First half 2015 - winners & losers

The global equity bull market has had a few wobbles but is still reasonably intact and into its sixth year. Photo / Thinkstock

We are halfway through 2015 and the global equity bull market has had a few wobbles but is still reasonably intact and into its sixth year. The big question facing investors is, with rises in short term US interest rates getting closer, how stockmarkets will react.

Commonsense says that higher interest rates are factored into prices given that just about everyone is anticipating the same however financial markets are unpredictable and anything can happen.

Of course, the theory says that higher interest rates should mean that the present value of a company's cashflow is worth less but that ignores the fact that higher interest rates might be due to the prospect of higher growth and inflation rates which would imply offsetting higher cash flows.

In any event share markets do look expensive relative to long term historic valuations but you could argue that stockmarkets today are less risky than those in the past and thus deserving of a higher valuation because central banks seem to be happy to cut interest rates at the first sign of trouble. The complacency that that last sentence implies may in itself be a warning sign along the lines of "this time is different".

Anyway what has worked so far in the first half of 2015? As the table shows the place to be was global equities which returned a whopping 16.5 per cent however most local fund managers' international portfolios won't match this return because some 10.7 per cent of that was due to a sharply lower NZ currency against the US$ in the six months and many fund managers are currency hedged.

This hedging strategy has worked well in the past but has spectacularly underperformed in the last year or so. Anecdotal evidence suggests that many retail investors' portfolios would have underperformed this year as well because most are underweight global equities and thus the US$.

Currency issues have impacted returns significantly year to date - whilst the NZ$ is down by 10.7 per cent against the US$ it is only down 5.7 per cent against the A$ and many retail portfolios are overweight Australian equities which underperformed global stocks in NZ$ terms by around 38 per cent.

Incidentally the GIRY illustrates that currency hedging can occasionally be a disastrous strategy. In 1942, possibly as a result of Japanese aircraft flying over Auckland, the NZ$ fell by 39.7 per cent. That's a big move in 12 months. Since 1900 the NZ$ has fallen against the US$ by an average of about 1 per cent pa.

Of the major markets in the global equity scene Chinese equities took out the top spot with a 58 per cent return. Of the major developed markets Japan was by far the best performer with a 28.3 per cent rise followed by European markets which rose by 18.6 per cent.

You might think that in this environment, with interest rates low and monetary policy so accommodating, that it would be difficult to lose money. Unfortunately that wasn't the case for investors in the many technology IPO's that were so popular last year.

The US stockmarket returned 15.1 per cent in the half year to deliver a 36 per cent gain in the 12 months in NZ$ terms and 17.4 per cent pa over 5 years. Australian stocks had another relatively disappointing six months with a 10.3 per cent return and have lagged global equities by 4.7 per cent pa over five years due to concerns about major companies' exposure to China, iron ore etc.

NZ shares underperformed returning just 4.0 per cent although 4.0 per cent in six months is still very attractive. Indeed if we look at the 2015 Global Investment Returns Yearbook we see that the average return on NZ shares from 1900 to 2014 is 10 per cent pa.

As mentioned the area that is foremost in investors' minds presently is the trend in interest rates and the trend year to date has been upwards with the US 10 year Government bond rising from 2.17 per cent in January to 2.31 per cent as at 17 June.

NZ Government bond yields took their lead from the US and also rose - from 3.65 per cent to 3.81 per cent but despite this headwind the NZ Government bond index still returned a worthwhile 2.7 per cent in the six months.

Putting all these numbers together and using the asset allocation of the average NZ pension fund we estimate that the average balanced KiwiSaver fund returned 6.9 per cent pre-fees, pre-tax in the six months. Better than working.

You might think that in this environment, with interest rates low and monetary policy so accommodating, that it would be difficult to lose money. Unfortunately that wasn't the case for investors in the many technology IPO's that were so popular last year.

As with so many fads infatuation has now turned to revulsion and the share prices of most technology IPO's languish well below their issue price. As the table shows the average loss on the selection of tech stocks since their IPO, or in the 12 months if they weren't subject to an IPO, is -5.5 per cent.

Although it is usually difficult for financial advisers to add value to retail portfolios the tech stock IPO craze provided a huge opportunity and it was easy - you just ignored it.

In fact you can extend that winning investment strategy further - if financial advisers want to outperform their peers all they need to do in NZ is advise their clients to avoid all IPO's except those sold by non-expert sellers ie the NZ Government.

With many NZ technology companies still years away from profitability and almost certainly requiring more capital their shareholders' appetite are likely to be further tested.

The bullish environment of the last six years has rewarded risk taking. Anyone adopting a balanced approach with a cash and bond component in their portfolios will probably have underperformed an all equity mandate however with stockmarkets looking fully valued and the tail wind from quantitative easing looking likely to ease things could be very different in the next six years.

The risk is that consistent high returns from equity markets have lulled investors into a false sense of security and asset allocation has become more aggressive as equity markets rose.

Retail investors, when contemplating their asset allocation, need to recognise that the good times won't last forever and that one common failure of investors is to rebalance into low risk asset classes after the correction rather than before.

Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.