Monday, June 25, 2012

Punters turn away from share investment

The return of the prudent consumer is being accompanied by the return of the risk-averse consumer. Households aren't only saving more of their incomes, they're saving more through banks and less through shares.

In the days when the public was less economically literate, many people had no conception of saving other than putting money in the "savings accounts" offered by banks. After a season in which we thought that was for mugs, saving through bank accounts is back.

In truth, the main way Australians saved was to take on a huge home mortgage, then pay it off over the next 25 or 30 years. By the time most people retired, most of their savings were embodied in the unencumbered value of their home.

And their outright ownership of their home was a big part of the reason they were able to scrape by happily enough on little but the age pension. Although the value of the pension has been rising in line with real wages for decades, ours is the first generation convinced it couldn't possibly live on the pension alone.

So it's probably just as well that, starting in the mid-1980s, employees have been compelled to save via superannuation. Super is now the chief rival to paying off a home loan as the main way Aussies save over their working lives.

Remember when John Howard was encouraging us to become "a nation of shareholders"? That was at a time when government-owned businesses such as the Commonwealth Bank and Telstra were being privatised and non-profit outfits such as AMP and the NRMA were being "demutualised", so many households acquired tiny shareholdings of this and that.

And, having taken the plunge, many then acquired shares in the more usual way. Well, owning shares directly is no longer fashionable. Of course, working households' indirect ownership of shares via superannuation increases as each pay day passes.

But, as the Reserve Bank observes in an article in last week's quarterly Bulletin, households have shifted their "portfolios" away from riskier financial assets, such as shares, and towards less risky assets, such as deposits. I'll be drawing from that article.

I've no doubt much of households' saving has taken the form of reducing debts and getting ahead on their mortgage repayments. There was a time when Aussies' highest financial goal was to repay the mortgage as early as possible. That goal is coming back into its own with the return of the prudent consumer.

I guess the chief motivation was a desire to be unencumbered but, as a tax-effective investment strategy, repaying the mortgage has always scored highly - exceeded only by negatively geared property or share investments.

Which brings us back to risk - and risk aversion. Between 2003 and 2007, the proportion of household financial assets held in shares (both directly and via super) increased from 35 per cent to 45 per cent.

Much of this increase came from capital gain. Total return on shares averaged about 20 per cent a year over this period, compared with average deposit rates of about 5 per cent. But then came the fall in wealth caused by the global financial crisis and the mild recession of 2008-09.

Between 2008 and 2011, there were net outflows from households' direct holdings of shares of $67 billion, while holdings of deposits rose by $225 billion.

It's likely people were reacting, on the one hand, to the large capital losses in the sharemarket, but also to the market's volatility, which has doubled since 2007.

But, on the other hand, people would have been reacting to the advent of much higher interest rates offered on bank term deposits as, in the aftermath of the global crisis, the banks bid up those rates in their competition to replace now-riskier overseas funding with more stable, "stickier" funding from domestic deposits.

Over the past 30 years, the average annual real return on Australian shares (including capital growth and dividends) has exceeded the average annual real return on deposits by about 5.5 percentage points.

Since 2008, however, that's been reversed, with a return on shares of minus 5 per cent versus 2.5 per cent on deposits.

The share of households' financial assets held directly in equities has more than halved from 18 per cent before the crisis to 8 per cent at the end of last year. In contrast, the share of deposits has increased from 18 per cent to 27 per cent.

That this shift has been driven mainly by households' greater aversion to risk is confirmed by the changed answers people are giving to relevant questions in the survey of consumer sentiment and other reputable surveys.

In theory, households have shifted to a less risky risk/return trade-off and, by doing so, are willing to live with lower returns over the longer term. But whether the "equity premium" - the much higher rate of return on shares relative to fixed-interest securities - will stay as high as it's been in the past is open to doubt.

The equity premium has always looked much healthier over long periods than it has over many shorter periods, meaning people in or approaching retirement shouldn't be too mesmerised by it and should be favouring more stable returns.

So the shift from shares to deposits may well be explained partly by the baby boomers' rapidly approaching retirement.

The big super funds have also shifted their mix away from shares to some extent, though they've done so by less than the self-managed super funds, suggesting they're more wedded to "equity" than they ought to be.

Why might that be? Well, part of the problem is that the dividend imputation system means share returns are more favourably taxed than fixed-interest returns. Not good.