components of the model started to really feel the short-term negative return squeeze (see commentary below).
Fixed interest Impact
The other sector that has impacted on investment portfolios and the AAN models has been fixed interest. This sector is normally seen as the ‘safer’ sector of the models and usually would protect the models to some degree as we enter volatile periods for shares like we are seeing now. However, the Australian and International fixed income markets have been falling since around September 2021 and are now down -9.8% and -8.0% respectively over the past year. Fortunately for our models we made the switch out of passive fixed interest to active fixed interest in June 2021 and as such we have managed to significantly reduce the negative impact on the models that this sector has had, with the allocations we have used in this space sitting with an approximate return over this same period of -2.6%, a significantly better outcome.
We have been discussing the current returns with our fixed income managers and they have confirmed that they do expect this negative result to translate into a positive result over the next 12-18 months as the bonds they hold mature, and they receive the full bond value back. We will continue to monitor this closely.
Perpetual Diversified Real Return Fund
Other changes made in the models include adding in exposure to the Perpetual Diversified Real Return fund for part of the AAN Growth model. This fund already has a 20% allocation in the AAN Core model and has protected the downside well over the past few months. By adding in a 10% exposure to this fund in the Growth model, this adjusts the safer portion of this model to a more actively managed safer portion which we believe will provide for a small amount of extra shock absorption through this cycle.
We are planning on making a similar change in AAN Sustainable Growth model by adding in Perpetual’s sustainable version of the Diversified Real Return fund to this model, and this is expected to be implemented in the very near future.
Overall, the Investment Committee remains very active in trying to reduce the volatility as we travel through this disruptive part of the cycle. We know that history shows us that the market will typically overshoot on the downside and then rally out of this current scenario, however there is still a lot to work through in relation to inflation, interest rates and supply chain concerns. We will maintain our focus as we continue to diligently manage the models to obtain the best outcome we can for clients of AAN.
As always, if you have any questions about your portfolio, please don’t hesitate to reach out to your adviser.
Regards
AAN Investment Committee
