Often cited as the densest year of technological innovation of all time, 1995 stands out for several reasons; The launch of the world's first internet enabled marketplaces (Craigslist and eBay), the start of online dating (Match.com), the first fully digital, animated feature film (Pixar's Toy Story) and of course, a humble "bookseller" was born (Amazon.com). While lesser known, 1995 was also the year the greatest internet startup in antipodean history was founded, REA Group.

Just like the great tech tales of Silicon Valley, our Aussie protagonist (REA Group) was started in a garage (1995), IPO'd just before the dotcom bust (1999) and lost ~90% of its value shortly thereafter (2001).

However just before complete failure, it was dealt a dose of good fortune, with Rupert Murdoch and his global media empire, News Corporation stepping in and providing a much-needed capital injection. News Corp. took 44% of REA Group (realestate.com.au at the time) in exchange for A$2 million in cash plus A$8 million worth TV and print advertising, giving REA Group a total equity valuation of A$23 million.

Fast forward twenty years to today and News Corp. owns 61% of REA Group which has a market capitalization of A$21 billion, or 910 times the valuation Murdoch paid in 2001. For comparison, a purchase of Amazon stock at its low point after the dotcom bust would have returned 510 times the initial investment today, or less than two-thirds what REA Group delivered (excluding dividends), which earns it a place among the greatest internet start-ups of all time.

Aside from being a multi-decade compounder for shareholders REA Group holds one of the most privileged positions in real-estate of any company in the world. Real-estate markets tend to be highly localized, with the comparable property radius only extending to surrounding neighborhoods, creating fragmented, non-uniform supply dynamics, which are highly supportive for an online marketplace like REA Group which can aggregate that supply more uniformly.

In addition to this, the Australian market is unique, in that it is impossible to function as a real-estate agent (or broker) without a subscription to REA Group's professional tools and access to its property listing portal, which as we will discuss, is entrenched with buyers and renters in the Australian market.

Through its flagship portal (realestate.com.au) REA Group has become "the destination" for real estate in the Australian market with ~65% of Australia's adult population (12 million people) checking property listings, real estate news, and home prices on the site every month.

Additionally, REA Group continues to increase its lead over the number two player (Domain Holdings), reaching 6 million more Australians and attracting over three times the monthly visitators of its peer, a gap which continues to widen.

REA Group is Australia's #1 Property Portal

Source: REA Group

Adjacent to its privileged position with Australian real-estate customers, REA Group also has an indispensable relationship with real-estate agents. To effectively operate in the Australia market a real-estate agent has very few choices outside of subscribing to REA Group's agent administration tools to find clients, build an online profile and market their listings, this has translated into extremely strong and durable pricing power for REA Group.

While the official strategy is to support agents and remain in their servitude forevermore, one cannot help but observe the increasingly potent value-added services it offers property buyers, sellers and renters, slowly disintermediating agents in the value chain, which is the natural progression of a genuine two-sided marketplace like the one REA Group oversees.

As REA Group continues to reduce friction costs of buying, selling, and renting properties for customers, it is likely to capture a larger share of transaction economics over time.

In Part-II of this series will discuss some of the powerful levers REA Group has at its disposal to increase its share of Australian real-estate industry economics and the numerous other valuable real options it holds within its portfolio. We are very grateful for the trust you have placed in Montaka Global to protect and grow your wealth, alongside our own wealth, and believe REA Group will continue to be a wonderful investment over the long-term.

Click here for Part II of this series

Our contention is that use by date of Emerging Market  (EM) funds has passed and that this has quietly happened over the last decade without much notice.   In Part One of this discussion we will look at the make up of EM Indices and their comparison to Asia ex-Japan funds.

What we will outline is that a decision to invest in an EM fund is already mainly a decision to invest in Greater China and the rest of Asia ex-Japan.  What is leftover in EM are countries that are speculative commodity countries largely with questionable or poor governance.  We contend that there are better ways of accessing resources and commodities than via a generalist manager.  Specialists for both are the better way to improve investment outcomes.   

As well it is reasonable to think that some of the emerging markets - particularly Greater China have in fact emerged. What that means for investing is a rethink about asset allocations.

Let's start our discussion with a quick look at Emerging markets.  Following is a framework for assessing emerging market status[1]:
 

1. Lower-Than-Average Per Capita Income
   
   The World Bank defines developing countries as those with per capita income of $3,995 or less.
    
2. Brisk Economic Growth
3. High Volatility
4. Currency Swings
5. Potential For Growth - successful, rapid growth can also lead to the fifth characteristic, which is the higher-than-average return for investors.  That's because many of these countries focus on an export-driven strategy. They don't have the demand at home, so they produce lower-cost consumer goods and commodities for export to developed markets[1].
    

In China, Taiwan and Korea, and to some extent India, however you can already see a clear shift to consumer led economies vs export led.

Let's start by breaking down the Emerging markets.  If you consider the table below - Emerging Market Breakdown using the MSCI - what you can clearly see is that 75% of the index is made up of four Asian countries: China, Taiwan, Korea and India.  Some EM indices also include Hong Kong which would further increase the dominant Asia exposure.

Looking into the smaller weights, we then come to a group of four which represent the next 14% of the index.  Brazil, South Africa, Russia and Saudi Arabia.  These countries have two things in common in our view:

1. They are all commodity countries which we contend are best invested in through a global resource or commodity specialist manager.
    
2. For different reasons, they also have questionable governance or corruption concerns, further increasing the need for specialist understanding, if not on the ground presence.
    

The final cohort of 19 countries in total represent only 11% of the index and individually and together are largely rounding errors, without also considering the Social and Governance challenges some face.

Emerging Market Breakdown (per MSCI 31.3.2021)
Note:  8 other countries are included in some EM indices - e.g., Hong Kong & Vietnam

Let's now dive a little deeper and look at the next chart which shows that an EM investment is effectively already an Asia ex-Japan investment with a dominant exposure to Greater China.

EM and Asia ex-Japan deeper dive

These charts show that investing in Emerging Markets IS already an Asia ex-Japan investment, but:

• With the addition of volatile and mostly detractor countries, and
• Missing what is arguably the strongest global thematic of all - an historic and enormous rise of middle class out of poverty.

So, to us this reinforces our contention that specialists are a better approach to investing in emerging markets.  Use of an Asia ex-Japan specialist with a deep China understanding combined with a Global resources or Commodities specialist makes more sense than an allocation to a generalist EM fund.

[1] Source: Emerging Market Countries and their 5 Defining Characteristics; Kimberley Adao www.thebalance.com; Aug 2020

Based on Plato's analysis, 2020 was the worst year for dividends in Australia over the past forty years, with the 35% cut in dividends surpassing the falls seen over three years in the recession we had to have and the GFC. 

For investors holding just bank shares, the outcome was even worse, with big four bank dividends falling roughly 60% in calendar 2020. Self-funded retirees also took a huge hit on their interest income, with term deposit rates plunging to near zero.

But that was last year. We faced nationwide lockdowns, no one knew how bad things may get, many assumed the worse, the Reserve Bank of Australia slashed rates to an all-time low of 0.1%, APRA initially discouraged banks from paying any dividends at all, and the Federal Government literally threw money at COVID with its Jobkeeper and Jobseeker payments.  As we have seen, Australia's island quarantine strategy has proved relatively successful, in fact very successful on a global context.  Our economy has bounced back quicker than anyone thought, and our GDP has now surpassed its pre-COVID levels. For most companies, too, the outlook is bright, apart from those still directly affected by international travel bans and local lockdowns. On our analysis, 2021 has emerged as very strong year for dividend income and with the August reporting season ahead we expect the good news for dividend investors to continue into the remainder of the year.

The picture for income from ASX-listed equities is stark when compared to other asset classes. Below we've charted the real earnings on $1,000,000 from the overnight cash rate, 1-year term deposits and 10-year bond yields. These so-called safe assets are producing negative real rates of return.

So, in a world where real returns on cash-backed assets are in the red, and will likely remain there for the foreseeable future, how can investors ensure they don't miss out on a piece of the dividend pie?

The dividend outlook looks good

We model expected dividends for S&P/ASX300 companies and our expectations for future dividends is looking very bright. We also forecast the likelihood of companies potentially cutting their future dividends. This helps us avoid dividend traps, which we think is key for income investors. 

We can use our dividend cut model to get a picture of the market as a whole, by calculating the average probability of a dividend cut across all stocks. The following chart shows how the probability has varied over time. The GFC in 2008/9 and the COVID pandemic in 2020 are very clear to see. The global pandemic set a new high for market wide probability of dividend cuts, but what is very interesting is how quickly the cut probability has fallen from its peak in April 2020 to a below average level. This underpins our positive outlook for dividends in 2021.

Source: Plato Global Dividend Cut Model

Diversify, but don't set and forget

We manage the portfolio of our Listed Investment Company, the Plato Income Maximiser (ASX:PL8), with the aim of paying monthly dividends and delivering investors above-market levels of income annually. It may come as a surprise that the majority of our top yielding holdings aren't what many consider to be Australia's traditional dividend-paying stocks.

Consider the miners. 3 of the top 6 dividend payers in Australia today are mining companies - Fortescue Metals (ASX: FMG), Rio Tinto (ASX: RIO) and BHP (ASX: BHP). For many investors this would have been inconceivable just a few years ago.

We've held a very positive view on the sector for a number of years, comfortable with the global supply/demand equation for iron ore. Over the past three years, FMG, RIO and BHP alone have delivered our portfolio 3.4% p.a. gross income.

The question we now face is how long will the mining stock dividend boom continue?

We still maintain a positive outlook on mining stock dividends for the foreseeable future. Our experience in active equity management has taught us things always take longer to play out than markets would indicate.

Samarco (the massive Brazilian Iron Ore miner owned by BHP and Vale) is only just coming back to full production five years after a devastating dam disaster. We often see miners forecast swift production resumption after major issues, but the reality is it usually takes longer. The COVID situation in Brazil is also another impediment.

Even when this Brazilian supply comes back on, steel production is on the rise with historical levels of infrastructure stimulus leaving the supply and demand fundamentals intact. Should Iron Ore prices for come off $100-$150 per tonne from the current highs, Fortescue, Rio Tinto and BHP will still be very profitable businesses.

Mining stocks do go through cycles, and this fact shouldn't be ignored. It's why a 'set and forget' approach isn't optimal for dividend investing. We like miners for the short-medium term, but our view is likely to evolve in the future as conditions change.

The same applies to retailers- again not a traditional area for dividends in the eyes of income investors - however it's a sector that has produced exceptional income in recent times for investors who have actively added the right names to their portfolios.

In the consumer discretionary space in particular, leading retailers including JB Hi-Fi (ASX: JBH), Super Retail (ASX: SUL) and Harvey Norman (HVN) have been thriving and delivering income far superior than most other asset classes.

These consumer discretionary businesses (and others) experienced a COVID-19 sugar-hit has consumers stocked up on products needed for working from home and increased domestic tourism, and we expect this to continue until borders are opened.

So, like the miners, as active managers we must consider if this will continue into the short-medium term.

It remains to be seen when full-scale international travel will resume. Australians love to travel and spend a lot of money abroad. A large chunk of that money is likely to continue flowing into domestic discretionary spending. There was evidence of this recently.

When it comes to the big 4 banks, they've traditionally been a major focus for income investors but in 2020 the outlook appeared dire as dividends were slashed across the board amongst the financials.

There has, however, been a remarkable turnaround, for three reasons. First, APRA have taken off all restrictions on bank and financial institution dividends in late 2020. Second, bad debts have proven much lower than expected, and finally, banks are seeing good loan growth fuelled by low interest rates.

In May we saw half-year results from Westpac (ASX: WBC), ANZ (ASX: ANZ) and National Australian Bank (ASX: NAB).

Across the board, there has been a significant write-back of provisions and strong increases in cash earnings, resulting from improving economic conditions.

Outside of the big 4, dividend strength is also evident. Bendigo and Adelaide Bank's half-year result earlier this year came in at almost 30% above expectations, Macquarie's FY21 net profit revealed in May, was up 10% on FY20.

While bank dividends aren't fully back to pre-COVID levels we believe the outlook is very positive for the sector and think Financial are once again an important element of a diverse equity income portfolio.

Individual dividend investors who set and forget can see their income plunge when the typical dividend stocks go through tough patches - such as the banks during the royal commission or the peak of the COVID crisis.

On the flip-side we're able to take a dynamic approach to generating high yield, moving around the market at any point in time to find the strong dividends and capital returns.

Dividend income to make ends meet

In our low-rate world, effective dividend investing has been a shining light for income-seeking investors. With Australia seemingly through the worst of the COVID-19 crisis the outlook for dividends is on the improve.

Looking forward to the remainder of 2021 and into 2022, we think there's a positive outlook for dividends, particularly from ASX iron ore miners, select consumer discretionary and the banks. 

Diversification, active management, and tax-effective investing can help fire up the dividend machine and ensure investors, who rely on their capital for income, don't miss out.  

Dr Don Hamson is the managing director of Plato Investment Management - a Sydney-based fund manager dedicated to maximising income for retirees, SMSFs and other low-tax investors.

As society was exhaling from the post-war world of 1946, Arthur Lefford from NYU's Department of Psychology took particular interest in people's decision-making ability, especially as many generations (if they were so lucky) had just survived several globally disruptive periods. The new world presented choices and options that could lead to solutions on the social and economic problems that were now presented before them. This evolving case study provided Lefford the platform to challenge whether people expressed the (in)ability to act based on objectivity and rationality. Unsurprising to many of us in 2021, the results of the study found that people's agreeability to a message is often strongly correlated with their perception of the choice being more logical or rational. The inverse also applies; when there is disagreement with a message, people often consider this to be emotional. Decades later as the natural progression of this field of study cascaded into the world of finance, behavioural finance emerged and sought to study the effect of psychological factors on the economic decision-making process.

The focus of behavioural finance is the idea that investors are limited in their ability to make rational economic decisions, whether that be influenced by their own biases, by a lack of self-control or resources (i.e. time), by peer pressure (i.e. herd mentality) or a number of other social, cultural and external factors. If studied and watched closely, this irrationality can begin to reveal some patterns of behaviour and can lead to opportunities. The opposing camp to behavioural finance however, is the Efficient Market Hypothesis. The Efficient Market Hypothesis asserts that investors are rational, fully-informed, and that (stock) prices reflect all available information at any given time and therefore always trade at their fair value. Essentially making the ability to generate an excess return impossible.

From our perch, it currently appears that the broader financial system may be playing out a behavioural finance tragic's greatest fantasy. Alongside the apparent equity market exuberance and interest in speculative assets, it seems experts and arm-chair journalists are also attempting to forecast when the RBA interest rates will begin to rise. Whilst these pre-emptive calls make for fascinating reading, they can feed into the broader market's fear & greed complex. Simply, when interest rates are rising (or are lifted ahead of schedule), people are fearful they won't be able to pay their (increased) mortgage repayment and when they are declining (or are cut AHEAD of market consensus), greed dominates as money is perceivably cheap(er). From a business perspective, when interest rates rise, it tends to have a detractive effect overall as debt becomes more expensive (increasing the cost of starting new projects, assuming they are partially debt funded), consumer spending rates generally reduce, and cash leaves the system to be channelled elsewhere (e.g. the household mortgage). The converse also remains true, should interest rates be lifted at a point which is BEHIND consensus, this may allow markets to continue climbing further over the near term.

Interestingly however, should interest rates rise ahead of schedule and shock the market into price recalibration to reflect this new environment, one would expect fear and by that virtue, volatility to accompany irrationality as it replaces the current market exuberance. Perhaps this is what pundits and experts alike are trying to time or forecast. Timed correctly, one can quickly adjust a portfolio on a value vs growth or technical vs fundamental basis with the intent to be in the more favoured style. We however prefer not to market time or fluctuate between styles to try and match the macro environment. Conviction (or lack thereof) to an investment strategy and ethos can often be the difference between consistent and inconsistent returns.

It appears quite likely that at some point in the medium term the RBA will lift interest rates; from the lens of our investment strategy, we believe that timing this movement is largely an exercise in futility. For as long as irrational economic decision-making continues, one can expect volatility and with it, market opportunities for those who look.

As Australian equities have rebounded from the lows of late March 2020, many investors have doubted the rally's staying power. Pessimists argue that, based on most valuation metrics, stocks are pricey, which implies weak returns ahead.

But we believe that this overrates the predictive power of valuations - particularly in the short term. Instead, investors need to understand that long-run equity returns are driven by multiple components, of which valuation is often the least important.

Indeed, it is likely that in coming years investors won't be able to rely on rising equity valuations for their returns. To achieve high returns and realise their investment goals in this environment, they are going to have to become even more focused on identifying the companies that can produce strong earnings growth and cash flow.

Only 3 components

                Source: Refinitiv

Figure 1 above decomposes Australian equity market returns into their key components. As you can see, there are only three sources of returns:

• Income (grey bar) - dividends
• Earnings (orange bar) - how fast have companies grown their earnings?
• Valuations (blue bar) - how has price/earnings multiple changed? Does the market now value companies more or less for a given level of earnings?

The first two components of return are generally referred to as the 'fundamental' components, whilst valuations are often referred to as the 'speculative' component of return. The latter has earned this moniker because it is driven by unpredictable investor emotions, such as fear and greed, in the short term. (The sum of these components approximates the return on the stockmarket, shown with a black diamond.)

An erratic contributor

The sources of return never change. But their order of importance does. That is, during any of the five-year periods presented, one of these variables will exert a disproportionate influence on total equity returns. Conversely, there will be periods where a component makes little contribution.

There is no doubt that when valuations expand it can have a dramatic positive impact on total return. But valuation's contribution is highly erratic: sometimes positive, sometimes negative. When the P/E ratio expands, the stock market generally produces double-digit returns. And when the ratio contracts, returns fall into the single digits.

In the second half of the 1980s and the second half of the 1990s, for example, the P/E ratio was a strong driver of the era's spectacular market returns. But P/E detracted from market performance through the years 2000 to 2015 when valuations subsided from the start of the high tech bubble.

The exhaustion of PE expansion

When P/E multiples are expanding, interest rates are typically falling, and vice versa. For the two decades between 1980 and 2000, the downward trend in interest rates boosted P/Es, which resulted in huge growth in total equity returns.

More recently, we have seen this play out as central banks worldwide have drastically cut interest rates to support economies facing pandemic pressures.

But with interest rates now having already been reduced to the floor, the era of P/E expansion has been exhausted: it is unlikely that rates can fall much low and push further P/E expansion. Instead, rising rates over the coming years -as economic growth recovers -- are likely to force a modest decline in equity valuation multiples, similar to what markets digested through the years 2000 to 2010.

This negative outlook for P/E ratios emphasises the other two sources of equity return: earnings and dividends. As you saw in Figure 1, earnings and dividends, unlike the highly volatile P/E ratio, have had a consistently positive effect on total return over the last forty years. In fact, for much of the last twenty years, earnings and dividends have continued to boost total return, while P/Es have hindered market performance.

The emerging primacy of earnings and dividends

But while earnings and dividends become more important as sources of returns, the period of double-digit earnings gains for the broader equity market will soon be behind us as economies normalise post the COVID-19 pandemic. Going forward, earnings growth will likely occur at a more modest single-digit rate.

Fortunately, our investment process has always focussed on finding the companies that can materially grow earnings. In this environment, our expertise in identifying the profitable growing businesses of the future comes to the fore.

Meanwhile, because they are often a preferred method of free cash flow deployment, dividends are set to emerge as a more important component of total equity returns. Although we are biased to companies that can grow earnings faster than the market, we will continue to learn everything we can about a company's free cash flow and what it signals for the businesses capital management policies.

A solid year of returns from equities

Valuations are not good predictors of short-term market returns. It is futile for investors to use valuations to time the market day-to-day or month-to-month.

Valuations could fall but that does not mean returns have to be negative if the other two drivers contribute enough.

For long-term investors, the best course is to continue investing according to your plan, regardless of what the market does. You may, at times, buy when valuations are high; on other occasions, you will buy when valuations are low. It should all come out in the wash over the long term.

Our base case is we expect a year of solid returns from equities in 2021, but with the usually very high degree of uncertainty. At a very high level, the global economic recovery, which is currently playing out, suggests that earnings growth should positively contribute to markets in 2021. The big differences could arise from valuations. Dividends should also be well supported this year, particularly in commodity and consumer-related stocks.

We think investors can no longer rely on a rising tide of higher valuations to lift all stocks. Alpha or outperformance, where it can be found, we be a larger portion of total investor returns. For us, we will continue to focus on finding undervalued small and mid-cap companies that through a superior product or service can one day become the future leaders of tomorrow. These type of businesses will continue to be rewarded with expanding valuations as the market recognises their superior growth trajectories.

Producers in both China and the US are facing higher costs, prompting growing concerns that inflation could threaten the global economy - but China isn't waiting to find out given its recent history with inflation.

Interestingly, Chinese consumers are facing much less pricing pressure than their American peers, so why are the Chinese more concerned over higher commodity prices? This could be a potential headwind to Chinese economic growth.  Top Chinese officials like Premier Li Keqiang and Vice Premier Liu He recently expressed concerns for manufacturers and the adverse effect of rising commodity prices including the potential pass-through to consumers for some goods. In response, Chinese regulators were tasked with curbing the excessive speculation in the commodity market by imposing new limits on the trading of commodities and increasing some export taxes.

China has clear reasons to fear inflation with memory of past price increases still vivid, including the +135.2% surge of pork prices and +5.2% consumption inflation in February 2020. But, in our view, the threat of no inflation pass-through is more pressing.

Is China exporting higher prices?

Since joining the World Trade Organisation in 2001, China has engineered a complete industrial system. The upstream raw materials sectors have been dominated by big companies, which are closely associated with central or local governments. These companies have the pricing power to transfer the input cost pressure to mid- and downstream companies. Notably, the producer goods price increased by +12.0% in the last twelve months, as of May 2021. But the inflation pass-through stopped here and did not flow downstream. The price of consumer goods increased by only +0.5% during the same period. Mid- and downstream companies failed to pass the higher input cost to the consumers. A few factors contributed to the no pass-through of inflation which are discussed below.

Figure 1 - China Producer Goods vs Consumer Goods

                                  Source: Bloomberg, JCB.

Firstly, the competition at the mid- and downstream level is fierce. When Chinese manufacturers had a limited technology edge, they won market share via lower prices thanks to cheap labor costs. This led to overcapacity and triggered the supply side structural reforms of 2015. Prior to the full blown COVID-19 impacts, industrial upgrading and technology innovation was still undergoing and far from complete. In short, if your competitive edge is price, you cannot jack-up price so easily.

Secondly, there is no positive domestic demand shock in China. Unlike many developed countries, the Chinese government didn't implement a large fiscal transfer to boost household balance sheets. The recent retail sales and service output data showed that demand is growing but at a lower-than pre-COVID-19 speed. With largely stable domestic demand, mid- and downstream manufacturers could not raise prices without losing market share. Due to the strong recovery of overseas demand, those downstream manufacturers, who have the capability to compete in overseas markets, may charge higher prices, i.e. exporting the inflation. However, the recent appreciation of RMB has posed a headwind. The latest survey data shows the slowdown of new export orders.

Figure 2 - Chinese producers pass through the price pressure to US customers

                                  Source: Bloomberg, JCB.

Overall, high commodity prices without inflation pass-through simply means profit squeezing for mid- and downstream firms. In late May 2021, Chinese state media reported that some downstream producers stopped taking new orders as the more they produced the more they lost. In our view, China shouldn't worry too much about the threat of the high consumer inflation for now as it is difficult for downstream producers to pass through the price pressure. However, the profit squeezing caused by the no pass-through is right here. We believe it is a headwind to Chinese economic growth, which explains why policy makers are tackling the high commodity prices.

Some Chinese trading firms have increased inventory of physical commodities and tried to corner the market. Regulators called them to stop the market speculation and manipulation. China would also maintain the macro prudent policy and keep the credit impulse low. This would avoid spurring the property bubble further. Historically, lower China credit impulse was linked to lower commodity prices.

However, things may be different this time. The expansionary fiscal policy from the Biden Administration could make the U.S., instead of China, the marginal buyer in the commodity market. While U.S. consumers use the stimulus money to pay for higher gasoline prices during their summer trips, Chinese producers could face further profit squeezing. History suggests that the turning of profitability in the Chinese corporate sector can have significant impacts on regional equity markets, with associated impacts across the macro spectrum, investors should pay attention to the lack of pass-through pricing power given this higher inflation impulse in China as an early warning sign of fading corporate profitability.

Figure 3 - China Credit Impulse falling

                                      Source: Bloomberg, JCB.

Figure 4 - China Corporate Profit Index vs MSCI Asia x Japan Index

                                      Source: Bloomberg, JCB.

Last year, we endured some major shifts in the market. Just 23 trading days resulted in the S&P 500 falling -34%. By June it had topped +40% (from its 23 March low). It can be disturbing when this happens in such a short timeframe, especially with the media going ballistic with doom and sensationalism. Is this usual?

Yes, it is. Large ups-and-downs occur all the time - though not for the past 10 years. So it feels unusual and can be tempting to time moves or cash out until things feel okay again. Here are the seven biggest market events over the last 90 years:

1. The 1929 Great Depression Crash lasted well into the 1930s. It's still by far the craziest ride in history. The market was up +32% in '29 until peaking in September. Then it fell -45% in two months. Then it rose +28%. Overall, the year was down just 8.3%. By four months into the next year the market was up +22%. It didn't last, as the next eight months would see a -44% drop. By December it was still down -25%.
2. 1931 had stocks rising in two months by +19%. It then flipped, closing around -57% by mid-December. That year is the worst year on record, finishing -44%. Would you have stayed invested? Another -51% drop over the next five months of 1932 would really test you! (This was THE bottom as it turned out.) Without warning or good news, markets rallied +112% in only 12 weeks. The S&P still fell again another -32% to settle for the entire year at -8.6%. Selling didn't subside in 1933 as there was another fall of -25%. After that, investors enjoyed a staggering +121% in July (and a bump of -29%) to finish the entire year +50% - one of the best years ever. 1934 saw another rise of +21% (and a fall of -29%). 
3. The '73/'74 oil crisis marked another rollercoaster of returns. Stocks fell -37% before bottoming in October, then rallied +21% the next month, ending the year at -26%.
4. 1980 saw stocks falling -17% only to rise +43%. The market was up +32% by year's end. 1982 witnessed a similar event with -17% followed by a +40% jump. Year-end stocks were up +20%.
5. The Black Monday crash of '87 saw the market falling -34% in only a week. It had risen +40% beforehand and ended the year almost +6% (after the worst one-day crash in history). 
6. The late '90s asset bubble had a +20% gain for five years straight up until 1999; yet in '98 it had a -9.3% fall before increasing +34% ending the last year of last century at +28%. As the dot-com bubble burst nudged by 9/11, three big 7. price swings occurred in 2001. Stocks fell -19% before rising +19%; then there was a -26% crash to close the year around -12%.
7. The 2009 GFC bottomed in early-March '09 at peak gloom but not before being slammed at -28% from 1 January. Prices then leapt +67%, closing the year at +26%.

What would you have done as an investor in response to each of these market events? Hindsight is a wonderful thing...

Three demographic discoveries that affect investments

To understand the drivers of the structural down-shift, we need to first look at the reality of the globe's demographic make-up. Our white paper discusses three demographic discoveries - and at least one of them will challenge long-held beliefs!

Discovery 1: The world population will grow for the next 30 years and there's not much that can be done to stop this. 

Discovery 2: World population will then decline and there is little that can be done to stop this if societies behave as they have done for millennia. 

Discovery 3: 'Peak Child' occured in 2011. There will never be a year in our lifetimes where more children are born. This has profound economic growth implications.

Learn more in our demographics White Paper: The GDP Downshift - Preserving Equity Returns

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Equity Trustees Limited ("EQT") (ABN 46 004 031 298), AFSL 240975, is the Responsible Entity for the Insync Global Quality Fund and the Insync Global Capital Aware Fund. EQT is a subsidiary of EQT Holdings Limited (ABN 22 607 797 615), a publicly listed company on the Australian Securities Exchange (ASX: EQT). This information has been prepared by Insync Funds Management Pty Ltd (ABN 29 125 092 677, AFSL 322891) ("Insync"), to provide you with general information only. In preparing this information, we did not take into account the investment objectives, financial situation or particular needs of any particular person. It is not intended to take the place of professional advice and you should not take action on specific issues in reliance on this information. Neither Insync, EQT nor any of its related parties, their employees or directors, provide and warranty of accuracy or reliability in relation to such information or accepts any liability to any person who relies on it. Past performance should not be taken as an indicator of future performance. You should obtain a copy of the Product Disclosure Statement before making a decision about whether to invest in this product.

Recently, there's been a lot of discussion about whether the significant government stimulus, combined with record low interest rates and unconventional monetary policy such as Quantitative Easing (QE) will finally result in rising inflation, something markets have not experienced for some time. After a number of false starts, it appears that almost every central bank is committed to these measures until they achieve their objective of realised inflation.

It's a risk of which investors should be aware. On a practical level, it means taking a look to see whether the assets in your portfolio are still match-fit in an environment of rising inflation. We have previously written on the critical role of the attacking defender as it relates to private debt illustrated through soccer, so we'll extend this soccer team analogy to explore this dynamic and the role private debt can play to help investors navigate an environment of rising inflation.

Moving market dynamics

Long-duration assets like government bonds, infrastructure, property, and high-growth equities benefit when interest rates fall by lowering the discount rate applied to all their future cashflows.  These are the first assets selected in your team when rates are falling. We have seen these champion investments perform exceptionally well over the bull market of the last 40-years, when interest rates have dropped from double digits to near-zero levels.

With the potential for rates to rise from zero and with the prospect of inflation, it's time for the coach and team manager - in markets, the portfolio manager - to make some difficult decisions about whether champion players in the twilight years of their career - for example sovereign bonds - should still be on the field, at least for the whole match. It may be time to re-evaluate whether your best past players are really your top choices going into a new season, or whether they should be retired, rested, or spend less time on the pitch because they've lost a yard of pace.

When inflation expectations rise, interest rates tend to increase, and the yield curve steepens. In these conditions, it's an opportunity to reconsider whether some of the long duration assets that have been tried and tested players in the portfolio are still fit for purpose. It might be time for short duration asset classes such as private debt to step into their role in the team.

In a rising interest rate environment, the value of long-duration assets like fixed rate corporate and sovereign bonds, fall in value because their future cashflows are discounted further than before. This isn't the case with private debt, which is short duration and senior secured debt, and in a rising interest rate environment does not fall in value, giving true diversification benefit.

Australian & New Zealand Private Debt: Appeal in a rising rate environment

The chart below illustrates various credit and fixed income investments with differing levels of duration. The longer the duration, the more sensitive the investment valuation will be to interest rate changes.   

     Source: Revolution Asset Management and Bloomberg. 'Aust & NZ Private Debt' is based on realised investment experience of the Revolution private debt strategy from December 2018 to May 2021.

In fact, the overall yield of private debt rises in line with interest rate movements upwards because the total interest earned on the assets is the floating rate benchmark plus the credit margin, instead of a fixed rate coupon. This is one of the most compelling reasons to consider an allocation to private debt in your current portfolio. The trade-off is that investors need to be comfortable with increased credit risk and the illiquidity that comes along when investing in private debt.

Like any soccer team, sometimes the coach or manager needs to bench certain assets because they don't suit the playing conditions. But when conditions turn, it could be time to bring them back into the team. Gold is a good example, which has historically served as a store of value when inflation rises. Perhaps it's also time to have an eye to the future and consider whether to promote up-and-coming players from the youth team. In this example, the coach or portfolio manager might examine whether an allocation to crypto currencies may add diversification to your portfolio in a QE world, but we'll leave it to others to continue this debate.

Re-positioning for the times

Overall, what's important is to have the right balance of attacking and defensive assets in a portfolio for the current conditions. You pick a different team when the game is played in rain and snow compared to when the conditions are fine. When it comes to investing, what's important is to choose the right assets for the prevailing economic and market environment.

Think of private debt as the attacking defender or wingback in the team, it provides the right balance in a portfolio because it produces uncorrelated returns to other assets, as we demonstrated in our previous article. It's an investment that's first and foremost a defender that aims to preserve capital, but at the same time, it can contribute to the attack and goals in the form of regular income that can either be spent or used to re-balance. Just as with soccer players, consistency is the key to selecting a fund manager that has the form for managing a portfolio through different conditions. At the same time, a good fund manager - and good players - will be well-balanced, durable and without weaknesses.

Private debt as an asset class is an especially attractive option, particularly when inflation is rising, something with which markets have not had to grapple for some time. Revolution Asset Management's goal is to be the attacking defender in investor portfolios by providing that winning and balanced combination of attack in the form of potential income, and defence in the form of aiming to provide capital preservation through all market cycles.

This article is for institutional and professional investors only and has been prepared by Revolution Asset Management Pty Ltd ACN 623 140 607 AFSL 507353 ('Revolution') who is the appointed investment manager of the Revolution Private Debt Fund I, the Revolution Private Debt Fund II and the Revolution Wholesale Private Debt Fund II (together 'the Funds'). Channel Investment Management Limited ACN 163 234 240 AFSL 439007 ('CIML') is the Trustee and issuer of units for the Funds. Channel Capital Pty Ltd ACN 162 591 568 AR No. 001274413 ('Channel') provides investment infrastructure services to Revolution and Channel and is the holding company of CIML. None of CIML, Channel or Revolution, their officers, or employees make any representations or warranties, express or implied as to the accuracy, reliability or completeness of the information, including forecast information, contained in this document and nothing contained in this document is or shall be relied upon as a promise or representation, whether as to the past or the future. Past performance is not a reliable indication of future performance. All investments contain risk. This information is given in summary form and does not purport to be complete. To the extent that information in this document is considered advice or a recommendation to investors or potential investors in relation to holding, purchasing or selling units in the Funds please note that it does not take into account your particular investment objectives, financial situation or needs. Before acting on any information you should consider the appropriateness of the information having regard to these matters, any relevant offer document and in particular, you should seek independent financial advice. For further information and before investing, please read the relevant Information Memorandum available on request.