Tuesday, 03 September 2019 15:00

The Best of the Best - August 2019

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Montgomery Investments team have prepared anohther bumper issue of "The Best of the Best".

This edition includes:

  • The 2 big themes for Aussie Investors
  • Risk perception for the modern investor
  • Do we view Brambles as a high quality investment?
  • Does Challengers announcement imply good news


Click on the image below to access the report.

Raymond Dalio (born August 8, 1949) is an American billionaire investor, hedge fund manager, and philanthropist.[3] Dalio is the founder of investment firm Bridgewater Associates, one of the world's largest hedge funds.[4] Bloomberg ranked him as the world's 58th wealthiest person in June 2019.[5]

What Ray Dalio says matters.  For further perspective we know that successful Australian global investor, Hamish Douglas (Magellan Financial Group) seeks Ray Dalio's views on a regular basis.

Ray Dalio has been involved with China for decades.  He assisted China estabilsh their stock market.  In this video he discusses the current trade tensions between China and the US and sees them as a natural development.

He also puts the rise of China in perspective by comparing it against the rise of the UK and US in history. 

Ray Dalio believes that the biggest risk for investors is not having exposure to the Chinese economy.














Jim Haskel:
I'm Jim Haskel, senior portfolio strategist. I'm here with co-CIO Ray Dalio and the subject today is China. And Ray, you've been going there since 1984, a lot of experience, China in the news today in many different regards. Can you walk us through a little bit about your experiences and how you've seen China evolve over the last 35 years?

Ray Dalio:
I've been able to go to China since 1984 and participate and see the evolution. Yeah, and it's been quite something. The first time I went, I was invited by CITIC, which was called a window company then, which was the only company that was allowed to deal with the outside world, and they were curious about the world financial markets. I was invited there.

At the time, the city was mostly Hutongs, which are small neighbourhoods, poor neighbourhoods. I remember speaking in their office building, called the Chocolate Building, and looking outside, and we were talking about opening up. And at the time, I knew what opening up would mean. The rest of the world had a cost and level that was here and China had a cost level there, and if they could eliminate their inefficiencies, it would go like this.

And so, I looked out there and I said, "You'll see those Hutongs become replaced by skyscrapers and so on." And they told me, "You don't know China," but that force and their character and the creativity that they exhibited took them to what is the greatest economic miracle of all time.

To put that in perspective, per capita income since then increased by 26 times. The share of world GDP went from 2% to 22% today, so it's a comparable power of the United States. The poverty rate went from 88% to less than 1%. And the life expectancy increased by 10 years. There're many, many others, and capital markets, very big changes.

But I never went for making money, I went for curiosity, you know? And that curiosity brought me in contact with the Chinese people who I really, really came to love and admire. The character of them, what type of relationships that they value, all of those types of things.

And I could see that character, and I was able to, over those years, build friendships, I was able to contribute in some small ways to the development of the financial markets and see it. And I remember these people, I have a great old group of friends who were the first pioneers to set up the stock market there.

There were seven companies, each had a representative, and it was in a dingy hotel, and these people were to form the stock market and the financial markets, and so evolved, and that evolution was an intimate evolution in which I brought my family, I brought my kids.

I remember bringing my son, Matthew, when he was very young, along and we would go in, and we'd have meetings, and they'd bring cookies and milk, and he'd be there, and he ended up going to school there when he was 11. It was a whole different world. He lived there.

And that whole different world, just to give you an idea of technology, you know where they are in technology now, which is comparable in many ways to the United States, when I went, I would bring them, as gifts, $10 calculators that they thought were miraculous.

I've gotten to know the people. I go there because I like and admire the people, and I've done that for 20 years or more before we ever did anything commercially.

Jim Haskel:

And so, we're sitting in a time now where China has evolved in a big way, and I wonder, just from your perspective, as an American who's gone to China for years and years and years, how do you make sense of this growing conflict that you've written a lot about between China and the United States? What do you think is the root cause of that?

Well, it makes total sense in a historical context. You know, I've been studying economic history, I used to study what the last 100 years is, and recently, because I wanted to study the rises and declines of reserve currencies, I've studied the last 500 years carefully, and I've looked at the last thousand years.

What I've seen over and over again is that when there's a rising power challenging an existing world power, that there is going to be a conflict. There's a global order, world order, and the way that usually happens is there's a conflict and there's a war quite often, and then after the war, whoever wins the war gets to set what the global world order is.

And then you have a period of peace because no country wants to fight that country until there's a rising power challenging an existing power again. That's happened 16 times in the last 500 years, and in 12 of those times, there's been wars, and sometimes you get around them. I'm not saying this is going to be a war, but I think it's a natural development in terms of China growing, expanding.

We have a small world and it's a big country, and we're going to bump into each other, and so it's that natural conflict. And then the question is how it's best dealt with, but I think just a natural evolutionary step.

Jim Haskel:

And you've sort of put the framework around this where trade is just the symptom of this broader conflict, whereas trade is always in the financial news, but it's really just one symptom. There's also military posturing, there's other elements of this whole conflict.

Ray Dalio

Sure. History has shown us that there's this pattern. I'll describe the pattern. We're now living in a US dollar reserve currency world, so I want to look at the US dollar and the US empire. Before that, I wanted to look at the UK and the British empire, and then before that, I wanted to look at the Dutch empire, and I wanted to follow them in their various dimensions.

I read all of those stories. I looked through the numbers and I read the stories, and I could see that the stories would repeat, the same basic stories. The charts on this page show six major measurements of power.

  • The first is technology and education. 
  • Second is output, how strong the economy is. 
  • Third is trade. 
  • Fourth is military. 
  • The fifth is the strength of the financial centre. 
  • And the sixth is reserve status.

What we did is to stitch together a whole bunch of statistics so that we could measure each one of those. And so, they go back to 1500 and you could watch the cycle repeat over and over again.

This next chart shows the averages of these rises and declines by each of the factors, and I think they tell the story pretty well as to what a classic rise and decline of the empires and reserves currency status is. For example, the Dutch, back in the 1600s, late 1500s and early 1600s, invented ships that could go all around the world.

And because Europe fought a lot, they put arms on the ships, and then they could go all around the world, and the world was their oyster. They could bring back great things. And they then increased their share of world trade to be 50% of world trade.

And when they went global, typically through their businesses, Dutch East India Trading Company, they had to be enabled with military to protect their trade routes, and they developed financial empires.

As a result, we saw not only trade grow, we saw the military grow, we saw them carry their reserve currencies around, and because they were used so commonly, they became world currencies and that's what made them world reserve currencies.

And as a result, they also developed financial centres because they developed capital markets, money came from around the world to invest through those capital markets in those currencies in those businesses that were their businesses and other businesses, so they developed financial centre. Amsterdam was the centre of world cap financial markets as a result of that.

And as a result, they built their trade and their commerce together. They quite often, then, over a period of time, there were forces that led to their decline, and those forces were typically a combination of higher levels of indebtedness, others gaining competitive advantage.

For example, the Dutch ship builders were hired by the English to learn how to build great ships that would carry them around the world, and there was a change in technology, and there was really not much of a difference between the businesses, the technologies, and the governments in terms of making those things happen.

For example, the British East India Trading Company had a military that was twice the size of the British military, and they were the ones that conquered India and so on. I just put together the averages of those forces so that you could just see, let's say, the average power, and it goes back to 1500.

And you could see the blue line is the United States, and you could see its rise and then its relative decline, and you could see the emergence of China to be almost a comparable power.

You look at the red line over a period of time and you could see going back to 1500 that China was always one of the highest, most powerful country, or one of the most powerful countries, until they had the decline from about the 1800 period, but you could see that emergence. And so, to me, this is all very classic.

Jim Haskel:
Now, if you bring this back to the current conflict between the United States and China, I think what's so interesting is that you also believe that global investors must look at China and explicitly start to consider whether China should be part of their portfolios. And so, it seems kind of interesting. We're talking about an emerging conflict, but we're also simultaneously talking about there's really some merit for China to be a component of a global portfolio. Give us your perspective on that and why.

Ray Dalio

Think about it. 

Would you have not want to invested with the Dutch in the Dutch empire? 

Would you have not wanted to invested in the Industrial Revolution and the British empire? 

Would you have not wanted to invested in the United States and the United State empire?

I think it's comparable. Would you not want to invest in those places? And look at the growth in the markets. Over the last 10 years, the stock markets in China has increased, market capitalization, by a factor of four. The bond markets, combining both the government and the corporate bond markets, have increased by a factor of seven. And they're each the second largest markets in the world.

And I've had plenty of contact with those markets and with those people, the regulators and so on behind them, and I have a lot of admiration for that. I also believe in diversification. Yeah, I believe that China's a competitor of the United States, or Chinese businesses with be competitors of American businesses and other businesses around the world, and that you're going to therefore, you want to be, if you're diversified, having bets on both horses in the race.

And then I think, from investing over the years, I've been doing this for a long enough period of time to know that there's a tendency of bias not to do the new things. When I first started, we were at the end of an era where pension funds invested mostly in bonds.

Okay, then they thought it was bold to go to equities, then they thought it was bold to go to international equities, a lot of people argued against going to global equities, and so on. Emerging market equities, and emerging markets, all of that was considered to be bold.

And so, the thing that people haven't yet done, seems like the big risky thing, where, in my opinion, going where the growth is and also having the diversification is a smart thing to do.

Jim Haskel:
When you consider the merits of that, even if you agree with what you're saying, is now the time when the trade part of the conflict may be getting even more serious because we're moving from tariffs into things like supply disruptions, and export interruptions, and prevention of particular exports? Is timing an issue, or do you ignore that completely?

Ray Dalio:
Well, the markets, as you know, are always discounting timing, right? If you have a new, good thing happens and the markets rally, if you have a bad thing that happens and the markets sell off, and so the markets kind of reflect, broadly speaking, the ebbs and flows and the good and the bad.

And so, if you wait for everything to be crystal clear, everything's going to be terrific, you'll pay a higher price than if you don't. I think the real question is, are we going to go to war? If we go to war, then we're in a different world.

I don't think we're going to go to classic war, I do think there's going to be a restructuring of the world order in terms of changes in supply chains, there'll be changes in who's making what technologies, important changes and sort of those things. But I don't think that that's going to mean that there won't be the evolution of China, the evolution of the United States, and I think that that diversification is good.

Yes, I would say that now is the time. The reason now, now is the time that it's opening up. Now, you could be early or you can be late. I think that it's better to be early because, as you know, the inclusion and the MSCI indexes and other such things are meaning that they're opening up, and that will accelerate, those percentages will keep rising.

And so, do you want to be early or do you want to be late? It's better to be early that it is to be late. And I think, also, it's a time for diversification.

Jim Haskel:
Right. Investing in China can be a risky thing to global investors, that's the way they perceive it. How do you think about that relative to the other risks they're already carrying in their portfolios?

Ray Dalio:
I think that every place is risky. We're talking about relative risk, okay? 

I think Europe is very risky. When monetary policy is almost out of gas, and we have political fragmentation, and they're not participating in the technology revolution, and I can go on and on as to why I think Europe is very risky.

I think the United States is very risky in its own ways, having to do with the combination of the wealth gap, the political system, the conflict between socialism and capitalism that'll be part of our election, the fragmented decision making, so many different things, and the absence of the effectiveness of monetary policy.

I think emerging markets, in their own ways, have their own distinct risks, and I think that China has its own particular, distinct risks, which are all different. When I look at it, I think that it's less, or no more, risky in the totality than other markets, and I think what is most risky is not to have a good diversification of those markets.

In addition, the Chinese have more ability to deal with monetary and fiscal policy relative to the United States. I'm not saying everything's a plus, there're pluses and minuses. But as you know, one of my big concerns, and I've got a number of big concerns about the United States and some of the issues that are facing the western economies, and among those are the inability of central banks to be as effective when interest rates get to zero and quantitative policies, quantitative, monetary easing is not as effective.

Let me pause on that and touch on that. If you look at the difference in interest rates to zero and the capacity of fiscal policy to be coordinated, they have a lot more room to be managing those things, and they are managing. I mean, I don't know how long I've heard everybody say, "Okay, the debt problem is going to be a problem there," and so on.

Again, I'd suggest you read the dynamics of my book about the nature of debt and what countries can do when the debt is in their own currency. I also think that not investing in China is very risky. I mean, think about it. Here we are in the early part of 21st century and there's this emergence of China. Do you really want to make the decision not to invest in China and not to be there in the future?

Look, I believe every place is risky. I'm very risk-focused. I tend to see things that are going to go wrong. I have an inclination to do that. I think every place is risky, which is why I like the notion of diversification. I just want people to see China objectively.

I know, over this past number of years, that I have been very pro-China, very bullish on China, in its various ways, and people say, "Why are you so bullish on China?" And I know it's very controversial to be, particularly in this time, to be very bullish on China.

I just want to let you know that I'm sincere. Okay? I've been there. Because I hope you know by now that my main objective is to be as accurate as I possibly can. Yeah, I really admire what is being done, and I want to be a part of it, and I think our investors should be a part of it.

Jim Haskel:
I want to ask you about the best way to actually invest in China. What we see is that most of the portfolio flows go to either the private equity markets or the public equity markets, and that's a little countered to your framework of how you invest across time and throughout the world. How would you think about best approaching the Chinese markets as a new investor?

Ray Dalio:
Well, I wouldn't think of it as being any different than in any other place. Public markets and the liquid markets are going to allow all the advantages that they allow, and the private markets are going to allow all the advantages that they allow.

The public markets are going to provide the liquidity, the diversity, the ability to move positions around and rebalance and so on, which is very important to us. And then the private markets, let's say the venture markets, expose one to the new technologies and the energy that's happening in terms of entrepreneurship and young technologies there, and I think that's important.

I think there's an awful lot of money that is chasing those venture capital investments, and then I think there's a whole lot of opportunity. I would say it's a reflection, really, of how that country has changed. Wow. From my $10 calculator days, to see what the mind-blowing technologies are.

To put that in perspective, they're now the number one country in fintech, number three in AI and machine learning, number two in wearables, number two in virtual reality, number two in educational technology, number two in autonomous driving, and they are wanting fast to be number one in those industries.

They now account for 34% of unicorns in the world, by comparison the 47% in the United States and only 19% in the rest of the world. And in terms of ... That's when they start as unicorns. If they take the share of unicorn value, it's 43% versus 45% in the United States and only 12% in the rest of the world.

If you're looking at venture, I think you've got to be there, so I think it would be important not to miss out on those. As far as the public equity situation, it's analogous. You could see the market capitalization accelerating in the stock, bond, corporate bond markets, all of their instruments, and you could see the foreign flows coming in at an accelerating pace.

You can expect those markets to be bigger than the markets that we have anywhere in the world with time, and they will serve a similar purpose. As far as, let's say, the legal regulatory system, it's advanced, but it hasn't advanced as much as some of the developed countries, but it is more advanced and developing at a fast rate than most of the emerging countries.

And if you deal with the question of whether it's a more autocratic system and whether you prefer a more autocratic leadership system than a democratic leadership system, you'll have to make that choice for yourself. Don't look at it as some unique place in terms of some of those impediments, look at the whole picture.

I would say that the Chinese or Confucian way of approaching things has a lot to be said for it, so you have to make your own choices.

Jim Haskel:
Let's get back a little bit to some of the questions that investors have. For example, should they think of China as an emerging market investment, should they think of it as a developed market investment, somewhere in between, in terms of the expected return, risk, correlation of that investment? You talked a little bit before about diversification, but what about the expected return and risk of an investment in China, and how would you structure that?

Ray Dalio:
When you asked me the question of is it more like an emerging country or more like a developed country, so many different aspects of what defines an emerging country or a developed country's market vary.

So what is the size of the market capitalization? What is the legal form? What are property rights? Just so many different dimensions, but I would make as a generalisation that China is somewhere between 60 or 70% more like an emerging country, 60 or 70% more like an emerging country in those respects than it is like a fully developed country.

It doesn't have a regulatory system that is as developed as the developed countries that have been at it a while, it doesn't have some things. It has market capitalization, it has liquidity, and that's a two-edged sword. It has also greater levels of inefficiency. The greater levels of inefficiency provide investment opportunity. As a generalisation, I would describe it that way.

If I'm looking at it instead in the question of expected returns and risks, I think, as you know, I look at each market and I look at the return relative to the risk, the expected return relative to the expected risk, and the past return relative to the expected risk and what drives it.

By and large, I find developed markets and emerging markets roughly comparable, and that being able to put together portfolios of those in an effective way is the way to engineer that portfolio.

When I look at China, I think that the expected return relative to the expected risk will be equal to or perhaps higher than elsewhere, partially because of the fact that there's the diversification that you could have and put together well.

But also partially because of the greater capacity of the central banks, the central bank, I should say, in being able to ease monetary policy and also run fiscal policy to be able to have a higher ratio. I think that that would be a plus.

Jim Haskel:
You've traced the arc over the last 35 or so years of Chinese history and described the evolution, if you look now forward five, 10, 15 years, what do you think the highest probability, what will we be looking at when we look at China's evolution?

Ray Dalio:
We'll be looking at a very different world, and we'll be looking at a very different China, and we'll be looking at a very different United States in five, 10, 15 years. In some ways that we will never be able today to anticipate, and in some ways that are inevitable in kind of the same sort of way that demographics is inevitable.

The following charts probably help to answer your question. They show a number of statistics, including the sizes of the economies, the relative sizes of the economies, the relative shares of world trade, the shares of the global market equity market capitalization, the shares of the global debt market capitalization over the next number of years.

These projections are based on our 10 year forecast that look at a lot of indicators to determine what the next 10 years growth rate is going to be, likely to be. They're based on the relationships between those types of growth rates and changes in market capitalization, and also work that's now being done to develop the market capitalization and open those economies.

They're not going to be exactly accurate, but they're going to be probably pretty much accurate. In a nutshell, it's going to have the largest economy in the world, the most trade in the world, the most market capitalization in the world.

Jim Haskel:
Those are big changes.

Ray Dalio:
Yeah. And the United States, and Europe, and Japan, and emerging countries are going to have big changes, too.

Jim Haskel:
You're sketching out a continuation of some dramatic trends that have already taken place. Any threats that you see to that progress going forward?

Ray Dalio:
Well, I mean there're always threats. I think the threat is the threat of conflict with the United States in whatever form that'll be. And then, there are always threats. They have to do with probabilistic things. You can have threats that'll affect our countries in terms of anything from climate change issues, pandemics, political disruptions. There's that whole range that can affect any of those countries.

Jim Haskel:
Ray, we've covered a lot. We've talked about the evolution of China, the opening of the capital markets, how to think about it from an investment point of view. I thank you for your time and perspective, and I look forward to sitting down once again and updating this in the not too distant future.

Ray Dalio:
It's my pleasure. It'll always be interesting.

Friday, 19 July 2019 10:29

Afterpay - the elephant in the room

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The daily gyrations in the Afterpay share price recently has given investors motion sickness.  In the light of new information ranging from the Austrac investigation, to Visa announcing a competitive threat, Afterpay investors have been re-examining the investment case.  Here we outline some of the thinking from 3 professional investors on this ASX top 100 company.

Afterpay has changed the habits of millennial spenders who prefer to pay in instalments mostly with debit cards to avoid the punitive interest rates and application process of credit cards.  Afterpay users purchase goods upfront and pay for them in 4 instalments, but the retailer receives the funds upfront from Afterpay. The consumer doesn’t pay interest on the transaction.  

Afterpay makes its money from charging retailers a merchant fee based on the transaction size.  Although Afterpay can charge a late fee in the event of a failure to repay the outstanding amount, the majority of Afterpay’s revenue comes from merchant fees.

“Retailers love Afterpay as average purchase size increases” according to Nathan Bell, Intelligent Investor.

Bell believes that the Austrac issue is of little long-term consequence, even under a worst case scenario.

Andrew Mitchell, Senior Portfolio Manager, Ophir Funds Management was one of the first institutional investors in Afterpay and says that while Australia now boasts 2.5m active Afterpay users since starting 4 years ago, “this is a sideshow to the real opportunity lying offshore with the US market approximately ten times the size and the UK market around three times larger.  Early signs are positive in the US where the monthly rate of customer signups has been higher than the experience in Australia with already over 1.5m active users after just 12 months.”

Late last year when Afterpay’s share price was under intense pressure, Mitchell travelled to the US to speak with retailers personally.  When he discovered the surging take up rate of Afterpay by several leading US retailers, Ophir doubled their position.  Afterpay recently confirmed that they have 4,400 retail partners in the US.

Nathan Bell thinks that Afterpay collecting so much data on spending habits could also lead to new services.  In a wildly bullish scenario he says, Afterpay could eventually have much more in common with a bank than it does today.

Michael Glennon, Glennon Capital is of the view that by being the first to the market does offer the company an advantage. “The best case for Afterpay is that it becomes a globally recognised brand like American Express” he says.  He thinks management is doing a good job and while Visa announced plans to enter the buy now pay later space he adds “these people (Afterpay) have got it right, I’m not sure Visa will get it right”.

Some broker research is dismissive of the threat from Visa as 80% of people using Afterpay don’t have a credit card, and instead use a debit card.  Glennon says that while the threat from Visa may not be in itself company changing, it does tell investors that “if Visa are looking at Afterpay, then you can bet others are too”.

Other risks to the Afterpay business according to Andrew Mitchell include ensuring responsible lending to consumers is adhered to, changes to regulatory framework governing the buy now pay later industry and a material increase in bad debts.

Nathan Bell adds “there have been several governance issues, and the founders have been selling large amounts of shares. This is typically a big red flag, but I would sell some shares at the current price too if I was them.”

The big elephant in the room is valuation. While rapid revenue growth is assured given its early success in the US, Afterpay must continue to grow sales quickly to justify a forecast market value to sales ratio of around 10x revenue based on 2021 estimates.  Those investors with grey hair will recall that the last time the market priced businesses on a price to sales basis (rather than price to earnings) was during the dot.com boom.  

Future growth in the US could of course justify the lofty valuation, but investors would be wise to closely monitor the US rollout.


This article is general advice only.  The author does not own shares in Afterpay.  This was published in the Australian Financial Review during the month of July 2019.

Monday, 01 July 2019 08:36

India - the next big growth opportunity

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For investors simply seeking growth tail winds, India has a far clearer economic growth story than China according to Douglas Isles, Investment Specialist at Platinum Asset Management, although he acknowledges that in practice investing is more nuanced.  

Already the world’s 5thlargest economy, with forecast growth of 6-8%pa over the next decade, India is likely to become one of the three largest economies alongside the US and China by 2030.

It is unlikely to be another China though, as India’s Government can’t simply mandate growth in the same manner as China. India is currently where China was around 15 years ago according to Mr Isles based on GDP per capita figures.  Each home to populations of around 1.4bn people, India and China are to become economic heavy weights in the coming decades.





India’s scale is extraordinary.  By 2025, one fifth of the world’s working age population will be Indian.  By 2030 there will be over 850 million internet users in India (currently around 500m) Source: Australia’s Dept of Foreign Affairs and Trade.

The Modi Government was re-elected in a landslide victory in May.  His first term was punctuated with many reforms including the introduction of GST, bankruptcy and insolvency changes, digitisation of subsidies which has resulted in large numbers of Indians now having bank accounts, and a steep rise in infrastructure spending on building roads, rail and electrification to power the nation.

India’s road and rail networks are critical to increasing its population’s standard of living and economic prosperity as they connect farmers to markets, children to education and goods to consumers.  During Modi’s first term, India built almost 200,000 km of rural roads. (that is building the road from Adelaide to Melbourne 275 times).  The number of rural villages connected by roads grew to 91%, up from 56% in 2014.  

Modi’s new Government has pledged 100 trillion rupees (US $1.44 trillion) over the next 5 years for infrastructure investment. This is huge considering the expenditure on roads and railways was only about 1.2 trillion rupees for the 12 months to March 2019.

Jack Lowenstein, Morphic Asset Management, believes that the infrastructure sector is one of the greatest opportunities in India and the sector presently looks cheap.  He adds “financials offer the best returns in India, but having seen so many false bottoms to what is now a nearly decade long bad credit cycle, we are going to sit on the sidelines until we see momentum in the recovery story.”

Douglas Isles, empathises and says “India’s banking system has gone through a process of repair, which sets it up for the prospects of an investment boom, perhaps akin to what we have already seen in China. 

This should be good for banks, and companies benefiting from investment in infrastructure. While it benefits the consumer, stocks in that area are well-liked, and the overall market, like the US, trades at all-time highs. This is a stark difference from China, but note that India is at an earlier stage of its economic evolution, and as a democracy, remains more chaotic than its northern neighbour.  The paradox of markets is that a simple growth story does not make such a simple investment case.”

Investing in India through global ETF’s or actively managed funds is the obvious way of gaining exposure to the India thematic.  But it is not just Indian companies that stand to prosper from India’s infrastructure boom.  

Australian businesses who provide finance, maintenance / construction expertise, or other products and services could also be beneficiaries.  

Some of the questions that Australian investors need to ask themselves are:

  1. What Australian goods are likely to be sold to Indian consumers (think A2 milk to Chinese consumers)
  2. What Australian expertise could be exported to India? (perhaps education, infrastructure maintenance)
  3. What Australian companies may be able to assist in the financing of Indian infrastructure? (Macquarie Group is the business automatically linked to infrastructure investing)
  4. Will the increase in infrastructure spending create the environment for another resources boom?

As legend investor Kerr Neilson (Platinum Asset Management) says “Investors have to invest on the basis of what the world is likely to be, rather than as it is now”.  Therefore investors would be wise to think about ways they may be able to gain from the rise of India over the coming decades.


This article was written by Mark Draper and published in the Australian Financial Review in June 2019.

Sunday, 05 May 2019 08:46

Property - Is this the tipping point?

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This article is reproduced with permission from Investsmart.


In this week's Property Point podcast with CoreLogic's Tim Lawless, home dwelling prices are patched into a deeper narrative, where everyday investors require expert guidance.

Welcome to Property Point, a podcast exploring all things related to property investment in Australia.

This week I’m speaking to Tim Lawless, Head of Research at CoreLogic Asia Pacific.

The CoreLogic home value index lost 0.5% in April. That’s after we saw a 0.7% fall in March, and a 0.9% fall in February.

Could this easing represent a turnaround to come?

House price declines seem to have moderated in Sydney and Melbourne. However, there are signs of further price slippage elsewhere, outside of our two capitals.

Sydney has come off 10.9% for the year and Melbourne has come off 10%. Prices are back to mid-2016 levels in both cities, and about 20-25% off their levels seen five years ago in 2014.

From the September 2017 peak, national house prices are now down nearly 10%. 

Sydney and Melbourne read as much worse, down 14.5% and 10.9% from their peaks respectively. Melbourne’s price declines have now surpassed the 1989 downturn – in addition to 2004, 2008, 2010 and 2015's downturns.

The current price adjustment has now extended for 19 months.


Tim, this spot of data, being CoreLogic home values, finds itself in a very patchy narrative.  Home sales volumes are at 23-year low, which was another set of data that came out this week, even though auction clearance rates have been holding steadier, in some pockets ticking up over the last little while.  The big question, of course, in light of all of this, are you expecting further declines through the rest 2019 or have we seen the bottom?

Well, of course the market is very different from region to region.  But broadly, yes, we are expecting values to continue falling across most areas of Australia.  That's certainly been a most recent trend, although we aren't seeing values falling quite as quickly as what they were late last year or a bit earlier in 2019, it's quite clear that markets like Sydney and Melbourne are still seeing a fairly rapid rate of decline.  In fact, our April figures showed Sydney values were down by 0.7 of a percent over the month, and Melbourne's down 0.6%.  Not quite as bad as the nearly 2% month on month declines that we were seeing late last year, but still quite a material decline and we are also seeing the geographic scope of weakening conditions has expanded to include other capital cities, where values were generally rising previously.

And taking a broader view from that, so what are we seeing in terms of data standouts outside of Sydney and Melbourne?  Is the troubled Perth turning around, or is Hobart continuing its upswing?

Well, touching on Perth, no, unfortunately, we're still seeing values falling in Perth.  In fact, about a year and a half ago, we were seeing some signs that Perth was close to levelling out and values were holding relatively firm, but there has been a bit of a freshening of the downwards trend, which I think probably coincides with the tighter credit regime we're in at the moment as well as the fact that local economic conditions across WA still remain relatively soft.  I could say the same things about NT and Darwin, as well.

Interestingly enough, in Hobart, that really has been the standout market.  It's the market where values having been trending higher quite quickly, but our April figures have shown had a bit of a crack in that façade, with values falling by nearly 1% over the month in Hobart, which I guess doesn't really come as much of a surprise considering that the growth rates were highly unsustainable in that marketplace.  A bit more than a year ago values were rising at nearly at nearly 13% per annum, and now the annual rate of growth is just below 4% across Hobart and, of course, affordability constraints in that market have really deteriorated quite quickly.

Source: CoreLogic

Last year, I think most of the warnings were around apartments, particularly Melbourne and Brisbane.  But now it seems like, to me, that everyone might have been worried about the wrong thing, where houses have actually shown a bigger price correction over the last year and the cycle to date.  But is that just a function of the price run-up we saw in houses, as opposed to apartments?  Or is there something more to it?

I think there's a few things happening here, and just to explain the numbers, looking at some of the largest cities.  For example, we could write a pretty good case study, so Sydney house values over the past 12 months are down 11.8% and Sydney unit values are down by just over 9%, 9.1%.  With a really similar story in Melbourne.  So absolutely, unit values are falling, but not quite as much as what we've seen in the unit sector.  So, I think what's driving that trend is a couple of things; one would be that we are seeing the market becoming very price sensitive, and of course apartments do offer up a much lower price point than detached housing.  And the reason I think we are seeing this price sensitivity comes back to affordability issues in the most expensive markets.  But probably more importantly is, I suppose, the change in the credit environment, where we are seeing lenders generally becoming much more cautious around high debt to income ratios and debt to loan ratios, which seems to be funnelling credit demand and credit availability toward that middle to low end of the market.

I think also with the surge first home buyer activity, particularly across Sydney and Melbourne, of course that segment of the marketplace is very price sensitive and I think that there is an anecdotal trend at least, where we're seeing more and more of first home buyers are willing to sacrifice their backyard and Hill’s hoist, and look for areas or housing stock that may be medium to high density, but located closer to where they're working, or where their family is, or closer to major transport nodes and so forth.

I'd like to just touch on clearance rates as well, which do remain at historically low levels.  Several are making predictions, like JPMorgan, that clearance rates will remain below 50% for most of 2019.  And elsewhere it’s been claimed that anything below 50% is a very weak result, and that it's evidence the market is still falling.  But I've noticed that markets like Brisbane are actually consistently below 50% for clearance rates.  So, what do you think about this?  Is 50% nationally actually a tipping point?  Or does it mean anything?

I think you can read a little bit too much into the national clearance rates.  And, generally speaking, clearance rates are very, I suppose, important, very indicative of market conditions.  In markets where auctions are still a very popular way of selling, and that's generally restricted to Melbourne, Sydney, and Canberra.  Most other markets see a very small proportion of properties being taken to auction and auction clearance rates are much less indicative of broader market conditions, probably more indicative of what's happening in the premium sector where you generally find unique properties or distressed properties are taken to auction. 

I think that when we look at auction clearance rates in say Sydney and Melbourne, to a lesser extent in Canberra, we're generally seeing the auction clearance rate holding around the mid to low 50% mark, which as you say is still very low.  It does suggest that there is ongoing weakness in the market, but they are much better than what we were seeing at the end of last year, where auction clearance rates were down around the low 40% mark, even at one stage dipping below 40% in Sydney.  I think that does coincide with this subtle improvement in the rate of decline that we've been seeing across Sydney and Melbourne over recent months.  The market's still falling, but not as quite as severe as what it was.  Auction clearance rates are still low, but not as quite as severe as what they were late last year.

Tim, looming large over property, of course, is the RBA, which is meeting next week.  The RBA has raised the issue of negative equity.  I'd like to ask you about this.  I don't know whether too much attention is paid to negative equity, like you've said with clearance rates, given the context where as long as a household with a mortgage has an income and a job, the RBA has said they don't seem to think it'll be a problem.  What's your view on the negative equity conundrum, where if house prices fall 25% nationally, I've read, it would put 850,000 home buyers in negative equity?

Yeah, that makes sense to me.  It's actually quite an elusive statistic to obtain in Australia.  Simply because there isn't a lot transparency or visibility on the debt side of individual home ownership.  Quite clearly, in our data we can see how much values have fallen, how much values have changed, but we don't know how much deposit, for example, was held against individual properties.  What we can see though that gives us a pretty firm hint around equity levels would be the areas around Australia where values have fallen by say more than 15 and more than 20%.  So if I look around the subregion of the capital cities, there's only one region across the country based on statistical area 4s, SA4 regions, where values have fallen by more than 20%, and that's the Sydney area of Ryde, where values are down by 22.7%.  You've also got areas like the inner south-west of Sydney, Sutherland Shire, the Hills District, the inner west and North Sydney, where values have fallen by more than 15%, and you could throw Parramatta in there as well.

In Melbourne, it would be the areas like the inner-east and the inner-south, which tend to be more exclusive markets, where values have fallen by more than 15%.  When you have value declines of that magnitude, it's pretty clear that if you're a recent buyer to the marketplace, and so you did have a 15% to 20% deposit, then there will be some evidence of negative equity creeping into those markets.

Source: CoreLogic

How likely, Tim, do you think a rate cut is next week by the RBA?  The market's pricing a 40% probability.

It's my view that we probably will see the RBA starting to position for a rate cut later this year, but probably not cut in the May meeting.  Simply because I think cutting before the federal election may be a thing a difficult thing to do politically, not that the RBA has political ties.  But also, the fact that I think the RBA probably will start changing their commentary to start setting up an expectation for a rate cut over coming months.  Of course, we did see the very low inflation numbers, in fact, you know, the donut after the March quarter, but we're still reasonably strong labour market indicators, mostly emanating out of New South Wales and Victoria, of course.  But I think that as we start to see labour markets potentially softening, as the residential construction sector in both those states starts to settle down, then maybe we might start to see more evidence of the labour market indicators, which is another key element of what the RBA is looking for before they cut, could start to soften out a little bit.

And another big question: Will rate cuts fire up housing again?  Do you think that will be the catalyst?

I'm not too sure about that.  Absolutely, if we do see rates coming down, and I think we probably will see rates move lower and then most of that being passed onto mortgage rates as well, but we still have a fairly substantial serviceability assessment as a barrier for a lot of borrowers.  I don't think, even if we do see mortgage rates moving lower, it won't have the same stimulatory effect as what we've seen over previous periods when rates have come down.  No doubt it's going to be a net positive for the marketplace, a lower cost of debt is always going to be positive, but I think there will be some prospective buyers out there who simply will still find that obtaining finance and getting through that credit assessment is going to be a barrier for a substantial or a mature enough lift in buying activity.

Do you expect that changes to negative gearing, should Labor get in at the federal level later this month, are they already factored into these changes in home prices?  Or do you think an even bigger slide could happen if Labor does get in?

Well it's certainly an uncertainty, and I think the truth is that nobody really knows what the effect of these policy changes might be if we do see a change in government and they do get through to the senate.  I think, generally speaking, if you remove an incentive from the marketplace, generally that's an overall net negative, and we'd expect there to be some dampening effect on investment activity in the market.  To what extent that impacts on prices is really the great unknown.  My expectation is if you take away some demand for the marketplace, it's likely to have some further downwards pressure on prices.  Maybe that could be compensated by some upwards pressure from lower mortgage rates, improved affordability, and so forth as well.  So overall, not too sure how that outcome's going to play out, but I think if we do see less investment of the marketplace, we potentially would see rental rates gradually starting to rise higher and I guess, encouraging that already evident trend where rental yields are moving higher, probably would result in higher rental yields longer term, alleviating the need for negative gearing in the first place.

I think the biggest question here is the adjustment period, if we do see these policies implemented, what's that adjustment period going to look like, and how much does it impact negatively on housing prices.

I might leave it at there for today with the great unknown.  Thank you so much Tim, for the chat.

Thanks, it’s been a good chat, great interview.  Thanks very much.

That was Tim Lawless, head of research at CoreLogic Asia Pacific.

Thursday, 18 April 2019 14:28

Roadsigns to Recession

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Mark Draper (GEM Capital) wrote this article for the Australian Financial Review and was published during the month of April 2019.


With the graphs of leading Australian economic indicators taking on the shape of a waterfall, investors would be wise to dust off the play book about how to invest in a recession.  While not in recession yet, we are likely to know in the next few months whether Australia will enter recession, and it depends on whether some indicators, that we examine here, can change direction.

Many investors have not seen an Australian recession during their investing life, with the last one taking place in 1990/1991.  During that recession the economy shrank by almost 2%, employment reduced by just over 3% and the unemployment rate moved into double digits.  Business failure rates increased along with bank bad debts, and two of Australia’s major banks were in financial stress with share price falls of at least 30%.

At the epicentre of the current downturn is the residential property market.  Property values have been heading south, rapidly, particularly in the eastern states.  The further and faster property prices fall, the greater the probability of recession.  The IMF believes the downturn is worse than previously thought.  This is one of the few times that property prices have fallen without the RBA raising rates or from rising unemployment.

The second key indicator is housing credit growth.  Housing credit growth is currently below the level seen during GFC and below the level witnessed during the 1991 recession.  Credit approvals are falling, particularly in the second half of 2018.  This reflects tightening of lending standards by banks, but also that Australian consumers may have reached their capacity to take on new debt.  Investors need to ask what will alter this environment.  Previous episodes of weak demand for credit have been met with cuts to official interest rates, but with rates currently at 1.5%, the RBA does not have much ammunition to fire.

Building approvals are collapsing.  While there is currently enough work from buildings currently in progress to keep tradesman busy, building approvals point to a more troubling future.

Falling property values can create a wealth effect where consumers feel less wealthy and as a result defer purchasing decisions.  This can be seen in new car sales figures and 2018 saw its worst annual result since 2014.  This is against a backdrop of strong population growth during that time.

The weakening economic outlook is unfolding during an election campaign that the ALP are favoured to win.  The ALP is proposing to significantly increase the overall tax levied, (ie franking credit changes, CGT and negative gearing changes) which is likely to suck further money out of the economy and act as an additional handbrake.

If Australia were to enter recession, there are several investment sectors where investors should tread carefully.

Given that 60% of the Australian economy revolves around consumer spending, discretionary retailers are most at risk to a consumer under pressure.  Caution should also be taken with the price paid for food retailers who may also come under pressure as consumers seek to lower their expenses during a downturn.  The recent Woolworths profit result shows the food retailers are already operating in a very difficult retail environment.

Travel is another sector at risk as consumers in a downturn could turn their focus away from discretionary leisure spending.  Businesses too could replace interstate travel with more teleconferences in tighter economic times.

Banks are obvious investments to suffer in an economic downturn as demand for credit weakens and bad debts rise.

Property investments with a focus on property development profits should also be scrutinised.

The currency could be one of the few safe havens as the Australian dollar most likely depreciates during recession.  Beneficiaries of a weaker currency are those Australian companies who earn income from overseas or unhedged International investments.  Australian exporters who have not hedged currency can also benefit from a lower Australian dollar.

Investors should pay attention to the next few months of leading economic indicators to determine whether Australia is likely to break the 27 year recession drought, and position their investments accordingly.  

Thursday, 18 April 2019 14:23

Montgomerys' Best of the Best Report - April 2019

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Montgomery Investments have recently produced their 'Best of the Best Report' for April 2019.


In this edition, they cover:

1. The recent company reporting season - opportunities for investors

2. Sydney Airport - is the runway for growth likely to continue?

3. Their view on Challenger


To download the report - please click on the image below.


April 2019 Best of Best image

Thursday, 18 April 2019 14:15

Major Parties' Tax and Super policies

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thinking aboutThe federal election has been called for May 18 and both major parties have outlined their superannuation and tax policies. With the federal election only weeks away many of our clients have been asking what the major political parties’ policies are that may impact their SMSF, individual taxation circumstances or personal investments. 



  • Australians aged 65 and 66 will be able to make voluntary superannuation contributions without needing to work a minimum amount. Previously, this was only available to individuals below 65.

  • Extending access to the bring-forward arrangements (the ability to make three years of post-tax contributions in a single year) to individuals aged 65 and 66.

  • Increasing the age limit for individuals to receive spouse contributions from 69 to 74.

  • Reducing red-tape for how SMSFs claim tax deductions for earnings on assets supporting superannuation pensions.

  • Delaying the implementation of SuperStream (electronic rollovers for SMSFs and superannuation funds) until March 2021 to allow for greater usability.


  • From 2018-19 taxpayers earning between $48,000 and $90,000 will receive $1,080 as a low and middle income tax offset. Individuals earning below $37,000 will receive a base amount of $255 with the offset increasing at a rate of 7.5 cents per dollar for those earning $37,000-$48,000 to a maximum offset of $1,080.

  • Stage 1 tax cuts: From July 1 2018, increasing the top threshold of the 32.5% tax bracket from $87,000 to $90,000.

  • Stage 2 tax cuts: From 1 July 2022, increasing the top threshold of the 19% personal income tax bracket from $41,000, to $45,000.

  • Stage 3 tax cuts: From 1 July 2024, reducing the 32.5% marginal tax rate to 30% which applies from $120,000 to $200,000. The 37% tax bracket will be abolished.



  • Disallowing refunds of excess franking credits from 1 July 2019 – this would mean SMSF members in pension phase no longer receive refunds for the franking credits they receive for their Australian share investments.

  • Banning new limited recourse borrowing arrangements.

  • Reducing the post-tax contributions cap to $75,000 per year down from $100,000.

  • Ending the ability to make catch-up concessional contributions for unused cap amounts in the previous five years.

  • Ending the ability for individuals to make personal superannuation tax deductible contributions unless less than 10% of their income is from salaries.

  • Lowering the higher income 30% super contribution tax threshold from $250,000 to $200,000.


  • Labor supports the stage 1 tax cuts and will match the $1,080 low and middle income tax offset. From 1 July 2018, individuals earning below $37,000, will get a $350 a year tax offset, with this amount increasing for those earning between $37,000- $48,000 to the maximum $1,080 offset.

  • Introduce a 30% tax rate for discretionary trust distributions to people over the age of 18.

  • Will limit negative gearing to newly built housing from January 1 2020. (Existing investments are grandfathered under the current law).

  • Reduce the capital gains tax discount for assets that are held longer than 12 months from the current 50% to 25%. (Existing investments are grandfathered under the current law).

  • Limit the deductions for the cost of managing tax affairs to $3,000.

Sunday, 31 March 2019 07:58

Investors Guide to the Federal Election

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The next Federal election will be held during May 2019.

It is difficult to remember an election that potentially has so many impacts on investors.  Mark Draper wrote this article for the Australian Financial Review which was published during the month of March 2019.

As if worrying about potential changes to franking credits and capital gains tax discounts weren’t enough, there are a myriad of other potential changes that investors need to think about should Australia have a change of Government at the next Federal election, as is widely anticipated.

Normally politics doesn’t usually need to feature prominently with investment decisions, but we suspect that this Federal election will bring politics to the top of mind for investors.

Here we examine some of the sectors that are likely to be impacted by the election.

Nathan Bell, (senior portfolio manager Intelligent Investor) says “If Labor reduce the CGT discount to 25%, that could drastically reduce demand for investment properties, which has already collapsed due to falling property prices and tighter lending.

This would be very bad news for the banks (and mortgage brokers and other lenders), which need to increase the size of their loan books to grow earnings.”  The banks could also face a higher bank levy from either side of politics as a politically acceptable way of funding election promises, particularly following the Royal Commission.

The ALP has proposed a cap of 2% on private health insurance premium increases. Matt Williams (portfolio manager Airlie Funds Management) is of the view that the insurers are already preparing for the introduction of this policy and that the question investors must ask is whether the health insurers, or the hospitals will have the upper hand in negotiating prices.  Who has the upper hand will determine whether the insurers can operate under this policy without a hit to their bottom line.  He points out that insurers are already looking to reduce claims and keep people out of hospitals with a focus on greater recovery at home and other alternatives. The recent profit result from Medibank Private showed very tight cost control.

Williams is also surprised that neither party as yet has committed to policy to write down the value of the NBN, thereby potentially reducing the price that NBN wholesalers, and by extension consumers, pay for their internet access.  He believes it is likely that the next term of Government write down the value of the NBN.  Such a write down would be broadly positive for the Telco sector as it could lead to higher margins for Telcos, which have struggled to generate a reasonable return from re-selling NBN.  This is unless the price reductions were ‘competed away’ in a highly competitive environment.

Nathan Bell is also concerned about the effects of policy changes to consumer behaviour.  He says “Labor's main policies all act as a tax on consumers. We've already got a recession on a per capita basis, so these policy changes will reduce spending. Non-discretionary retailers, including Woolworths and Coles, recently reported weak earnings growth. These policies could see growth evaporate altogether. People will find ways to cut their spending by buying more discounted groceries; shopping less often; buying more generic brands; and avoiding small treats.  Imagine what that then means for discretionary retailers, such as Harvey Norman and JB HiFi.” 

The Coalitions’ energy policy has ensured that the share prices of Australia’s energy retailers have been heavily discounted on the concerns of electricity prices being capped or companies broken up.  

Bill Shorten late last year also contributed to the uncertainty in energy policy suggesting the ALP will redirect east coast gas, earmarked for export, to the domestic market, if certain price levels (which weren’t disclosed) were reached.  Australia’s gas producers have export contracts to deliver gas that usually spans decades.  Investors are right to be concerned if a Government considered mandating that export contracts be put at risk in order to fulfil domestic demand.  Williams believes that this uncertainty is creating opportunities to buy energy companies that are cheap as a result.

It’s hard to be definitive about how to position investments for the Federal election at this stage, given that both major parties haven’t really put many cards on the table.  What ends up being legislated is often not necessarily what is promised during an election campaign, so investors need to ensure they don’t over react too..  

One thing however is certain, populist politics and business bashing is with us for the moment, and is likely to have material ramifications for investors.  Investors must respond by paying more attention than usual to this years’ Federal election.

Roger Montgomery (Montgomery Investments) talks with Mark Draper (GEM Capital) about the Australian property market which is now firmly in decline.

They discuss whether the market has bottomed and what indicators investors should be watching out for as well as some investments to be cautious about.