In uncertain times, where markets become more volatile, a common theme or solution presents itself: a “flight to quality” mentality wherein investors, business owners, and other decision-makers prioritise investment in more secure assets with lower risk profiles. This typical behavioral pattern is seen in even the most challenging economic climates, and it’s a testament to how businesses strive not just to survive difficult periods – but to come out of them in a better position than before.
Companies with strong leadership actively seek out strategies that will control their destiny and attain positive returns despite any challenges they may face. In an ever-changing market, the flight to quality is an effective tactic for achieving such stability.
An AFR article published in August 2023 in conjunction with the Australian Institute of Company Directors (AICD), highlights that there is an understandable level of trepidation among Australia’s company directors about navigating the road ahead in FY24. The combined impact of inflation, higher interest rates, geopolitical uncertainties, climate change and technological disruption are making for challenging and uncertain times.
Although the latest AICD Director Sentiment Index (DSI) shows some glimmer of cautious optimism, albeit off a low base, confidence about the economic outlook still remains in negative territory.
Fundamentally what the Index points to is a complex landscape that won’t be easily traversed. The DSI shows directors anticipating a further weakening in the economic outlook over the coming year, with the economic environment throwing up major challenges on multiple fronts.
The AFR highlights that these challenges include skills shortages, inflation and interest rates, cyber security and issues of regulation and compliance. These have been identified as some of the priority areas for the AICD as it develops the FY24 agenda to ensure its members are constantly informed, updated and fully represented in the policy debate.
In Australia’s flight to quality, many sophisticated investors are turning away from riskier investments and instead focusing more on three strategies:
These strategies are collectively bringing Australian markets back to reality. With the cost of capital having sat at near zero for almost a decade, the economy was full of projects that did not make financial sense. With risk-free rates now sitting at a comfortable 4% in Australia, the financial bar is now set at a level that ensures only projects with a clear path to profitability are cleared, cleaning the Australian economy of inefficient, non-sensical projects.
For companies that kept an eye on fundamentals, this “flight to quality” is a welcome return to normal from a period that rewarded careless spending. For companies created out of the zero cost of capital environment, the flight to quality will continue to be a brutal reality check.
The current “flight to quality” will serve to benefit the Australian economy and savvy investors who are resilient. The combination of obtaining sound investment advice and continued confidence in the scale of the Australian economy will provide apt opportunities to deploy capital.
While there are still many question marks about what will happen in the next 12 to 24 months, SeventyTwo feels confident that the flight to quality will serve as an advantage for markets, and one that will assist with the challenges of this volatile period of the economic cycle.