The perils of late-cycle investing


Perpetual Private Insights

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For over a year, we’ve been talking to clients about what to expect from their investment portfolios during the latter stages of the business cycle. We ask Kyle Lidbury, Head of Investments Research at Perpetual Private to shed light on what is a ‘late-stage cycle’ and what this means for investors.

Q: What does it mean to be in a late-cycle or late-stage cycle?

Late-stage markets are typically characterised by slowing economic growth, declining interest rates (as stimulatory measures are taken) and a general decline in the quality of company balance sheets, as firms take on more debt in response to the lower rate environment.

Q: What does this mean for portfolios?

Higher levels of debt actually help to support continued strength in company earnings growth. However, higher debt also leads to higher valuations, which can cause higher volatility in securities prices. Lower rates can result in greater correlation between asset classes: stock prices are supported through both earnings growth and valuations while bond prices rally (as yields fall). As the market overheats, bond prices then drop against a potential backdrop of rising rates and increasing inflation expectations. This can be challenging because if asset classes move together, investors lose some of the benefits of diversification in their portfolio leaving them more exposed to the risk of downturn in the market.

Q: Why is late-stage investing challenging – and what level of return can investors expect?

Late-stage cycle investing can be a difficult and complex environment to invest in. We’ve seen significant volatility in markets, as demonstrated by the sell-off in equity markets during the last quarter of 2018. Investors have felt nervous and uncomfortable, which runs counter to the fact that we’ve seen some of the strongest equity market returns in years.

In terms of recent performance, Australian and global shares have delivered rolling annualised returns of 19.5%pa. and 15.83%pa. respectively1. These asset classes have outperformed our average long-term return expectations of about 8%pa. Even if markets are flat over the next two months, these 12-month numbers will get even stronger as the poor quarter of 2018 won’t be included in the rolling 12-month returns for November and December 2019.

Q: Given we’re late cycle, has your investment philosophy changed?

No. At Perpetual Private, we believe that picking the end of the cycle is extremely difficult. In fact, we are yet to see many fund managers that can consistently and accurately pick market cycles over the longer term. That’s why we don’t advocate highly active asset allocation moves, where the costs of execution and the risks of being wrong can have profound implications for portfolio returns over the long term. Since many of our clients rely on sustainable and growing income streams in order to support their lifestyles in retirement, we take an opportunistic but long-term approach to investing.  This has not changed.

Q: Should investors move to cash in order to protect portfolios?

When investors experience negative returns, the ‘need to react’ often takes the form of selling out of equities (after incurring losses) in an effort to protect their portfolios. Investors need to recognise that there are actually two questions to be answered – not just ‘when to sell’, but also ‘when to buy back in’.  Investors who sold at the end of 2018, after one of the worst drawdowns in equity markets since the GFC, would have found buying back into markets extremely difficult during the strong rally over the first half of 2019. With the benefit of hindsight, had investors simply done nothing and maintained the course, their losses would have been completely recouped in the first quarter of 2019 and delivered a healthy annual return of about 11% for the year ending June 2019 (for Australian equities). Protecting portfolios is more often about maintaining the course as opposed to trying to react to events after they’ve already happened.

Q: What’s your approach to asset allocation and portfolio construction?

Acknowledging the challenge of not being able to accurately time the market, we tend to keep broader asset allocations largely stable through time. Our approach seeks to employ fundamental, bottom-up active managers within each asset class that can re-position portfolios in response to markets in order to manage downside risk as the market cycle progresses. Over the last few years, we’ve repositioned client portfolios to be more active in this volatile environment. We have included more active management and unconstrained managers in our fixed income allocation, in order to generate a higher level of active returns during the current low rate environment, as well as manage the growing risks in this asset class.

Q: What opportunities are you currently investing in?

We have moved out of quantitative, passive strategies in shares to 100% active fundamental, unconstrained strategies, maintaining a focus on downside risk so that portfolios don’t just ‘follow the market down’ when shares correct. We have moved away from real estate investment trusts (as core property valuations have become inflated) in order to focus on more active, value-add real estate strategies. Overall, we have invested an increasing proportion of our time and energy in alternative assets, looking for active strategies in inefficient markets where managers can exercise their competitive advantage and generate true skill-based returns irrespective of the market cycle.

Q: Any advice for investors?

The late-stage business cycle can arguably be one of the trickiest and most complex phases of the market for investors. As volatility increases and market dislocations become stretched, human behaviours compel investors to ‘react’ to market sell-offs – potentially leading to a significant impact to portfolios. By maintaining the course and employing an active, fundamental approach to security selection and market opportunities, investors can have increased confidence to stay invested; taking comfort in the knowledge that as the cycle ages and comes to its conclusion, their portfolios are well-positioned to take advantage of opportunities that market corrections can ultimately provide.


Perpetual Opportunities Funds

Kyle Lidbury, Head of Investments Research at Perpetual Private manages the Perpetual Income and Growth Opportunities Funds. For more information about these products, visit our information page: Perpetual Income Opportunities Fund


1. Australian shares benchmark: Australian S&P/ASX 300 Accumulation Index; Global shares benchmark: MSCI All Countries World Net Return (AUD), as at 30 September 2019. Past performance is not a reliable indicator of future performance.


If you’re an investor who wants to learn more about the income and growth opportunities of investing in a late-cycle, it may be worth talking to your Financial Adviser about the Perpetual Private Opportunities Funds – or calling Perpetual Private on 1800 631 381 to find out more.

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Perpetual Private advice and services are provided by Perpetual Trustee Company Limited (PTCo) ABN 42 000 001 007, AFSL 236643. This information was prepared by PTCo. It contains general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.