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  • 1. Introduction to investments The material in this presentation is for information purposes only – your personal financial situation was not taken into account when preparing this presentation and we recommend you seek professional financial advice before making any investment decisions. Welcome to the Aon Master Trust’s online learning program. The information contained on the Aon Master Trust website, including these education modules, is general in nature and has been prepared without taking account of your personal objectives, financial situation or needs. Before you make any decisions about your super you should read the relevant Product Disclosure Statement and consider seeking independent financial advice from a licensed adviser. The trustee and Aon Corporation will not be liable for any loss or damage arising from any inaccuracies, errors or omissions in information made available through these modules. © 2009 This work is copyright. Apart from any use permitted under the Copyright Act 1968, no part may be reproduced by any process nor may any other exclusive right be exercised without the permission of Aon Consulting Pty Limited. Aon Consulting Pty Limited (ABN 48 002 288 646, AFSL 236667) is a related body corporate of Aon Superannuation Pty Limited (ABN 83 057 982 822, AFSL 237465), the trustee of the Aon Master Trust (ABN 68 964 712 340). 1
  • 2. Introduction to investments Risk and return Asset classes Defensive and growth assets Asset class performance Managing risk through diversification Index and active investment The impact of inflation This module explains many of the fundamental investment concepts like risk and return, asset classes, diversification, and inflation. 2
  • 3. The basic investment tradeoff – risk versus return Emerging markets Higher risk, higher return SHARES Medium risk, medium return Return PROPERTY Lower risk, lower return FIXED INTEREST (or bonds) CASH Money in bank Risk The fundamental investment principle is that you can only earn a higher return if you take more risk. To put this another way, if you want to reduce your risk, you must be prepared to accept a lower return. For example, if you put all your money in the bank, your return will probably be very low but you have the comfort of knowing that the amount you deposited will always be there. On the other hand, if you put all your money into emerging markets, your return could be very high for one or two years, then very low and quite possibly negative the next. In other words, your returns, particularly over the short term, are likely to be very volatile. Neither of these investments is necessarily right or wrong. Whether you invest your money in cash, fixed interest, property or shares depends on what type of investor you are – more conservative or more aggressive. This depends on things like your age, income, savings and personal preferences. 3
  • 4. Asset classes AGGRESSIVE Shares ASSERTIVE • Part ownership • Capital gain + dividends BALANCED • Potentially very risky Property • Highest average Return long-term returns CAUTIOUS • Access to range of property • Listed property trusts • Capital gain + rent CONSERVATIVE • Potentially risky investment Fixed interest • A ‘loan’ agreement Cash • Interest plus principal • Instant access, security • Price reflects interest rates • Low return BUT low risk • Lower risk / lower returns • Short-term timeframe • Interest but no capital gain • No inflation protection Risk The main asset classes are cash, fixed interest, property and shares. The Aon Master Trust also invests in alternative assets (for example in its sector options). Cash offers instant access to your money, a high level of security and, historically, the lowest return of all asset classes. It is usually the best option when you have a very short investment timeframe and you want a stable return. Although cash is considered to be a very low-risk investment, it offers little protection against inflation. Fixed interest or bonds are a loan agreement between a borrower and a lender. Fixed interest investors receive regular interest payments plus their original investment at maturity date. Bond prices fluctuate according to movements in interest rates. If interest rates rise, then bond prices fall and vice versa. Although bond prices fluctuate, they are generally less volatile than property or share prices and for this reason they usually offer a lower return. Property trusts allow smaller investors to pool their money and invest in large-scale, professionally-managed property assets. Property trusts offer capital appreciation from rising property values and income from rent. Property can be a risky investment because property prices fluctuate. Property trusts that are listed on the share market are not only subject to movements in property prices but also to movements in the share market itself. Shares provide investors with the potential for capital gain from rising share prices and income from dividends. Share prices can also fall so share investors must be prepared for the chance of short-term losses. Over the long term, however, shares have delivered the highest average returns. Alternative assets typically include hedge funds, private equity and infrastructure. Hedge funds use specialist investment strategies to trade shares and fixed interest assets. Private equity investments are made in companies not listed on a stock exchange. Infrastructure investments include utilities and other physical assets. These funds aim to achieve positive returns in both rising and falling markets and are typically included in diversified portfolios to reduce exposure to risk over longer time frames. Superannuation funds tend to invest in the main asset classes in different proportions so that generally speaking, all types of investors – from the more conservative to the more aggressive – will find a suitable investment option. 4
  • 5. Defensive and growth asset classes Asset class performance 10 yrs to 31 Dec 08 (% pa) 7.5% 7.0% 6.2% 5.8% 2.5% Defensive assets Growth assets 0.0% -2.0% Cash Aust fixed Int’l fixed Listed Aust Int’l interest interest property shares shares The asset classes are broadly divided into defensive or income assets and growth assets. Defensive assets include cash and fixed interest investments. They’re called defensive because their returns are generally more stable than growth investments. All the return from cash is in the form of interest. There are no capital gains, and therefore no capital losses, on cash. You can make a capital gain from some longer-term fixed interest investment such as government bonds, but the regular interest payments are still the main attraction of fixed interest investments for most investors. Growth assets include shares and property and they are called growth assets because historically, the bulk of their return has come from increases in their price. They also provide some income in the form of dividends from shares and rent from property, but this is typically a smaller proportion of the total return over the long term. Over the long term, growth assets tend to offer a higher return than defensive assets, which reflects the increased risk of investing in shares and property. This higher return can make a big difference to long-term investments like superannuation. The weak performance of growth assets over the 10 years to 31 December 2008 reflects the great uncertainty stemming from the global financial crisis of 2008. Please note that past performance should not be considered a guide to future performance. This graph uses the following market indices: Australian shares: S&P/ASX 200 International shares: MSCI World ex-Australia index in A$ Listed property: S&P/ASX 300 Listed Property Trust Accumulation Index Australian fixed interest: UBS Composite Bond Index Global fixed interest: Citigroup World Govt bond Index hedged in A$ Cash: UBS Bank Bill Index 5
  • 6. Asset class performance (value of $1,000) Markets are affected by political and economic events and ups and downs are a fact of life for investment returns. This graph shows the performance of the different asset classes over the 20-year period 31 December 1988 to 31 December 2008. The share and property markets have had a bumpy ride while the cash and fixed interest markets have been comparatively stable. The strong bull market in Australian shares and property in the early years of this century reversed dramatically as the global financial crisis emerged in 2007 and 2008. Please note that past performance should not be considered a guide to future performance. This graph uses the following market indices: Australian shares: S&P/ASX 200 International shares: MSCI World ex-Australia index in A$ Listed property: S&P/ASX 300 Listed Property Trust Accumulation Index Australian fixed interest: UBS Composite Bond Index Global fixed interest: Citigroup World Govt bond Index hedged in A$ Cash: UBS Bank Bill Index 6
  • 7. You just can’t pick it This year’s winner could be next year’s loser Investors are constantly reminded that past returns are no guarantee of future returns. This graph shows how a market can go from best to worst performer, or from worst to best, in just 12 months. It can be a real roller-coaster ride - look at Australian shares between 1990 and 1994. The lessons here are: this year’s winner could be next year’s loser trying to pick the winners is a risky practice spreading or diversifying your money across different investments reduces that risk and helps smooth investment returns. Please note that past performance should not be considered a guide to future performance. This graph uses the following market indices: Australian shares: S&P/ASX 200 International shares: MSCI World ex-Australia index in A$ Listed property: S&P/ASX 300 Listed Property Trust Accumulation Index Australian fixed interest: UBS Composite Bond Index Global fixed interest: Citigroup World Govt bond Index hedged in A$ Cash: UBS Bank Bill Index 7
  • 8. Growth assets can mean volatility 41.6% Minimum and maximum returns 45.4% 1988 - 2008 34.0% 24.7% 20.1% 18.4% 4.8% -2.6% -4.7% -27.4% -38.4% -55.3% Cash Aust fixed Int fixed Listed Australian International interest interest property shares shares People tend to concentrate solely on return when they are evaluating their investment options. But the RISK of the investment, which refers to the extent to which returns fluctuate from year to year, is equally important. The chart shows the highest and lowest returns recorded by the major asset classes over the 20-year period December 1988 to December 2008. The volatility, as indicated by the difference between the highest and lowest returns, is clearly evident. Cash is the least volatile but tends to offer the lowest return while shares offers the highest potential returns but are the most volatile. In the third quarter of 2008, highly-geared listed Australian property securities continued to feel the fallout of the credit crisis - this is reflected in the worst single-year return over this 20-year period. The lesson for investors in all this is to think about what’s more important to you – the opportunity to earn higher returns and the likelihood of a bumpy ride, OR more stable but lower returns and a good night’s sleep. Please note that past performance should not be considered a guide to future performance. This graph uses the following market indices: Australian shares: S&P/ASX 200 International shares: MSCI World ex-Australia index in A$ Listed property: S&P/ASX 300 Listed Property Trust Accumulation Index Australian fixed interest: UBS Composite Bond Index Global fixed interest: Citigroup World Govt bond Index hedged in A$ Cash: UBS Bank Bill Index 8
  • 9. Types of investment risk (volatility) Mismatch Legislative Diversification The investment you Your investment could All your capital could be choose may not be be affected by changes affected if you invest in suitable for your needs in current laws and a single asset class and circumstances regulations Inflation Credit INVESTMENT The purchasing power Your interest payments of your money may not or your capital may not RISK match inflation be repaid Liquidity Interest rate Market You may not be able to Your expected income Investment markets access your money might not be available if might move suddenly quickly or without cost interest rates move and unfavourably when you need to unfavourably There is no single type of investment risk. Rather, there are many different types of risk that together make up investment risk. For example, you may choose investments that aren’t suitable for your particular circumstances, sometimes called mismatch risk. Then there’s the risk you may not get your money back, or you may not be able to get it quickly, or legislation might change, interest rates could go up or down, you may not have spread or diversified your investments sufficiently, inflation could erode your purchasing power, or investment markets might move unfavourably. As an investor, you’ll never be able to avoid these risks entirely but with the right advice, they can be managed. 9
  • 10. Managing risk through diversification Diversified investment Investment A Return Investment B Diversification 1. Across asset classes 2. Within asset classes 3. Across managers and manager styles Years Years Even professional investment managers cannot accurately predict the future direction of investment markets. So rather than take a bet on which asset class will perform best, a better strategy is to spread your money across all the different investment types. In this way, you will reduce the impact that a poor performance in one particular sector will have on your overall return. The theory says that by diversifying your investments, you will benefit from some investment ‘ups’ while avoiding the worst of the ‘downs’. There are a number of ways to diversify your investments. You can spread your money across asset classes – for example, by putting some money in both shares and cash. There are different sectors within the share market such as banks, mining, retail, food and household goods and so on. There are also different share market managers who have different investment styles so you can spread your investment across managers as well. The whole idea of all this spreading or diversification is to make sure that if one asset class, or individual investment or individual investment manager doesn’t work out, then all isn’t lost because you had all your eggs in the one basket. 10
  • 11. Pre-mixed investment options HIGH GROWTH Growth 100% GROWTH Defensive 15% Growth 85% BALANCED Return Defensive 30% Growth 70% CAPITAL STABLE Defensive 70% Growth 30% Growth assets Defensive assets SECURE Australian shares Aust. fixed interest Defensive 100% International shares Int’l fixed interest Property Cash Alternative Alternative Risk One way to make sure your investment is diversified is to invest in a pre-mixed investment option. Pre-mixed investments typically hold a mix of defensive and growth assets. The pie charts show the strategic asset allocations for the Aon Master Trust’s Pre-mixed investment options: • Secure and Capital Stable hold a greater proportion of defensive assets. • Balanced, Growth and High Growth hold a greater proportion of growth assets. Please note that actual allocations may vary from strategic allocations. Most investors, regardless of whether they are more conservative or more aggressive, will usually find a pre-mixed option suitable for their particular investment profile. 11
  • 12. Index and active investment Index – seeks to track performance of relevant index – sometimes known as ‘passive’ – typically a lower-cost approach. Active – uses research, active portfolio management and trading strategies to outperform benchmark – typically a higher-cost approach than index. Major considerations when investing include how a fund manager can add value to exceed an underlying market index or benchmark, the risk undertaken by the manager, and the management fees. Index fund managers seek to track the performance of a stock index. For example, the Australian Shares – Index option is designed to closely match the performance of the S&P/ASX 200 Accumulation Index for Australian shares. Index managers typically charge less than active managers. See also Understanding performance – an outline of how performance has been affected by the 2008 credit crisis in ways you may not expect. Active fund managers aim to outperform their benchmark by using research, active portfolio management and trading strategies. There is a risk, especially over short time horizons, that an active manager may underperform the relevant market index. Active fund managers typically charge more for taking this approach, but believe potential improved investment performance will justify the cost. 12
  • 13. Inflation – a powerful enemy IMPORTANT From an investment point of view, the $100 quot;realquot;, after-inflation $90 return is the most Purchasing power $80 important because this figure determines $70 what your money will $67.30 $60 buy Rate of $50 $45.60 inflation $40 2% $31.18 $30 4% $21.45 $20 6% $10 8% $0 1 5 10 15 20 Years Inflation is the rise in the price of goods and services and if it is not managed properly, it has the potential to undo much of the good groundwork laid down by compound interest and regular saving. If the price of goods and services rises faster than your income, both your purchasing power and your standard of living will fall. Inflation in Australia has been relatively low in recent years, compared to the high inflation rates of the 1970s and 1980s. Over the 10-year period to September 2008 inflation has averaged just over 3% per annum. But no one can predict where inflation will go in the future. One way to offset the impact of inflation is to have at least some of your money in growth assets such as shares. This is because the price of growth assets, like the price of any asset, tends to move in line with the general rise in prices, so the rate of inflation will also boost the performance of growth assets. From an investment point of view, the ‘real’, after-inflation return is the most important because this figure determines what your money will buy. In Australia we use the Consumer Price Index (CPI) to measure inflation. 13