Slowly, the reverberations settle

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Slowly, the reverberations settle

PUBLISHED: 31 Oct 2012PRINT EDITION: 07 Nov 2012

The clouds are parting ... Scott Powers says sense will prevail in the US and Europe. Photo: Nic Walker Sally Patten Anyone thinking that the Australian dollar might start to retreat anytime soon would do well to think about the likely direction of global capital flows. International investor capital, says Scott Powers, chief executive of State Street Global Advisers, is heading for yield and Australia, relatively speaking, offers it in spades. Even though forecasts for local growth have been downgraded, unemployment is rising and official interest rates are falling, Australia still looks like a winner compared with other developed countries such as the United States, Japan and Europe. You are starting to see easing, but Australia is still viewed on a relative basis as reasonably strong. Rates in Australia are pretty attractive, says Powers, noting that investors in the US are earning close to nothing on cash. Speaking of the US, Powers observes the economy is grinding, but grinding higher, though accompanied by market volatility because long suffering investors cant shake off their nerves and indeed would like to see even stronger growth. Like many, Powers has little trouble believing that the upcoming, much talked about fiscal cliff, shorthand for the expiry of tax cuts and a simultaneous reduction in public spending due to take place at the end of 2012, will go down to the wire. Much like last years debt-ceiling debacle, when lawmakers only agreed to increase the amount of money the US could borrow at the 11th hour, the fiscal cliff is likely to lead to political brinkmanship on a grand scale. If the US falls off the cliff and $US600 billion is taken out of the economy, the worlds largest economy is likely to fall into recession. However, the State Street executive predicts that in the end cool heads will prevail and politicians will find a compromise. But he warns the uncertainty over the next few months could have a dramatic, destabilising impact on investor sentiment. Last time it was pretty hairy stuff, remembers Powers, whose firm oversees $US2 trillion of assets on behalf of investors.

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Slowly, the reverberations settle

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In the week before the debt ceiling was raised in mid-2011, the Dow Jones Industrial Average lost 500 points, the largest fall for more than a year. Investors had suffered months of volatility prior to that. Powers is not overly-optimistic about the fate of Europe but neither is he in the Armageddon camp waiting for a Grexit. Rather, he argues, a break-up of the European single currency would be far more expensive than more bailouts. I dont think Greece can afford to be cast aside. Neither side can afford it. The European Union has make a big investment. I think they will muddle through. A combination of the desire to flee to safe investments and a benign outlook for inflation has triggered a huge buying spree in bonds in recent months and years, leading to much talk of a bubble in the asset class. Powers predicts that bond yields wont go much lower, but neither does he see any reason for a sell-off any time soon. With unemployment rates around the world high and growth sluggish, the prospect for inflation is low. Unless we see some fiscal shock that supports higher rates, yields are likely to remain low, Powers says. We are certainly at a peak in asset pricing for fixed income, but that peak might be maintained for some time. Of State Streets $US2 trillion of assets under management, about $US1.4 trillion is in so-called passive strategies, which track an underlying index, and some $US100 billion is in active portfolios, where professionals try to pick winning investments. The passive investments include exchange traded funds, of which State Street is a huge issuer. The take-up in Australia is tiny compared with the US, because ETFs do not pay commissions, which have typically been a major source of income for financial advisers. But Powers hopes that financial planners attitude towards the asset class will change with the impending ban on commissions. Another trend Powers can see in Australia is a rise in the use of target date funds or investment portfolios that change over time to reflect the age of the saver or superannuation fund member. He is clearly a fan of the products. Over the past five years in the US almost all new cash flowing into retail pension funds has headed for target -date portfolios, as investors have become acutely aware of the dangers of retiring with too many risky assets, such as equities, that may need to be sold and the losses crystallised. Target date funds are still crude, as they dont take into account other characteristics such as an individual investors risk appetite or size of their account, and to that end Powers does not pretend they are a perfect solution. Still, he argues, they are potentially far better than selecting a typical balanced fund and staying put for 40 years. The Australian Financial Review

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