Quarterly investment update – October to December 2014

New absolute return manager

In November 2014, VicSuper awarded a $100m mandate to a new investment manager to manage part of VicSuper’s Alternatives asset class. Before November, Alternatives consisted only of private equity. The new mandate is for an absolute return strategy, with an aim to achieve a positive return rather than match or exceed a specific benchmark.

While this strategy uses fixed interest investments as the core driver of returns, its risk and return characteristics differ significantly from traditional fixed interest. Rather than simply investing in a diversified portfolio of sovereign and corporate debt with different maturities, the strategy looks to protect the portfolio by combining duration risk management – that is, limiting the price sensitivity of the portfolio to changes in interest rates – and hedging. These are designed to help the fund achieve a positive return irrespective of the direction of interest rates or other factors that influence traditional fixed interest returns.

This mandate represents about 22% of VicSuper's Alternatives asset class, which aims to diversify away from equity risk and duration risk. The chart shows the strategic asset allocation to Alternatives for the total fund. As highlighted, Alternatives remain a relatively small part of VicSuper’s total investments relative to the other asset classes.

* Also applies to Equity Growth Sustainability

Key themes underlying financial markets in the next 12 months

  • World GDP growth will likely be moderate, led by the US and China.
  • Bond yields will likely rise in 2015 – depending on the timing of interest rate increases in the US
  • Implications for VicSuper fund:

    » Equities are moderately attractive relative to bonds
    » Alternatives are attractive as a means to diversify risk to enhance total return.

VicSuper's investment option returns for the December quarter

  • Equity Growth was the best performing option for the December quarter (4.0% for both FutureSaver and Flexible Income). All other options were positive for the quarter, with options other than Australian Shares performing in line with their exposure to equities.
  • For the calendar year Equity Growth gained the most for FutureSaver (9.6%) while Growth was the top performing option for VicSuper Flexible Income (10.3%).
  • Emerging market equities underperformed Australian and developed markets and finished the year with negative returns. Non-emerging market equities were positive but were surpassed by double digit Australian and international fixed interest returns for the year.
Table 1: VicSuper Investment Option returns

VicSuper FutureSaver

Accumulation (%)

VicSuper Flexible Income (%)

3-months 1-year 5-year 10-year 3-months 1-year 5-year 10-year
Cash 0.5% 2.2% 3.3% 4.1% 0.7% 2.7% 3.9% 4.9%
Capital Secure 2.2% 6.5% 6.0% 5.3% 2.1% 7.1% 6.8% 6.1%
Capital Stable 3.1% 8.4% 7.3% 5.9% 3.0% 8.9% 8.3% 6.8%
Balanced 3.4% 9.1% 8.2% 6.3% 3.5% 9.9% 9.4% 7.3%
Growth 3.5% 9.5% 8.6% 6.4% 3.7% 10.3% 9.9% 7.3%
Equity Growth 4.0% 9.6% 9.7% 6.9% 4.0% 10.1% 10.9% 7.7%
Equity Growth Sustainability 3.9% 8.8% 9.2% 7.3% 3.6% 9.0% 10.3% 8.1%
Australian Shares* 2.4% 4.9% N/A N/A 2.7% 5.5% N/A N/A

Source: VicSuper

Note: Past performance is not a reliable indicator of future performance. The 5 and10-year return is annualised.

* The Australian Shares investment option was introduced on 4 February 2013 for VicSuper FutureSaver and on 5 February 2013 for VicSuper Flexible Income.

current Term Deposit rates.

Asset class performance for the December quarter

  • Within VicSuper's key benchmarks, Australian and international fixed interest were the top performers over the December quarter and year. Australian Equities were hurt late in 2014 by weakening oil and iron ore prices, but still fared well for the year.
  • International developed market equities finished the year in positive territory helped by the US. Meanwhile, emerging markets finished in the red due to tumbling commodity prices, USD strength and continued geopolitical tensions.
Chart 1: Major Index Returns (VicSuper’s Asset Class Benchmarks)

Source: IRESS, Bloomberg, Barclays, MSCI

Australian Equities

  • The ASX 300 accumulation index gained 3% in the December quarter and 5% for the 12 months despite a poor performance by resources stocks in the second half of the year, on the back of falling oil and iron ore prices. Crude oil fell more than 50% of since June while iron ore lost almost 30%. Oil prices were impacted by surging US oil supply, lower global demand (particularly from China) and the refusal by Saudi Arabia to reduce oil production.
  • Healthcare, Property and Telcos all performed well, reflecting investors’ appetite for relatively defensive and high dividend yielding stocks.
  • The AUD ended the year down 8% at $US0.817. Reserve Bank of Australia (RBA) governor Glen Stevens stated he would prefer to see the AUD down to US$0.75. While the lower AUD makes overseas purchases and travel for Australians more expensive, it is important for increasing the competitiveness of Australia’s non-mining exports, which it is hoped will help close the gap left by the end of the investment phase of the mining boom.

Developed Market Equities (excluding Australia)

  • Developed market equities were strong in 2014 despite softness in the global economy, conflicts in Ukraine and the Middle East, and falling commodity prices later in the year. The US led the gains, as the S&P500 reached all-time highs helped by strong GDP growth (+5% in the third quarter) and consumer confidence.
  • Europe lagged the US and ended the year with significant deflationary concerns. Despite much speculation, the European Central Bank has yet to implement quantitative easing (stimulus) measures. Fears of a Greek exit from the European Union reignited in December as the nation’s populist anti-austerity party looked set to win the snap January 2015 election caused by parliament’s inability to elect a President.
  • Japan continued its 'Abenomics' program in 2014. Abenomics is Prime Minister Shinzo Abe’s three-arrowed approach to reviving the economy after more than a decade of deflation and no growth. The first arrow was increased government spending which was successfully fired, and later complemented by the delay of the planned hike in the consumption tax until 2017. The second arrow was monetary easing, recently re-fired with a new surprise stimulus in October. The third arrow being structural reform remains the point of focus. Critics suggest Abe, despite winning a snap election in December, may not have the political clout or will to take on protected or restrictive industries such as agriculture and healthcare, and overhaul corporate governance and the labour market.

Emerging Market Equities

  • Emerging markets underperformed in 2014 despite China’s Shanghai Composite index gaining 53% for the year. Chinese property prices have been falling but ordinary Chinese individuals have been piling into the stock market at a rate not seen since 2007. Chinese growth is forecast to be only slightly lower in 2015, as the economy moves from being driven by investment to being driven by consumption. In December, Russia increased rates by 6.5% to 17% in an emergency attempt to reduce inflation and save the currency. The Russian economy has been hurt by sanctions from the US and European Union due to its annexation of Crimea, and the fall in oil prices.

Australian and International Fixed Interest

  • As reflected by the UBSA Composite Bond Index (proxy for Australian fixed interest) and the Barclay’s Global Aggregate Index (proxy for international fixed interest), Australian and international fixed interest markets finished quarter up 4% and 3% respectively. Both indices finished the year up 10%. Despite expectations of US interest rate rises and resultant spikes in yield, the US Federal Reserve (Fed) kept rates on hold through 2014. Tapering of the Fed’s quantitative easing program did little damage to US treasury bonds and investment grade corporate debt as both performed well in 2014. Emerging market hard currency (USD) sovereign debt also performed well thanks to very low long term yields in the US.

Cash

  • The RBA left the official cash rate on hold at 2.5% in 2014. Some economists were calling for a cut to the cash rate towards year-end to boost demand and put more downward pressure on the AUD. This is a difficult decision for the RBA because lower rates may lead to further house price inflation and mortgage lending.
  • The 1-year return for the Cash Option broadly reflects the official Cash Rate in Australia, which was held at 2.5% all year.

Noteworthy indices and rates in 2014

Noteworthy indices and rates in 2014

Source: IRESS, Bloomberg, Barclays

International equities: MSCI World ex Australia index unhedged used. MSCI Emerging Markets index (not shown) was $95 at 31/12/2014.

Fixed interest: Barclays Global Aggregate index used. Bloomberg AusBond Composite (Australian benchmark index) was also $110 at 31/12/2014.

Winners for 2014 were Australian property, international and Australian fixed interest, and developed market equities (including Australia). Underperformers were key Australian export commodities and the AUD.

New absolute return manager

In November 2014, VicSuper awarded a $100m mandate to a new investment manager to manage part of VicSuper’s Alternatives asset class. Before November, Alternatives consisted only of private equity. The new mandate is for an absolute return strategy, with an aim to achieve a positive return rather than match or exceed a specific benchmark.

While this strategy uses fixed interest investments as the core driver of returns, its risk and return characteristics differ significantly from traditional fixed interest. Rather than simply investing in a diversified portfolio of sovereign and corporate debt with different maturities, the strategy looks to protect the portfolio by combining duration risk management – that is, limiting the price sensitivity of the portfolio to changes in interest rates – and hedging. These are designed to help the fund achieve a positive return irrespective of the direction of interest rates or other factors that influence traditional fixed interest returns.

This mandate represents about 22% of VicSuper's Alternatives asset class, which aims to diversify away from equity risk and duration risk. The chart shows the strategic asset allocation to Alternatives for the total fund. As highlighted, Alternatives remain a relatively small part of VicSuper’s total investments relative to the other asset classes.

* Also applies to Equity Growth Sustainability

Key themes underlying financial markets in the next 12 months

  • World GDP growth will likely be moderate, led by the US and China.
  • Bond yields will likely rise in 2015 – depending on the timing of interest rate increases in the US
  • Implications for VicSuper fund:

    » Equities are moderately attractive relative to bonds
    » Alternatives are attractive as a means to diversify risk to enhance total return.

VicSuper's investment option returns for the December quarter

  • Equity Growth was the best performing option for the December quarter (4.0% for both FutureSaver and Flexible Income). All other options were positive for the quarter, with options other than Australian Shares performing in line with their exposure to equities.
  • For the calendar year Equity Growth gained the most for FutureSaver (9.6%) while Growth was the top performing option for VicSuper Flexible Income (10.3%).
  • Emerging market equities underperformed Australian and developed markets and finished the year with negative returns. Non-emerging market equities were positive but were surpassed by double digit Australian and international fixed interest returns for the year.
Table 1: VicSuper Investment Option returns

VicSuper FutureSaver

Accumulation (%)

VicSuper Flexible Income (%)

3-months 1-year 5-year 10-year 3-months 1-year 5-year 10-year
Cash 0.5% 2.2% 3.3% 4.1% 0.7% 2.7% 3.9% 4.9%
Capital Secure 2.2% 6.5% 6.0% 5.3% 2.1% 7.1% 6.8% 6.1%
Capital Stable 3.1% 8.4% 7.3% 5.9% 3.0% 8.9% 8.3% 6.8%
Balanced 3.4% 9.1% 8.2% 6.3% 3.5% 9.9% 9.4% 7.3%
Growth 3.5% 9.5% 8.6% 6.4% 3.7% 10.3% 9.9% 7.3%
Equity Growth 4.0% 9.6% 9.7% 6.9% 4.0% 10.1% 10.9% 7.7%
Equity Growth Sustainability 3.9% 8.8% 9.2% 7.3% 3.6% 9.0% 10.3% 8.1%
Australian Shares* 2.4% 4.9% N/A N/A 2.7% 5.5% N/A N/A

Source: VicSuper

Note: Past performance is not a reliable indicator of future performance. The 5 and10-year return is annualised.

* The Australian Shares investment option was introduced on 4 February 2013 for VicSuper FutureSaver and on 5 February 2013 for VicSuper Flexible Income.

current Term Deposit rates.

Asset class performance for the December quarter

  • Within VicSuper's key benchmarks, Australian and international fixed interest were the top performers over the December quarter and year. Australian Equities were hurt late in 2014 by weakening oil and iron ore prices, but still fared well for the year.
  • International developed market equities finished the year in positive territory helped by the US. Meanwhile, emerging markets finished in the red due to tumbling commodity prices, USD strength and continued geopolitical tensions.
Chart 1: Major Index Returns (VicSuper’s Asset Class Benchmarks)

Source: IRESS, Bloomberg, Barclays, MSCI

Australian Equities

  • The ASX 300 accumulation index gained 3% in the December quarter and 5% for the 12 months despite a poor performance by resources stocks in the second half of the year, on the back of falling oil and iron ore prices. Crude oil fell more than 50% of since June while iron ore lost almost 30%. Oil prices were impacted by surging US oil supply, lower global demand (particularly from China) and the refusal by Saudi Arabia to reduce oil production.
  • Healthcare, Property and Telcos all performed well, reflecting investors’ appetite for relatively defensive and high dividend yielding stocks.
  • The AUD ended the year down 8% at $US0.817. Reserve Bank of Australia (RBA) governor Glen Stevens stated he would prefer to see the AUD down to US$0.75. While the lower AUD makes overseas purchases and travel for Australians more expensive, it is important for increasing the competitiveness of Australia’s non-mining exports, which it is hoped will help close the gap left by the end of the investment phase of the mining boom.

Developed Market Equities (excluding Australia)

  • Developed market equities were strong in 2014 despite softness in the global economy, conflicts in Ukraine and the Middle East, and falling commodity prices later in the year. The US led the gains, as the S&P500 reached all-time highs helped by strong GDP growth (+5% in the third quarter) and consumer confidence.
  • Europe lagged the US and ended the year with significant deflationary concerns. Despite much speculation, the European Central Bank has yet to implement quantitative easing (stimulus) measures. Fears of a Greek exit from the European Union reignited in December as the nation’s populist anti-austerity party looked set to win the snap January 2015 election caused by parliament’s inability to elect a President.
  • Japan continued its 'Abenomics' program in 2014. Abenomics is Prime Minister Shinzo Abe’s three-arrowed approach to reviving the economy after more than a decade of deflation and no growth. The first arrow was increased government spending which was successfully fired, and later complemented by the delay of the planned hike in the consumption tax until 2017. The second arrow was monetary easing, recently re-fired with a new surprise stimulus in October. The third arrow being structural reform remains the point of focus. Critics suggest Abe, despite winning a snap election in December, may not have the political clout or will to take on protected or restrictive industries such as agriculture and healthcare, and overhaul corporate governance and the labour market.

Emerging Market Equities

  • Emerging markets underperformed in 2014 despite China’s Shanghai Composite index gaining 53% for the year. Chinese property prices have been falling but ordinary Chinese individuals have been piling into the stock market at a rate not seen since 2007. Chinese growth is forecast to be only slightly lower in 2015, as the economy moves from being driven by investment to being driven by consumption. In December, Russia increased rates by 6.5% to 17% in an emergency attempt to reduce inflation and save the currency. The Russian economy has been hurt by sanctions from the US and European Union due to its annexation of Crimea, and the fall in oil prices.

Australian and International Fixed Interest

  • As reflected by the UBSA Composite Bond Index (proxy for Australian fixed interest) and the Barclay’s Global Aggregate Index (proxy for international fixed interest), Australian and international fixed interest markets finished quarter up 4% and 3% respectively. Both indices finished the year up 10%. Despite expectations of US interest rate rises and resultant spikes in yield, the US Federal Reserve (Fed) kept rates on hold through 2014. Tapering of the Fed’s quantitative easing program did little damage to US treasury bonds and investment grade corporate debt as both performed well in 2014. Emerging market hard currency (USD) sovereign debt also performed well thanks to very low long term yields in the US.

Cash

  • The RBA left the official cash rate on hold at 2.5% in 2014. Some economists were calling for a cut to the cash rate towards year-end to boost demand and put more downward pressure on the AUD. This is a difficult decision for the RBA because lower rates may lead to further house price inflation and mortgage lending.
  • The 1-year return for the Cash Option broadly reflects the official Cash Rate in Australia, which was held at 2.5% all year.

Noteworthy indices and rates in 2014

Noteworthy indices and rates in 2014

Source: IRESS, Bloomberg, Barclays

International equities: MSCI World ex Australia index unhedged used. MSCI Emerging Markets index (not shown) was $95 at 31/12/2014.

Fixed interest: Barclays Global Aggregate index used. Bloomberg AusBond Composite (Australian benchmark index) was also $110 at 31/12/2014.

Winners for 2014 were Australian property, international and Australian fixed interest, and developed market equities (including Australia). Underperformers were key Australian export commodities and the AUD.

Sign up for investment updates

Want to find out how investment markets are performing and how they affect your super? Sign up to receive our quarterly investment update via email.

*
*