the sporting philosophy to help investors find opportunities

how are your nerves The first half of the year gave investors a lot to digest – and to test their patience.

Problems are deepening in a way rarely seen in Australia – the highest inflation in decades, rising energy costs and rising interest rates are just the beginning.

Factor in supply chain bottlenecks, the pressure on the workforce from record-low unemployment and the never-ending pandemic, and you can almost hear the strain on the economic machine.

The ups and downs can be maddening, like watching a popular sports team struggle for consistency – world champion one minute, lightweight the next.

With so many factors currently going into play, this can cloud our judgement. But if we can put aside the emotional and sentimental elements currently affecting the market, we can look objectively and uncover pockets of opportunity.

In this article:

What is the problem?

Rising interest rates and inflation have not been a major concern in Australia for some time.

The most obvious implication is that asset markets sold off sharply early in the year, both in bond and equity markets, partly due to shifting expectations of future interest rates.

However, we expect rate hikes to peak in 2023, at which point rate cuts may start in response to a much weaker growth outlook.

While there is a risk that inflation will continue to rise in the near term, there are also early signs that inflationary pressures may be peaking. If recession risks arise, they can support the fight against inflation.

Higher interest rates result in higher discount rates in the models used to value fixed assets. All other things being equal, a higher discount rate equates to a lower present value of the asset. This puts downward pressure on asset prices as market participants reassess an asset’s value.

government bonds

This can provide attractive investment opportunities. Australian government bond yields briefly exceeded 4%, a level not seen in almost a decade. Although they are now between 3 and 3.5 percent again.

Returns between 3 and 3.5 percent don’t seem like a particularly noticeable return. However, investors should keep in mind that if economic conditions become unduly strained, we could slide into a recession. In this case, government bonds can be a safe haven as buying pressure drives bond prices higher.

Investors may see policymakers focus on stimulating economic activity via lower interest rates. This has the opposite effect – lower interest rate expectations mean higher government bond prices. Now might be a sensible time to add bonds as insurance against future events.

Keep an eye on A-REITs

Another area we are closely analyzing is Australian Real Estate Investment Trusts (A-REITs).

Everything has been sold lately, but selling of A-REITs has been particularly strong in recent months as the Reserve Bank began its cycle of interest rate hikes. The market was concerned about commercial real estate valuations and the impact on the fund management business.

This has resulted in some A-REITs trading at or below the value of their net tangible assets (the value of tangible assets less debt). This can be an attractive purchase price, although the future value of the underlying assets and the potential for discounts should be taken into account.

A-REITs can also provide viable inflation protection through property value (replacement costs increase with inflation) and inflation-linked rents.

What lies beyond the Australian coast?

The third asset class we add is international equities, particularly high quality companies. Quality companies not only survive weaker economic conditions, but can emerge stronger through reduced competition.

We look at companies that have a franchise or a really strong brand or patent on a product, the elements that give it a lasting competitive advantage, and we look overseas because the international markets are selling out more than the domestic market.

Our guiding principles for identifying quality companies to invest in are threefold:

• The competitive advantage, which may include trademarks, patents, intellectual property, cost advantages and the like;
• a strong record. Although some companies naturally have more debt (infrastructure is an example); and
• a history of good administration with sound capital management.

The final result

Patience is easy said, but can be difficult to implement when it comes to investing, and it’s not easy watching portfolios and assets fall in value. Allowing emotions or psychological factors to influence your investment decisions can lead to irrational decisions.

When you’re committed to the investing game plan, you don’t ride ups and downs like a football team. Take a leaf out of the trainer’s book and stick to the process.

Selling on bad news and buying on good news is an almost certain way to permanently lose your savings. It’s almost impossible to choose the bottom or the top.

Factors that affect stock prices in the short term, such as interest rates and speculation about inflation, are unpredictable. Long-term returns are determined by factors such as valuation, profitability, earnings growth, balance sheet strength and competitive advantages.

Be practical and objective when it comes to investing and look for opportunities. Talk to experts, do extensive research and check your thought patterns before making an investment decision.

After a decade in two senior positions at Australia’s largest and oldest financial institutions, Andrew Wilson joined Pitcher Partners and quickly worked his way up to Director. He provides clients with advice and guidance on all financial matters as part of an ongoing relationship, focusing on helping clients achieve sufficient passive investment income. Andrew’s expertise includes investment management, tax minimization, debt management, wealth protection, retirement planning and estate planning.