It’s with a certain trepidation that anyone sits down to type the words ‘I think Ken Henry is wrong’. This is the Dr Ken Henry who was the long-term head of Treasury and is now the responsible for writing the federal government’s white paper on Australia in the Asian Century. Dr Henry has the rare distinction of being respected by both sides of politics as well as economists and academics. I count myself among his fans. More bonds, fewer shares Despite the respect and admiration I have for Ken Henry, I was surprised to see him reported in the weekend…
It’s with a certain trepidation that anyone sits down to type the words ‘I think Ken Henry is wrong’.
This is the Dr Ken Henry who was the long-term head of Treasury and is now the responsible for writing the federal government’s white paper on Australia in the Asian Century.
Dr Henry has the rare distinction of being respected by both sides of politics as well as economists and academics. I count myself among his fans.
More bonds, fewer shares
Despite the respect and admiration I have for Ken Henry, I was surprised to see him reported in the weekend Australian Financial Review calling for a reduction in the weighting given to shares in superannuation funds. Dr Henry believes Australian super funds should have a greater weighting of fixed interest investment – corporate bonds in particular.
Dr Henry was quoted as saying “I was told that equity would always outperform debt over any period relevant to superannuation fund members. I wasn’t convinced then, and I’m even less convinced today.”
That comment is somewhat puzzling. Specifically, a report issued by the ASX and Russell Investments in June of last year found precisely what Dr Henry reports being told.
Medium and long term outperformance from shares
The ASX/Russell report shows that over a 20-year period to December 2010, Australian shares outperformed all other asset classes, regardless of the form of holdings (inside or outside super) and tax rate of the investor.
In fact, to Dr Henry’s specific point, the greatest margin between shares and the next best performing asset class (residential property) was greatest for funds held within super.
Shares beat residential property, real estate investment trusts, fixed interest, cash, and unhedged overseas shares handily.
It’s true that over the ten years to 2010 residential property outperformed shares (thanks largely to the GFC right at the end of the decade), but both asset classes showed fixed interest a clean pair of heels – by at least 2.5 percentage points per annum.
No guarantees, but a good form guide
Of course, in the words of the famous disclaimer, past performance is no guarantee of future returns, but 10 and 20 year time periods are likely to be reasonable historical guides.
In fact, if anything I’d expect shares to perform better in the coming decade than in the past, given the price earnings ratio finished the decade at one of its lowest levels in the past 20 years. If (and I think when) both the multiple returns to more ‘normal’ levels, and company profits continue to improve, share prices should benefit.
The above is simply an opinion as to why the relative out-performance is not greater than it actually was. But even if you disagree with that thesis, the actual historical returns (GFC and all) are still significantly better from equities than fixed interest.
The importance of bonds…
Don’t get me wrong – it’s a great (and beneficial) idea to have an active and healthy local bond market. It’s important to have a range of funding sources for our listed companies, and we’ve seen major corporates – Fortescue Metals Group Limited (ASX: FMG), Rio Tinto Limited (ASX: RIO) and Telstra Corporation Limited (ASX: TLS) raise money overseas, and Woolworths Limited (ASX: WOW) launch a bond issue here at home in recent weeks.
In the US, listed businesses are tapping the bond markets like there’s no tomorrow – and doing it at extraordinarily low rates, provided in part by the very low official cash rates in the US and Europe.
My issue then isn’t with the existence or importance of bond markets, but rather the extent to which superannuation funds should be encouraged to invest therein.
…the opportunity in shares
Portfolio management is important for individual investors – as retirement approaches, it makes sense to move assets to less volatile options if you plan to withdraw a significant lump sum. But for those who are fortunate enough to live on dividends and other distributions – and for superannuation funds whose assets are likely to show net growth for many years yet – there’s no similar need.
These funds are well able to withstand volatility, given they have a clear view of their members likely withdrawal rates many years out. In fact, volatility is the patient investor’s best friend – it gives them a wonderful opportunity to buy quality businesses when they’re out of favour.
Corporate bonds are likely to offer a higher rate than cash, and with lower volatility and surer regular returns than shares. However, the past has shown, and I believe the future will show, that equities outperform fixed interest. Not only that, but we’re comparing averages – there’s every opportunity for a well-chosen portfolio to beat the benchmark, and widen the gap further.
Sorry Dr Henry, I just can’t agree – I’m sticking with shares.
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Scott Phillips is a Motley Fool investment analyst. Scott owns shares in Woolworths and Telstra. You can follow him on Twitter @TMFGilla. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691)