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One of the most important decisions an investor makes is the portfolio’s mix of cash, bonds, property and shares. These are the four different types of assets and the mix of them is the overall investment strategy of the investor.

The mix is important because it ultimately explains the return that the investor receives. So investors need to decide how much of each asset type they should “normally” have and whether, because of the current environment, they should have more or less of one than normal.

Each of these decisions are not easy to make.


Normal mix

The normal mix of cash, bonds, property and shares for an investor, is a combination of what will “theoretically” achieve the investor’s return requirements and what risks the investor then chooses to take. While determining the theoretical mix can be straightforward, understanding an investor’s emotional drivers (hope, fear, greed and regret) for risk is a lot harder.

The theoretical decision will depend on the investor’s personal situation:

  • the level of their savings
  • when will they spend their savings i.e. their need for regular income and extra lump sums
  • the importance of the expenditure and the level of certainty required i.e. making sure it is there when needed.

The above will affect how much the investor should have in each type of asset. They may then be willing to have more volatility with the potential for a higher return, or more certainty and accept that they will likely get a lower average return. This part of the investment strategy decision will be based on the investor’s personality, beliefs and emotions, as well as the current environment and recent experience.


Current environment

Despite what some people say, no one knows what will happen in the investment markets in the immediate future. The comments below are therefore general observations about the current market based on our current views and guesses.

Cash rates are now low and lower than they have been over the last 20 years (see chart 1). They are lower than where we think they will be long-term. At these levels they provide little margin for inflation. Therefore, either there will be nil or low inflation over the next 3 to 5 years, or we are in a sustained period where holding cash is more important than the possibility that inflation will erode the value of an investor’s savings. Investors need to look at other types of assets to protect their savings against the potential for inflation.

Chart 1

90 day bank bill rates.JPG


Also relevant are the interest rates on longer dated bonds (see chart 2). Like cash rates, these are lower than normal and therefore the risk of a poor return over the short-term, is higher than normal. Investors can manage that risk by holding bonds to maturity.

At the same time, the gap between 10 year bond rates and cash rates is significantly higher than normal (see chart 3). Combined, these factors imply that bonds are riskier than normal but currently better value than cash, from a return perspective. So unless an investor is only interested in very short-term returns, the current cash rate suggests that investors should have less cash than normal and more invested in bonds.

Chart 2

10 year government bond yields.JPG

Chart 3

10 year yield cash rate.JPG


Our general advice is that investors should have, as a normal level of cash assets, an amount equal to what they will spend (from their investments) over the next three years. However, because of the low cash rates, if an investor was looking to improve their return for moderate additional risk, they may prefer to hold less cash and more bonds than normal. We expect this to be the better one year strategy.

The price of a share reflects a multiple of the profit of the company and the normal supply and demand considerations. The multiple of profits is referred to as the PE (price/earnings) ratio. Sometimes, investors will pay more than average, and sometimes less than average for the future profits of a company. Buying shares when PEs are low is often best (a lower price for a given level of earnings). But no one knows with any certainty what the profits will be in 3, 5, or 10 years, yet alone in 1 year from now, and therefore whether the PE is truly low. What might be a low PE multiple today of past profits, may be a high PE of the future profits; we do not know. The profits will reflect the general economy, the type of company it is and the quality of the company’s management.

Currently (see chart 4), the market suggests that the PE multiple of the average company is lower than what it has historically been, not as low as it has been at times, but definitely less than normal. This implies that shares are “cheaper” than normal (and should be bought), or that the profits of companies are about to fall, or at least will not grow as much as normal.

Chart 4

NZ share historical PE ratios.JPG


There is a lot of speculation on whether the NZ economy will grow and whether the prices of our dairy products and other exports will stay high. This places an element of doubt on the immediate profit levels of companies. The implication therefore, given the current lower than average PE multiple, is that it is a better than average time to buy shares but not guaranteed short-term. Remember however, that buying shares should be done only with money that you do not intend to spend in the next 10 to 12 years, unless you wish to speculate. If investors have reduced their share holdings in recent years, continuing to rebuild them to the normal level may make sense.

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