Conversations beyond numbers: How advisers navigated the economic storms of 2023

High inflation, rising interest rates, and the looming risk of recession have driven uncertainty in markets and among investors throughout the past year.

But while news has been indicative of a fairly dire predicament for the economy, Nigel Baker, chief executive at Scientiam and founder of advice firm Arch Capital, says that the past year has actually been “pleasingly unexpected”.

“I think returns have been relatively positive, which I suppose, if we were sitting here nine months ago, that might have seemed unlikely,” Mr Baker says.

“There’s always volatility, but interest rates and inflation were all forecast to lead to doom and gloom, but things haven’t been probably as bad as those forecasts predicted.”

AMP chief economist Shane Oliver broadly agrees, noting that, overall, 2023 was a better year than 2022 for investment markets.

“Investment returns have mostly been fairly good, although Aussie shares have been a bit of a disappointment relative to global shares and bond yields have remained under a bit of upward pressure,” says Dr Oliver.

“But generally speaking, from an economic point of view, economic growth has held up, we haven’t gone into the much-feared recession. Things have slowed down, but they haven’t collapsed, and at the same time, we’ve seen inflation come down – albeit not as much as might have been hoped – but it has been coming down around the world and in Australia, and that has provided some support for investment markets.”

According to Dr Oliver, this slower-than-expected progress on inflation, which has forced interest rates higher, is a key disappointment.

“The good news is that, as we come into the end of the year, it looks like central banks are either at or very near to the top, and the same would apply to the Reserve Bank,” he adds.

“Overall, I think it’s been a better year than last year was for investors. But still, it’s a fairly messy year, and of course, just as we had Ukraine last year as a geopolitical issue, we’ve had recently the latest war in Israel returning as a geopolitical issue at the time that the Ukraine war continues. So, on the geopolitical front, it’s still fairly messy.”

Shifting strategies

Reflecting on the past year, Fox & Hare co-founder and financial adviser Glen Hare says that the biggest change at his firm has been a shift in clients’ overall investment strategies.

“Yes, there’s obviously a conversation around what the markets are doing, interest rates, inflation, all of that – but our conversations have started with just understanding their level of job security,” he explains.

“Are they feeling secure in their workplace? Have there been any restructures at work? What’s been the change in their income if they do have a fairly heavy sales commission-type structure?”

Mr Hare shares that conversations with Fox & Hare’s clients, who are predominantly in their 30s and 40s, have changed, compared to some 12 to 18 months ago.

“Markets were still very, very uncertain, but there wasn’t this conversation around: is there job security? Are you going to still receive that income that you’ve become accustomed to? But that’s becoming more and more a conversation, which is playing into how we manage our members,” he notes.

“Where we might have been allocating a high percentage towards growth-style assets, we’re now looking at probably balancing out that a little bit more and making sure that we have the cash reserves that we need, bolstering up offset balances and things like that.”

Clients ‘on the edge’

The current challenging investment environment is a mere continuation of what Mr Baker argues has been a challenging past couple of years.

“I think more investors are constantly on the edge of what’s going to happen next,” he observes.

“It’s been a pretty volatile couple of years really for a while now. It’s just a normal occurrence that we’ve got the changing landscape in front of us.

“Obviously, not many people have invested through a higher inflationary period and a high interest rate period, so that’s quite a new concept, and obviously talk of recession always scares investors and keeps people a bit worried.”

In this unpredictable environment, Mr Hare says that ensuring clients have a healthy cash buffer of at least three to six months is critical. He also notes that the “simple power” of an offset account has come to the fore in recent years.

“Two years ago, you’d be offsetting 2 per cent, which wasn’t that exciting. But if you’re able to offset 5 1/2, 6 per cent, or 6 1/2 per cent, that money is definitely working a lot harder in that offset account than it potentially was two years ago,” he says.

“Not, I guess, the sexiest strategy, but it is one that is playing quite favourably at the moment, given the uncertainty and obviously the challenges in the Middle East. And particularly here in Australia, inflation, although obviously still coming down, it’s coming down at a slower pace to potentially what we’re seeing overseas.”

When developing client strategies in such an environment, Mr Baker explains that his firm uses the “no forecasting” approach.

“We use a very evidence-based type approach, which I suppose is becoming more common. It’s been something we’ve been using for over 20 years. So, what that does is gives clients really clear expectations,” he states.

“We go into a lot of detail about what to expect from different asset classes. What are the historic returns? How will that help their portfolio? Because it’d be easy to chop and change all the time and chase the latest thing or chase the latest article, obviously, but it’s really important that people have a process around it.

“If they’re going to add a new asset class, then what does that really mean and what to expect out of that, and not only what the returns might look like, but what are the costs and what are the tax implications of any changes?”

Alternative opportunities

Alternative investments have recently entered the mainstream as a way to seek lower volatility, higher returns, and broader diversification.

But Mr Baker warns that advisers need to consider several factors before venturing forth into alternative investments.

“Does it add value to a portfolio? Does it help smooth returns? Does it help add returns? What are the costs of these alternatives? What are the tax implications? They tend to be relatively expensive, so be really careful to understand what the expected return could be, what impact costs could have on those alternative investments, and things like liquidity, and all those things are really important,” he says.

“What I’ve found, having been around doing this now for over 20 years, is that liquidity is very important and if things get tough, you want investments to be liquid. So just be careful with alternatives that they sometimes are not very liquid.”
Mr Baker notes that clients may take a liking to alternative assets such as gold, which is widely viewed as a safe haven asset in a volatile market. But he stresses the importance of helping clients understand whether such investments are actually suitable for them.

“If they’re a retiree and they need income, then maybe gold isn’t that good,” he says.

“Does it work as a hedge against inflation? Just looking at some of the data and how it adds to an overall portfolio. But yeah, those sort of commodity-type products are often something that does come up quite regularly.”
Mr Hare’s clients prefer not to “play” in the alternatives space. Instead, he tells ifa, they have a heavy exposure to growth-style assets.

“Gold is one of those things people tend to go to in volatile times, but our members aren’t interested in investing in gold for a couple of years. They’re looking at the long-term play. They’re looking at that long-term investment,” he says.

His clients predominantly invest in international and Australian equities, with “very limited” exposure to bonds. This, he notes, comes down to the “nature of our demographic”.

“They appreciate that there’s obviously considerable volatility, but they also acknowledge that money that they’re investing now is a long-term play. So, most of our members’ portfolios still would have a very high skew towards international, Australian equities.”

However, more recently, the firm has shifted its focus to an emerging area influenced by the clean energy transition, bolstered by funding unveiled by the federal government.

“A lot of our members choose to invest with sustainability and obviously the climate crisis front of mind. With the federal government announcing a $2 billion funding boost for the critical minerals sector, powering that clean energy transition, that’s certainly an area that we’re looking at, and we certainly already do have exposure to and are very much interested in,” Mr Hare says.

“A lot of our members refuse to invest in fossil fuel producers. Some of our members won’t invest in companies that even lend to fossil fuel producers. So, looking at that space – I guess the Albanese or the federal government’s support of that space – is an area that we’re looking at.”

Like alternatives, Fox & Hare’s clients have chosen to shift their focus away from property.

In fact, according to Mr Hare, they’ve become “a little bit disenfranchised with it”.

“The prediction is that next year, if you look at the chief economists of the big four, they reckon it’s going to go up another 3 to 5 per cent. So not the exponential growth we’ve potentially seen over the last two, three years, but this rhetoric of the market pulling back significantly isn’t really playing out,” Mr Hare notes.

Investment properties are being viewed by many as a way to get on the property ladder, Mr Hare says, with the hope that an investment property that has a smaller price tag will enable individuals to buy a home in an area that they want to live in down the track.

“Property is still something that a lot of our members have heavy exposure to, but it’s very different case by case. Some are getting support from parents to buy their first home, while others are choosing the investment property route in order to get their foot on the ladder,” he adds.

2024 and beyond

Looking ahead, Dr Oliver predicts that there’s more volatility on the horizon for investment markets. But, on the upside, he believes that the Australian share market could soon shake off its reputation as a relative underperformer.

“Relative to US, European, and Japanese shares, and global shares, generally, we’ve been a little bit of an underperformer on the back of concerns about China and the impact on the household sector in Australia of higher interest rates. But as we start to go through next year, that may reverse to some degree once some of these issues regarding a recession are resolved one way or the other, and as Chinese growth starts to improve,” he says.

“There’s still a lot of uncertainty about China which has weighed on the Australian share market’s relative underperformance, but we have seen the announcement recently of more stimulus going through in China. If they follow up on that, then it could provide a fair boost to Australia, enabling our market to flip from being a relative underperformer to an outperformer.”

Mr Hare’s expectation for 2024 is continued growth, albeit at a slow pace.

“The global economy has continued to recover since, I suppose, the pandemic, but Russia’s invasion of Ukraine, cost of living – the markets have been relatively resilient, despite war-disrupted energy and food markets and unprecedented monetary tightening. I envisage, in 2024, markets will grow, but growth will remain slow,” he states.

Meanwhile, Mr Baker says that the higher interest rate environment has positioned retirees well for the future. As for younger clients seeking growth, he calls for a sensible investment approach given concerns are still clouding the outlook.

“For the retiree clients, income levels are higher, bond yields are higher. If they’re invested soundly and have a well-diversified portfolio, their income levels are now much better than they had been over the last 10 years, so there are some positives there. So higher interest rates actually aren’t too bad, perhaps,” he says.

“But for those younger clients who are looking for growth, there’s certainly some concerns, and we don’t profess to forecast things perfectly. But again, it just comes down to people having a sensible approach, not making rash decisions, and having a well-considered investment policy around it, not just making guesses.”