Predicting the investment year ahead

By BRENT SHEATHER


At this time of year investors often give thought to where the gains are likely to be found in the next 12 months.

One place to start is by looking at what happened last year.

It was a year in which the thousands of New Zealanders who contribute to balanced superannuation funds and unit trusts saw something unusual - a positive return.

A typical balanced fund would have returned about 8.8 per cent, before fees and taxes. But that pales in comparison with the 25 per cent gain enjoyed by investors who ignored the experts' advice and put all their money into metropolitan Auckland residential property.

But even with a balanced portfolio it was possible to do better than 8.8 per cent; investment funds which hedged their overseas assets - effectively insuring against changing currency values - will have achieved much higher returns.

The graph shows how the various types of investments performed over the year, in NZ dollars. The best result came from the local sharemarket - 26.4 per cent.

Some of the best-performing large companies on the local market were INL (up 74 per cent last year), Sky Network TV (up 71 per cent), F&P Appliances (64 per cent) and Contact (44 per cent).

This must be galling for many local fund managers and a few mums and dads, as for the last five years it has been fashionable to move share investments overseas.

International shares had their first positive year in the last three, returning a healthy 7.1 per cent in NZ dollars.

Investors in the US must be thinking it is 1999 all over again; measured in greenbacks, global share prices were up by 34 per cent last year. The difference between that gain and the much lower return earned by New Zealand investors results from the rising Kiwi dollar. Its increase ate up many of the gains on overseas shares.

Despite last year's gain, the longer-term record of international shares still makes depressing reading. In NZ dollars, world shares lost 11.7 per cent a year over the past three years.

Investors in AMP's WiNZ fund may wonder which overseas share index their fund tracks. WiNZ shares are down about 19 per cent a year over the same three years.

Global bond markets started 2003 confidently and by mid-year bond investors were sitting on gains of almost 10 per cent in NZ dollars. But as economies strengthened, bond yields soared, resulting in a capital loss for bond-holders.

Today, markets are firmly focused on the risk of possible inflation, so the traditional hedges - property, gold and inflation-indexed bonds - are the instruments of choice.

Probably the most consistent type of investment over the year has been property.

The global listed property index returned 13.7 per cent in NZ dollars, with Australian, New Zealand and US property earning 15.7 per cent, 13.3 per cent and 11 per cent respectively.

While most pension funds have some of their money in property, the average is generally well below 10 per cent - surprising given the yields on offer. The NZ Super Fund says it will put a few per cent of its billions into international listed property.

But for some real action, the place to be last year was in gold, particularly gold stocks.

While gold itself gained US$73, or 21 per cent, gold stocks did much better. One of the leaders in Australia, Newcrest, rose 71 per cent in the 12 months.

On the more traditional sharemarkets, returns, in NZ dollars, ranged from 3.4 per cent in the US and 5.8 per cent in the UK to 9 per cent in Japan and 20.1 per cent in Australia. Globally, smaller companies had a great year, returning 26.9 per cent. Our own smaller companies index again excelled with a 26.2 per cent return.

So what does last year tell us about this year? Typically investors look at the previous year's figures and, depending on their personality, the moon and how much coffee is in their system, they either extrapolate the past (and buy last year's winners) or assume markets will swing back towards the norm (and buy last year's losers).

For share investors, the second strategy would mean buying global shares. But there are a few good reasons why that might not work too well this year. Performance figures depend on which currency you use, and, while international shares underperformed when measured in New Zealand dollars, prices were up 34 per cent when measured in US dollars.

That means international share prices are still relatively high. Second, the low dividends mean you won't get much income from that part of your portfolio.

As usual, there are as many experts forecasting a good year for international sharemarkets as there are expecting bad times. But the bearish camp may have the more convincing story when they point to the low dividends on offer (2 per cent or so) and long-term earnings growth (3 or 4 per cent), which suggest that total expected returns are likely to be 5 or 6 per cent.

This might be too pessimistic if profit results in the short-term are better than expected, and/or investors are prepared to pay more for companies. Either is possible, but profit forecasts already look optimistic.

Alternatively, if you are one of those people who like to stick with last year's trend, then Auckland property, New Zealand shares and gold stocks could appeal.

One useful check when looking at investments is to ensure that the dividend has kept pace with the price of the asset in question. So if Auckland metropolitan house prices rose 25 per cent last year, a key question is: what did rents do?

By the end of last October, rents were up just 1 per cent from a year earlier - well below the increase in house prices. In Auckland, like the US and Britain, the house price boom appears to have resulted from people being prepared to pay higher prices for homes (as a multiple of rent), in the same way that share investors paid higher and higher multiples of profits back in 1999-2000.

Today, a typical three-bedroom Remuera home offers a gross yield of about 4 per cent, before rates, insurance and so on. That's more than the yield on international shares but well below the 6 per cent dividend paid by NZ shares, and below the after-tax cost of borrowing.

With overseas bond yields low and share prices high, we may need to rely on a fall in the Kiwi dollar to generate a decent return from these investments.

In the meantime, New Zealand shares and global property, both of which offer good dividends, look likely to again exceed the return from bank deposits, even if their prices remain stable.

* Brent Sheather is a Whakatane investment adviser