MLC Horizon 4
Balanced Portfolio
MLC Horizon 4
Balanced Portfolio
31 December 2012
About the portfolio
The MLC Horizon 4 Balanced Portfolio aims to grow wealth for a moderate level of expected volatility. The portfolio is invested with a bias towards growth assets.
The portfolio is designed to be a complete investment portfolio solution. It’s well diversified within asset classes, across asset classes and across investment managers who invest in many companies and securities around the world.
Source: MLC Investment Management
MLC Horizon 4 Balanced Portfolioperformance
Economic and market overview
While financial markets remain volatile, investment returns over the last two quarters and the year to December were very solid. Share markets performed extremely well, and the world’s major markets are now close to levels seen before the global financial crisis (GFC). The key driver of these strong recent returns was the stimulus measures implemented by the world’s major central banks. They included the announcement of another round of quantitative easing, or “QE3” by the US Federal Reserve, the Bank of Japan’s commitment to providing additional monetary stimulus, and European Central Bank President Mario Draghi’s launch of the Outright Monetary Transactions program in Europe.
While markets reacted positively, as intended the impact of the support measures inflatedbond valuations –more recently bond returns have moderated, reflecting the very low yields now on offer. Non-government securities have posted stronger returns than sovereign bonds. Lower quality corporate securities have provided particularly strong returns lately, as investors continue to chase higher yields.
Developed world growth remains anaemic. Overall eurozone growth has slowed to a crawl as a range of austerity measures have made economic conditions worse – especially on the European periphery – and a more permanent solution to Europe’s sovereign debt crisis remains elusive. While the US finished the year with signs of life in the US housing sector and a recovery in lending to both businesses and households, the recovery remains one of the slowest on record. The Chinese economy continues to report growth rates that are the envy of the world, but growth has moderated and there are few signs that the economy is set to re-accelerate soon.
Australia’s economy slowed over the course of 2012, but still posted an internationally respectable 3.1% growth in output for the year to September. However, the boost to Australia’s national income from the boom in our terms of trade came to an end in 2012.
A strong Australian dollar, uncertain global environment, and a desire that our multi-speed economy does not converge to a low growth scenario,prompted the RBA to reduce official cash rate on six occasions since November 2011. At 3%, the cash rate is now at its lowest level since September 2009.
MLC’s Strategic Overlay and strategy changes
There were limited changes to the diversified portfolios in the December quarter. We continue to focus on moderating portfolio risk.
During the quarter we evolved the way the portfolio invests in hedge funds. To bring greater diversification to our hedge fund strategy, we introduced the Low Correlation Strategy. This strategy aims to generate returns that are mostly independent of share market performance. It consists of two strategies we’ve used successfully in the MLC Horizon portfolios for several years, plus one new strategy managed by Balestra Capital. By increasing diversification in the portfolio, we expect it to help produce more reliable returns. Over the quarter this strategy has returned 1.1%.
In addition to the new alternative strategies outlined above, over the last year we have also invested in a number of other alternative strategies to further diversify equity risk. These enhancements include the addition of:
- Defensive Global Equities which aims to produce returns consistent with global share markets over the medium term but with a greater degree of capital preservation:
- Multi asset real return, a flexible mandate that gives managers the ability to invest across a range of asset classes without being constrained by a market benchmark.
We continue to be overweight foreign currencies (underweight the Australian dollar), with an increased allocation to unhedged global shares at the expense of hedged global shares. This is a risk control position, and is appropriate given the exceptionally strong local currency and significant global economic uncertainty.
We’ve also retained our underweight position in longer-dated global government bonds, as we believe future returns are likely at some point to be very disappointing. During the quarter we tilted the debt portfolio away from more expensive global debt markets, towards the better valued domestic market.
Absolutereturns
Thischart shows absolute total returns of the portfolio over one, five and ten year periods.
Source: MLC Investment Management
One year returns are strong as a result of a general rise across all asset classes. Five year returns remain low as a result of the GFC. However, these numbers should start to improve as that period of extremely poor returns falls away.
This table outlines the performance of the MLC Horizon 4 Portfolio components before taking into account fees and tax.
Contributors to the portfolio’s absolute returns
•After a disastrous performance during the worst of the global financial crisis, our global listed real estate strategy has shown amazing gains over the past year. The higher yields that were offered on these securities proved extremely attractive to investors.
•Non-investment grade bonds, including high yield bonds, bank loans and mortgages, have higher credit risk and therefore the portfolio doesn’t have significant exposure to them. However, their strong performance was helpful to returns. US high yield bonds were in significant demand from retail investors. US mortgages also performed strongly, mainly due to the US Federal Reserve’s decision to purchase up to $40 billion of US agency mortgages per month as part of QE3.
•The MLC global share strategy has delivered strong positive returns over the last three years and has also outperformed the broader market benchmark over that period. The performance has been due to careful company selection by the underlying managers and MLC’s reassessment of exposure to those managers.
Detractors from the portfolio’s absolute returns
All strategies made a positive contribution to the portfolio over the past year.
Over recent months, unhedged global share returns have again lagged those of hedged global shares. The strength of the Australian dollar in recent years has resulted in hedged global shares outperforming unhedged global shares over all the time periods shown in the chart below.
The chart shows total returns of eachover various time periods.
Source: MLC Investment Management
Asset class role and performanceDetailed commentaries for each asset class are available online.
Asset class / Role in portfolio / Contribution to one year performance
Australian shares
(31%)
Eight managers / Australian shares aim to deliver capital growth by using investment managers who invest and diversify across many companies listed in the Australian share market. Results can be volatile over the short term (under three years), but are expected to provide growth over longer terms (more than five years). / For the year to 31 December, the strategy returned 17.9% (before fees and tax). While this was 2.0% under the market return, the strategy’s absolute return was very high.
In the twelve months to 31 December, the market returned a substantial 20.3%, making 2012 the best calendar year performer since 2009 (when the market rose by 37%). However, most of the return occurred in the second half of the year.
Investor preferences were narrowly focused for much of the year. The uncertain macro environment and lacklustre global growth meant sectors and companies with ‘defensive’ characteristics, such as earnings certainty, were in demand. Another powerful driver of investor preferences was the fall in bond yields to historic lows and lower term deposit rates, which increased the demand for companies with attractive and sustainable dividend yields. Sectors that benefitted from these themes were Healthcare (up 49.6% for the year), Telecommunications (42.3%), AREITs (33%) and Financials ex-REITs (29%). In this environment, the Industrials market (measured by the S&P/ASX200 All Industrials Accumulation Index) increased by 28%, substantially outperforming Resources (1.3% increase measured by the S&P/ASX200 All Resources Accumulation Index).
Global shares (unhedged)
(21%)
Eight managers / The global shares strategy invests in global companies listed in share markets from around the world. The strategy also invests in emerging markets, helping capture key opportunities from these new markets. / For all the negative headlines (and there were many), 2012 was a great year to invest in global companies. The MLC global share strategy (unhedged) returned 17.1% for the year before fees and taxes, beating the benchmark by 1.8%.
The strategy has delivered strong positive returns over the last three years, and has also outperformed the broader market benchmark over that period. The performance has been driven by careful company selection by the underlying managers and MLC’s reassessment of exposure to those managers.
All managers provided strong double-digit returns for the year, and all beat the benchmark except Mondrian. Companies in the Information Technology sector and good stock selection in the Industrial sector helped the strategy the most. Emerging market shares performed on par with their developed markets counterparts during the year.
Global shares (hedged)
(2%)
In addition to the managers above, there are two specialist currency managers. / In addition to the description above, returns are hedged back to the Australian dollar. The amount of hedging is determined by risk considerations – a foreign currency exposure can reduce the riskiness of global shares exposures in a number of adverse scenarios. / The MLC global share strategy (hedged) returned 21.7% for the year before fees and taxes, beating the benchmark by 1.9%.
The strategy has delivered strong positive returns over the last three years, and has also outperformed the broader market benchmark over that period. The performance has been driven by careful company selection by the underlying managers and MLC’s reassessment of exposure to those managers.
All managers provided strong double-digit returns for the year, and all beat the benchmark except Mondrian. Companies in the Information Technology sector and good stock selection in the Industrial sector helped the strategy the most. Emerging market shares performed on par with their developed markets counterparts during the year.
Defensive global shares (unhedged)
(1.0%)
One manager / The strategy is expected to deliver returns similar to global share markets over the medium term, but its capital preservation focus means the pattern of returns will be different. So while the strategy may not perform as strongly as the market in highly speculative environments, the quality of the investments means it should be more resilient in adverse economic conditions. / This strategy was added to the portfolio during 2012. We’ll include commentary on this strategy when it has been in the portfolio for a year.
Global property securities
(4%)
Three managers / The strategy is designed to provide comprehensive exposure to global listed property securities. It aims to deliver growth by using investment managers who invest and diversify across many companies and securities within that asset class. Returns from property are generally expected to be higher than those from bonds, but lower than shares over the medium to long term. However, the volatility of this sector has increased over time. All returns from this asset class are fully hedged back to the Australian dollar. / Positive real estate investment trust (REIT) market returns reflect generally benign conditions in the global property market and investors’ comfort with the investment characteristics of REITs and real estate operating companies.This is evident from comments by our REIT managers, who continue to express optimism on the global environment for real estate.
While property yields are low by historic standards in most markets, REITs continue to attract support due to their relatively high distribution yield premium over bond yields, which are at very low levels. The strategy’s hedged return in the year to 31 December was 34.7% (before fees and tax), outperforming the FTSE EPRA/NAREIT Global Developed Index (hedged) by 2.7%.
Among the managers, Morgan Stanley outperformed by a substantial margin as a result of stock selection in Asian markets and being underweight US REITs. Resolution Capital also outperformed, while LaSalle’s under-benchmark return was due to their overweight US and underweight Japan positions and stock selection.
Multi-asset real return strategy
(1.0%)
Two managers / The strategy gives managers the flexibility to invest across many types of assets without being constrained by a market benchmark. The managers aim to generate attractive real returns (ie returns above inflation) over a period of several years. At the same time, they aim to minimise the risk of negative returns in the short term. The strategy is expected to provide a more reliable path of returns and better preserve investors’ capital in difficult markets. / This strategy was added to the portfolio during 2012. We’ll include commentary on this strategy when it has been in the portfolio for a year.
Emerging markets strategy
(1.0%)
One manager / This is a flexible multi-asset strategy that focuses on emerging markets, giving the portfolio another way of accessing the rapid growth potential of these economies. The manager aims to generate attractive returns while limiting the volatility of those returns. The strategy isn’t limited to emerging market securities, but can also invest in companies listed in developed markets which have significant exposure to emerging economies. / This strategy was added to the portfolio during 2012. We’ll include commentary on this strategy when it has been in the portfolio for a year.
Low correlation strategy
(0.5%)
3 managers / Through a fund of hedge fund structure, this strategy seeks to combine individual strategies to deliver a pattern of returns that is relatively unconnected, or “uncorrelated”, with share market performance. It may include investments such as insurance-related investments and hedge funds. / This strategy was added to the portfolio during 2012. We’ll include commentary on this strategy when it has been in the portfolio for a year.
Global private assets
(6%)
35+ managers / These are investments in assets that aren’t traded on listed exchanges. An example is an investment in a privately owned business. Private assets can be volatile and are included in this portfolio for their growth characteristics. All returns from this asset class are fully hedged back to the Australian dollar. / Global private assets produced a return of 15.2% (before fees and tax) over the year to 31 December 2012. This return was driven by investments across all regions and strategies.
MLC made commitments to several funds and co-investments in the December quarter. We invested with Oak Hill Advisors, a distressed debt player in Europe; InvestIndustrial, a buyout group also in Europe; and in the US, a mid-market fund managed by Carlyle. We continued to build our relationship with top-tier venture capital manager Sequoia through commitments to their China, Israel and core US venture funds.
The companies in which we made co-investments were Barbeques Galore, Australian furniture company Super Amart, and leading US personal care company Parfums de Coeur.
Debt securities
(30%)
13 managers / Debt securities are usually included in a portfolio for their defensive and income-producing characteristics. Our strategy is designed to provide diversification when growth assets are weak. Bond yields are currently unusually low and this reduces both return and diversification potential. / The strategy performed strongly over the year. The return (before fees and tax) was above its market benchmark over the quarter and year.
During the year, relatively low government bond yields in developed markets and bold moves by policy makers and major central banks provided support for bond markets and underpinned strong returns in non-government bonds and non-investment grade bonds.
Towards the end of the year, the market’s focus turned to the potential negative impact on economic growth from the US “fiscal cliff” and the lack of an immediate political resolution. This resulted in renewed demand for the relative safety of bonds.
In Australia, data indicated that the economy is losing some growth momentum. The challenge for the economy is the negative combination of falling commodity prices and a strong Australian dollar. In response, the Reserve Bank of Australia cut the official cash rate by a total of 1.25% over the year. At 3.0%, the cash rate is now equal to the historic low it reached during the GFC in early 2009. As a result, yields on Australian bonds fell, boosting the strategy’s performance.
All the strategy’s sectors and managers contributed strongly to absolute returns for the quarter and year.
Long-Term Absolute Return strategy (LTAR)
(3%)
65+ managers / The LTAR strategy has a unique and highly flexible investment mandate to provide reliable real returns over the investment time horizon. This gives LTAR a strong risk management focus. LTAR has a non-traditional and dynamic asset allocation which changes in response to the evolution of investment conditions. In addition to investing in traditional assets, the strategy has the ability to invest in unique assets such as insurance-related investments. / The strategy returned 15.0% (before fees and tax) in the year to 30 December, and 3.0% over the quarter. LTAR continues to perform very satisfactorily, demonstrating a greater degree of risk and return efficiency than more traditional diversified portfolios.
The Low Correlation Strategy was introduced to LTAR in September, replacing direct holdings in Bridgewater Pure Alpha and insurance-related investments, and introducing exposure to the global macro manager Balestra Capital. The managers of the Low Correlation Strategy use “alternative” strategies – that is, they may make investments outside the traditional asset classes of shares, bonds and property, and will manage those investments in an unconventional way, using an absolute return approach. For more information on the Low Correlation Strategy, please visit mlc.com.au
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