How to invest $100K safely

There are plenty of big questions to contend with in markets right now and few clear answers.

The bears are focused on the lagged effects of monetary tightening, whilst the surge in bond yields sets the scene for things to break as financial accidents occur.

The bulls are holding onto the soft-landing narrative, which has been supported by strong employment data and signs of disinflation. And, until recently, equity markets had held up quite well.

So, what are investors to do? 

How does one position a portfolio to protect against downside shocks while at the same time leaving some opportunity to participate in upside, should it eventuate?

Ultimately, the question becomes, “How does one invest safely?”

That’s the question I asked David Lane, Senior Private Wealth Advisor at Ord Minnett. David has very kindly provided robust answers to this thought experiment (we’ve chosen a nominal $100K figure to add some detail), but it should be noted that these answers are generic and not specific to any one individual.

As always, investors should do their own research considering their own personal circumstances. Past performance is not a reliable indicator of future return. 

What has been the general consensus you are seeing from investors - have they been more cautious of late, or are they seeking risk?

Each client is an individual, so their personal views will vary based on their own goals and risk tolerance. However, in general, we are finding that investors have cash to invest and are looking to generate healthy returns while being cautious about the impact of inflation and rising interest rates on the broader economy, the markets and their own portfolios.

Ord Minnett’s strategic view over recent months has been cautious about the level of the US equity market, which appears to be overly optimistic. The underlying strength of the US economy is continuing to drive prices higher, putting pressure on the Federal Reserve to continue to raise interest rates. We have viewed the US equity market as overvalued and riskier than most other markets.

Although there was widespread caution entering the August reporting season, many of the results announced by consumer-related companies were better than expected. The underlying resilience of the economy has been a bright spot so far in 2023.

However, the perverse nature of economics is that ‘good news’ (economic strength) can lead to ‘bad news’ (further interest rate rises leading to declining growth). This is the main cause of investor concern at present.

Investors have been beneficiaries of healthy dividend receipts over September, but it seems that there is a preference to retain these in cash. Super funds – whether they be SMSFs or the larger retail and industry funds – also seem to be preferring to hold higher levels of cash in the short term.

For those who are more cautious, what strategies have you been employing?

We have reduced our allocations to international equities to underweight, which has meant that we have taken some profits on positions in US equities as they have performed reasonably well for the first half of 2023.

For some selective stocks that have performed well or were overvalued, we have been taking profits or trimming positions. This has included the large iron ore miners (BHP (ASX: BHP), RIO Tinto (ASX: RIO) and Fortescue Metals Group (ASX: FMG)) as well as Qantas (ASX: QAN). These views were based on the fact that they had all experienced strong recent profits and that these were ‘as good as it gets’ for these companies.

Thankfully the view on Qantas – which was based predominantly on the shares being fully valued at $6.75 – has played out well in the short term . . . although I can’t take credit for foreseeing the media and political issues that have engulfed the company in recent weeks.

To take a more conservative approach to the portfolios, we have increased the allocation to interest rate securities (bank hybrids and corporate bonds) and cash. 

To our larger client portfolios, we have also begun adding some alternative assets through listed absolute return managers, such as Regal Investment Fund (ASX: RF1) and L1 Long Short Fund (ASX: LSF). For international exposures, we have like Talaria Global Equity Fund (TLRA) as it has a lower market exposure, higher income and could be a beneficiary of a market correction due to the fund’s strategy of selling put options.

If a client walked into your office tomorrow with $100K to invest and said that they wanted to do it ‘safely’, what would the portfolio look like?

By far the safest investment is to keep it in cash or invest it in a term deposit. 

However, while this strategy would ensure that they don’t lose capital, they would both miss out on any potential long-term capital growth and lose ‘buying power’ due to negative real rates (ie. if inflation is 5.5% and the interest rate is 3.5%, the real interest rate is -2%). 

Therefore, holding the entire amount in cash would not be recommended.

We would discuss their individual risk tolerance and investment objectives, but broadly we would invest the funds in accordance with the following Asset Allocation, which reflects a combination of our Strategic Asset Allocation (long-term) and Tactical Asset Allocation (short-term):

If our near-term concerns about the markets were to be correct, and we witnessed a sell-off in equity markets, we would look to reduce the cash by buying more equities at more attractive prices.

Assuming the client was reasonably young and has a High Growth risk tolerance, this portfolio might look something like this:

• $20,000 VanEck Australian Equal Weight ETF (ASX: MVW)
• $20,000 BetaShares Australian Quality ETF (ASX: AQLT)
• $10,000 VanEck MSCI World ex-Australia Quality ETF (ASX: QUAL)
• $10,000 Talaria Global Value Fund (TLRA)
• $5,000 SPDR S&P/ASX 200 Listed Property ETF (ASX: SLF)
• $10,000 L1 Long Short Fund (ASX: LSF)
• $15,000 BetaShares Active Australian Hybrid Fund (ASX: HBRD)
• $10,000 BetaShares Australian High Interest Cash (ASX: AAA)

Given the portfolio is $100,000, I would recommend utilising ETFs to provide low-cost diversification to replicate the asset allocations of larger portfolios. For larger portfolios, we would replace some of the above ETF exposures with direct investments to provide some additional ‘alpha’ in an effort to generate above-market returns.

Why have you allocated that way? 

Our recommended asset allocations are informed by a combination of our expected long-term returns and risks for each asset class and our short-term views on the relative valuations of these asset classes. When we refer to long-term, we are talking about the next seven years.

Our Strategic Asset Allocation has considered higher cash and bond yields in response to multi-decade high inflation, which has lifted the outlook for defensive assets (cash and fixed interest). 

Growth assets (shares, property and alternatives) face the near-term challenge of late-cycle economies and longer-term headwinds such as demographics, debt and deglobalisation that should counter new technologies. 

China faces growing structural headwinds while Australia faces significant productivity challenges.

Both our balanced and high growth allocations have higher allocations to fixed interest and cash in the short term, and we would look to reduce these weightings as the outlook for equities becomes more positive.

How does this portfolio look different from the one you might have suggested 12 months ago?

12 months ago, we would have had significantly higher weightings to international equities (and slightly more to Australian equities), while we would have had lower weightings of both cash and fixed interest. 

With higher interest rates, the returns on cash and fixed interest have improved markedly, and the increased concerns about the outlook for equities has also added to the optionality of holding more cash.

What are the markers you are looking for in order to turn more bullish?

We would become more positive on the outlook for equities if we did see the US markets sell-off in the near term. 

We believe that the US markets are overvalued and haven’t appropriately priced in the risks of persistently higher inflation and the possibility of the US economic growth continuing unchecked.

Conversely, we would be encouraged by inflation moderating and heading toward the central bank preferred band of 2 – 3% (both in Australia and the US). This would give weight to the ‘no landing’ scenario and alleviate our concerns about a recession in the US.

Further economic stimulus in China would also be a positive sign, as this would underpin the demand for Australian commodities and assist in our long-term growth expectations.