Alan Duncan, Curtin University and Rebecca Cassells, Curtin University

Successive Australian governments are usually judged on how they balance the budget and spend taxpayers’ dollars. The stereotypes are that Liberal governments keep a tight hold on the purse strings, while Labor governments are spendthrifts. The Conversation

While total government spending has increased from around A$240 billion in 1998-99 to a predicted A$451 billion in the 2016-17 financial year, it’s also accompanied by an increase in revenue from around A$250 billion to A$417 billion over the same period.

But the pressure on the budget under a Turnbull government is more acute now than ever before, because spending is outpacing revenue. It’s now at an estimated 26.6% of GDP in 2016-17, higher than at any point since before the start of the millennium.

When you look at the mix of government spending over the past fifteen years, you start to see some of the drivers of the growth.

To compare spending over time, we have adjusted for the effect of inflation by using real measures.

The Conversation/Emil Jeyaratnam, CC BY-ND

Social security continues to dominate government spending at A$161.4 billion, constituting around 35% of all government outlays on latest figures. This has fallen from a high of 39% during the Rudd government stimulus package in 2009-10 and is similar to levels at the beginning of the millennium.

In the graph below “other” spending includes the distribution of GST revenues to states and territories as well as spending in areas such as job seekers assistance, industrial relations, vocational training, tourism and immigration. This constitutes the second highest share of government spending, at 18% (A$83.4 billion) of the total spend. General revenue assistance to states and territories accounts for two thirds of spending in this category.

Governments spend almost as much on defence and public safety (around A$32.6 billion) as they do on education (A$34.3 billion), although the states ultimately pick up most of the education bill.

The global financial crisis saw a temporary blip in the mix of general government spending. Social security spending rose by 22% in the year to June 2009, and education expenditure jumped 60% a year later as a result of Rudd’s economic stimulus package.

Government spending on public debt interest has more than tripled in real terms to A$15.4 billion since the start of the global financial crisis, and now accounts for 3.7% of all government spending.

The Conversation/Emil Jeyaratnam, CC BY-ND

Many of the changes in real government spending between 2008 and 2010 were driven by the impact of the global financial crisis, which resulted in a slowdown in economic growth, rising unemployment and a negative hit on the sharemarket.

The Rudd government response was a stimulus package. The main spending increases came from a combination of accelerating public debt interest, increased payments to assist the unemployed, but mainly the government’s stimulus measures channelled through increased spending on education, housing and cash payments to families.

If a spending measure is truly temporary, a rise in real spending should be followed by an equivalent fall in subsequent years when the spending runs out or the program ends. This is evident to some degree for the social security and welfare and fuel and energy portfolios, but less so in other areas.

For example, the 45% rise in fuel and energy spending in 2008-09 was primarily driven by the introduction of the Energy Efficient Homes package within the Rudd stimulus suite. The scheme ended in February 2010, resulting in a 33% drop in spending.

On the other hand, spending on education rose by A$16 billion as part of the Rudd stimulus package, but remained A$10 billion higher than pre-global financial crisis levels in subsequent years.

Overall government spending has continued to grow since 2010-11, but less dramatically than during the heart of the global financial crisis, by around 8% in real terms over the five years to 2015-16.

The Conversation/Emil Jeyaratnam

Social security and welfare spending constitutes the largest spending commitment of any government budget. It has risen by 70% in real terms over the past fifteen years, from A$91 billion at the turn of the millennium in 1999-00 to A$155 billion in 2015-16.

The biggest welfare spending is for assistance to the aged, families with children and people with a disability. Together, these three items make up almost 85% of all welfare spending.

The 2008-09 Rudd stimulus package had a substantial yet temporary effect on welfare spend, with “bonus” cash payments to families in the 2009 calendar year increasing assistance to families by around A$10 billion. Additional cash payments were also made to students, pensioners and farmers under the stimulus program. And 8.7 million Australian workers earning $100,000 or less also received a cash payment.

Australia’s ageing population and increases in both disability prevalence and disability support are the main driving forces behind welfare spending growth. These factors will continue to exert pressure on future government budgets, especially with the full rollout of the National Disability Insurance Scheme (NDIS).

The Conversation/Emil Jeyaratnam, CC BY-ND

More than 40% of the government’s 2015-16 health budget of around A$71.2 billion was committed to community health services spending. At A$28.7 billion, spending in this sector has nearly doubled since the start of the millennium and by a quarter since the start of the global financial crisis in 2008-09.

This stems from the need to deliver medical services to a growing – and ageing – population, and the increased prevalence of chronic disease. In this respect, Australia is little different to most countries around the world.

Specific measures contributing to this growth included the expansion of health infrastructure, the costs of enhanced primary care attracting higher Medicare rebates, and indexation of health related payments to states and territories. Pharmaceutical spending increased by 12%, from A$1.4 billion year-on-year to A$12.1 billion in 2015-16.

The Conversation/Emil Jeyaratnam, CC BY-ND

Education spending rose dramatically during the global financial crisis, with spending on primary and secondary education increasing 81% to A$24.7 billion in the year to 2009-10 as part of the economic stimulus package.

Rudd’s “education revolution” led to a 12% growth in education spending in the 2008-09 budget, quickly followed by a further 61% spending increase in 2009-10 as part of the economic stimulus package. Spending in the following year fell as the temporary stimulus measures came to an end, but overall, education spending has remained significantly higher in real terms than pre-global financial crisis levels.

Spending on the university sector rose to around A$10.9 billion over the same period, but has remained relatively stable since.

The Conversation/Emil Jeyaratnam, CC BY-ND

Federal government money given to the states and territories

The federal government committed A$60.8 billion in general revenue assistance to states and territories in 2015-16, almost all of which came through the distribution of GST revenue. General revenue assistance spending rose A$3.8 billion in real terms in 2014-15, up 7% on the previous year, but has since stabilised.

Spending on superannuation interest has grown by a quarter since the end of the Howard years, reflecting the increase in the government’s superannuation liability. Lower public sector wages and employment have led to superannuation interest payments stabilising over the last two budgets to around A$9.4 billion in 2015-16.

Immigration spending rose between the Gillard and Abbott governments to a peak of A$4.7 billion in 2013-14, but has since fallen back to around A$3.8billion in 2016 dollars.

Much of the growth in immigration spending occurred during the Rudd and Gillard governments, by an average of 23% annually. This compares to an average of 7% during the previous Howard years. Additional government spending on detention facilities for irregular arrivals was the principal reason for this spending growth.

Natural disaster relief spending spiked between 2009 and 20-11 to assist with the damage and recovery costs from the Black Saturday bushfires in Victoria in 2009, and the 2010 Queensland floods.

The Conversation/Emil Jeyaratnam, CC BY-ND

Government approaches to supporting various industries has typically been applied on an ad hoc basis. Budget spending on specific industries has risen from A$3.2 to A$5.6 billion in real terms. Agriculture, forestry and fishing typically received a greater share of industry spending during the Howard budgets, reaching a high of A$4.8 billion in Swan’s final 2007-08 budget.

Growth in industry spend slowed during the Rudd years, picking up again with the Gillard and Abbott governments, with a greater preference towards spending in mining, manufacturing and construction projects.

The Conversation/Emil Jeyaratnam, CC BY-ND

Spending on housing and community amenities has increased from A$2.7 billion to A$7.6 billion, reaching a high of almost A$12 billion in the Rudd years. Spending in this portfolio increased with the Rudd stimulus package, incorporating a number of housing affordability measures including the First Home Buyers Grant Scheme and a boost in investment in social housing.

Spending on sanitation and protection of the environment also expanded rapidly during the Rudd/Gillard government, relative to the Howard years. The establishment of the Climate Change Action fund introduced by Rudd in 2009-10 and the Clean Energy Futures package in 2010-11 have been the main drivers behind this increase. Spending in each has been pared back since the Liberals came to power with Abbott at the helm.

The Conversation/Emil Jeyaratnam, CC BY-ND

Commonwealth spending on transport and communications projects has more than doubled from A$3.1 to A$7.5 billion over the last 15 years. Spending remained relatively stable under Howard’s government, and then got a further injection on roads in the last two Swan budgets. The Rudd government continued this trend, with Gillard following suit with increases in both road and rail projects.

Spending in this portfolio has been clawed back since the Abbott government, falling from A$9.2 billion to A$7.8 billion between the final Labor government budget (2013-14 financial year) and the first Liberal government budget (2014-15 financial year). The most recent Turnbull/Morrison budget has reaffirmed spending commitments under this portfolio, committing to more than A$11 billion in 2016-17.

The Conversation/Emil Jeyaratnam, CC BY-ND

The Howard/Costello years were characterised by good economic times, with an extended period of strong revenue growth, yet this prosperity wasn’t matched with any significant spending growth. In fact, overall government spending fell as a share of GDP – from 25.7% in 2000 to 23.6% in 2006-07 – the lowest share since the start of the millennium. And the combination of strong revenue and limited spending commitments under Howard drove down public debt, and public debt interest payments.

We saw some pretty dramatic increases in real spending when Rudd came into power in December 2007. Rudd’s first budget in 2008-09 saw some substantial spending commitments in the area of education but nothing exorbitant.

However, the major turning point in government spending has been driven by the response to the global financial crisis. There were significant spending commitments over the course of the crisis, some of which are still present.

Spending on public debt interest has increased to A$15.4 billion since the global financial crisis - more than the spending on transport and housing combined. And it’s projected to increase further to A$18.7 billion by 2019-20. This just emphasises how high the stakes are for Scott Morrison in delivering a credible budget repair strategy.

The spending of incumbent governments inevitably draw from the commitments of previous administrations, especially for those programs – in infrastructure, education or housing - that involve medium-term funding commitments.

The growth in real spending in areas that directly affect households – social security, NDIS, health or pensions - is an issue that no government can ignore. NDIS costs have been hugely underestimated already, and social security and health spending will inevitably increase with the ageing population.

Set against this context, it’s clear that a piecemeal approach to budget repair is unsustainable. A drop in revenue has ramped up budget pressures, and highlights the compelling need to return to a sustainable spending path and a credible budget repair strategy.

The Turnbull government cannot shy away from making the big decisions that secure a sustainable future for Australia. And the roadmap towards a sustainable future has to include revenue as well as spending as part of the recovery narrative.


The graphs in this article were created by The Conversation’s Multimedia Editor Emil Jerayatnam

Alan Duncan, Director, Bankwest Curtin Economics Centre and Bankwest Research Chair in Economic Policy, Curtin University and Rebecca Cassells, Associate Professor, Bankwest Curtin Economics Centre, Curtin University

This article was originally published on The Conversation. Read the original article.

Wednesday, 03 May 2017 08:36

French election in 3 charts

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The final phase of election for President of France comes to a close on May 7th. After the first round of voting, voters are left to choose between Marine Le Pen (hard right) and Emmanuel Macron (Centre). We know that Marine Le Pen stands for France leaving the EU, which would be particularly problematic given France was a founding member of the EU.

The issue of leaving the Euro currency would be complex. In our opinion this is the last of the key elections in Europe this year given that there seems to be high quality candidates from both sides in the German elections later this year. The financial markets were relieved to see the final two candidates of Macron and Le Pen, as it was earlier feared the 'Hard Left' may get through to the final round against the 'Hard Right'. The French share market rose by over 4% the day following the election result.

That said, the final election result is still yet to be decided, so we thought it timely to bring you the latest thinking in this important election. The first round voting was close but Macron was the ultimate winner securing 24% of the vote, with Le Pen in second place.

 

There are some similarities to the Trump election in the composition of voting, where Le Pen is appealing to the 'rust belt' in France, gaining support from those negatively impacted by globalisation.

 

Finally, we finish on the voting intentions of French voters for the Final Round and note that unlike the US election and Brexit, the French polls have been very accurate.  The polls currently suggest a comfortable victory for Macron - but we are likely to be more comfortable once the final result is known.

 

 

Marc C-Scott, Victoria University

How Australians watch cricket on screens in the future could depend on what happens with the Nine Network’s current discussions with Cricket Australia over the 2018-23 media rights. The Conversation

UBS media analyst Eric Choi said the current deal costs Nine about A$100 million a year but generates only A$60 million to A$70 million in gross revenue.

Choi said the network should either ask for access to more content at no additional cost, or step away from its long association with cricket.

The ramifications of Nine’s decision could be broad, impacting not only its potential revenue and viewers, but also participation rates among Aussies playing grassroots cricket.

Cricket’s current standing

The current media rights deal for cricket includes the Nine Network and Network Ten. Nine has the rights to international tests, one-day internationals and T20 international games played in Australia, whereas Ten has the rights to the Big Bash League (BBL).

The BBL has become a crucial cricketing brand, continuing to gain high ratings and listed in Australia’s Top 20 engaging programs for 2016.

The league also has excellent crowd attendance, having recently ranked 9th in the world’s top-attended sports leagues.

Based on the BBL’s success and the increases seen in the new media rights for the Australian Football League (AFL) and National Rugby League (NRL), Cricket Australia will want to see an increase in the bidding for its rights.

This is particularly relevant if Cricket Australia still relies as heavily on these rights as in 2012, when it said the rights accounted for 60%-80% of the total annual income.

But can the media rights continue to increase with the current unstable media landscape?

The current media landscape

According to Arnhem Investment Management, the era of advertising-supported premium sport on Australian television is “drawing to a close”.

The free-to-air (FTA) broadcasters are also currently requesting that the government reduce license fees and reconsider plans to further restrict gambling ads during the broadcast of sports.

Ten has said it expects its revenue to be “above the 1.2% increase” it outlined in February this year. Yet it will still need to undertake a “significant focus” on a corporate cost-cutting program and profitability as a priority.

New stakeholders

With FTA broadcasters under financial pressures, any increase in new rights will require new stakeholders.

Foxtel currently shows international cricket matches played overseas, but does not have local coverage rights. If it could gain local cricket rights, this would further strengthen Foxtel’s sports offering of AFL, NRL, A-league, V8 Supercars, and many international sports.

Australia’s anti-siphoning regulation could prevent Foxtel completely dominating the cricket media rights. But this list is expected to be trimmed further by the government this year, furthering opening up the sports media battleground for pay television in future rights deals.

The future for digital rights

Digital rights will also be a major consideration with the new cricket media rights. While most would be looking at Telstra and Optus, there have been new players in this area who may also wish to place a bid.

Currently Cricket Australia has the Cricket Australia Live app which allows users to pay a subscription (A$30 per year or A$5.99 a day) to gain access to live streaming of games, but the new rights could also see this change.

Optus may continue its affiliation with cricket. It recently become the official mobile media partner of Cricket Australia, and principal sponsor of the Melbourne Stars Big Bash League team. Customers can access cricket content via the Optus Sports app, which also includes Optus’ recently acquired English Premier League.

Twitter has had success with broadcasting the US National Football League (NFL) and the Melbourne cup last year. This year it signed a two-year deal with the US National Lacrosse League. Twitter may consider its interest in a global sport like cricket.

Amazon, which recently launched its Prime Video service in Australia, could also be a contender. This year Amazon won the rights for NFL Thursday night matches. It paid US$50 million for ten games, five times the price paid by Twitter last year. Amazon may look at the cricket as another potential global sport to add to its catalogue.

Another consideration is if Nine or Ten were to obtain the digital rights and use the free and subscription approach that the Seven Network used as part of their Rio Games coverage last year.

The impact on the viewing experience

Can you “slice and dice” too much? This is a question being asked in the US by CBS chief executive Les Moonves with regard to the NFL.

Adding another stakeholder to cricket will impact the viewers’ experience. This year the new AFL media rights created some frustration linked with the way the rights had been negotiated, particularly the digital rights.

Telstra, the digital rights holder, is restricted by its agreement to limit live match videos to a 7-inch screen size. Highlights and replays are available in full-screen size 12 hours after the match ends. (Foxtel, meanwhile, can stream the games full-screen.)

This change has outraged some fans who paid the A$89 subscription fee for the AFL Live app. Because of the screen size restrictions, Telstra users with a large phone or tablet have a large amount of black space on their screen.

Some Australians are being creative in working around the restrictions.

Media coverage and participation

The media rights for sport can be looked at far more broadly than solely the coverage of the game itself.

In the United Kingdom there has been ongoing debate associated with cricket’s coverage. Since the sport moved to pay-TV, there has been a decline in participation levels, which many argued is primarily due to the game no longer being broadcast free to air.

Reports of a Sport England Active People survey show a 32% drop in participation levels in people aged over 16 since coverage of cricket moved to satellite and cable TV.

There are now steps being taken to introduce a new Twenty20 tournament in the UK, built around the success of the Indian Premier League and Australia’s BBL, which had some games live broadcast in the UK during the last season.

This is an interesting case study for Cricket Australia, which only last year announced cricket as “No 1 as the current top participation sport in Australia”.

Any changes to the rights that impact the percentage of Australians with access to the coverage, could also see a decline in participation based on the UK experience.

Marc C-Scott, Lecturer in Screen Media, Victoria University

This article was originally published on The Conversation. Read the original article.

Hugh Giddy and Anton Tagliaferro (Investors Mutual senior management) recently wrote about the Trump induced rally in share markets.  The title of their publication is "Trump's election as President - has it changed the world that much?

The article covers their views of the US and China in particular, written in an easy to follow manner, and littered with some amusing quotes.

You can download your copy of this article by clicking on the icon below.

 

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Monday, 01 May 2017 10:55

Will Amazon destroy retail as we know it?

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Mark Draper (GEM Capital) recently spoke with Clay Smolinski (Platinum Asset Management) about the threat to retailers of Amazon.  Clay talks about how investors should be thinking about Amazon.

 

Mark Draper and Shannon Corcoran (GEM Capital) recently met with Dom Guiliano (Chief Investment Officer - Magellan Financial Group) to talk about Donald Trump's agenda and how investors should be thinking about it.

We also covered the risks with European politics, particularly in France and Germany, with so many elections coming up in 2017.

 

Monday, 03 April 2017 07:58

Why we don't like Telstra

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Telstra is a favoured stock among many retail investors, assumingly for the current high franked dividend.

While Telstra's balance sheet is in pristine condition, which would allow it the flexibility to borrow in order to support this dividend, we remain concerned about Telstra's earnings outlook.  Not only have earnings virtually gone nowhere over the past decade, the NBN is likely to pressure Telstra's future earnings in the absence of a new growth stragegy.

NBN is a game changer for all Australian telecommunications companies as it results in them becoming a reseller of the NBN service, rather than selling their own data networks which attracted a higher margin.  This is likely to leave a 'black hole' in earnings for Telstra in coming years once the NBN is rolled out.  This is clear in the table below.

While the above table is forward looking, there is not much joy in earnings in the rear vision mirror for Telstra share holders.  This graph shows earnings per share, which have virtually 'flat-lined' over the past decade.  Source of this data is Skaffold software.

We conclude this article with a 3 minute video from Michael Glennon (Small Cap Investor) who outlines the reasons he does not wish to invest in Telstra.

Over the last few years, there has been a significant increase in the interest in Environmental, Social and Governance (ESG) investing. According to a paper released recently, over $8trn of the $40trn of money managed in the USA is now under some form of Sustainable and Responsible Investing (SRI) or ESG, up 33% since 2014 and up fivefold from $1.4trn in 2012 for money run by fund managers.

In many respects Australian fund managers have been caught unready for this change. If we look at the Mercer survey data for January 2017, the Global Equities strategy section contains 127 global funds that are sold in Australia. Of this, only 5 are classed as SRI funds. It is somewhat better for Australian equities with 157 funds in the survey, of which 13 are SRI. If we were to use the ratio of assets in the USA, the number of SRI funds should be 27 and 34 respectively.

One reason could be that there is a view amongst many people (and particularly fund managers) that “you can’t have your cake and eat it too”: that SRI results in lower returns for investors and the investors have to pay a price to be responsible.

In some ways this misconception, of accepting lower returns for being ethical, goes against another tenant of conventional investing wisdom: buy good businesses. The grandfather of long term investing, Warren Buffett, discusses a lot in his letters to shareholders the importance of ethics and the quality of the character of the people running the businesses he owns.

Implicitly he is saying that businesses that have an ethos and focus on ‘doing the right thing’ by staff and customers, should generate higher returns. Now admittedly he is discussing the character of the people rather than the nature of the business, and some people would find owning Coca Cola unethical.

And it is this differentiation between good people and bad unethical businesses that opens an interesting next line of inquiry.  Download the complete 4 page report from Morphic Asset Management by clicking on the link below.

Sunday, 02 April 2017 18:00

The Australian Housing Market - bubbling away

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Written by Shane Oliver - Chief Economist AMP

The cooling in the Sydney and Melbourne property markets evident in late 2015 in response to macro prudential tightening deployed by APRA has proved ephemeral. Price gains have reaccelerated and auction clearance rates & lending to property investors have rebounded. Over the last five years Sydney dwelling prices have risen a ridiculous 73% and Melbourne prices are up 47%. As a result the Australian housing market continues to cause much angst around poor affordability and high household debt. This note looks at the main issues.


Source: CoreLogic, AMP Capital

Is Australian housing overvalued?

On most measures Australian housing is overvalued:

  • On the basis of the ratio of house prices to rents adjusted for inflation relative to its long term average Australian houses are 39% overvalued and units 13% overvalued.
  • According to the 2017 Demographia Housing Affordability Survey the median multiple of house prices in cities over 1 million people to household income is 6.6 times in Australia versus 3.9 in the US and 4.5 in the UK. In Sydney it’s 12.2 times and Melbourne is 9.5 times.
  • The ratios of house prices to incomes and rents are at the high end of OECD countries.


Source: OECD, AMP Capital

Why is it so expensive and household debt so high?

There are two main drivers of the surge in Australian home prices over the last two decades. First, the shift from high to low interest rates has boosted borrowing and hence buying power. This has taken Australia’s household debt to income ratio from the low end of OECD countries 25 years ago to the top end. Second, there has been an inadequate supply response to demand. The following chart shows a cumulative shortfall relative to underlying demand had built up by 2014 and is still yet to be worked off despite record construction lately.


Source: ABS, AMP Capital

Consistent with this, while vacancy rates have increased they have only increased to around average long term levels. In Sydney vacancy rates are below average.

What about investors and foreign buyers?

A range of additional factors may be playing a role in accentuating demand beyond that implied by population growth. These include negative gearing and the capital gains tax discount, foreign buying and SMSF buying. Negative gearing is just part of the normal operation of the Australian tax system. However, the interaction with the capital gains tax discount by enhancing the after tax return available to property investment may be resulting in higher investment activity than would otherwise be the case. This may particularly be the case when past property price gains have been strong encouraging investors to think future gains will be too. While commitments to lend to property investors slowed in 2015 after APRA tightened macro prudential controls, this has since worn off.


Source: ABS, AMP Capital

Foreign buying is likely also impacting – with indications that it is around 10-15% of demand – but it is also concentrated in particular areas and SMSF buying appears to be relatively small. But like lower interest rates, all of these should have a less lasting impact if the supply response was stronger.

Is a crash likely?

The surge in prices and debt has led many to conclude a crash is imminent. But we have heard that lots of times over the last 10-15 years. In 2004, The Economist magazine described Australia as “America’s ugly sister” thanks in part to a “borrowing binge” and soaring property prices. Most recently the OECD has warned of the risks of a property crash. However, the situation is not so simple:

  • Firstly, we have not seen a generalised oversupply and at the current rate we won’t go into oversupply until 2018 and in any case approvals suggest supply will peak this year.
  • Secondly, mortgage stress is relatively low and debt interest payments relative to income are around 2003-04 levels.
  • Thirdly, lending standards have not deteriorated like they did in other countries prior to the GFC. In recent years there has been a reduction in loans with high loan to valuation ratios and interest only loans are down from their peak.
  • Finally, generalising is dangerous. While prices have surged in Sydney and Melbourne, they have fallen in Perth to 2007 levels and seen only moderate growth in other capitals.

To see a general property crash – say a 20% plus average price fall - we need to see one or more of the following: a recession - which looks unlikely; a surge in interest rates - but rate hikes are unlikely until 2018 and the RBA will take account of the greater sensitivity of households to higher rates; and property oversupply – this would require the current construction boom to continue for several years. However, the risks on the supply front are high in relation to apartments.

What can be done to fix it?

Recent RBA commentary strongly hints that more macro prudential measures to tighten lending standards are on the way. These could include a further lowering in the 10% growth cap on the stock of lending to investors and tougher debt serviceability tests. This is in part about reducing the risks to financial stability when it’s too early to consider raising rates.

More fundamentally, policies to help address poor housing affordability should focus on boosting new supply, particularly of standalone homes which have lagged. This includes relaxing land use restrictions, releasing land faster, speeding up approval processes and encouraging greater decentralisation. This is largely a state issue. Policies designed to make better use of the existing housing stock (eg, by relaxing constraints on empty nesters downsizing) could also help.

Policies that are unlikely to be successful include increased first home owner grants (as in periods of high demand they just result in higher prices) and allowing first home buyers to access to their super (again this will just result in even higher prices unless supply is fixed before and will mean less in retirement).

Tax reform should ideally be part of the package and include replacing stamp duty with land tax (again a state issue), removing the capital gains tax discount that is a distortion in the tax system and lower income tax rates to discourage use of negative gearing as a tax avoidance strategy. Piecemeal cuts to stamp duty targeted at FHBs will just result in higher home prices. Abolishing negative gearing would just inject another distortion in the tax system and could adversely affect supply (although I can see a case to cap excessive benefits).

What is the outlook?

Generalised price falls are unlikely until the RBA starts to raise interest rates again and this is unlikely until later in 2018, which after a few hikes will likely trigger a 5-10% pullback in property prices as was seen in the 2009 & 2011 cycles:

  • Sydney & Melbourne having seen big gains are most at risk.
  • Prices are likely to fall further in Perth and Darwin this year, but they are close to bottoming and should rise next year.
  • The other capitals are likely to see continued moderate growth this year and a less severe down cycle around 2019.
  • But units are at much greater risk given surging supply and this could see unit prices in parts of Sydney & Melbourne fall by 15-20% as investor interest fades as rents falls.

What are the risks to the economy?

Slowing momentum in building approvals points to a slowdown in the dwelling construction cycle ahead. This combined with a slowing wealth affect from rising home prices means that the contribution to growth from the housing will slow. However, as this is likely to coincide with a fading in the detraction from growth due to falling mining investment and higher commodity prices it’s unlikely to drive a slowing in the economy. However, a likely decline in rents (as the supply of units hits) will constraint inflation helping keep interest rates low for longer.


Source: REIA, AMP Capital

A property crash would have bigger impact given the exposure of banks, but as noted above such a development is unlikely.

Implications for investors

 

  • While there is a strong long term role for residential property in investors’ portfolios at present their remains a case for caution. It is expensive on all metrics and offers very low net income (rental) yields of 2% or less. This leaves investors highly dependent on capital growth.
  • But it is dangerous to generalise. Apartments in parts of Sydney and Melbourne are probably least attractive. Best to focus on areas that have lagged behind.
  • Finally, investors need to allow for the fact that they likely already have a high exposure to Australian housing. As a share of household wealth it’s nearly 60%.

 

 

 

 

Australian shares delivering around 9%pa income sounds too good to be true.  In this article, we take a look at a couple of professionally managed investment strategies that have been able to achieve this over the last 5 years.

With cash rates at 1.5% and the Australian cost of living rising at a rapid pace, those who require income from their investments face a dilemma.  Do SMSF’s remain in cash and fixed interest and either burn capital, reduce their living standards due to the low rates, or do they pursue higher income strategies elsewhere.  According to the recent ATO statistics, the allocation of SMSF’s to cash and fixed interest  is 26% (Source ATO Annual Statistics overview)

The Australian share market currently offers investors a higher income yield than cash, with potential for capital appreciation over time as can be seen in the chart below.

While the income yield from Australian shares is above 5%pa (incl franking) some professionally managed funds employ strategies to enhance this yield for income hungry investors.

Plato Investment Management are launching a listed investment company (called the Plato Income Maximiser) which uses the strategy of the Plato Australian Shares Income Fund that has been in operation for over 5 years.  This fund is unique in that it is a long only fund (not using derivatives) that achieves higher income by buying securities on the ASX300 in the lead up to a dividend payment and then selling once the dividend has been paid.  Historical evidence shows that share prices tend to appreciate in the lead up to a dividend payment, which the fund uses to boost returns.  In the 5 years to 28th February 2017 this strategy returned income to investors of 9.1%pa with some capital appreciation.

CEO of Plato Investment Management, Dr Don Hamson talks about the Plato fund with Commsec in the video below.

 

 

 

 

 

 

 

 

 

 

 

 

 Other high income equity strategies focus on investing into high income stocks, and then bolster income by writing call options over some of their holdings.  A call option is an agreement that gives an investor the right but not the obligation to purchase a share at a specific price during a specific period in exchange for a financial payment.  Many investment managers offer this style of high income equity fund including Investors Mutual, Colonial First State, AMP just to name a few.

For example an investor who owns 1,000 CBA shares could write a call option that would allow another investor to purchase their shares for a set price of say $90 (currently CBA trading at around $83) and in exchange for this agreement, receives a payment.  This payment is considered additional income over and above the dividend that the investor receives. In the event that the CBA share price rose above $90 it is likely that the investor who wrote the call option initially, would be obligated to sell the CBA holding for $90. 

Therefore it is important to understand that an investment strategy revolving around writing of call options carries the risk of limiting the upside when share prices rise.  These strategies tend to outperform during flat or ‘down’ market conditions and underperform during strong markets.

We are not criticising equity income strategies that use call options, we are merely making a comparison which demonstrates the limiting of upside.  Below we have compared the Investors Mutual fund that use call options, to the Plato fund which does not.  The figures are to the end of February 2017 sourced from company websites.  Readers can see the limiting of upside returns in the strategy using call options over the last 12 months when the market has been positive.

 

Plato Aust Shares Income Fund 1 Year 3 Years pa 5 Years pa
Income 9.6% 9.1% 9.1%
Growth 13.3% -0.2% 4.7%
Total Return 22.9% 8.9% 13.8%

 

Investors Mutual Equity Income Fund 1 Year 3 Years pa 5 Years pa
Income 7.9% 8.3% 8.8%
Growth 6.9% 1.7% 3.3%
Total Return 14.8% 10.0% 12.1%

 

Both of these managers are highly rated, so the purpose of the comparison is not to place one manager above the other, simply to highlight the difference in strategies during a period of strong market returns (which is shown in the 12 month numbers).

We would also highlight that the soon to be listed, Plato Income Maximiser is a listed investment company, which is different to the other income funds which are available in the format of a unit trust.  The benefit for SMSF trustees of investing in a listed investment company structure is the ability of the company to smooth dividend payments, where as a unit trust must pay out all income received to investors during the financial year in which it is received.  This can result in income being somewhat ‘lumpy’.

Finally the other difference between a listed investment company and a unit trust is that investors can purchase units in a trust by purchasing them directly from the investment manager, where as a listed investment company must be purchased via the ASX, or in the case of Plato Income Maximiser, can be purchased in the IPO which closes in April 2017.

This blog article is of general nature only and describes the new fund and is not in itself making an investment recommendation.  Investors are urged to read the prospectus and seek professional advice before investing.  The prospectus can be downloaded by clicking on the 'Download' icon below.