In this month’s Cross Asset Review produced by Foresight Analytics, we look at the performance of various asset classes in the last Financial Year. Central Bank policy pivot was the single largest factor in our opinion that defined the cross-sectional variation of asset class returns. Falling interest rates, both short- and long-term, resulted in significant outperformance of real assets such as gold, infrastructure and real estate. Developed market equities also benefited from the falling cost of debt and a weaker AUD over the period benefited unhedged investors.
1. Central bank policy pivot central to cross-sectional return variation
- Accommodative global central bank policy has benefited every asset class except cash
- Real assets (gold, infrastructure and real estate) benefited most from the shift in central bank policy.
- The 12 month returns of real assets were driven by changes in the last 1 and 3 months
- Australian REITs topped our asset class table with 19.4% return, followed by Gold with 18.7% return.
- In equities, Large Caps across Australian, Global and Developed markets continued to beat Small, mid and Micro cap equities.
- The worst performing asset sectors were Australian Emerging Companies (-2.89%) and Global Commodities (-2.66%). Cash was the 5th worst asset class on returns.
Exhibit 1: Accommodative central bank policy significantly benefited long duration real assets as well as Gold.
2. Central bank policy pivot created a v-shaped recovery for most asset classes in the second half of the FY
- The current and longest running bull market has benefited investors quite substantially. Over the 10-year period, the riskiest asset sectors such as small- and mid-cap equities have delivered the strongest returns. Risk seeking behavior was well rewarded.
- Continued fall in bond yields across both short- and long-term has been positive for bonds and bond-proxy assets such as real estate and infrastructure.
- Commodities and VIX were the worst performing asset classes over the past 10 years followed by Cash and Gold.
- While price of gold rebounded very strongly in 2019 (assisted by geo-political risks and central bank actions), commodity price index remained weak over the extended period.
Exhibit 2: A V-shape recovery in asset prices over the second half of the financial year
3. A weaker AUD against all major trading partners was reflective of domestic growth and interest rate differentials
- The biggest relative losses for AUD were against the Japanese Yen (-7.58%) and Swiss Franc (-6.57%). The volatility of AUD/JPY and AUD/CHF is similar to long-term averages.
- Both Yen and Swiss Franc are perceived as 'safe haven' currencies and have benefited at the expense of 'risk currencies' like AUD.
- Weaknesses were also witnessed against Canadian Dollar, US Dollar and Hong Kong Dollars (which is linked to USD).
- AUD/GBP continued to recover over the past three months (1.56%) as the Brexit drama continued to weigh on outlook for GBP.
Exhibit 3: AUD continued to be weaker against its major trading partners
4. A broad weakness 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.
- Over past year unhedged investors in developed market Equity and REITs have benefited most from a weaker AUD.
- Unhedged Global equity (DM) investors realized a positive currency effect of 5.53% over the past year, 1.36% over the past 3 years and 3.84% over the past 5 years.
- 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 lower starting point for AUD 10 years ago but can also be an indication that currency strategies over the longer term can be very challenging.
- Overall, the favourable currency moves (such as weaker AUD) have accounted for a substantial proportion of 12-month unhedged 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.
Exhibit 4: Unhedged Defensive & Growth assets benefited substantially from weaker AUD
5. Analysis of cross-asset correlations and volatilities 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 followed by mid-caps and EM REITs.
- The least volatile assets outside of Cash were Australian and Global Bonds.
- Correlation statistics give a better insight into the relationship between the performance of two or more asset classes. Importantly, correlation is not stable over time so investors need consider cyclical and secular relationship between asset classes.
- Exposure to gold offers diversification benefits to investors but one needs to consider that gold is not a typical financial asset that generates income. It is often highly volatile. It can be used for hedging tail risks in portfolios as it is one of the asset classes that’s positively correlated with VIX.
- 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 proved to be the riskiest but correlation of Gold & VIX suggests Gold may be used as a tail-risk hedge
In summary, the central bank policy pivot was the single most important factor defining the cross-sectional dispersion in returns for Australian investors over the past financial year. Investors with diversified portfolios across major asset classes have done well. Unhedging the currency exposure throughout the year boosted returns for investors by a notable margin. While any exposure to Gold and Volatility (VIX) provided good diversification benefits over the financial year, the longer term returns from both these investment remained below most asset classes.
The material contained in this document is for general information purposes only. It is not intended as an offer or a solicitation for the purchase and/or sale of any security, derivative, index, or financial instrument, nor is it an advice or a recommendation to enter into any transaction. No allowance has been made for transaction costs or management fees, which would reduce investment performance. Actual results may differ from reported performance. Past performance is no guarantee for future performance.
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