Facing the bull market

Rolleston, a director of UBS Wealth Management Australia, has noticed that shares and superannuation today seem to rival each other around the dining room table. Rolleston says that during bull markets, inexperienced investors tend to expect share prices to keep forever rising. And the opposite typically applies in bear markets.

The Australian sharemarket recently began its fifth year of a breathtaking bull market, with the flagship S&P ASX 300 Accumulation Index (capital gains plus dividends) delivering an annualised 25.4 per cent over the three years to 28 February. There is no way that the market will keep producing returns that are so far in excess of historic averages.

But Rolleston and other investment professionals do not yet believe the Australian market has reached the point of being overpriced although value is harder to find.

'The market is supported by liquidity [much of the money flowing into superannuation, at least within Australia] and still has a robust earnings outlook,' says Rolleston, who is a member of CPA Australia's financial advisory services centre of excellence.

'Valuations are stretched in some places, though resource and financial stocks are giving the market a sound base for further gains in the medium term.'

And financial planner Robert Lipman, chief executive of Investec Private Advisers, adds: 'The Australian sharemarket is fully priced rather than significantly overpriced. I don't think we are in speculative bubble territory right at the moment.'

Lipman, like many investment professionals, is expecting more subdued yet solid returns from Australian shares in the 2007 calendar year.

His group anticipates returns more in line with the norm rather than the stunning returns of the past four years. Lipman expects that share prices could rise in the order of 7 to 8 per cent in 2007, with dividends adding 3 to 4 per cent.

This would be a little less than half of the total return of 24.5 per cent from the S&P ASX 300 in 2006. (Last year's return was much higher than anticipated by many market professionals.)

Investors who follow a few simple rules should be unperturbed when the bull market eventually ends. These rules intended for rising and falling sharemarkets are so simple that many investors may wonder, 'Surely there's more to it'.

1 Understand sharemarket volatility

Arun Abey, executive director of ipac Securities, says investors shouldn't be alarmed when they read newspaper reports of the sharemarket moving up or down by 1 to 2 per cent. This is in line with historical fluctuations for global markets.

'Don't go into the stock market if you have a problem with that level of volatility,' Abey advises. (Overreaction to volatility can lead investors to panic, breaking one of the cardinal rules of sound investment.)

'Volatility has been unusually low over the past three years,' Abey says, but points out that highly geared personal and professional investors, including hedge funds, are becoming more sensitive to any economic and corporate surprises.

And highly indebted consumers are more sensitive in their spending to, say, rises in interest rates and that, in turn, is reflected in the prices of shares exposed to their spending.

Rolleston says the widespread negative reaction of global markets to the sharp downturn in the Shanghai Composite Index in late February was the first shock of any magnitude after a prolonged period of market stability. (Share prices have subsequently rebounded.)

While emphasising that volatility will always be part of financial markets, Rolleston also believes it will increase in 2007. Lipman says that movements in the Australian and international sharemarkets have become more correlated in recent years.

This means, of course, if the Wall Street market moves up or down, the Australian market is more likely than in the past to follow. Unfortunately, the risk-reduction attributes from diversifying offshore are no longer as significant.

2 Buy quality and don't panic when the market DIPS

Rolleston says a concentration on buying quality shares in the first place and a determination not to sell in panic during market downturns has been 'shown time and time again to be good practice'.

3 Don't sell too early

Investec Private Advisers' Lipman says two classic mistakes in a booming sharemarket are to buy too late and sell too early in a cycle. In other words, investors should not try to time the market.

The selling of shares too early worries Lipman. 'Good companies should perform well and continue to make money through any short-term weaknesses in the market,' he says. 'Shareholders often fall into the trap of behaving like traders, not long-term investors.'

Martin Kerrigan, chief executive of Snelleman Tom Consulting Accountants & Financial Services in Queensland, adds: 'So many financial planners pretend to have some knowledge of whether markets are going up or down.'

Kerrigan, a financial planner and chairman of CPA Australia's financial advisory services centre of excellence, is stinging in his criticism of such advisers. 'In my experience, no one at all has the skill of market timing.'

4 Get your asset allocation right

Investors should ensure that the long-term asset allocation of their overall investment portfolios the diversification of their investments between mainly shares, property, fixed interest and cash is set with the aim of achieving the highest returns possible within their individual personal tolerance to risk and volatility.

Financial planners typically believe this is the cornerstone of sound investment practice. One of the main reasons to have an efficient asset allocation is that different investment markets can perform differently at different times.

Consider the average asset allocation of the balanced pooled superannuation trusts surveyed by Mercer Asset Consulting. This average portfolio holds:

36.4 per cent of its total assets in Australian shares
overseas shares, 25.7 per cent
direct property, 0.7 per cent
listed property trusts, 7.4 per cent
Australian bonds, 13.7 per cent
overseas bonds, 6.8 per cent
indexed bonds, 0.7 per cent
cash, 5.7 per cent
other investments, 2.9 per cent.

In short, 70 per cent of the portfolio is in growth assets.

UBS Wealth Management's Rolleston suggests that investors always keep to their appropriate long-term or strategic asset allocation but be willing to make marginal adjustments known as tactical asset allocations in light of short-term fundamentals in the market.

5 Regularly rebalance your portfolio

The extraordinary performance of Australian shares over the past four years means many investors' once-carefully diversified port-folios will be overweight in domestic shares as well as listed property trusts. This is unless their portfolios were regularly rebalanced back to their long-term allocation, if still appropriate.

Australian shares and listed property trusts both produced annualised returns of 25.4 per cent over the three years to 28 February against 12.6 per cent by overseas shares.

And over the past five years, overseas shares recorded an annualised return of a miserable 1.7 per cent against 16.2 per cent by Australian shares and more than 20 per cent by listed property trusts.

The regular rebalancing between asset classes of your overall investment portfolio provides an opportunity to take profits on assets that have risen sharply. And another crucial benefit of regularly rebalancing your investment portfolio is that you are guarding against being overexposed to a particular investment sector, such as Australian shares, if that market were to suffer an abrupt downturn.

'Discipline is the key to successful investing,' says ipac Securities' Abey. He says the foundation for disciplined investment is to have an appropriate long-term or strategic asset allocation then to regularly rebalance your portfolio to remain within that allocation if this is still appropriate for your circumstances.

Abey makes the analogy of a well-intended plan to go on a diet. 'Everyone begins a diet with the intention of continuing it,' he says. 'But then real life intervenes.' The same real-life factors that can ruin a diet inertia and emotion can overturn an investment plan.

Rolleston adds: 'The taking of profits may generate capital gains tax [CGT] and should be considered in any strategy. But CGT should not be an overriding reason for not reweighting. Depending on a person's circumstances, the CGT may be reduced or offset by making deductible super contributions.'

Lipman strongly urges investors to overcome their natural reluctance to sell such top-performing assets as domestic shares and listed property trusts when markets are running high.

'Everyone would be a multi-millionaire if the same asset sector was going to be the best performer every year,' he says. 'Certainly, it is likely that shares will do better than property over the long term but it is very dangerous to think that shares are going to do better year in and year out.

'It is a more pragmatic and prudent approach to regularly rebalance your portfolio [in accordance with your long-term strategic asset allocation] rather than becoming overweight in any sectors.

'Sell when the market is up and buy when the market is down.' In other words, sell in boom and buy in gloom.

6 Give yourself room to move

The rebalancing back to your appropriate strategic asset allocation need not be a 'straightjacket' approach, advises Lipman. 'Give yourself flexibility at the margins.'

Rebalance your portfolio back to its initial diversification if still appropriate within a 5 per cent tolerance, advises Abey. That buffer will act against triggering unnecessary capital gains and transaction costs.

This means that if your long-term asset allocation includes, say, a 50 per cent exposure to shares, consider rebalancing it if that holding falls to 45 per cent or rises to 55 per cent.

Abey says rebalancing your portfolio can be 'emotionally hard to do' when the market is rising. He points out that an attribute of a diversified investment fund that is true to label and that has an asset allocation that suits your needs is that the rebalancing is done for you.

Abey is one of Australia's most respected observers of market and investor behaviour. He's also the co-author of several editions of Fortune Strategy, a book on how to achieve the highest investment returns within your personal tolerance to risk. Yet his personal investment style is amazingly simple.

'The vast majority of my family wealth is in a single diversified fund, which is diversified across fund managers,' Abey says. 'Ninety per cent of the portfolio is in growth assets.'

7 Consider concentrating more on dividends

Lipman points out that many retirees, for example, surprisingly might be able to take on more risk by having a higher exposure to shares than otherwise thought appropriate. Much depends, of course, on personal circumstances.

He says a retiree might, say, decide to concentrate more on stable dividends being paid by their blue-chip stocks. Stable dividend income should enable them to take a slightly higher risk without focusing on day-to-day fluctuations in share prices. 'A focus on volatility is somewhat misplaced,' Lipman says. 'Quality companies pay fairly predictable dividends that increase in line with or faster than inflation.'

8 Take care when buying in market downturns

Seasoned financial planners sometimes suggest buying in market downturns. 'Good buying opportunities present themselves on market dips but only on fundamentally good stocks,' warns Rolleston. 'Leopards don't change their spots on market dips.' In other words, a second-rate company doesn't suddenly become a good buy because it's cheaper.

9 Ensure you can service your debts

Kerrigan from Snelleman Tom Consulting Accountants & Financial Services advises investors to ensure they have sufficient cashflow to service their debts in all market conditions, taking into account the reliability of dividends from stocks in their portfolio.

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