Economic shocks and volatile markets: What next for client portfolios?Jeffrey Johnson

Head of Investment Strategy Group, Asia-Pacific, Vanguard Investments Australia

Investors are nervous

slowdown

warning

globalvolatility

currencyslow

chinacredit

ratesmarketsbear

crisis

fragilepolicy

oilcautious

fall

correction stress

Fed

dollar

Volatility has increased

-14% 11 276

Many economic concerns are not new

Slowing growth of labor force

Private sector debt deleveraging

Sluggish capital investment

Fiscal sustainability and committed fiscal austerity

Commodity exports dependency

Currency strength

Rising income inequality

Most of the world is in a structural deceleration

Frustratingly fragile (but not bearish) outlook

• Global growth will remain frustratingly fragile in 2016

• In Australia, risks remain tilted to the downside

• A “dovish tightening” cycle by the U.S. Federal Reserve

• Outlook for global bonds remains guarded

• Global equities do not appear to be overvalued

• Investment environment is likely to be more challenging and volatile

Diversified and patient investors are likely to be rewarded

10 year annualised nominal return projections

0%

2%

4%

6%

8%

10%

12%

14%

ConservativePortfolio

30/70

BalancedPortfolio

50/50

GrowthPortfolio

70/30

Advice will be as important as ever

The advice value proposition is changing

Traditional advice proposition:

Investment Adviser

• Outperformance

• Picking winners

• Security/manager selection

• Market conversations dominate

• Market timing

Adviser’s Alpha advice proposition:

Strategic Adviser

• Asset allocation

• Portfolio construction

• Wealth management

• Behavioural coaching

• Holistic planning

Low fees and frequent communication trumps performance

0

1

2

3

4

Co

nta

ct p

er y

ear

Current

Preferred

Face-to-face Phone Email

Preferred type of contact varies, but clients want more

Sources: Vanguard Calculations using data from Investment Trends Financial Advice Report August 2015.Notes: Based on clients desiring more contact than they currently receive

26%Lower fees

22%Regular updates

15%Greater frequency of contact

12%Simpler explanations

11%Better performance

49% of clients cite communications as an area for improvement

Quantifying Adviser’s Alpha

Source: Vanguard

1. Asset allocation

2. Minimising cost

3. Rebalancing

4. Behavioural coaching

5. Tax efficiency

6. Total-return vs income investing

Potential value added

>0 bps

75

42

150

>0

>0

“About 3%”

3. Rebalancing

4. Behavioural coaching

42

150

Consumers have many tools to help with key purchases

With large purchases quality and high cost tend to persist

University 2004 2013

Princeton

Harvard

Yale

MIT

Stanford

Family Sedan 2005 2014

Toyota

Honda

Hyundai

Mazda

Volkswagen

Subaru

Nissan

“World’s Most

Livable Cities”

“The 100 best suburbs in every single state”

There is persistence with restaurants…

New York Michelin-starred

Restaurant 06 07 08 09 10 11 12 13 14 15

Le Bemardin

Per Se

Jean-Georges

Daniel

Masa

Eleven Madison Park

Brooklyn Fare

The Age Good Food Guide top hats: Melbourne

Restaurant 2011 2012 2013 2014 2015

Vue de Monde

Attica

Flower Drum

Café Di Stasio

Cutler and Co

Ezard

MoVida

…And with sport!

AFL preliminary finals Australian Open finalists (last five years)

2011 2012 2013 2014 2015

What about investments?

Asset class performance lacks persistence

Asset class performance lacks persistence

Source: Vanguard Investment Strategy Group analysis using index data from MSCI. Based on total return data in AUD.

2006 2007 2008 2009 2010 2011 2012 2013 2014

Europe JapanEmergingMarkets

EmergingMarkets

USAEmergingMarkets

Australia USA USA

EmergingMarkets

USA JapanWorldex AU

Australia Australia EuropeWorldex AU

Worldex AU

Australia Europe USAWorldex AU

EuropeEuropeEmergingMarkets

JapanEmergingMarkets

Worldex AU

AustraliaWorldex AU

Worldex AU

Worldex AU

AustraliaEurope Europe Australia

USA Australia USAUSAWorldex AU

USAJapan Australia Japan

JapanJapanEmergingMarkets

EmergingMarkets

Japan EuropeJapanEmergingMarkets

Europe

2015

USA

Worldex AU

EmergingMarkets

Australia

Japan

Europe

Investment persistence is rare

Top quintile funds in first 5 years and subsequent 5 year results:

Source: Vanguard calculations, using Morningstar, Inc data. .

30 %

15%15%

13%

16%

11%

0%

5%

10%

15%

20%

25%

30%

35%

Remainedin top

quintile

Fell to2nd

quintile

Fell to3rd

quintile

Fell to4th

quintile

Fell tobottomquintile

Liquidated/merged

Perc

enta

ge o

f Fu

nd

s in

Eac

h Q

uin

tile

With investments, low costs improve the odds of success

Percentage of Australian actively-managed funds that outperformed their benchmark, last 10 years

Source: Vanguard calculations using data from Morningstar Inc.

0%

5%

10%

15%

20%

25%

30%

35%

40%

Last 10 Years

Highest cost

Lowest cost

Adviser as a behavioural coach

60

80

100

120

140

160

180

Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 Apr-12 Jan-13 Oct-13 Jul-14 Apr-15 Jan-16

100% Fixed Income 100% Cash 50% Equity / 50% Fixed Income

February 28, 2009 -18.2%

Trough to Peak

93%

71%

27%

Loss aversion: Rebalancing is critical

Source: SPIVA and S&P Dow Jones Indices LLC, Morningstar. Data as at June 2015.

"Over the last 1-year, 3-year, and

5-year periods, the majority of

Australian active funds in all but one

category failed to outperform the

comparable benchmark"*

0.0

0.1

0.2

0.3

0.4

0.5

0.6

United States Australia

Risk adjusted returns of funds lag their benchmark

Fund returns

Policy returns

Source: Vanguard

Self-control: Performance chasing tends to disappoint

Difference between 10-year investor dollar-weighted fund returns in Australia

Sources: Vanguard calculations, based Morningstar, Inc. data.

-5.2%

-7.9%

-1.4% -1.4%

-9%

-8%

-7%

-6%

-5%

-4%

-3%

-2%

-1%

0%

Australian Large-Cap Australian Mid & Small-Cap Global Equity Multi Sector

Self-control: Performance chasing tends to disappoint

Source: Vanguard calculations using Morningstar data.

Historical Outperformance

Fund Turnover

Cost

×

×

Fund Size

Active Share

×

×

What characteristics actually predict outperformance?

Cognitive dissonance: Focus on what really matters

Where do we observe groupthink?

• Market and economic forecasts

• High levels of home bias in Australian portfolios

• Similar degrees of home bias in Australian portfolios

• High concentration in property

• High levels of cash in portfolios

• Low levels of fixed interest

Source: Vanguard

Groupthink: Resist the urge to follow the heard

-7.0%

-6.0%

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

Australian Equities Global Equities Emerging MarketEquities

Global Fixed Interest -Government

Global Fixed Interest -Credit

April 1990 - Present

Jan-16

Groupthink: Following herd can have consequences

Median return of various asset classes during the worst decile of monthly Australian equity returns

Sources:Vanguard, AUD, 1990-2016

01Implement

key principles for investment success

02Educate

on the importance of maintaining long-term

perspective and discipline

03Communicate

with clients frequently using empathy and understanding

04Promote

clients to take a big picture view

Advisers can help clients improve investment decision-making

What have we learned?

• The outlook is guarded, and volatility may continue, but

• Diversified and patient investors may be rewarded with reasonable returns, if

• Focus shifts from seeking outperformance to behavioural coaching and holistic Advice

Thank you

Connect with Vanguard®

vanguard.com.au

1300 655 205

Important InformationVanguard Investments Australia Ltd (ABN 72 072 881 086/AFS Licence 227263) (Vanguard) is the product issuer.

Past performance is not an indication of future performance. This presentation was prepared in good faith and we accept no liability for any errors or omissions. This presentation contains general information and is intended to assist you. We have not taken yours or your clients’ circumstances into account when preparing this information so it may not be applicable to the particular situation you are considering. You should consider yours and your clients’ circumstances, and our Product Disclosure Statements (“PDSs”), before making any investment decision or recommendation. You can access our PDSs at vanguard.com.au or by calling 1300 655 205.

Morningstar data ©2016 Morningstar, Inc. All Rights Reserved. Neither Morningstar, nor its affiliates nor their content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. Any general advice has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), a subsidiary of Morningstar, Inc, without reference to your objectives, financial situation or needs. You should consider the advice in light of these matters and, if applicable, the relevant Product Disclosure Statement before making any decision to invest. Neither Morningstar, nor Morningstar’s subsidiaries, nor Morningstar’s employees can provide you with personalised financial advice. To obtain advice tailored to your particular circumstances, please contact a professional financial adviser. Please refer to Morningstar’s Financial Services Guide (FSG) for more information www.morningstar.com.au/s/fsg.pdf.

© 2016 Vanguard Investments Australia Ltd. All rights reserved.

Disclaimer© SMSF Association 2016

This presentation is for general information only. The material and opinions in this presentation are those of the author and not those of the SMSF Association. Every effort has been made to ensure that it is accurate, however it is not intended to be a complete description of the matters described. The presentation has been prepared without taking into account any personal objectives, financial situation or needs. It does not contain and is not to be taken as containing any securities advice or securities recommendation.

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