In this month’s Cross Asset Review produced by Foresight Analytics, we look at the outperformance of domestic assets despite losses in global equity markets and rising uncertainty around the global economic outlook. Gold, bond assets and bond proxies (AREIT/GREIT) also outperformed as investors sought exposure to safety assets. A weaker AUD relative to the major trading partners delivered a strong and positive translation effect for unhedged investors. Currency volatility for AUD/JPY continues to be higher then its long-term average. In May alone AUD lost 4.3% against Yen, to be down 9% over the past 12 months.
1. Risk-off sentiment weighs on global assets, Australian shares buck offshore trend
- Weakening global economic data and rising concerns around the ongoing China - US Trade War spooked investor sentiment.
- Despite the global risk-off mood, the Australian large-cap and all-cap stocks continue to advance, thanks to a Coalition victory and a largely anticipated RBA rate cut.
- Bond proxies such as Australian REITs and Global REITs also performed well alongside rising domestic and global bond prices.
- Gold prices advanced over the month to be 9.75% up for the year as investors seek exposure to safe-haven assets.
- Broad global equities indices (MSCI ACWI, MSCI ex-Aust and MSCI EM) all delivered losses of over -4%.
- Emerging market equities were among the biggest losers (-5.8%) as investors allocated capital towards safety assets.
Exhibit 1: Risk-off sentiment lead to declines in growth asset classes
2. Australian bonds delivered one of the best monthly returns, beating global bonds
- The Bloomberg Australian composite bond index delivered 1.70% return for the month, to be up 8.93% on a 12-month basis. The continued fall in bond yields across both short-term (RBA assisted) and long-term (global concerns) was positive for bond investors.
- The FTSE World Global government bond index and the Barclays Agg Global Bond index delivered 1.47% and 1.38%, respectively. Both indices are up about 6% on a 12-month basis.
- Australian cash as proxied by the Bloomberg Ausbond Bank Bill index delivered 0.15% return to be up 2% for the year. Investors in bank term deposits are being squeezed out as returns tumble on the back of further RBA cuts in coming months.
- Gold, which is often treated as a defensive asset, was up 3.59% over the past month and 9.74% over the past 12 months as investors sought safe-haven assets.
Exhibit 2: The shorter-term retracements need to be placed in the context of very strong markets since 2009
3. AUD continues to weaken on the back of soft domestic economic and inflation data, and RBA cut
- The Australian Dollar Index weakened over the month, reflecting weakness against most major trading partners.
- The biggest relative losses were against the Japanese Yen as volatility of AUD/JPY over the past year continues to be abnormally high.
- Weaknesses were also witnessed against the Swiss Franc, Indian Rupee and USD.
- AUD/GBP continued to recover over the past three months as the Brexit drama continued to weigh on investor sentiment towards GBP.
- The volatility of AUD/CHF is also extended and is closely tracking its 15-year average.
- From the dataset, it appears that the Swiss Francs (CHF) has lost its stripe as a safe-haven currency for now.
Exhibit 3: AUD continues to be weaker against its major trading partners
4. A broad weaknesses in AUD over recent years deliver positive currency effects for unhedged investors.
- The FX moves over the past 1, 3 and 5 years have translated into positive currency effects for unhedged defensive and growth assets.
- The unhedged developed market global equity investors realised a positive currency effect of 3.17% over the past year, 1.43% over the past 3 years and 5.65% over the past 5 years.
- A similar quantum of positive currency effects has been recognised across Global Fixed Income, GLI and GREITs.
- Currency effects over the longer period (10 years) were negative, reflecting a lower starting point for AUD 10 years go.
- Overall, the favourable currency moves (such as a weaker AUD) have accounted for a substantial proportion of 12-month total returns delivered by offshore growth assets.
- Investors should be careful in extrapolating the positive impact of currency unhedging in the future as starting levels are as important as the direction of FX move.
Exhibit 4: Unhedged defensive and growth assets benefited substantially from weaker AUD
5. Analysis of correlations and volatilities continue to demonstrate the benefits of multi-asset diversification for investors.
- Longer-term volatility trend continues to rise for growth assets and in particular small and mid caps.
- The most volatile asset over the past 12 months in AUD was small-cap equities (MSCI World ex Aus, MSCI ACWI & S&P/ASX Emerging Companies) followed by mid cap and emerging market REITs.
- The least volatile assets outside of cash were Australian and global bonds. The realised 12-month volatility for Australian bonds was 2.34% while for global bonds (Aggregate) it was 2.45%.
- Correlation statistics give a better insight into the relationship between the performance of two asset classes.
- Evidence from correlation analysis shows that multi-asset investors continue to benefit from cross-asset diversification with most defensive and bond proxy growth assets continuing to offer good diversification benefits against the most dominant holdings for most investors – Australian shares.
Exhibit 5: Small and mid-cap equities prove to be riskiest but correlation matrix shows active investors should be able to create a strong diversified portfolio
In summary, the risk-off sentiment globally was negative for risk assets in general. Australian equities were an exception to the rule, reflecting idiosyncratic domestic drivers – a Coalition victory and RBA rate cut. Bond assets, gold and bond proxy assets (AREITS/GREITS) did well on the back of rising uncertainty and a bond market rally. Australian investors with unhedged exposures continue to do well as the AUD weakens further against major trading currencies.
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