John McDuling - Source from: http://afr.com/

To say that the past two decades have been kind to investors in equities is an understatement.

Between October 1991 and October 2011, Australian shares returned investors 433 per cent, including dividends, or 8.7 per cent compounded annually.

That is way ahead of more defensive assets such as cash or bonds, according to analysis by CommSec’s Craig James.

He says if $100,000 had been invested in stocks 20 years ago it would have been worth $804,000 at the start of this year.

That same $100,000 would have appreciated to just less than $305,000 in cash.

Making the numbers even more remarkable is the fact that the period in question encompasses the tail end of Paul Keating’s “recession we had to have”, the September 11 attacks on the United States and three serious financial market meltdowns: the Asian crisis of 1997, the “tech wreck” of the early 2000s and the continuing financial crisis, which began in late 2007 and is arguably unresolved.

But what about the next 20 years? Will equities offer investors the same kind of super-charged returns they did in the 1990s and 2000s? And if so, where should investors look to find them?

The bad news for investors is that a golden era for stocks could be behind us.

Industry observers are becoming concerned that the “cult of equity” could be losing its disciples.

Australia’s love affair with stocks really took off in the 1980s when a succession of high-profile privatisation and demutualisations and the introduction of compulsory superannuation combined to lift share ownership rates to among the highest in the world.

But the global financial crisis exposed a glaring flaw in most Australians’ portfolios: they were too heavily tilted towards shares.

Jarred by the experience of the crisis, it’s a bias many investors have sought to rectify by embracing more defensive asset classes such as cash, term deposits and bonds.

“We are seeing quite a significant loss of belief in equities as an asset class,” explains BT Investment Management head of equities Crispin Murray.

“Part of that is cyclical because of the low returns. But part of it is structural.

“With an ageing population, more people are moving into the retirement phase rather than the accumulation phase and clearly, as they do that, then their asset mix is going to shift,” he says.

In other words, ageing investors will pour more funds into cash and bonds.

This means there will be less money chasing equity returns, reducing the upward pressure on earnings multiples and ultimately, share prices.

“So I think we are probably in a lower equity return environment on a 20-year time frame than we were on the previous 20 years. But I still think equities will be a better place to be than cash,” Murray says.

The ageing population will be one of the biggest challenges investors, executives and boards grapple with in the next 20 years and beyond.

The Australian Bureau of Statistics expects the median age of the Australian population to rise to between 38.7 years and 40.7 years in 2026, up from 36.8 years in 2007.

By 2056, one in four Australians will be older than 65.

This bodes well for companies servicing the needs of older Australians.

The most obvious place to look is the healthcare sector.

Private hospital operator and aged-care provider Ramsay Health Care, pathology providers Sonic Healthcare and Primary Health Care and biotech giant CSL, which has high hopes that its intravenous immunoglobulin products could be used to treat Alzheimer’s disease, are all plausible beneficiaries of this demographic shift.

 

And, within the biotechnology sector, there are a string of companies researching and developing medical technologies that could pay handsome rewards.

These include market darling Mesoblast, a developer of regenerative stem cell treatments, pain treatment developer QRxPharma and Prima Biomed, a developer of cancer vaccines.

Scouring the rest of the market, it is much more difficult to tell which sectors and companies will be obvious beneficiaries of the new world order.

Any product disclosure form will tell you that past performance is no guarantee of future returns, but most of us look to the past as a guide to the future; whether punting at the racetrack, a stock or a loan candidate. We’re looking for form.

The best-performing blue-chip shares over the past 20 years, according to analysis by CommSec, underscore the massive changes that have enveloped the world in a relatively short time.

Arguably the biggest paradigm shift, and most profitable theme for investors to tap into, has been China’s rapid economic growth, underpinning demand for Australian resource exports.

Fortescue Metals tops the list, returning a staggering 248,645.5 per cent in a period in which it transformed itself from a little-known explorer into a bona fide iron-ore giant, CommSec says.

Mineral sands producer Iluka Resources, slightly different to Fortescue in that it has been around since the 1960s, has had its share price ignited by China’s ravenous appetite for minerals, surging 450.4 per cent.

Other beneficiaries of this dynamic include diversified miners Rio Tinto (up 1038.7 per cent, or 12.9 per cent compounded annually), BHP Billiton (up 963.5 per cent, or 12.5 per cent compounded annually) and Newcrest Mining, surging 992.3 per cent.

It raises the question: how much further does the resources boom have left to run?

Growth in the world’s No. 2 economy has already retreated from the double-digit pace achieved over the past two decades. And if you listen to the bears such as Société Générale strategist Albert Edwards, China is in the midst of a massive asset-price bubble that will eventually burst.

But the general consensus among economists is that China’s economy will expand at a pace that most developed economies can only dream of.

And, according to the International Monetary Fund, China is expected to surpass the United States as the world’s biggest economy in real terms as soon as 2016.

Even if China slows, other emerging economies are expected to take up the baton.

PwC estimates that the “E7” economies – China, India, Brazil, Russia, Indonesia, Mexico and Turkey, will overtake the combined size of G7 economies – the US, Japan, Germany, Britain, France, Italy and Canada – as soon as 2020, adjusted for purchasing power parity.

Continued emerging market growth, particularly in China and India, bodes well for Australia’s resources-heavy sharemarket, particularly in the iron ore, coal and uranium sectors.

Murray says there are two characteristics that investors should look for when choosing stocks for the long haul.

The first, he says, are businesses that generate solid and sustainable rates of return on their invested capital, which he likens to “an annuity stream that builds over time”.

In this camp he includes Coca-Cola Amatil and Brambles.

“The banks have been examples of this in the past, but I think it will be tougher for them now without the tailwind of credit growth,” he adds.

The second group were businesses in industries that were likely to experience structural improvements in their returns.

The oil and gas sector was one example of this, he says, mentioning Santos and Origin Energy as stocks in the sector to watch.

He says natural gas prices will keep rising because of simple supply-demand dynamics.

On the demand side, emerging economies such as China only use a small proportion of natural gas to satisfy their energy needs and he thinks the proportion will increase sharply.

On the demand side “you won’t see a copper-like situation where there is a squeeze on prices . . . because the cost of bringing on new gas supply is always rising and therefore the economic price will require prices to rise over time,” he explains.

Of course, no one can be certain about what the future holds, and investors are no exception. But one way to mitigate this uncertainty is to have strong management teams in place to cope with, and even more importantly, take advantage of change.

One of the few common themes among the best-performing companies over the past 20 years is that they were almost always led by high-profile, even visionary chief executives, whether it was Andrew Forrest at Fortescue, Ian Smith at Newcrest, Roger Corbett at Woolworths or Wal King at Leighton Holdings.

But Murray says good management goes beyond just the CEO.

“It’s boards as well. If you have a strong board with good management and there is good interplay between the two, you really get the best combination,” he says.

“The value of good management in a world that is changing quickly is that they are able to adapt and direct their businesses to take advantage of opportunities that others aren’t seeing.”

The Australian Financial Review