Q. What is the AMP Capital Specialist Geared Australian Shares Fund and how does it work?
A. The Specialist Geared Australian Shares Fund (the Fund) aims to provide high returns over the long term (multiple market cycles) through geared exposure to securities listed, or about to be listed, on the Australian Securities Exchange. The multi-manager fund holds a complementary blend of active strategies, alongside index futures and ETFs. The Fund is dynamically geared, meaning the level of gearing varies through different stages of the market cycle with the aim of magnifying returns through higher leverage in rising markets and limiting downside by cutting leverage in falling markets.
There is a strong case for gearing Australian equities, where dividends are typically higher and a more reliable source of returns relative to global markets. We expect the dividends to exceed borrowing and other costs, therefore enabling the franking credits to pass through to eligible investors.
Additionally, investors can benefit from the scale of AMP Capital to access cheaper financing through preferential institutional interest rates - which are substantially lower than retail interest rates. Reduced borrowing costs in the gearing process is a key contributor to improving long-term compounding returns. As the gearing is managed internally, there are no margin call requirements for investors. All the gearing obligations are met by the Fund with no further action required by the investor.
Q. What is the underlying investment philosophy of the Fund?
A. The philosophy that underpins our investment process has three pillars: gearing, risk and market cycles.
- When it comes to gearing, we believe dynamic gearing can result in asymmetric return profiles, whereby investors can benefit from holding greater exposures (higher gearing levels) in rising markets and experiencing smaller losses through lower exposure (reduced gearing) in falling markets. The key to building superior long-term wealth occurs when this pattern is compounded over multiple market cycles.
- We view risk as the probability of permanent capital loss, and not the industry standard measure of volatility – which refers simply to the variability in returns over a period. For geared funds, the objective is to avoid being forced to sell due to a margin call (which often occurs during large sell-offs), thereby permanently locking in losses. Our process seeks to minimise the probability of receiving margin calls, allowing the Fund to remain invested through market volatility.
- And finally, on market cycles, we believe that market crashes are difficult to predict with any consistency. Our investment process navigates these market cycles by reacting to shifts in volatility and market uncertainty in a timely and decisive way.
Q. What type of investor is the Fund targeted at?
A. Investors in geared equity funds commonly share the following three characteristics:
- Above-average risk-taking ability due to long-term time horizons (i.e. multiple market cycles)
- Above-average risk tolerance
- High return requirements.
Generally, there are three types of investors that typically fit these characteristics:
- Those in the early accumulation phase of superannuation, say 20 to 40-year-olds saving for retirement. Their allocations to a geared fund should typically start close to 100% as they commence their working life, gradually tapering down as they approach 40.
- Investors who have higher priority goals supported by lower risk strategies AND have the ability to invest excess capital into strategies offering the potential for high prospective returns.
- Pre and post-retirees (50+) who are planning to leave a legacy for their children or grandchildren.
Q. Where we are in the cycle and is now a good time to gear?
A. Most commentators would agree we are towards the latter phase in the current market cycle, but how far we are away from the next market crash is very difficult to predict (consistent with our investment philosophy).
There are several reasons market crashes are difficult to predict:
- There are no set of indicators that work every time (e.g. If an investor used valuation to predict the end of the cycle, they would have been wrong for the last three years);
- History rhymes, but it doesn’t repeat. In other words, it is very unlikely that a market crash has the same root cause as another market crash (e.g. the subprime housing crisis in the US that led to GFC was quite specific. This limits the value of using history as a hard and fast guide) and
- Market crashes can be driven by risk sentiment which is globally-linked (e.g. a crisis in the US, such as subprime housing, can cause a market crash in Australia).
Without knowing exactly how far we are along in the cycle, there is some evidence to support our constructive view on the Australian market over the next year:
- Monetary policy remains accommodative in Australia (and at least not-restrictive globally);
- Global growth is positive;
- Earnings growth in Australia is expected to remain in mid-single digits;
- Dividends remain sticky (stable) and are a reliable source of total returns;
- Valuations are not excessive (put a different way, price movements have been supported by earnings) and
- Volatility remains subdued.
In terms of timing, with the benefit of hindsight, the best time to invest in a geared fund is at the end of a bear market. In real time, for the majority of investors, this is extremely difficult to do.
The end of the GFC (January to February 2008) can be used to illustrate this point:
- Equity markets around the world had just fallen by over 40%;
- The VIX (the index often used to measure the market’s expectation of future returns fluctuations) was still near historical highs;
- Investor sentiment (general mood of the market) was extremely negative and
- The macro environment and prospects for company earnings was highly uncertain.
For most investors, although rational, investing in ungeared equities at that time would have been difficult from a behavioural perspective. To invest in geared equities would have been behaviourally even more difficult. The only justification would be valuation, which is an unreliable market timing tool.
The above applies to time periods post-bear market. Logical in theory, but difficult in practice. We think a more pragmatic time to invest in a geared fund is when the conditions below are satisfied:
- After a market correction, to avoid excessive valuations;
- Where there are positive earnings growth expectations;
- When global growth is positive;
- When monetary policy is accommodative (or non-restrictive) and
- When there is low macro and geopolitical uncertainty.
Given our view that the current sell-off is a market correction (which is typical in a bull market phase) four of the five conditions above are currently met. And while we still have geopolitical uncertainty surrounding the US-China trade war, we are not overly concerned as over the long-term, we expect that there will be substitution effects that should minimise its negative impact on global growth. In the short-term, however, it could be a source of market volatility.
On balance, despite being towards the latter stages of the cycle, we think it is not necessarily a time to avoid geared equity exposure as conventional wisdom may suggest, particularly for those who have long-term investment horizons.
One final point on timing is the Fund’s dynamic gearing approach – aimed at creating an asymmetric return profile which promotes the long-term compounding of returns. Dynamically adjusting the gearing level through the market cycle helps to mitigate the risk to investors around timing.
AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMPCFM) is the responsible entity of the Specialist Geared Australian Share Fund (Fund) and the issuer of the units in the Fund. To invest in the Fund, investors will need to obtain the current product disclosure statement (PDS) for the relevant Fund from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232 497) (AMP Capital). The PDS contains important information about investing in the Fund and it is important that investors read the PDS before making a decision about whether to acquire, or continue to hold or dispose of units in the Funds. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to their objectives, financial situation and needs.
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.