Published in The Australian 16 February 2016
Last week stockmarkets tumbled around the world triggered by doubt that global giant Deutsche Bank could pay distributions on some of its hybrids
Deutsche’s share price fell 10 per cent in one night meaning it has almost halved in value since late October. Other major European banks’ share prices fell by about 5 per cent.
Of course there were other contributing factors, lower growth in China, declining oil prices, and worse than expected US payroll data.
Worldwide, investors seem fearful.
In volatile markets like these, the key objective for investors must be to retain capital. Here are four simple defensive investment options listed from lowest to highest risk that will help you protect your portfolio.
- Government bonds of the biggest and best sovereigns are perhaps the ultimate defensive asset.
Australian three and 10 year government bond yields rallied Monday night as other investments declined. The 10 year bond yield was 2.58 per cent last Monday but contracted to 2.40 per cent mid-week, as prices of the bonds rose. This was a relatively big move given strong demand. When prices of other assets are falling, Australian Commonwealth bonds tend to outperform as bond prices rise, thus smoothing out volatility and losses elsewhere in your portfolio.
Unfortunately, as the lowest risk investment, government bonds will generally only offer very low yields. However, if there is more nervousness about global markets ahead, these bonds may increase in price delivering better returns and cushioning other investments. That’s something deposits can never do because they are not tradeable and have no capacity to provide higher than expected returns, unlike bonds.
In the 2012 financial year, Commonwealth government bonds were the best performing asset class, earning 24 per cent for investors over the year. Roughly 20 per cent came from capital appreciation and 4 per cent in interest payments. That year market a period of great uncertainty with the sovereign debt crisis in Europe and concerns over high unemployment and low growth in the US. Foreign investors actively sought the lowest risk investments and targeted AAA rated Australian Commonwealth government bonds. Over the same 12 month period the ASX200 showed a loss of 7 per cent, illustrating the bonds’ outperformance in volatile markets and their capacity to smooth overall portfolio returns.
State government or ‘semi’ bonds are also very low risk investments. All of the states and territories issue them. Yields can be up to 3.3 per cent per annum for long dated bonds.
- Australian deposits held with an authorised deposit taking institution (ADI) are sound defensive assets, protected by a government guarantee of up to $250,000 per entity per ADI. You know you will be paid your income and get your capital back at maturity. A good one year term deposit rate is 3 per cent.
- Major bank senior bonds held their value during the GFC, despite recent spread widening. A raft of new regulatory requirements has further reduced risk. Even if there is further price movement, investors can expect to be paid quarterly or half yearly interest and have face value of the bonds returned at maturity.
- Essential monopoly infrastructure, investment grade corporate bonds are higher risk than other investments mentioned above and we have seen spreads widening and prices declining slightly in recent months. However, these assets provide essential services and cannot be easily replicated. Examples include: Royal Women’s Hospital, Sydney Airport and toll road operator, Transurban.
Two other assets worth investigating are very low risk annuities that can provide a pre-determined income over a specific time and gold, a common hedge in declining markets.
Forget the bravado of market commentators and others around you, bunker down and critically assess what you are invested in and if it will stand up to volatility and meet your goals.
No investor should be ashamed to say they are defending the capital that they have worked hard to build. If you are not comfortable watching your shares lose value or are worried about mounting losses then you need to rethink your asset allocation.
Note: Some Commonwealth government bonds can be bought on the ASX as can some corporate bonds in a unitised format. To invest direct you will need to find a bond dealer/ broker.