Ampol - fueling the economy from a strong position


One of the most solid results for us this reporting season was Ampol, one of our top 5 holdings. It is the largest fuel supplier to the Australian and New Zealand market with a vertically integrated operation, supplying fuel to industrial customers and retail customers through the Ampol brand in Australia and the Z Energy brand in New Zealand. It also operates one of the two refineries left in Australia, Lytton.  

Coming out of Covid, Ampol has recovered strongly. Our positive view rests on not just the short-term tailwinds but also on a favourable medium-term outlook and improved business quality. Ampol today is more cash generative, can sustain higher dividends, and many areas of the business have been derisked and are well set up.

AmpolBusiness quality

Australia and New Zealand currently have one of the largest short positions of petroleum product in APAC. Over the last decade, Australia has shifted from relying on fuel imports for 25% of its supply to now 75%. New Zealand has gone further, shutting down all its domestic refineries and importing 100% of its fuel. Increasing reliance on imports favours players like Ampol with their extensive infrastructure assets that can yield better asset returns and supply fuel at a competitive cost. This dynamic also underpins the rationale behind the company’s acquisition of Z Energy, which has been performing strongly and is a greater than 20% Return on Invested Capital (ROIC) investment for the company.

Refining margins are inherently volatile, and at times we have seen Lytton swing to a loss. In 2021, the threat of Lytton’s closure led to a favourable agreement with the Australian government, which will provide government support in a downturn to ensure the asset remains viable to supply into the domestic market. The Australian government did not want to go down the New Zealand route of closing all refineries and relying on fuel imports. This would leave Australia in a precarious situation if global geopolitics shifted and we did not have a domestic source of production. This deal effectively caps potential losses at Lytton at zero, and allows Ampol all the earnings upside, dramatically reducing the volatility of Ampol’s earnings. That said, we don’t believe the agreement will cost the government much – we expect restricted global supply and stronger controls over Chinese refining exports should be supportive of Lytton’s medium-term earnings outlook.

In convenience retail, business quality and industry setup have also improved. Ampol and others are investing to improve their retail offering (Quick Service Restaurant, improving range, store refurbishment) and we think Ampol has a strong competitive position. This strategy will also be increasingly important to adapt to a future of EVs.

Ampol was earlier to embark on this strategy than its peers, starting in 2016, and although it has not been the smoothest journey, we think Ampol is well positioned now. Investors, ourselves included, can often underestimate the complexity involved in a retail transformation. It’s easy for us to look to growth without appreciating the nuances like procurement, costs or systems. After seven years of hard work, we think Ampol finally has a strong foundation. The company has taken control of its network from franchisees, allowing it to better implement retail initiatives, reconsolidated to a smaller set of profitable sites with a focus on highway sites, which have stronger returns, and built retail capabilities. Incidentally, I recently drove to and from Sydney and the Gold Coast over the Easter break. With two young kids in the car, we must have stopped at least eight or nine times. Every single petrol station we visited up and down the Pacific Highway was an Ampol site – we think Ampol’s highway-heavy site portfolio has stronger earnings potential and less EV disruption risk.

Beyond the shop, the retail fuel side has also improved. Counterintuitively, headwinds like inflation, tobacco and EV help widen the gap between the most profitable and scaled players from the marginal players. In a fragmented industry like this, marginal retail operators need to remain viable through fuel pricing, and the high cost of doing business helps enforce rational competition. We see similar trends playing out in North America. Again, going back to the network strength, we think Ampol is well positioned here with profitable sites, more premium fuel, and rent advantage through more freehold property. All in all, we think the quality and earnings potential in Convenience Retail is underappreciated.

Management quality

Management has executed well with their reset of the convenience retail, securing Lytton support, Z Energy acquisition and track record in capital recycling. Since 2015, Ampol has returned $5.5bn of capital to shareholders (more than half of its market cap today)

Source: Ampol

Financial strength

When we compare Ampol to its peers on the ASX, like energy and utilities, we come away with the following assessments: 1) it is more cash generative and can sustain higher dividends; 2) the market structure, especially retail, is much more favourable and reliable; 3) strong ROIC (15% pre-tax); and 4) strong balance sheet. At 13.8x PE, we think the risk/reward looks attractive, particularly considering the average ASX Industrial stock trades on 23x PE despite earning an inferior 13% pre-tax ROIC.

ESG Consideration

We believe the energy transition has weighed on Ampol’s multiple, as it is viewed as a ‘loser’ in the inevitable shift to EVs. While it’s probably fair to say that EV penetration might take longer in Australia, we also don’t want to fool ourselves into thinking that “it will take so long that it won’t affect our investments”. Although the company is actively involved in future energy (piloting EV charging, potential biofuel operation), it’s important for us to understand the potential economic impact. This is essential to our process.  

We spoke to Alimentation Couche-Tard, one of the largest convenience retail operators globally with the #1 position in Norway. Norway is an important test case for the impact of EV penetration on convenience retail profitability, given EVs comprise >90% of new car sales there. Couche-Tard sees strong demand for on-the-go charging, healthy charging economics for the electrons, uplift in shop sales from longer dwell time, and strong fuel performance. Couche-Tard made it clear to us that EVs do not displace fuel earnings but rather add to it. Fuel performance continues to surprise to the upside, especially in industries that find it even more difficult to transition. Couche-Tard is more profitable in Norway with EVs than without.

Similarly, McKinsey estimates that by 2030 on-the-go charging and destination charging in Norway will make up ~75% of EV charging profit pools but only around 40% percent of total power demand. In contrast, home charging will provide 25% of power demand but will account for only 12% of profit pools.* 

Regardless of geographies, we think the economics of public EV charging will be driven by the limited availability of attractive charging locations. We think this adds to the model in Australia with a constrained electricity transmission network and vast distances between cities, making the real estate and network strength even more critical and valuable.

Source: Company filings



This article has been reproduced with permission from Airlie Funds Management

Pathology - beneficiary of ageing of population and AI

Some of the best investment ideas come from observing daily life.  Smartphones have around 90% penetration rate in Australia ( which has resulted in many profitable investments including Apple, Facebook, REA and Life 360 just to name a few.

Doctor’s visits are a normal part of life for most people.  Pathology tests are a natural consequence of visiting a doctor, and this sector too is investable. 

Outside of the COVID pandemic, the proportion of Australians accessing pathology services is relatively constant at around 55%.  This means that growth in tests is likely to come from population growth and the ageing of the population.  This can be seen in the graph below which shows the growth in pathology in Australia in recent years.

Pathology Tests growth

Worldwide, the number of people aged over 60 is forecast to double to 2.1bn by 2050.  As a statement of the obvious, as people age, the chances of contracting illness increases dramatically.  The National Cancer Institute says that those over 60 are around 40 times more likely to develop cancer than young people in their 20’s.  Pathology is required 100% of the time to diagnose cancer.

Developing countries also present a growth opportunity to the pathology sector as those countries embrace Western medicine.  This can be seen in the world map which shows the number of pathologists per million people.  The orange, pink and red coloured regions show countries that are not well represented by pathology services.

World pathology heatmapSource:

In Australia there are 3 listed pathology companies, Sonic Healthcare (which also operates in Europe, UK and the US), Healius and ACL.  Sonic has a market capitalisation of $12.8bn, Healius $936m and ACL has a market capitalisation of $500m.

Our preferred investment in the pathology sector is Sonic Healthcare which locally operates under the brand name Clinpath.  Scale matters when it comes to pathology as the more tests that can be completed by your existing network results in higher return on capital.

Sonic, as the largest player in the market can also afford to heavily invest into the future.  Sonic has invested into technology required to make it the dominant pathology provider for telehealth which has dramatically increased in size since the pandemic.

The other area Sonic is heavily investing in is Artificial Intelligence (AI) where it has invested $350m over the last two years.

Sonic owns 49 per cent of, its joint venture with Through another joint venture,, has developed AI models for interpreting brain scans and chest X-rays, already available to one third of radiologists in Australia and clinics in APAC, Europe, UK, Middle-East and the US.  These developments should allow pathology providers to complete a larger number of tests using the same resources.  Sonic may also have the option to sell this technology to other pathology companies.  Sonic management have said they expect AI to make a material improvement to future earnings.

The other area where AI has potential to be transformative is in the histopath part of the business which involves the testing of tissue.  This is currently a manual process with pathologists viewing tissue samples through a microscope in order to diagnose.  Sonic has acquired Pathology Watch which provides a laboratory information system, digital pathology viewer, image storage and AI algorithms.  This allows high quality digitised whole slide images to be accessed and reported by a pathologist wherever they are located.  This allows images from multiple sites to be distributed to pathologists in any location to balance workloads and speed up expert second opinions.  Additionally, the use of AI can help to further increase the efficiencies of pathologists and improve turnaround times.

The pathology sector typically grows its revenues by 3 – 5%pa and recently Sonic reported in May 2024 that their revenue had increased 6% in the 2024 financial year to date.  Included in this announcement was a minor profit downgrade for this financial year due to higher costs which is largely due to the residual of COVID testing.  These expenses are anticipated to cease at the end of calendar 2024.

Sonic revenue historyThe current share prices of all 3 Australian listed pathology companies are below pre-COVID levels.  In Sonic’s case, this is despite earnings per share in financial year 2023 being 19% higher than that in the 2019 financial year.  Investors should ask themselves whether this represents a buying opportunity. 

Sonic’s balance sheet is strong with net debt to equity ratio of around 40%, while ACL’s is 170% and Healius has net debt to equity of over 140% (source  

Investors are being offered a gross forecast dividend in 2025 of 5% from Sonic, 6.4% from ACL and below 2% from Healius. (source

The key risks in the pathology sector are changes to Government funding policy and technological advances that could render third party pathology tests obsolete.

The pathology sector though is a business with stable revenue growth and upside potential from AI, the ageing of the population and additional tests from developing countries in time.  Investors should examine it under the microscope.

In times of war, look hard before leaping to sell

War usually brings about uncertainty, and the natural reaction for some investors can be to sell during these times. History shows that selling at the start of a conflict can be a hazard to long term wealth.

Clay Smolinski, co-Chief Investment Officer and Portfolio Manager at Platinum Asset Management says that looking back on nine of the most significant global geopolitical shocks over the last 30 years, the markets tend to look through the periods of geopolitical conflict.  The table shows the ‘standard’ experience is for share markets to initially fall in the first week and month post the event, and then the market to recover over the following months as the conflict is unlikely to have a lasting material impact on economic fundamentals or company profits.


Smolinski highlights that the First Gulf War in 1990 and the Russian invasion of Ukraine in early 2022 follow a different pattern where markets failed to recover 12 months after the event.  He argues that the long term negative stock market reactions in those situations were due to factors other than the geopolitical tensions, such as the oil price shock in 1990 and 1991 and the increase in interest rates in 2022.  In the case of Russia’s invasion of Ukraine, the MSCI AC Europe index is near all time highs nearly two years after the start of the war.  

Hugh Dive, Chief Investment Officer from Atlas Funds Management believes that investors should think about the companies they own in their portfolio and the actual links to the conflict in question.  For example, is the military conflict likely to impact CSL’s sales of life saving biotherapies or will the conflict impact Woodside’s LNG sales or what consumers buy at Bunnings.

If the conflict is unlikely to impact sales in the companies investors own, then the initial share market panic can present a buying opportunity for long term investors according to Dive.  

Smolinski says that investors should consider the unique aspects of each conflict.  The stock market returns outlined in the table above are largely made up of countries where the conflict was not happening on their own home soil. Investments in Russia post the Ukraine invasion fared very differently.  

Smolinski believes it is important to think ‘will this business be bigger and stronger in 5 years time?’  if the answer is yes, a pullback in prices can provide a buying opportunity.

With reference to the current conflicts, Smolinski points to the risk that the focus on the Israeli/Hamas war diminishes the attention on Ukraine and gives Russia time to refocus, rebuild and carry on its war in the Ukraine.  The resistance effort within Ukraine requires continued aid from the US and EU and should this aid be diverted to the Middle East, it may change the calculus around ceasefire treaties from the Ukrainian perspective.

Platinum is also paying attention to the role China is playing on the world stage during these conflicts.  In particular, the uncomfortable position they are maintaining keeping Russia as an ‘ally’, whilst also keeping trade routes open and maintaining trade with both the US and the EU.  

Dive thinks the key risk in the middle east is if the conflict widens as it did in 1914 from a conflict between Austria-Hungary and Serbia, to engulf Europe.  This could disrupt global oil flows and the corresponding spike in energy prices would have a negative impact on the global economy.

Investors should continue to monitor these issues.

Dive says that investments that typically perform well during wartime include defence companies, energy companies and commodity companies particularly gold for its ‘safe haven’ status.

Investors can be drawn to other ‘safe haven’ investments such as food retailing, but care should be taken to ensure investors do not overpay for these assets simply to hide during geopolitical tension.

Smolinski suggests investments that can struggle during conflicts include airlines due to increased energy prices and reduced demand for travel.  Financial stocks also have been consistent underperformers during conflicts, with insurance stocks faring the worst.

The geopolitics of today’s world is uncertain, but it always has been.  Investors need to keep newsflow in perspective and act on information rather than running with the herd.


Mark Draper writes monthly for the Australian Financial Review - this article appeared in the 15th November 2023 edition.

October trading updates

In October each year, listed Australian companies with a June financial year end host their annual general meetings (AGMs). Fund managers rarely attend these events as they are designed to allow retail investors to pose questions to company management and vote on directors and the company’s remuneration report. Institutional investors do not vote in person but rather by instruction to the custodians holding their fund’s shares. They would have met with company management in August when they released their financial results.  

In this week’s piece, we will look at the quarterly trading updates given by a range of Australian companies to try and piece together what is going on in the Australian economy. While the broad-based fall in share prices since mid-September suggests that companies are struggling, the quarterly updates showed robust trading conditions for many Australian companies.

agm 1666575a

Normally, we don't pay much attention to AGM's and the trading updates given by management are usually very similar to the conditions the company was facing in August. However, this October has seen greater interest in company updates at the AGMs due to the sharply changing economic conditions. Over the last 18 months, the average mortgage rate has increased from 2.14% to 6%, along with cheap fixed-rate mortgages converting into higher variable rates dubbed the "fixed rate cliff" by the media. This should have seen cratering retail sales in 2023 and significant falls in house prices, neither of which have occurred. Consequently, Atlas has been looking closely at management presentations over the past two weeks at company AGMs. 

AGM & Trading Updates for Q1
Company  What Happened  Our Interpretation 
Woolworths Group sales up 5%, food inflation continues to moderate A good result with consumers trading down to cheaper alternatives
Coles Group sales up 7%, Ecommerce sales up 32% Supermarket Sales below market expectations with EBIT margins suffering 
Ampol  Total fuel sales volumes up 26%, EBIT up 65% Higher refining margins and fuel sales saw earnings above market expectations
Mineral Resources Lithium volumes up 80%, Iron ore voumes up 9%, Mining services up 14% Volumes up from mine expansions though offset by lower realised prices
Dexus $1.3 billion in divestments with the CEO Darren Steinburg stepping down  Market concerned about the falling office occupancy
JB Hi-FI Top line sales was flat compared to Q3 2023 A great result in which was thought to be a deteriorating market 
Wesfarmers  No explicit Update to guidance that Bunnings and Kmart are in good shape Sales continue to grow in hardware, office supplies and discount retail. New Lithium mine completed
Fortescue Iron Ore mined up 4%, Ore shipped down 6% Operational performance was in line with expectations 
Region 4% sales growth, 98% occupancy In line with market expectations
Woodside Sales volume up 10%, driven by 8% increased in production. Sales volumes were above consensus but offset by lower realised prices
Bapcor Lower retail and non-discretionary revenue The result was lower than what the market was looking for but not a structural problem with the business
Atlas Arteria Traffic volume up 2.3%, Revenue up 6.1% Traffic higher than pre CV-19,  revenue increasing at a faster rate due to inflation escalators
Transurban  Highest ever quarterly average daily traffic  Traffic higher than pre CV-19,  revenue increasing at a faster rate due to inflation escalators
CSL Retained guidance for profit growth of between 13-17% In line with expectations, expected boost once in Australian dollars
Harvey Norman Australian sales down -14% Weaker sales result than JBH indicating loss of market share to rival
Endeavour Group sales up 2.1%, driven by 5% price inflation but less items sold Weaker sales result, market concerned about Dan Murphy and BWS Strategy


Retail Mixed 

The non-discretionary grocers had a good start to their years, with Woolworths and Coles posting sales growth of over 5% for the first quarter. The grocers both mentioned that food inflation is moderating in late 2023 to between 2-3%, with the prices for some items such as fruit, vegetable and packaged meat now falling. Higher interest rates have seen shoppers trading down to cheaper home brand items, which deliver a higher profit margin, with Woolworths citing an 8% increase in home brand sales.  Liquor retailer Endeavour saw modest sales growth at BWS and Dan Murphy's of 1.8% and like the grocers, experienced value-conscios customers trading down to mainstream beer, rose and pre-mixed drinks.

JB Hi-Fi's first quarter was much better than expected, with Australian sales falling -1.4%, cycling off a very strong first quarter last year. Conversely, electrical goods rival Harvey Norman saw Australian sales falling by -14% but announced a surprise $440 million on market buy-back as a salve for investors. Atlas' calculations indicate that the company will be borrowing to buy back their shares, an aggressive move from an already highly geared company in a market with rising interest rates and weakening retail sales. JB Hi-Fi appears to be benefiting from their lower cost business model, which has seen them take market share off Harvey Norman.

Wesfarmers produced a fantastic first-quarter result, demonstrating that consumers are still willing to spend money and trade down to lower-cost products across their offerings. We see that Bunnings and Kmart, the lowest-cost operators across the hardware and discount department store markets, will continue to benefit and take market share over the short-medium term.


The iron ore producers had in-line first quarters and are continuing to benefit from higher iron ore prices but will face headwinds over the coming months and years. BHP, Rio Tinto, and Fortescue are all facing inflationary problems, with higher oil prices set to be higher for longer and ongoing labour costs, which will increase production costs. We remain cautious towards the iron ore producers due to concerns about the sustainability of iron ore prices above US$100/t in the face of a slump in Chinese residential construction and a government plan to cap steel production at 1 billion tons per annum. 

Energy powering ahead 

Woodside Energy had a solid quarter, with production up +8% to 48 million barrels of oil. The company also announced that they had started producing at a new field in the Gulf of Mexico which was six months ahead of expectations, which saw full year guidance being upgraded.  Woodside Ahas little exposure to a weakening Australian consumer, selling energy into a global market primarily via long-term off-take agreements to utilities in Japan, China and Korea. Stronger energy prices in the latter part of 2023 and a weaker Australian dollar are setting Woodside up for a strong finish to the year. Similarly, oil refiner and petrol retailer Ampol released a stellar quarterly update in October, showing that profits were up +65% on the previous quarter. The company continues to benefit from higher fuel sales, strong margins from refining crude and, surprisingly, an increase in convenience retail sales. We had expected a big fall in convenience retail sales for Ampol due to higher petrol prices, but motorists are still buying Gatorades, Mars bars and Guzman y Gomez burritos after filling up! 

Toll Roads Stronger than Ever

After the Ampol quarterly that showed Australian fuel sales were up +11%, it was not a great surprise to see the toll road operators report strong traffic numbers in October. Transurban reported record quarterly average daily traffic across their network with 2.5 million trips per day, with traffic up +3% on the prior period. Similarly, Atlas Arteria saw traffic up +2.3% in the past quarter, mainly in their French assets, with revenue up a healthy 6.1%. Due to the impact of quarterly escalators on their inflation-linked tolls and long-term fixed-rate debt, higher traffic will see expanding profit margins. 

Healthcare robust, but weight loss Fears Dominate.

The past quarter has been tough for investors in healthcare stocks, with the dominant theme being concerns that GLP-1 weight-loss drugs will impact demand for a range of therapies treating sleep apnea, cardiovascular diseases and kidney damage.  Indeed, these weight loss drugs have even impacted the share prices of pathology testing companies under the assumption that a potentially slimmer society will result in fewer oncology, fertility, gastrointestinal and respiratory tests. 

Resmed has seen its share price hit the hardest,  losing a third of its market capitalisation due to the view that slimmer patients will see diminished demand for sleep apnea devices. While this may occur in the future, Resmed's quarterly update showed revenue of +16% and profits up +9%. Similarly, CSL's share price has been under pressure due to the unproven potential of the GLP-1 weight-loss drugs on the company's kidney disease treatments, despite dialysis comprising a small part of company earnings . At their annual capital markets day in October, CSL revealed that the company was trading strongly and confirmed guidance for profit growth in 2024 between 13-17%. 

 Our Take  

Global equity markets have fallen by close to 10% over the last three months, and at the close of October 2023, many companies on the ASX200 are trading near or even below the lows of March 2020 despite having better business operations and higher profits in 2023. Toll road operators Transurban and Atlas Arteria are trading at a 25% discount to their pre-COVID share price despite higher traffic volumes and toll prices. Similarly, healthcare companies Sonic Healthcare and CSL both have share prices below January 2020 despite having higher earnings per share and servicing more customers worldwide. While some companies will struggle in an environment where money is no longer free or falter due to higher geopolitical tensions, for many companies, these factors will have limited to no impact on corporate profits and distributions to their shareholders.

“In the short run, the market is a voting machine, but in the long run, it is a weighing machine” – Warren Buffett.



This article was written by Hugh Dive, Chief Investment Officer Atlas Funds Management and reproduced on GEM Capital website with his permission.

Qantas - what should investors do now?

One of the key issues for investors is to determine whether the recent woes at Qantas are temporary or permanent.  If they are permanent, that spells danger, but if the issues are temporary it could provide opportunity.

Matt Williams, the head of equities at Airlie Funds Management says that the Qantas Domestic business and the Loyalty businesses are the most profitable in the Qantas group and the most highly rated by investors.  Qantas Domestic accounted for over 40% of operating profit and the Loyalty business generated $1bn of free cash flow in the 2023 financial year.  He says that this is unlikely to change and while the ‘fallout’ remains unknown, consumers will still fly and spend on their credit card.

Qantas earnings chart

Williams adds that earnings are very sensitive to changes in demand and demand has been very strong coming out of COVID.  Qantas Domestic capacity is almost back at pre COVID levels, while Qantas International capacity is 66% of pre COVID levels, which provides some opportunity for growth.  He is of the view that Qantas earnings are more likely than not to be closer to peak earnings in the short/medium term, particularly given the fall in Qantas average fares (both domestic and international) of 11% in the last 6 months of the 2023 financial year.  Jetstar domestic recorded a 17% fall in average fares.

Nick Markiewicz, portfolio manager from Lanyon Asset Management says that Alan Joyce is leaving the business with record profitability, but with low public support, fragile Government relations, and a near record capital expenditure bill.  From these facts one could make a powerful argument that short term profit objectives have been pursued ahead of the longer term interests of customers.  

Markiewicz believes that while the profit pendulum may have swung too far in one direction more recently, this needs to be considered against some of the reasonable long term decisions by management.  These include the establishment and growth of Jetstar, resetting union relations, the restructuring of Qantas (particularly the International arm) back to profitability in 2014 and the navigation of COVID.

Williams believes the problems at Qantas are fixable but they will take time and money.  Markiewicz is of the view that the history of corporate scandals suggests that the current furore around Qantas is likely to be short lived, particularly given the change in leadership.

So if the problems are fixable, does the current share price represent opportunity?  Markiewicz says the share price is at the same level as it was in mid 2017, despite net income doubling over this period.  As a result the Qantas price earnings (PE) ratio has fallen from around 10 times to 5 times earnings, which is amongst the lowest in Qantas history.  This also compares favourably to global peers, where the median PE ratio is 6.6 times, making Qantas one of the cheapest airlines in the world.

The share price appears to be factoring in risks such as changes in Government attitude toward Qantas, potential for increased competition and the need to upgrade the fleet in coming years.

Williams flags that history is littered with companies that have tried and failed to compete with Qantas (Tiger, Compass, Ansett, and Virgin 1.0), so its risky and he considers it a lower probability.

Markiewicz highlights the group’s fleet age has increased from 7.7 years in 2014, to nearly 14 years in 2022, putting it just below the global average. Management intend to purchase 65 aircraft over the next three years. This will see annual capital expenditures rise above $3bn for each of the next three years. This will directly impact profits, which will in turn, make future earnings far more sensitive to changes in revenue.

The more noticeable impact will be to free cashflow, which will likely fall to negligible levels as these aircraft are received. This raises risks for shareholders, as it increases the importance of the operating business sustaining record profits to fund these purchases, and means management may have to draw on the balance sheet (i.e increase debt) if they want to pay a dividend or continue buying back stock.

However new aircraft will add to the airlines customer proposition as well as significantly reduce fuel burn and other operating costs.

Investors should invest into companies that have rising customer satisfaction and strong balance sheets.  Generally profits follow customer satisfaction.  For Qantas this is a work in progress.



Each month Mark Draper (GEM Capital) writes for the Australian Financial Review - this article appeared in the 20th September 2023 edition.

Cheat sheet for reporting season

Good investors constantly ‘take the temperature’ of the economy, and companies, in order to make decisions.  Company reporting season offers investors a smorgasbord of information, but investors need to assess what information is useful.

This reporting season draws to a close at the end of August and is expected to feature broad themes according to Hugh Dive, Portfolio Manager at Atlas Funds Management.  These include 1) effect of higher interest costs on earnings 2) impact of inflation on operating costs 3) lower Australian dollar and 4) slowing consumer demand as a result of higher interest rates.

Every sector needs to be looked at differently, so some of Australia’s leading fund managers share their views on what investors should be looking for from this reporting season.

The banking sector is probably one of the most widely owned in Australia, but Nathan Bell, Portfolio Manager at Intelligent Investor, highlights that most banks have produced next to no capital gains over the past two decades despite the largest credit and housing boom in history.  He expects investors will suffer more of the same over the next decade as net interest margins are not going back to the high levels of years ago.  CBA’s result showed lower net interest margin as a result of higher funding costs, depositors switching banks for higher deposit rates, which are offsetting the benefits from higher mortgage rates.  While Bell expects bad debts to remain low, margin pressure and relatively high valuations doesn’t augur well for future returns.

major banks net interest margin

Dan Moore, Portfolio Manager at Investors Mutual says that investors in discretionary retailers should pay attention to the level of inventories as this will highlight the outlook for margins.  High inventories is negative for margins.  Dive believes that the sales results for the first 4 weeks of July, which is announced when companies report, is a key indicator of future sales activity.

For supermarkets Moore is focussing on signs of consumers ‘trading down’ and switching to own label products which can protect margins.  Dive will be watching for wages pressure and goods inflation and whether these higher costs can be passed onto consumers.  An increase in a supermarkets net margin implies that higher costs have been passed on successfully to consumers.

Bell says that the ferocious competition in the Telco sector has recently been replaced with more sensible and higher pricing.  Average revenue per user (ARPU) is the key metric he is looking for to determine whether consumers are accepting price increases.  Given Telco’s low margins, small movements in ARPU can have a huge bearing on profits and dividends. Telstra recently announced ARPU increased by 5.4% and profits grew by 13%.  The 3 major telco’s have all increased their prices in recent times which should flow through to their financial statements this reporting season.  Moore also looks at customer growth relative to peers to highlight whether consumers are trading down to budget carriers.

The important aspects for the property sector according to Moore are the re-leasing spreads, which is defined as the difference between the new rent and the prior expiring rent.  Positive spreads indicate future rental growth and vice versa.  Industrial spreads are likely to be positive while office spreads remain under pressure.  Dive says that another focus will be on valuations and expects falls in shopping centres and office trusts with minimal movements in industrial.  The cap rate used to determine valuation is key, (higher cap rate results in lower valuation) so investors should make sure the cap rate used is appropriate.  

Bell thinks that profit results from iron ore miners will play second fiddle to expectations for the iron ore price. Supply is expected to increase over the next couple of years, plus China’s lower focus on fixed investment bodes poorly for Australia’s iron ore miners given their current high valuations.

Markets are forward looking by nature.  Profit reports that on the surface appear poor, but result in the share price rising, suggests the market was factoring in a worse scenario than what was delivered.  Investors should be alert to these situations as they can suggest an inflection point for company earnings and result in a profitable trade.

Profit reporting seasons presents investors with sign posts of what may lie ahead, but knowing which signs are important is key. 


Mark Draper writes monthly for the Australian Financial Review - this article was published on 23rd August 2023

The world is going green but it's still worth investing in oil and gas

Investors would be forgiven for believing there is no future in the oil and gas sector when listening to global politicians talk about 2030 targets of renewable energy production and emission reduction.  Clearly a world that is powered by green renewables is a desired outcome, but calling the death of oil and gas would seem premature.

Josh Snyder, Global Investment Strategist at GQG Partners, says the belief that everyone can drive electric vehicles (EV’s), and the air quality suddenly improves is simply not true.  Synder is very much for renewable energy, but he is of the view that the global discussion around energy transition is currently unrealistic and he thinks the role of oil and gas in the energy transition is likely to be measured in decades not years.  

He cites Norway, where 80% of new car sales are EV’s, and more than a fifth of the country’s fleet is now battery powered and yet total oil consumption has only fallen around 10% over the past decade.  While automotive gasoline useage has dropped by 37% in Norway in the last 10 years, demand for Diesel (to power heavy transport) and Jet Fuel has continued to grow.

Norway Fuel

The International Energy Agency forecasts oil demand continues to rise at least until 2028, at which point demand is forecast to be 5 million barrels per day higher than at 2019.  Snyder says that it may be an uncomfortable truth, but oil is central to everyday life in a way that will be difficult and expensive to change without impacting current living standards.  Consider these everyday items that use petroleum products in their manufacture – solar panels, plastic packaging for medical, computer components, electrical goods, cosmetics, furnishings, clothing in the form of polyester and aspirin.

Global Oil Demand

Hugh Dive, the Chief Investment Officer from Atlas Funds Management says that China signed a 27 year LNG purchase agreement starting in 2027 with Qatar for 4 million tonnes annually and an equity stake in the expansion of Qatar’s North Field LNG project.  The Chinese Government (2nd largest economy) clearly believes gas won’t be a useless molecule from 2030 onwards.

Put simply, the demand for oil remains elevated while supply is constrained due to a general underinvestment in exploration since 2014, and in particular during COVID when oil prices fell which resulted in oil companies conserving cash.

To some, Hydrogen is a threat to the oil and gas sector, but Dive says it is also an opportunity as hydrogen is difficult to transport as it is flammable and also corrosive to steel.  Oil and gas companies have experience in handling hydrogen as it is used to scrub sulphur and crack heavy oils into lighter blends.  Oil companies would be the natural companies with the experience and assets, such as pipelines, storage and tankers to transport green hydrogen globally.

Environmental/Social/Governance (ESG) focus has been both positive and negative for the oil and gas sector.  Snyder highlights that large banks have shrunk their lending exposures to the sector which has led to management teams having to be more disciplined in how they allocate capital.  This results in them becoming more share holder friendly where companies are keen to return money to share holders in the form of dividends.

Dive sees the US shale oil producers as an indicator of the marginal cost of oil, with their cost of production around US $60 per barrel.  This is an important likely floor for the oil price.  Currently the oil price is around US $70 per barrel.

Dive’s top pick in the energy sector is Woodside Energy because they have the lowest production cost ($US 8.50 per barrel) and the lowest gearing (7%).  He prefers Woodside to Santos as Woodside has minimal exposure to the East Coast Australian gas market which is subject to great political uncertainty and he is also attracted to Woodside’s 7% fully franked dividend.

Snyder’s top pick is Brazilian-operator, Petrobras. It has some of the lowest oil breakeven costs globally and richest reserves outside of Middle East and Russia, providing resilience through commodity cycles. Petrobras generates tremendous free cash flow (more than Chevron despite being one third of Chevron’s size) and an aggressive capital return policy. Currently trades at 4x 12-month forward PE and expected to pay ~20% dividend yield this year.

Oil and gas will be around for some time to come and investors could be missing handsome dividends by ignoring this sector.


Mark Draper writes monthly for the Australian Financial Review and this article featured in the 26th July 2023 edition

Investment risks and opportunities in the multi trillion dollar energy transition

The world is undergoing a profound change to the way we source, produce and deliver energy in an attempt to transition to a Net Zero global economy. Jens Peers is the global CIO of equities and fixed income for Mirova, an investment manager dedicated to sustainable investing. He compares this change to the societal changes brought about by the industrial revolution, or the internet revolution, in terms of the scale of change and the level of human adaptation required - as well as our current understanding of exactly what is needed. 

Tim Wood is the Head of ESG for Australian quality and value equities manager, IML. He says that we are: “very, very early in a multi-decade journey into the energy transition. If this was a cricket game, we would only be in the opening overs of a 5-day test match.” 

For Chris Wallis, CIO and CEO of US-based global equities manager Vaughan Nelson, we are: “maybe in the second or third inning but this game is going to last a lot more than one or two decades.” 

Whichever sporting analogy you use, our experts agree that we are in the initial stages of a transition which will play out over decades, not years, and there are massive opportunities for investors, across a broad spectrum of different investment categories. 

This report outlines the opportunities that energy transition presents for investors and a framework around how investors should be thinking about this change.

Click on the report below to download your copy.


IML Global opportunities image

Artificial Intelligence - opportunities in more than big tech

Artificial Intelligence, known as AI has been a hot sector so far in 2023.  Computer chip designer Nvidia Corp, the current poster child of AI, has seen its share price rise around 200% this calendar year, while Microsoft is up around 50% so far this year.

The recent excitement has been ignited by the development and release of AI powered technologies with the most high profile being ChatGPT, an AI chatbot which is trained to follow a conversational instruction and provide a detailed response.  This format makes it possible for ChatGPT to answer follow up questions, admit its mistakes, challenge incorrect premises and reject inappropriate requests.  This was developed by OpenAI and released in November 2022.

Adrian Lu, an investment analyst at Magellan Financial Group describes AI as computers capable of thinking and understanding the world around them, that is they can reason, learn and act with autonomy.  He believes the pinnacle of AI is likely to be far away but engineers are getting better at building models that can mimic human perception, behaviour and abilities.  These models can already perform tasks better and faster than humans which promise vast productivity gains, as well as potential threats to investors.

540184720026Andrew Clifford, CEO at Platinum Asset Management says investors are excited that AI could be a major disruptive force in the global economy.  It reminds him a lot of the excitement around data on mobile phones back in 1999 when NTT DoCoMo first pioneered full internet access on a mobile phone in Japan.  It took around 5 years for that to translate into widespread economic outcomes and significant revenue for a company like Research in Motion (maker of Blackberry) which was then decimated by the release of Apple’s touchscreen iphone in 2007.  With that in mind Clifford is of the view that AI could be a genuine investable theme, but investors need to be careful in this initial period of excitement.

Investors have been quick to identify many of the primary beneficiaries of the ongoing development of AI already.  Lu characterises these as the ‘enablers’ of AI and highlights that many technologies had to come together to make AI possible, from semiconductors to software to hyperscale data centres.  Some of the leading companies in these enabling technologies have been among the greatest beneficiaries of the acceleration in AI spending so far, including Microsoft in enterprise cloud computing, Nvidia in AI accelerator chips, ASML in chipmaking equipment and TSMC in leading-edge manufacturing.  Investors now need to assess whether the current share prices of these companies represent an opportunity or a bubble.

Other beneficiaries from AI range from Industrial automation, consumer devices, automotive and healthcare are yet to be fully appreciated by the market according to Bianca Ogden, portfolio manager at Platinum Asset Management.  In the healthcare sector Ogden points to research and drug discovery.

AI is used to assist and ultimately design new therapies (small molecules and biologics) that have the desired attributes. The issue today is that the process from target to lead compound takes roughly 4-5 years and requires testing of a large number of molecules that then have to be refined over and over again.  AI is showing great promise to reduce that timeline significantly. Oxford-based Exscientia is one of these companies leading the way here and working closely with Sanofi, a company that has put together an impressive network of AI partners. Vancouver-based Absci is another interesting company who is working closely with Nvidia to make the discovery of antibody therapeutics more efficient using its own wet-lab generated database along with AI tools.

Lu highlights some of the risks to investors with AI including political and regulatory risks that will touch companies in different ways, and not just the AI enablers.  In particular intellectual property ownership, misinformation, data privacy and jobs displacement are among the key issues.

Clifford says that from an investment standpoint, the risks he is most mindful of are valuation risk (i.e. paying too much for an investment) and the risk of technological disruption. We remember Kodak, Blockbuster Video and Blackberry, where their businesses were decimated by new technology. It is very likely that AI will have that impact on various businesses over the coming years.

Technology moves fast and investors need to balance their thinking between the opportunities and the threats from AI.


Mark Draper (GEM Capital) writes monthly for the Australian Financial Review - this article appeared in the 28th June 2023 edition.

Best days are behind the banks

With unemployment at 3.5% and likely to rise, the full force of higher interest rates yet to be felt in loan losses, and the talk of recession, how should investors be thinking about the banks. 

Those who remember the 1990’s recession which pushed Westpac to the brink due to large commercial lending losses would be comforted to know that Australian banks today are largely focussed on residential mortgages.  Matt Haupt, a portfolio manager at Wilson Asset Management believes this is positive as in times of stress, residential mortgages are the safest place to be.  He says that even in severe downturns, residential loss rates are actually low.

Bad debts are a risk to banks, and the bears on the sector point to the risk of an expensive Australian housing market falling over, thereby increasing bad debts.  Hugh Dive, Chief Investment Officer at Atlas Funds Management quotes from Westpac’s recent profit result where the bank forecast two scenarios.  The base case was for a 7.8% fall in residential prices and 4.7% unemployment, and the worse case scenario was a 27% fall in property prices and 11% unemployment.  Currently Westpac has credit provisions of $4.9bn versus expected credit losses in the base case being $3.4bn and worse case scenario producing expected credit losses of $6.8bn.  Dive believes it is hard to see a 27% fall in property prices as they have already fallen 8.4% over the last 12 months, and providing employment holds up, thinks the banks are adequately provisioned.  

Bank Provisioning

Dive says that at this point in the cycle the Australian banks are more conservatively positioned than they were during GFC.  For example, the average loan to valuation ratio on CBA’s mortgage book is less than 50% according to their most recent profit report.  We would need to see some big property falls before banks actually feel the pinch, but possibly the newer private credit funds maybe where the ‘excitement’ will occur when bad debts tick up as they have been taking on the credit risks the banks have declined.

The other most important number is net interest margins.  Net interest margin is earned by lending out funds at a higher rate than by borrowing these funds from depositors or money markets.  CBA’s margin was the highest in recent reported results at 2.10%, while NAB was sold off heavily on the day of its result after reporting its margins had fallen by 0.04% in the second quarter of 2023.

Haupt believes that bank margins have peaked in this cycle.  Rising interest rate environments are good for bank margins and margins were expected to keep rising until the RBA stopped increasing interest rates.  However aggressive competition for mortgages and deposits started to kick in late last year, resulting in falling margins.

Dive agrees that margins have peaked but notes that both CBA and NAB have dumped their cashback offers for new mortgages and increased their variable rate by 0.1%, which indicates a lessening of the aggressive competition.

The big question is how the banks achieve profit growth against a backdrop of a cautious consumer and falling margins.  Haupt is of the view that bank profitability has peaked in this cycle and that the best days are now behind us.  He says it feels like investors have to wait for the interest rate cutting cycle to start and finish before he can get excited about margin expansion and this feels a long way off.

Migration and the reopening of the Chinese economy however are likely to be tailwinds in the future for the banking sector as they should contribute to growth in lending.

Other risks to the banks include the ACCC inquiry into deposits, competition and liquidity.  Dive says that the ACCC is likely to find that banks have historically been slow to increase deposit rates when interest rates rise, but this has now changed and doesn’t see this as a material risk.  

Haupt says that liquidity issues arise when there is a loss of trust in the financial system.  A credit crunch impedes the ability of banks to rollover existing funding and access new funding.  He believes this risk is low.

So while the banks appear well provisioned for problems in their home loan books, profit growth is likely to be difficult to come by for a while.


Mark Draper (GEM Capital) writes monthly for the Australian Financial Review - this article was published on 30th May 2023

Finding the sectors where old is gold

With the ageing of the population having become an investment megatrend, investors need to assess what consumer-led changes are likely to occur.

Investment Megatrends are powerful transformative forces that change the economy, business and society and have been changing the way we live for centuries.  Electricity, cars and the internet are some common examples.

Nick Markiewicz, a portfolio manager from Lanyon Asset Management says the Australian population is ageing quickly as a result of declining fertility rates as living standards rise, as well as rising life expectancy.  Based on current demographic forecasts from the Australian Institute of Health and Welfare, the proportion of Australia’s population aged over 65 has more than tripled from around 5% in 1922 to 16% currently and is expected to increase to 21% by 2066. In other words, the population over 65 is expected to grow at twice the rate of the Australian population more broadly.

Figure 1.1

Investors need to assess what consumer led changes are likely to occur as the population ages.  Older people with more leisure time tend to travel, require financial services, get sick more often which can also lead to changes in accommodation, and ultimately die.

At an economic level, other changes that are likely include a slowdown in GDP growth as the working age population stagnates, rising deficits as the Government has fewer workers which it can tax to fund higher spending on aged care and healthcare programs.  These programs, coupled with pension spending account for a quarter of commonwealth spending and are projected to rise significantly.

Nathan Bell, Head of Research at Intelligent Investor believes that the ageing population is great news for Australia’s healthcare companies.  Some are the world’s best including Sonic Healthcare (pathology), CSL (blood products and biotech), Resmed (sleep apnea) and Cochlear (hearing).

Bell says that the older Australia’s population gets, the sicker it gets and the more medical tests are required from the likes of Sonic Healthcare.  The number of pathology tests conducted in Australia has increased from 119.5m in 2015/2016, to 150.9m in 5 years.  (Source:  This represents a compound growth rate of around 5% per annum which means that the pathology industry is growing at a faster rate than the broad economy.  Bell is of the view that Sonic is reasonably priced due to fears of falling revenue due to fewer COVID tests, however the base business (ex-COVID testing) is in good shape and growing steadily.

Another medical industry benefitting from the ageing population is diagnostic imaging.  Growth in diagnostic imaging has been at a similar pace to pathology with the number of services rising from 22.8m in 2015/2016 to 27.7m in 2020/2021.  (Source  Bell likes a radiology company, Integral Diagnostics in this sector.  Bell flags that Intregral’s profits have been hurt by restricted medical procedures during COVID lockdowns, but if they recover and recent acquisitions pay off then it could once again regain favour in the market and reward investors.

One of the biggest risks to healthcare companies is the potential for Government to change healthcare rebates, particularly as pressure grows on Government deficits.

It is this reason that Markiewicz is preferring to play the ageing of the population via the financial services sector. Markiewicz puts forward Challenger as a beneficiary of the ageing population as they provide annuities to retirees, offering them protection against the risk of outliving their savings.  Challenger is by far the largest provider of annuities in Australia with a market share exceeding 80%.  Markiewicz expects  Challenger to benefit from a growing target market and increasing take up of annuities over time which is likely to be enhanced by regulatory reforms by Governments such as the Retirement Income Covenant.

Investing on a megatrend thematic alone is an easy way to lose money.  Investors must ensure they are avoiding substandard or risky businesses within sectors that on the surface are beneficiaries of the ageing population.  Both Markiewicz and Bell nominate the aged care sector as one to tread carefully, despite mouth watering demographic changes.  This is because a large portion of their earnings are derived from Government funding.  After Government cuts to age care funding in 2016, the listed ASX aged care providers share prices fell sharply.  The recent Royal Commission into the aged care sector has also resulted in rising costs.

Megatrends are not a guarantee of investor success, but there can be important tail winds to recognise.



Mark Draper writes monthly for the Australian Financial Review - this article was published in the Wednesday 3rd May 2023 edition

How to recession proof your portfolio

With the recession drums beating louder following 10 straight interest rate rises in Australia, it’s worth dusting off the recession playbook to ensure that investor’s portfolio can withstand the heat. 

A recession is a period of temporary economic decline during which trade and industrial activity decline, generally identified by a fall in GDP in two successive quarters.  Recessions are a normal part of the business cycle, but it is the depth of a recession that investors should consider most.  A deep recession is normally characterised by high unemployment.

Dan Moore, portfolio manager at Investors Mutual, says that markets are forward looking so they usually fall well before a recession actually starts, often 6-12 months before.  Share markets also tend to bottom well ahead of the economy recovering, and quite often when the news is at its worst, which explains why sometimes the best time to invest is when the news flow seems like the worst possible time.  

The table below shows share market returns from the S&P 500 in the US during the last 11 recessions.  The key takeaways are that the average negative return from the S&P 500 during the 12 months before a recession was -3% and that the average return for the 12 months after a recession was 16%.

 Recession returns

Most recessions are characterised by rising unemployment, but this indicator also lags financial markets.  In November 2007 the share market peaked before the GFC and unemployment was 4.7%.  The market ultimately bottomed in March 2009 and unemployment reached 8.7%.  Unemployment only started to improve in November 2009, but by that time the share market had already risen 50% from the March lows.

Hugh Dive, portfolio manager with Atlas Funds Management, believes that the sectors that tend to do well during a recession are those that offer non-discretionary goods and services or benefit from cost-conscious consumers trading down during hard times.  These sectors include utilities, health care and consumer staples such as supermarkets.

Moore also likes Telcos in difficult economic times. 

Sectors that tend to do poorly during recessions include discretionary retailers, construction companies and some real estate according to Dive.  

Investors seeking to protect themselves during a recession / downturn should seek specific qualities from their investments.  Moore suggests investing in companies that are industry leaders with a competitive advantage as they usually have higher profit margins that can help ride out the storm.  A strong balance sheet, which generally means lower debt levels is very important to ensure the company can avoid dilutive equity raisings if the downturn becomes severe.  Recurring revenue and a capable management team also make a difference in tougher times.

Moore says that Telstra and Brambles both look well placed and both companies are industry leaders that sell essential products and services.

Dive nominates CSL to be well placed to deal with tough economic times as historically in the US, plasma donations have risen when the economy is suffering.  CSL’s health products are not linked to the economic cycle and its balance sheet is strong.  One of CSL’s major competitors on the other hand is also financially stressed which could provide CSL with a tailwind in years to come.

According to Dive, during recessions, investors want to own companies that generate consistent cash flows to service debt, invest for growth, pay dividends and potentially acquire weaker competitors that may be available at a discount.

For example, during the GFC the Australian banks strengthened their competitive position with Westpac taking over St George and CBA taking over BankWest.  Similarly in 2009 Amcor took over Alcan Packaging in a move that propelled the company on a course to become the largest packaging company in the world and raise its margins.

Both Dive and Moore warn investors against selling out of their investments in anticipation of a recession.  Moore says always having some cash is useful to take advantage of market falls, but increasing cash holdings in anticipation of a recession is fraught with danger.  This is largely because economists are famous for predicting far more recessions than actually occur, and even if there is a recession an investor must also be able to pick when markets are likely to bottom and then have the stomach to reinvest.  

With storm clouds gathering, investors should ensure their investment strategy can withstand, and ultimately benefit from, a downturn should one eventuate.


Mark Draper writes for the Australian Financial Review each month - this article featured during April 2023.

How to position for re-opening of Chinese economy

ChinaInvestors in Asia have endured a difficult few years.  The combination of China’s COVID zero policy together with it’s crackdown on property developers, regulation of  the tech sector and increased geopolitical tension with the West have made investment returns hard to come by.

Cameron Robertson, portfolio manager at Platinum Asset Management believes that the poor sentiment towards China has dampened investor interest across the whole of Asia.  As the Chinese economy picks up, there is a chance this could reignite interest across the region more broadly.

2022 witnessed the slowest pace of growth in the Chinese economy since 1976.  Chinese retail sales (ex-autos) in November 2022 fell almost 6% during lockdowns.  For perspective, at the worst point of the GFC, US retail sales fell around 10%.

Nicholas Markiewicz, portfolio manager at Lanyon Asset Management says that most pundits saw the 20th party congress in late October 2022 as the government’s ‘turning point’, but he has noticed subtle policy shifts from the Chinese government in the months before that.  He believes the crackdown on the technology sector appears to be more or less over, property developers are in the process of being recapitalised and the government is beginning to thaw relations with the West.

Many investors associate a stronger Chinese economy with demand for Australian iron ore.  However with China recently consolidating purchases of raw materials under a single state owned buyer called China Mineral Resources Group in an effort to control prices, the iron ore trade may not be the one way bet it has been in the past.  Investors should consider other ways of participating in an Asian rebound. 

Robertson and Markiewicz are investing in the Chinese consumer theme.  Robertson says that during COVID household bank deposits increased by 42% and he thinks that we could see the same sort of ‘revenge spending’ that we saw in other economies following the end of lockdowns.  While the sharp rally at the end of 2022 and in early 2023 has captured some of the benefits of the changed environment, Cameron remains optimistic about Chinese parcel delivery company ZTO Express, which is a natural beneficiary of consumer spending.

Markiewicz suggests that the doubling of the savings rate during COVID means that Chinese households have an additional US $800bn in their bank accounts.  He says that the most obvious plays are the large domestic consumer platforms and Lanyon’s preferred pick is Alibaba which still trades at a heavily depressed valuation.

Outside of direct consumer plays, travel is clearly another segment likely to benefit from China’s reopening.  Airbus and Boeing continue to dominate the commercial aviation market according to Markiewicz, with Airbus having an 8 year backlog, no debt, and still writing new orders for Chinese airlines.

He adds that for those with apprehensions about investing directly in Chinese companies, there are still many Western consumer businesses that derive significant revenue from China and likely to experience a strong recovery.  BMW for example derives nearly 40% of its sales from China, has one of the world’s best balance sheets and trades on a single digit earnings multiple.

Robertson says that pre-COVID, around a third of Thailand’s tourists came from China.  As the flow of tourists from China gathers momentum, money is expected to return to the Thai economy and that will have wide ranging effects across that market.

ASX listed investment, Auckland Airport is another likely beneficiary of reinvigorated Chinese tourism.  According to a recent ASX announcement, New Zealand is one of 20 countries open to Chinese travel agencies. 

The changing of conditions in China are likely to have other second-order effects, such as increasing demand for energy.  This could bring another squeeze on energy markets at some point which could benefit Australia’s world class energy companies including Woodside and Santos. 

While it is often considered that higher energy prices resulting from China’s reopening may contribute to inflation, Robertson suspects that the impact is likely to be at the margin.  He believes that the inflationary environment we’re seeing across the Western economies is driven by a broad range of complex factors, such as shifting supply chains, monetary policies unleashed by our central banks over recent years and automation.

The landscape has changed materially in China over the past year, which could well deliver good medium returns in the Asian region for alert investors.



This article was written by Mark Draper and featured in the Australian Financial Review in March 2023

5 areas investors should be wary of in 2023

DohInsideWarren Buffett’s two golden rules for investing are, 1. Don’t lose money 2. Never forget rule one.

To assist investors adhere to these rules, some of Australia’s leading investors shine a light on where some of the dangers may be hiding in the current markets.  These dangers are in 5 categories:  crowded trades, expensive investments, earnings downgrades, business models and popular short positions.

crowded trade is a popular position or theme embraced by large numbers of investors.  Crowded trades may not be wrong, but are usually associated with high prices, bubbles and irrational behaviour.  Matt Williams, Portfolio Manager at Airlie Funds Management says that the resources sector is currently a crowded trade.

Hugh Dive, Chief Investment Officer from Atlas Funds Management nominates  lithium as a crowded trade.  He says there are currently 62 lithium stocks on the ASX but only a few are profitable.  The majority of lithium miners are exploration companies or companies with a resource that may or may not be economical to mine.  He believes the great bulk of these lithium companies will never see their projects developed and are likely to head towards insolvency as investor patience wanes.

Investments that look expensive according to Dive include consumer staple companies and the tech sector.  Dive supports this by saying that the food retailers have done well out of COVID lockdowns, but are now moving through tougher comparable sales periods that will see declining earnings and higher costs from labour and supply chain issues.  While Woolworths and Coles are efficient retailers, paying over 21 times earnings that are declining, doesn’t make much sense.

Reporting season is just around the corner with investors braced for earnings downgrades as a result of higher interest rates and consumer caution.  Williams is most worried about earnings downgrades for consumer exposed retail companies and the building sector.  The difficulty for investors is to determine what is already priced in.  For example James Hardie has sold off by 35% in the last 12 months and may well already have adjusted for expected earnings downgrades. 

Nathan Bell, Portfolio Manager at Intelligent Investor says that business models likely to struggle in the higher interest rate environment are those that have borrowed lots of money, particularly for shorter terms.  He suggests many of the new breed of fintech companies could have this issue exposed if higher interest rates send a deflationary pulse through the economy.

Williams believes that business models most at risk are those that are not yet profitable and hence rely on equity markets to fund their operations.  This is prevalent in the tech sector and investors should exercise great care when investing in companies that do not make a profit.

Investors are always wise to be aware of stocks that are being heavily shorted.  A short position is essentially betting against the market, and the short position profits when prices decline.  Some of the most heavily shorted companies in the ASX200 currently include Megaport (tech), Sayona Mining (resources) and Core Lithium (resources).

Williams nominates REIT managers exposed to the retail sector as a source of potential danger as they continue to face a difficult environment as the economy softens.  They are also negatively impacted by rising rates on valuations and borrowing costs.

Dive is cautious on the iron ore sector going into 2023, which has been a short term beneficiary of China amending their COVID Zero policy on the basis that it leads to a rise in construction activity.  Dive’s concern centres around China recently announcing the establishment of a centralised state-owned buying company for iron ore to consolidate the purchases of iron ore for the 20 largest Chinese steel makers.  This will likely reduce the pricing lower the four main iron ore producers currently enjoy from selling their iron ore to a fragmented group of steel makers.  With China consuming 70% of globally traded iron ore, more disciplined centralised buying leads Dive to believe that the price of iron ore is likely to face downward pressure.

Bell is wary of the oil and gas sector.  He says that while a higher oil price may increase short term profits, paying high multiples for capex heavy companies that don’t control their product prices is usually a recipe for disaster.

Avoiding permanent capital loss increases investment returns.  2023 has its unique list of things to be wary of.

Medibank Private - will the patient recover or is this terminal?

The share market has wiped out $1.87bn of equity value from Medibank Private following the cyber attack with the share price down close to 20%.

As with any investment event, investors need to determine whether this event is temporary in its impact, or permanent.  If the event is temporary it may represent an opportunity, but if the event results in permanent change or damage then investors need to realign their thinking.

Hugh Dive, the Chief Investment Officer at Atlas Funds Management highlights that Medibank has taken a hit to this years profit of $25 - $35m in one off costs relating to customer service initiatives, reissuing customer ID’s and external experts.  Medibank has also deferred the statutory premium increase until January 2023 at a cost of $62m which is offset by lower than expected claims expense. These costs would appear temporary in nature.

Nathan Bell, Head of Research at The Intelligent Investor says that more permanent financial impacts are likely to come from ongoing higher IT expenses as it beefs up cybersecurity, and also potential fallout from a probable class action.

Bell says that the potential result from a class action is difficult to quantify.  The most the Australian Information Commissioner has awarded in damages for non-financial loss associated with a privacy breach was $20,000 per individual.  This incident was related to someone’s health information being published on a website, causing distress.  Medibank says that 480,000 customers had health claims data stolen containing some potentially embarrassing information.  A similar damages award to this group of 480,000 would be larger than Medibank’s market cap.

Precedent can be helpful when thinking about the potential effects of legal action, and Bell points to the data breach by Premera Blue Cross in 2015, which is a US health insurer with a similar number of policy holders affected.  The company settled the class action for US $32m (AUD $48m).  Premera Blue also had to commit US $42m (AUD $63m) to improve data security, which means that it might be wise for investors to leave room in their valuation for a much larger IT spend by Medibank than management has already set aside.

Dive confirmed that Medibank self-insure against cyber risk, but Medibank management advise that the type of insurance available wouldn’t have paid out for the hack.  While the class action lawyers are circling, the class action may struggle as the right to sue for the tort of breach of privacy or invasion of privacy is quite novel in Australia.  The class action would have to prove that Medibank’s cybersecurity was incompetent or negligent which could be challenging for the plaintiff.  Dive also questions whether the Government would be happy to allow Australia’s largest health insurance provider with 29% market share to be financially crippled.

Other than the risk of financial damage from a class action, the other key risk is that Medibank customers switch to other providers.  NIB mentioned at their AGM in November that they are starting to see some unhappy Medibank customers contact them, but the transition costs of private health insurance are high.

Dive said he would be surprised if HCF/BUPA/NIB used the cyber attack as a way to opportunistically gain market share by offering no waiting periods for hospital cover, which is usually 2 months before making a claim or 12 months for a pre-existing condition.

Contrasting these risks, Medibank is debt free with surplus capital and trades on a price earnings multiple of 16 times.  It offers investors a fully franked dividend of 5%pa.  Prior to the data breach Medibank reported 14% customer growth since June 2022. Consensus valuation for Medibank is around $3.20 per share (source Stockdoctor).

But Bell is cautious about referencing consensus valuations, as the final cost of the breach is unquantifiable and uncertainty could linger for years due to litigation, which could weigh on the share price.

The question for investors is whether the market has over-reacted to the cyber attack by slashing almost $2bn from the value of Medibank versus currently only a once off $35m hit to profits. 

Investing is a game of probabilities, and investors need to balance off Medibank’s attractive price on offer against the risks from customer loss and potential legal action.


Each month Mark Draper (GEM Capital) writes for the Australian Financial Review - this article featured in the 30th November 2022 edition

Beaten up REIT's - time to revisit

0ee70163e29bae5db9d4be0d088a4c1c MThis year’s dog can often be next year’s star for investors.  The second worst sector so far in calendar 2022 belongs to REIT’s, second only to the tech sector.  

Hugh Dive the Chief Investment Officer at Atlas Funds Management says there are two reasons for the REIT sell off.  Firstly the whole sector has been derated.  The REIT index was trading on a price earnings multiple of 21 times in January 2022 and is currently trading on a multiple of 14.9.  Secondly, interest rates have risen for the first time in a decade with the 10 year bond rate up by around 150% so far in 2022.  REIT’s are viewed as an interest rate sensitive sector.

Pete Morrissey the Head of Real Estate Securities at Dexus Asset Management highlights that the REIT’s with higher gearing, aggressive cap rates and lower levels of interest rate hedging suffered the most along with those with funds management businesses contributing to their earnings.

Higher interest rates are negative for the REIT sector as they increase the discount rate (referred to the cap rate) used to value the expected cash flows from owning property which reduces the asset value.  Higher rates can also increase the interest costs for REIT’s so if rents do not keep pace with interest costs, income distributions can decline.

Cap rates are a measure that helps evaluate real estate investment and a higher cap rate results in a lower property value, so the higher the cap rate, the better it is for the investor.

Each REIT uses its own cap rate to determine its valuation.  A comparison of two industrial trusts, Centuria Industrial REIT (CIP), and Dexus Industria REIT (DXI) shows that CIP uses a cap rate of 4.19%, while DXI is using a far more conservative cap rate of 5.04% to determine valuation.  This means that investors need to consider the merits of the individual trusts as not all REIT’s are equal.

Dive believes that while cap rates will expand, there are still transactions in the physical markets being settled in the 4% range for industrial and office property, and 5% for supermarkets, so the pressure to revalue assets downward isn’t intense.

Dive says the broad based sell off in REIT’s in August and September saw most trusts fall 17%, with little consideration for the differences in underlying tenants, lease escalators, debt costs or debt structure. 

Morrissey believes there is reason for optimism and points to many REIT’s now trading at 30% plus discounts to their June 2022 net tangible asset backing.  He says that the market reaction has provided investors with the opportunity to invest in REIT’s at deeply discounted values while collecting income yields averaging around 6%.

Morrissey prefers REIT’s with strong balance sheets and above average hedging of debt to protect their interest costs.  He also likes REIT’s that offer inflation linked earnings growth in the current environment.  Morrissey likes non-discretionary supermarket anchored retail REIT’s due to earnings predictability, tenant covenant quality and longer lease terms.  

Supermarket landlord Shopping Centres Australia has an average term of its debt of 5.5 years and is 80% hedged with rents linked to CPI.  It will see a kicker in turnover rent from food inflation, and as mortgage payments rise we may see budget conscious consumers limit restaurant visits in favour of cooking at home.

In addition to non discretionary retail, Dive also likes the Industrial, Educational and Medical sectors.

Morrissey remains cautious on the office sector due to the high level of uncertainty created by working from home.  He adds that Office REIT’s are some of the cheapest going around and it is clear that quality office buildings remain in demand for many businesses as culture can only be built in the office.  Dive is limiting exposure to REIT’s with earnings from property development due to the volatility of their earnings.  He is also cautious on discretionary retail REIT’s.

The REIT sector in general is far better equipped to handle rising rates in 2022 than it was in 2007, when many trusts used the short term wholesale market to fund their debt.  On average, in October 2022, the REIT sector has a gearing level around 20% with  debt maturity of 5.1 years.  While some REIT’s may struggle with a slowing economy and higher debt costs, other trusts are likely to see minimal or even positive impacts from changing economic conditions resulting in a stable and growing income stream.  Among the price destruction of 2022, the REIT sector is likely to present investors with some good opportunity.


This article featured in the Australian Financial Review on Wednesday 2nd November 2022.  Mark Draper writes monthly for the AFR.



** Mark Draper owns shares in Shopping Centres Australia and Dexus Industria REIT

Dangers of market timing recessions

When there is a fall in the market investors are bombarded by opinions from ‘experts’ speculating on how far markets will fall.  These experts are currently debating how far interest rates will rise and whether or not we enter recession.

Recession is defined as ‘a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters’.  Investors need to appreciate that periods of recession are a normal part of the business cycle and for investors reasonably positioned, are temporary in their effect.

Hugh Dive who is the chief investment officer at Atlas Funds Management believes that the chances of Australia slipping into recession are much lower than the USA and Europe due to the different composition of our economy, minimal direct impact from the Ukraine war (in fact several sectors are benefitting), lower inflation which should reduce the need for the RBA to raise interest rates as hard as some expect.

Dive cites strength in the labour market as a key indicator for investors to watch with the ANZ Job Ads currently the strongest it has been in over a decade.  Typically recessions are accompanied by high unemployment.  During the 1982-83 recession the unemployment rate peaked at 10.5% and in the 1991-1992 recession the unemployment rate peaked at just over 11%.

Dan Moore portfolio manager at Investors Mutual points out the current rate of unemployment in Australia is 3.5%, the lowest it has been in over 45 years which is likely to be as good as it gets.  Moore says that other indicators including rising interest rates and relatively high inflation, at least in the short term, point to more difficult economic conditions.

The key question for investors right now is whether they should sell everything and move to cash, or stay invested in the markets.

To some, during periods of market stress the least risky option appears to be for investors to sell everything and move to cash.

History however shows a different story for those who sell during a downturn and miss out on the rebound when it occurs.  The average bear market in Australia declines 29% and lasts 14 months, versus the average bull market rising by 157% and lasting 65 months.  For reference, the Australian market last peaked in August 2021.


Dive believes that successfully timing the market both to exit at the top and re-enter at the bottom is beyond the ability of virtually all investors, a feat not managed by even the most exalted fund managers.  In early 2020 a few fund managers were patting themselves on the shoulder for reducing their equity exposure early on in the pandemic.  These same fund managers spent the remainder of 2020 and 2021 holding too much cash, cursing the fast recovery and missing out on gains.

Dive points out that famed investor Jeremy Grantham received positive press for calling the major bubbles of 2000 and 2007. However Grantham famously predicted doom for equity markets in 2010, 2011, 2012, 2013, 2014, 2015, 2017 and 2021.  Those who predict gloom regularly, will look like a genius every few years, but if an investor had heeded these calls, they would have been sitting in cash, earning a negative real rate of return for most of the past decade.

Moore highlights that selling for market timing purposes gives an investor two ways to be wrong.  The decline may or may not occur, and if it does, you’ll have to figure out when the time is right to reinvest.

There is no doubt that investors face a challenging set of circumstances which include rising interest rates, high inflation, China’s COVID zero policy and the Ukraine war.

To navigate the current environment, Moore suggests investors be conservative and seek high quality investments.  He defines high quality investments as those with recurring revenues, strong balance sheets (ie not too much debt), capable management and businesses with a strong competitive advantage.  Brambles, Aurizon and Amcor are examples of such businesses according to Moore.

Dive says that during high inflation periods investors must seek companies with the ability to pass on higher costs to their customers.  The recent company reporting season showed companies such as ASX and Woolworths inability to pass through higher costs, whereas Amcor and Transurban passed through increased costs to maintain profit margins.

Tough times don’t last, tough investors do.


Mark Draper (GEM Capital) writes for the Australian Financial Review each month and this article was published on 5th October 2022

What to takeaway from company reporting season?

Company reporting season can provide an enormous amount of information to investors, not only about the previous 6 months, but also what lies ahead.

The standout winners were the energy sector which benefitted from higher oil and gas prices not only because of the Ukraine war, but from years of under investment since 2014.  Woodside Energy generated free cash flow of US $2.568bn for the 6 months to June 2022 and forecast that demand from Asia for gas is likely to peak in the mid 2040’s, which suggests that the energy sector may enjoy higher earnings for longer than many would have believed.

David Prescott who is the founder of Lanyon Asset Management said that the common themes coming out of reporting season were inflation, particularly in relation to input costs, lingering COVID 19 issues disrupting supply chains and adding costs, tighter labour markets and a resilient consumer despite the consequences of rising interest rates.

Nathan Bell, the head of research at Intelligent Investor said that the results from reporting season were very stock specific and gave the example of Xero’s results which suffered from slower than expected growth in the UK while fellow tech company Wisetech had a superb result.

Building materials companies Adelaide Brighton and Boral struggled to recoup input cost increases whereas James Hardie and Reece passed on input costs quite easily according to Matt Williams, portfolio manager at Airlie Funds Management.

With inflation likely to remain elevated for some time, investors need to assess to what extent companies can pass on higher costs to their end customers.  Cleanaway reported weaker earnings margins partly due to higher diesel prices, but the report also stated their contracts allow to claw back higher fuel prices, indicating higher costs are likely to be recouped in future reports.

Toll roads showed that they can be beneficiaries of rising inflation as toll revenue is largely linked to inflation.  Atlas Arteria reported record dividends thanks to their interest on debt being fixed for over 5 years, while their income largely is rising with inflation.

Williams said that higher interest rates negatively affected listed property trusts as increased interest costs dampened the outlook for income distributions.  This would appear to be largely factored into share prices of property trusts which have endured a tough first 6 months of the calendar year.  The art form for investors is to understand what expectations about the future have been built into current share prices.

Prescott said that recent interest rate rises did not have a noticeable impact on the earnings of companies reporting at 30th June 2022.  But he added that the outlook statements from various senior managers however portrayed a slightly different story.  Management inability or reluctance to provide formal guidance emphasises the great unknown as to how rising rates will impact future operating profits.

Higher interest rates were yet to have a substantial impact on retailers with JB Hifi and Wesfarmers (Bunnings) reporting good numbers.  Interest rates only began to rise in May this year, so it is too early to understand their impact on consumers.

Williams highlighted QBE as a beneficiary of rising interest rates by increasing investment returns on their fixed interest portfolio.

Bell believes that company profits (particularly from consumer facing companies) will be tested when the nearly 50% of Australian borrowers on fixed rate loans have to refinance in the next 12 – 24 months at far higher rates than they are currently paying.  This is likely to reduce consumers spending power and change spending habits.  Early evidence of this came from the Woolworths result where CEO Brad Banducci said “inflation is beginning to impact all aspects of our customers’ shop and we are seeing a gradual change in customer shopping behaviour. We are seeing some customers trade down from beef into more affordable sources of protein and trade across from fresh vegetables into more affordable frozen and canned offerings.”

Healthcare company CSL is recovering from the effects from COVID lockdowns that reduced plasma collection, and other companies are still reporting COVID costs.  Wesfarmers for example invested $49m into their team to provide paid pandemic leave during lockdowns.  There is potential earnings upside here as the costs of dealing with COVID slowly unwind.

Investors are faced with a complex environment today, but would be well served to read media releases and presentations that companies release during reporting season to provide clues on how to best navigate it.

Each month Mark Draper (GEM Capital) writes for the Australian Financial Review - this article was published on 7th September 2022

Aged Care Investments - Tread Carefully

Investors would think that with the ageing of the population, loading up their portfolio’s with aged care stocks would be a no brainer. Judging how difficult it was to obtain comment from fund managers about the sector, maybe that’s not the case.

The key attractions for investing in aged care are the tailwinds provided by an ageing population. Hugh Dive who is the Chief Investment Officer from Atlas Funds Management says there are currently 4 million Australians aged between 65 and 84 and the Australian Bureau of Statistics forecast that this will increase to 6 million by 2030. He adds he is not an investor in the sector however.

In 2021 the Government spent $24bn on aged care, with the largest spend on residential aged care.

The other attraction to the sector lies with development of new facilities as operators can receive a large amount of their capital back when the first residents enter the facility.

In Australia, there are two remaining ASX listed ‘for profit’ Aged Care providers, Estia Health and Regis Healthcare in addition to ‘not for profits’ such as Calvary Healthcare that took over Japara in 2021.

Theoretically the standard of care should be the same in both the for profit and not for profit sectors as minimum standards of care are regulated. A leading fund manager who spoke on the basis of anonymity said that those facilities that had received sanction notices were from all parts of the sector, which shows no divergence in quality of care between the ‘for profits’ and the ‘not for profits’ or government run facilities.

One major difference between the major players is that the ‘not for profit’ sector does not have to pay payroll tax and do not have to pay income tax. This possibly led to Calvary buying the listed operator Japara and could result in the ‘not for profits’ being able to employ more staff. Fund managers cite this unlevel playing field as a reason for caution for the ASX listed operators.

Government incentives for senior Australian’s to remain in their own home is a threat to the aged care sector as the Australian Government seeks to limit the cost to the Healthcare budget.

The other major risk appears to be the ever changing regulatory environment.

The recent Royal Commission into the sector has recommended a range of changes that are positive and negative, but most likely add to costs for the providers:

- Mandated minimum care hours from October 2023 and a 24/7 Registered Nurse rostering will improve conditions in aged care but also increase costs

- ACAR (Aged Care Approvals Round licencing system) abolition will be a positive when it occurs in June 2024 as the ACAR currently restricts both the number and location of residential aged care places.

- The new Australian National Aged Care Classification which starts in October 2022 will see an increase of $28.20 (per resident per day) in the base rate of funding in return for requiring higher staffing.

Inflation is likely to crimp margins within the aged care sector given that around 75% of revenue is allocated toward employment expenses whereas revenue is largely regulated. Dive says that the sector also faces higher non-wages costs from energy, cleaning to medical devices as well as higher incremental costs from COVID-19. These costs are increasing more swiftly than the increase in government support for aged care, and this has been shown in recent results from ASX listed operators who both reported a first half loss in 2022.

It is always useful to consider global experiences and to this extent Dive highlights that in the US there are 3 large listed nursing home chains and 8 Real Estate investment trusts (REITs) that specialise in nursing/retirement homes. In the US an aged care operator will lease a retirement home from a specialised retirement home REIT. The investment performance of the sector in the US is not dissimilar or probably worse than the experience in Australia. In 2016 giant operator Kindred Healthcare decided to delist from the NYSE, revealing it owed US$423 million in unpaid rent to its landlord Welltower REIT.

Despite the seductive demographics, the high level of changing regulation plus the reliance on government funding for most of the sector makes aged care a challenging sector to derive consistent profits for investors.



This article was written by Mark Draper (GEM Capital) and featured in the Australian Financial Review on 10th August 2022

China continues to offer huge investment opportunities

China is certainly on the nose for investors.

The most common reasons for this revolves around China’s position on Russia, Taiwan and the government changing rules under the ‘common prosperity’ program.

Cameron Robertson who is the co-portfolio manager for Platinum Asia ex-Japan strategy says that people overplay China’s relationship with Russia with respect to the war. He acknowledges that they did not vote in support of the UN resolution condemning the invasion, but they were one of 35 countries that abstained. It should be noted that there were 5 countries that voted in support of Russia, China was not among these.

Alasdair McHugh a director at Baillie Gifford adds that China has distanced itself from Russia since the Ukraine invasion. The foreign minister of China has officially referred to the Russian invasion as a ‘war’, having not done so previously. McHugh believes that the idea that China is ‘all in’ with Russia is wrong as the threat of secondary sanctions if China continues to do business with Russia is a much higher stakes game than what we’ve seen with Russian sanctions. Baillie Gifford’s base case is that China is likely to tread carefully, not least because exports to the US and EU are in excess of US $1trn versus just US $68bn to Russia. McHugh does not think that Beijing will risk losing access to markets in the developed world.

Robertson says that Russia’s invasion seems to have worried people about parallels with China-Taiwan, but thinks people under-estimate how different these two scenarios are. China is a country with huge foreign trade relationships with the West, and trillions of dollars of USD assets, so even just the threat of sanctions are a much bigger stick. Meanwhile Russia’s own attempts have really shown the risks of pursuing such a path as there is no one saying “that looks like a success for Russia, we want to follow that path”. Taiwan has one major political party that is somewhat sympathetic to China, so there is still the glimmer of hope of a peaceful accommodation in China’s eyes – whereas attacking would surely harden resolve against any (even nominal) reunification efforts.

McHugh claims that the current focus on ‘common prosperity’ in much of the Western media portrays this as some sort of attack on capitalism. Helped by the insights we’re gathering from Baillie Gifford’s Shanghai office, he understands common prosperity to instead be about sustainable and inclusive growth. Many companies are well-aligned to such policy directions and he therefore continues to see exciting opportunities ahead.

McHugh believes that China remains a great opportunity for long term growth, and to provide an idea of the scale he says that China has 160 cities with more than 1 million inhabitants versus only 10 in the US. That is a lot of potential consumers.

Robertson asserts that China is out of favour and cheap, which is commonly a buy indicator. The discount of the Chinese market can be seen from the chart below which compares the price to earnings (PE) ratios of several countries share markets.

China PE ratios

Source: Minack Advisers

Exposure to China has a role to play in investor’s portfolios, tapping into the dynamism of this country and riding the wave of technological innovation that is taking place as new industries develop there.

Robertson highlights AK Medical is a leading provider of hip and knee orthopaedic replacement joints in China accounting for roughly one fifth of the domestic market, providing high-quality cost effective solutions. Their products are internationally competitive, seeing acceptance even in developed markets like the UK. The business expects they will sell around 180 million hip and knee implants this year, up from around 80 million just five years ago. Currently only one out of every 2,000 people in China has a joint replacement each year, this compares to wealthier countries where we typically see rates of one in every 200-300 people having joint replacement surgery each year.

McHugh showcases NIO (electric vehicle maker). NIO’s Chinese name literally means ‘blue sky coming’. It is rapidly scaling production of EVs and thereby supporting China’s climate ambitions. Its trailblazing battery swapping model is inherently more conducive to battery recycling, thereby reducing waste – and it protects the car’s resale value as battery degradation isn’t a factor.

Investing in out of favour sectors is hard, but to ignore one of the world’s largest markets could be a big mistake.


This article was published in the Australian Financial Review during May 2022.

Why Toll Road Are Attractive

In uncertain times, toll roads can provide investors with high levels of certainty.

A toll road by definition from the Cambridge dictionary is ‘a road that you have to pay to use. Your journey will be quicker but more expensive if you take the toll road’.

Generally there are three types of toll roads – ‘greenfields’, which are under construction, newly opened toll roads in ‘ramp up’, and mature roads. Hugh Dive who is the Chief Investment Officer at Atlas Funds Management is of the view that mature roads are preferable as investors can more accurately assess the traffic numbers and the earnings.

Dan Moore, Portfolio Manager from Investors Mutual says that history shows traffic forecasters tend to be overly optimistic and forecasting errors in the past saw the original owners of greenfield toll roads, Cross City Tunnel and Lane Cove Tunnel go into receivership.

It is important to understand that toll road investors don’t own the physical land or the road they build, they merely own the right to collect tolls for a specific period which is known as the concession period. After this period, the road reverts to the government and the debt repaid. Dive says that the finite life of a toll road concession is sometimes used as a reason not to invest in the sector but believes that this approach is too simplistic and doesn’t account for the actions that toll road operators can take to extend the life of the concession. In 2015, Transurban added extra lanes on the M2 motorway in Sydney and in exchange, saw an 11.5 year increase in the concession period for the Lane Cove Tunnel and an increase in truck tolls of 33%.

A toll road contract usually allows for tolls to increase, commonly in line with inflation, which makes their operational earnings resilient during periods of higher inflation.

Toll roads are attractive according to Moore due to their high level of recurring revenue, with built in price escalators, particularly if they are located in an area with a growing population.

Dive says that toll roads are long dated monopoly assets as no rival is going to build a competitor road next door to an existing road. Once construction is complete, ongoing costs for a toll road are low which results in high margins, which can be up around 80%.

Dive also likes the Government support for the sector and uses the example in NSW where Revenue NSW collects unpaid tolls on behalf of Transurban, suspending a drivers licence if they don’t pay. Trucks are required to use the recently completed North Connex and will receive a $194 fine if they attempt to use the ‘free’ roads above the tunnel.

While high fuel prices present some risk to toll road investors Moore believes that this is not a major concern for investors as most traffic is non-discretionary. He says that recessions accompanied by high unemployment is a bigger concern. The chart below supports Moore’s view as it shows continued traffic growth on the Sydney Harbor bridge during the oil crisis during 1973 – 1974.

sydney harbour traffic 2

Political risk, commonly referred to as sovereign risk is another factor when investing in infrastructure. Dive highlights the two key risks are:

Expropriation, which is the concession taken away from the toll road operator and
Regulation, where the government defaults on the toll road’s contractual obligations, ie not allowing tolls to increase in line with the formula stated in the contract

Political risk are quite low in the western world according to Dive and highlights these risks have largely been confined to developing countries such as South Africa and Malaysia.

Other considerations for investors is the capital structure of the company according to Moore. Excessive debt levels, makes any company more susceptible to short term risks and can lead to untimely dilutive equity raisings which impact investor returns.

Investors can gain access to this asset class through the two ASX listed toll roads in Transurban (largely Australian roads) and Atlas Arteria (European roads). Exposure to toll roads can also be achieved by investing in infrastructure funds offered by several funds management groups.

In a low interest rate environment, toll roads can help drive investors dollars further.


This article was published in the Australian Financial Review (AFR) on Wednesday 20th April 2022. Mark Draper (GEM Capital) writes monthly for the AFR about investment topics that impact investors.


Investments to Avoid in 2022

The current investment environment feels a lot like 1999 just before the dotcom bubble burst, with a hint of 1994.

Investors would probably need to be over 40 to remember the fallen angels of 1999 when the dotcom bubble popped. Back then the new paradigm was that price to earnings ratio’s were irrelevant and it was price to revenue that mattered. Sound familiar?

One of the most high profile busts in 1999 was One Tel. At it’s peak, One Tel had a market capitalisation of $5.3bn in November 1999 making it one of Australia’s largest companies at the time. It reported a record operating loss in August 2000 of $291m, before entering receivership in May 2001.

1994 saw the Australian 10 year bond rate rise from around 6.3% in January 1994 to over 10% by the end of 1994. Long term interest rates are important as valuations of shares and property are anchored to them and generally speaking as rates rise, property and share valuations fall.

Fast forward to 2022 and investors could be forgiven for thinking they have been cryogenically frozen from the periods of 1994 and 1999. Long term interest rates have doubled in the last 6 months, and share markets are laden with many companies trading at lofty valuations, making little or no profit today.

While history doesn’t exactly repeat itself, the lessons from these two time periods can help investors today avoid repeating the mistakes of the past.

Hugh Dive, the Chief Investment Officer at Atlas Funds Management believes that investors should look to avoid tech stocks and growth stocks on high price earnings multiples as rising interest rates will be unkind to them. The companies Dive refers to have minimal to no earnings today but the promise of large profits in the distant future. Asset valuation models are sensitive to interest rates, and higher rates result in lower valuations.

Nasdaq dotcom bubble

Dive says that rising interest rates make the “boring” profits and dividends of companies such as Amcor, Ampol and Transurban look more attractive than a tech company promising large “blue sky” cash flow in 20 years time. This occurs as the present value of profits delivered today are worth more when rates rise than profits that may or may not be generated in 10 to 20 years time.

Matt Williams, portfolio manager at Airlie Funds Management is wary of loss making tech companies but acknowledges that there will be some winners amongst them and nominates Spotify and AirBnB as looking interesting. Williams says crypto and NFT’s are obviously impossible to value making them speculative.

Williams adds that investors should be careful of some of the reopening beneficiaries which are now priced for perfection. Qantas and Flight Centre for example now have enterprise values higher than what they were pre-COVID which means that investors are already factoring in a strong travel recovery. Ultimately we will revert back to pre-COVID travel levels at some point but it’s taking longer than what was previously envisaged.

Another high profile casualty of rising interest rates is Government Bonds. Dive is of the view that investors should stay away from bonds. He says that bonds have enjoyed a 40 year bull market as 10 year rates have fallen from 16% in 1982 to 2% today. The capital value of bonds increase as rates fall, but as long term rates rise, the capital value of bonds fall. As a rule of thumb, for every 1% rise in long term rates, investors can expect the capital value of a 10 year bond to fall by around 9%. Superannuation investors in Balanced, Conservative or Fixed Interest funds are likely to have a large allocation to Government Bonds and would be wise to review these funds.

Williams sums up the current environment by saying that the market dynamics will change as central banks slowly but surely wind back monetary settings from “ridiculously easy” to just “easy”. Volatility will create headlines and headlines build psychological pressure in investors minds to “do something”. That “something” should be to think 5 – 10 years ahead and look to buy great companies that are being sold cheaply by the market.


Mark Draper writes monthly for the Australian Financial Review - this article was published in February 2022

Why The 10 Year Bond Rate Matters

The most important number right now for professional investors is the 10 Year Bond rate.

The 10 Year Bond rate is an important anchor point for investors as a ‘risk free rate of return’ that is used in valuation models to calculate the value of assets including equities, property, infrastructure and fixed interest investments.

In short, lower bond rates result in higher asset values and by contrast, higher bond rates result in lower asset values.  Since 1994, investors have enjoyed the tail wind of falling bond rates, but the tide has turned since the last quarter of 2020 which has seen Australian 10 year rates rise from around 0.7% to around 1.7%.  That is a 140% increase.

In valuation terms, Arvid Streimann (Head of Macro, Magellan Financial Group)  says that a 1% increase in 10 year bond interest rates generally result in a 9% decrease in the capital value for 10 year bonds and around 15% for equities.

The factors influencing movements in bond rates according to Streimann are expectations of inflation and real economic growth.  Rising bond rates generally imply increased economic activity.  In recent times however Central Banks have artificially lowered long term rates through their Quant Easing (aka money printing) programs.

The chart below shows the difference in government bond prices for both a 1% and 2% rise in long term rates.

Bond chart

Investors in funds that are called ‘conservative’ or ‘stable’ usually have a high exposure to bonds and are at risk of loss from rising rates and would be wise to review these investments given the landscape has changed.

Streimann says that the impact of rising bond rates on the equities market is more nuanced. He points out that equity valuations fall due to rising bond rates but not all equities are treated equally. Those companies with higher levels of debt suffer a double whammy as they also receive a drop in earnings as they pay higher interest costs over time. Vince Pezzullo (Deputy Head of Equities Perpetual) says that expensive growth stocks are more vulnerable to rising bond rates as they have distant prospective profits that are now discounted at a higher rate than before.

Pezzullo believes that if rising bond yields are signalling economic recovery, then cyclical exposed value stocks including energy, financials and mining, are likely to be beneficiaries as their business models have the most to benefit from the upswing in the economic cycle. Streimann highlights the banks as a potential beneficiary of rising bond rates as they tend to earn higher rates of return on their loan portfolios which can boost profits.

The other issue for equity investors is that not all investors use the same bond rate when valuing assets, and some investors don’t use this valuation method at all. Investors need to have an appreciation of the bond rate assumption being applied when reading research reports.

History generally doesn’t repeat itself unless people have forgotten about it. The last time bond rate movements caused extensive market damage was 1994 which is a long time ago. Pezzullo says the similarity to then and now is that markets were relaxed about the low inflation economic recovery, while the US Federal Reserve decided to push ahead with a surprise interest rate rise as growth accelerated. During 1994, the Australian 10 year bond rate rose from around 6% to over 10% resulting in short term damage to bonds and shares.

Streimann says the main difference between 1994 to today is the level and speed of communication courtesy of the internet, from the Central Banks. It’s all about expectation versus reality and the Central Banks are articulating the economic indicators such as the unemployment and inflation rates required to be reached before raising rates. This lowers, but doesn’t eliminate the probability of a bond market led panic.

Bond markets are currently stating that they believe Central Banks are likely to raise rates earlier and possibly higher than Central Banks have said on the back of an inflation scare. The question is whether the Central Banks are willing to view an inflation scare a transient and leave rates low. Investors would be wise to stay tuned to the communication coming out of the Central Banks for any changes in message. Either way investors must prepare for an investment landscape with rising long term rates. 

The article was written by Mark Draper (GEM Capital) and appeared in the Australian Financial Review on Wednesday 24th March 2021

Chinese Credit Boom - will it go BOOM?

The rate of Chinese debt growth, particularly in the corporate sector and local government sector is now at a level that is drawing attention from ratings agencies to infamous investors like George Soros.

The chart below shows credit levels compared to GDP, and the rate of growth of credit (lending) in 5 countries at various points in time that represent 5 years that preceded a credit crisis.  (Obviously Chinese credit crisis has not yet happened).












This chart shows similarities between China's level of debt and growth in debt in the past 5 years with the US and UK most recently and Japan and Korea in the 1990's.  What followed in each of these scenarios was recession.

This growth in lending has largely funded Fixed Asset Investment, which is defined as capital expenditure of large items, such as roads, power stations, buildings.

If the rate of lending were to slow significantly, this would more than likely disrupt the level of fixed asset investment in China.

What does this have to do with Australia?  Everything.

Australia currently exports vast quantities of commodities such as iron ore to China that is required for their Fixed Asset Investment program.  A lower level of fixed asset investment would more than likely result in China importing lower quantities of some of Australia's major exports.

The chart below shows that China is now Australia's major export partner.  It used to be said that if the US sneezed, Australia would catch a cold.  Investors must now consider what happens to Australia if China sneezes.





Australia has enjoyed a decade of prosperity on the back of a China construction boom, which is now cooling.  Many investments have profited from this.  The challenge for investors now is to ensure that their investment strategy now is not anchored in the past.


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.



US Federal Reserve - Not ready to taper stimulus yet - impact for investors

Key points

- The Fed’s decision not to taper reflects a desire to see stronger US economic growth and guard against uncertainties around coming US budget discussions.

- The Fed clearly remains very supportive of growth and this will help growth assets like shares, albeit there may still be a speed bump in the month ahead.


In what has perhaps been the biggest positive policy surprise for investors this year, the US Federal Reserve decided not to start tapering its quantitative easing (QE) program and leave asset purchases at $US85bn a month. This followed four months of almost constant taper talk which had led investment markets to factor it in. As a result the decision not to taper combined with very dovish language from the Fed has seen financial markets celebrate. This note looks at the implications.

Ready, set…stop

With the Fed foreshadowing from late May, that it would start to slow its asset purchases “later this year”, financial markets had come to expect that the Fed would start tapering at its September meeting. In the event the Fed did nothing. Several factors explain the Fed’s decision:

  • The Fed always indicated that tapering was conditional on the economy improving in line with its expectations whereas recent data – particularly for employment and some housing indicators – has been mixed.
  • Second, the Fed has become concerned that the rapid tightening of financial conditions, mainly via higher bond yields, would slow growth.
  • Third, the upcoming budget and debt ceiling negotiations (with the risk – albeit small – of a Government shutdown or technical default) and accompanying uncertainty appear to be worrying the Fed.
  • Finally, the Fed may have concluded that any forward guidance it would have provided to help keep bond yields down may have lacked sufficient credibility given the coming leadership transition at the Fed.

Observing the run of somewhat mixed data lately and the back up in bond yields, I and most others concluded that the Fed would address this by announcing a small tapering, ie cutting back asset purchases by $US10bn a month, and issue dovish guidance stressing that rate hikes are a long way away in order to keep bond yields down. However, it turns out that the Fed is more concerned about the risks to the growth outlook from higher bond yields at this point than we allowed for particularly given the US budget issues.

The Fed’s announcement is ultra-dovish with tapering delayed till “possibly” later this year and the Fed further softening its guidance. For example, the mid 2014 target for ending QE is gone and the 6.5% unemployment threshold for raising interest rates has been softened with Bernanke saying rates may not be increased till unemployment is “substantially” below 6.5%. The median of Fed committee members is for the first rate hike to not occur until 2015, and for the Fed Funds rates to hit only 1% at the end of 2015 and 2% at the end of 2016.

The key message from the Fed is very supportive of growth. They won’t risk a premature tightening in financial conditions via a big bond sell off and tapering won’t commence until there is more confidence that its expectations for 3% growth in 2014 and 3.25% growth in 2015 are on track.

Given that we also see US growth picking up tapering has only been delayed, but there is considerable uncertainty as to when it will commence. The Fed’s October 29-30 meeting looks unlikely as there is no press conference afterwards and US budget concerns may not have been resolved by then. The December 17-18 meeting is possible as it is followed by a press confidence but is in the midst of holiday shopping. So it could well be that it doesn’t occur till early next year.

Perhaps the main risk for the Fed is that by not tapering (when it had seemingly convinced financial markets that it would) it has created a lack of clarity around its intentions which will keep investors guessing as to when it will commence. This will likely add to volatility around data releases and speeches by Fed officials.

The US economy and inflation

In a broad sense though, the Fed is right to maintain a dovish stance:

  • Growth is on the mend thanks to improving home construction, business investment and consumer spending but it’s still far from booming and is relatively fragile as the private sector continues to cut debt ratios. This is also evident in the mixed tone of recent economic indicators with strong ISM business conditions readings but sub-par jobs growth and some softening in housing indicators on the back of a rise in mortgage rates to a still low level of around 4.6%.
  • Spare capacity is immense as evident by 7.3% official unemployment, double digit labour market underutilisation and a very wide output gap (ie the difference between actual and potential growth).

Source: Bloomberg, AMP Capital

  • A fall in labour force participation has exaggerated the fall in the unemployment rate. At some point participation will start to bounce back slowing the fall in unemployment.
  • Inflation is low at just 1.5%. There is absolutely no sign of the hyperinflation that the Austrian economists and gold bugs rave on about.

So while some will express annoyance that the Fed has confused them, at the end of the day the economic environment gives the Fed plenty of reason to be flexible.

Implications for investors

The Fed’s decision to delay tapering for now and its growth supportive stance is unambiguously positive for financial assets in the short term and this has been reflected in sharp falls in bond yields, gains in shares and commodity prices and a rise in currencies like the $A.

The sharp back up in bond yields since May when the Fed first mentioned tapering had left bonds very oversold and due for a rally. This could go further as market expectations for the first Fed rate hike push back out to 2015. However, the Fed has only delayed the start of tapering and as the US/global growth outlook continues to improve the upswing in bond yields is likely to resume, albeit gradually. This and the fact that bond yields are very low, eg 10 year bonds are just 2.7% in the US and just 3.9% in Australia, suggests that the current rally will be short lived and that the medium term outlook for returns from sovereign bonds remains poor.

For shares, the Fed’s commitment to boosting growth is very supportive. QE is set to continue providing a boost to shares going into next year even though sometime in the next six months it’s likely to start to be wound down. But it’s now very clear that the Fed will only do this when it is confident that economic growth is on track for 3% or more and this will be positive for profits. This is very different to the arbitrary and abrupt ending of QE1 in March 2010 and QE2 in June 2011, that were associated with 15-20% share market slumps at the time. See the next chart.

Source: Bloomberg, AMP Capital

With shares no longer dirt cheap, it’s clear that the easy gains for share markets are behind us. But by the same token shares are not expensive either and an “easy” Fed adds to confidence that profit growth will pick up next year driving the next leg up in share markets.

Source: Bloomberg, AMP Capital

Shares are also likely to benefit from long term cash flows as the mountain of money that has gone into bond funds since the GFC is reversed gradually over time with some of it going into shares. See the next chart.

Source: ICI, AMP Capital

However, while the broad cyclical outlook for shares remains favourable, there will be some speed bumps along the way. The coming government funding and debt ceiling negotiations in the US could create uncertainty ahead of the usual last minute deal. And investors will now be kept guessing about when the first taper will come which means any strong economic data or hawkish comments from Fed officials could cause volatility. The May-June share market correction was all about pricing in the first taper and that process might have to commence all over again at some point.

For high yield bearing assets generally, eg bank shares, the Fed’s inaction and the rally in bonds will provide support. However, underperforming cyclical stocks, such as resources, may ultimately be more attractive as they offer better value and will benefit as the global and Australian economies pick up.

For emerging world shares, the Fed’s inaction takes away some of the short term stress, but it’s likely to return as US tapering eventually comes back into focus with current account deficit countries like India, Indonesia and Brazil remaining vulnerable.

Finally, the Fed’s decision not to taper does make life a bit harder for the Reserve Bank of Australia in the short term in trying to keep the $A down. It has added to the short covering bounce that has seen the $A rise from $US0.89 this month and so adds to the case for another interest rate cut. However, the rebound in the $A is likely to prove temporary as the Fed is expected to return to tapering some time in the next six months.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

US Debt Ceiling - still a stalemate

Two days out from the 17 October deadline, negotiations in Washington have (yet again) come to a halt. Key Senate figures had been working towards a compromise proposal, but those discussions stopped once news got out that House Republicans had rejected the plan without seeing any details, instead choosing to focus on their own initiative. If that wasn’t bad enough, it subsequently came to light that the House Republicans may not even have enough support to get their bill through the House, let alone the Senate. That this is the case has since been confirmed, with the Republican leadership cancelling a planned vote on the bill. There have since been some reports that the Senate has recommenced negotiations, but the House and Senate clearly remain miles apart.

We continue to see very little chance that a resolution will be found this week. 17 October is not the true deadline for non payment by the US government. Rather, it is 1 November and beyond where the real risk lies. Markets have, broadly speaking, remained sanguine on the fiscal situation to date, but recent market developments provide evidence that the market psyche may be shifting.

Here is what high profile investor and author of investment report "Boom, Gloom and Doom", Marc Faber:

"It's basically a dysfunctional government that we have that is far too large that is essentially wasting money left, right and center. The Republicans are wasting money on the military complex and the Democrats are basically buying votes with transfer payments, with entitlement programs, it goes on. It is a huge waste. The problem is that I don’t see a solution."

We remain of the view that the US is highly unlikely to default on its debt obligations and that an '11th hour' solution will be found.

DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

Global Investment Update - October 2013

Hamish Douglass (CEO Magellan Financial Group) talks with Mark Draper (Adviser, GEM Capital) about his views on the current state of global financial markets.

In particular Hamish discusses:

1. How he does not believe that the US will default on their debt

2. Withdrawal of US stimulus in the form of Quant Easing and what investors should be watching in this process

3. How the Magellan Global Fund is positioned to generate returns for investors over the next 3 years

For more information on our views

Australian Share Market Outlook - October 2013

John Grace (Deputy CEO, Ausbil Funds Management) and one of Australia's most respect Australian Share investors talks about the most recent company reporting season.

John also talks about his outlook for the share market, and his optimism despite a solid rally over the past 12 months.

More importantly he discusses how he has positioned his fund to take advantage of what has been very much a two tier market.


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

Deeming rates lowered by Centrelink

Here is the press release from the Commonwealth Government announcing a lowering of the Deeming Rate for the Income Test to determine Centrelink allowances and pensions.

More than 740,000 Australian pensioners will benefit from the lowering of the social security deeming rates from 4 November 2013.

The Minister for Social Services, Kevin Andrews, said the deeming rate will decrease to 2 per cent from 2.5 per cent for financial investments up to $46,600 for single pensioners and allowees, $77,400 for pensioner couples and $38,700 for each member of an allowee couple.

The upper deeming rate will decrease to 3.5 per cent from 4 per cent for balances over these amounts.

“The deeming rules are a central part of the social security income test,” Mr Andrews said.

“They are used to assess income from financial investments for social security and Veterans’ Affairs pension/allowance purposes.

“This announcement means that part-rate pensioners and allowees will have less income assessed from their investments and receive a boost in Government income support.

“Returns available to pensioners and other allowees have decreased since deeming rates were last changed, in March 2013.

“This announcement brings the deeming rates in line with available financial returns,” Mr Andrews said.

Deeming rates reflect the rates of return that people receiving income support payments can earn from their financial investments. If income support recipients earn more than these rates, the extra income is not assessed.

Payments affected by the deeming rates include means tested payments such as the Age Pension, Disability Support Pension and Carer Payment, income support allowances and supplements such as the Parenting Payment and Newstart, paid by the Department of Human Services and the Department of Veterans' Affairs.

GEM Capital Comment:

For the want of spoiling a good press release, we hasten to add, that this change is likely to only benefit those people who are currently paid under the income test, rather than the assets test.  For those who are currently paid under the assets test, this change is likely to have no effect on their entitlements. (remembering that Centrelink apply an assets test and an income test and pay the recipient a benefit based on which test delivers the lowest outcome)

Nevertheless this is a welcome move considering the downward movement we have seen in interest rates.

"Nein" to Nine

Channel Nine is being floated on the share market shortly, and for many investors the thought of investing in a household name might be appealing.

Here we outline some of the reasons that investors should be wary of this listing:

1. TV advertising spending has gone nowhere over the last 5 years.

 2. Traditional TV is facing a significant threat from the internet such as YouTube, Apple and Google TV just to name a few.

3. Channel Nine's price to earnings ratio is 14-15 - which doesn't strike us as cheap for a business that is being structurally challenged.

4. Current owners are selling 40% of their shares in this offer, and only have to hold their other shares for 12 months.

 Before subscribing to shares in Channel Nine, investors should seek professional advice.

 DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.




Bank Shares - Safe as Houses?

Mark Draper (GEM Capital) talks with Daniel Moore (Investors Mutual) about the impact of a potential property bubble in Australia on Australian Banks.

The average punter on the street considers Bank Shares to be a safe haven , but just correct is that assumption.

DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.



Fed Tapering - what it means for investors

Key points

- After much talk since May, the US Federal Reserve is finally reducing (or tapering) its asset purchase program - by $US10bn a month.

- However, the Fed has enhanced its very dovish forward guidance, highlighting that interest rate hikes are still a long way off and dependent on the economy.

- Fed policy remains market friendly & generally supportive of further gains in shares.

- While, Fed tapering and speculation around it has and will contribute to bouts of market uncertainty, it should be seen as good news as it indicates the US recovery is becoming more sustainable.


In what was perhaps the most anticipated event this year the US Federal Reserve has announced it will reduce the pace of its third quantitative easing (QE3) program by $US10bn a month. The Fed has been foreshadowing a “tapering” since May 22nd so it’s a surprise to no one. This note looks at what it means for US monetary policy and investment markets.

The Fed tapers

The key aspects of the Fed’s decision to taper are:

  • A cutback in QE from $US85bn a month to $US75bn.
  • This to be focussed on both reduced Treasury bond purchases (which drop from $US45bn a month to $US40bn) and reduced purchases of mortgage backed securities (which drop from $40bn a month to $35bn).
  • Tapering is not a “not on a preset course” but dependent on further economic improvement & higher inflation with Chairman Bernanke implying the wind down will be such that QE will likely continue into late next year, implying an ongoing reduction of about $US10bn in bond purchases each meeting, which is slower than many expected,
  • More dovish guidance on the outlook for interest rates with the Fed indicating rates will remain near zero well beyond the time when unemployment falls below 6.5% and 12 of the 17 Fed committee officials not seeing a rate hike until 2015. In other words the clear message is that tapering is not monetary tightening and does not mean that the first rate hike is any closer.

The Fed’s dovish guidance is significant as Fed research suggests it has greater effects on the economy than signals about asset purchases.* Specifically, it’s aimed at pushing back against rising bond yields as it has led to higher mortgage rates.

Our assessment

The first thing to note is that the Fed’s move is positive as it indicates the US economy is getting stronger and the recovery more self-sustaining and so the US can start to be gradually taken off life support. However, the emphasis is on gradual. It’s quite clear the Fed is still committed to easy monetary policy until more spare capacity is used up. While the economy is on the right path, it’s still got a way to go, particularly with inflation running well below the Fed’s 2% target.

In this regard, tapering is not the same as monetary tightening. Pumping cash into the US economy is continuing but at a slightly lower rate. It’s very different to the premature and arbitrary ending of QE1 in March 2010 and QE2 in June 2011 that went from $US95bn & $US75bn respectively in monthly bond purchases to zero overnight at a time when US and global economic data was poor and contributed to 15-20% share market slumps at the time. This time around QE is only being reduced gradually and only because the economic data shows the US economy improving.

More fundamentally, tapering does not signal earlier interest rate hikes. Quite clearly the Fed has gone out of its way to stress this message by indicating that near zero interest rates will likely remain well beyond the time when unemployment falls below its previous target of 6.5%. Our own view of the US economy is very similar to the Fed’s in seeing growth of around 3% next year driven by housing, business investment and consumer spending. However, barring a much faster acceleration in growth, interest rate hikes are still probably 18 months or more away:

  • Growth is still far from booming.
  • Spare capacity is immense as evident by 7% official unemployment, double digit labour market underutilisation and a very wide output gap (ie the difference between actual and potential GDP).

Image 1
Source: Bloomberg, AMP Capital

  • A fall in labour force participation has exaggerated the fall in the unemployment rate. While much of this is structural some is cyclical and at some point will start to bounce back slowing the fall in unemployment.
  • Inflation is low at just 1.2%.

Comments during her nomination hearings quite clearly indicate that Janet Yellen, the likely next Fed Chairman after Bernanke’s term ends at the end of January, will not be rushing to raise interest rates.

Put simply the Fed may be easing up on the accelerator, but they are a long way from applying the brakes.

Finally, while the US is slowing its monetary stimulus this is not so in other key developed regions with both the ECB and Bank of Japan likely to ease further if anything.

Implications for investors

While the days of expanding US monetary stimulus are probably over, the message from the Fed remains market friendly. The pace of quantitative easing is slowing only gradually, this is contingent on the US economy continuing to strengthen and rate hikes are unlikely until 2015, at least.

For sovereign bonds our medium term view remains one of poor returns. Despite the back up in yields, they remain low relative to long term sustainable levels suggesting the risk of rising yields and capital losses over time as the global economy mends. Even if bond yields stay flat at current levels they offer poor returns, eg just 2.9% for US 10 year bonds and just 4.3% for Australian ten year bonds. However, a 1994 style bond crash which saw extreme long bond positions unwound triggered by a sharp 300 basis point rise in the US Fed Funds rate looks unlikely.

For shares, the period of dirt cheap share markets and support from ever expanding monetary stimulus seems over. More significantly, taper talk since late May has clearly made some nervous given the positive relationship between rounds of quantitative easing in the US and share markets, with many fearing that a move to end it will be followed by slumps as occurred after QE1 and QE2 ended. See the next chart.

Image 2

Source: Bloomberg, AMP Capital

Slowing QE suggests share market returns are likely to slow from the 20% or so pace of the last 18 months. Bouts of uncertainty regarding the Fed’s intentions are also likely, as we saw in May-June and more recently. However, the overall picture remains favourable for shares:

First, the tapering of QE3 is very different to the abrupt and arbitrary ending of QE1 and QE2. This time around US data is stronger and the wind down in QE3 is dependent on further improvement in US economy.

Second, although the Fed isn’t undertaking monetary tightening many tend to see it as such so past monetary tightening moves, which have been via rate hikes, are instructive. The next table shows US shares around the first rate hikes in the past 8 Fed tightening cycles. The initial reaction after 3 months is mixed with shares up half the time and down half the time. But after 12 and 24 months a positive response tends to dominate. So even if this were the start of a monetary tightening cycle it’s not necessarily bad for shares.

The reason for this lies in the improvement in growth and profits that normally accompanies an initial monetary tightening. It’s only later in the cycle when rates are going up to onerous levels to quell inflation that it’s a worry. Right now we are seeing improving growth and profits, but with the start of rate hikes (let alone rises to onerous levels) looking a long way off given very low inflation.

US shares after first Fed monetary tightening moves

First rate hike -3 mths +3 mths +6 mths +12 mths + 24 mths
Oct 80 4.8 1.6 4.2 -4.4 2.4
Mar 84 -3.5 -3.8 4.3 13.5 22.5
Nov 86 -1.5 14.0 16.4 -7.6 4.8
Mar 88 4.8 5.6 5.0 13.9 14.6
Feb 94 2.9 -6.4 -4.9 -2.3 14.9
Mar 97 2.2 16.9 25.1 45.5 30.3
Jun 99 6.7 -6.6 7.0 6.0 -5.6
Jun 04 1.3 -2.3 6.2 4.4 5.5
Average 2.2 2.4 7.9 8.6 11.2

Source: Thomson Reuters, AMP Capital

Thirdly, the rally in US shares recently has been underpinned by record profit levels. It’s not just due to easy money.

Finally, shares are likely to benefit from long term cash flows as the mountain of money that has gone into bond funds since 2008 is gradually reversed with some going to shares.

Image 3

Source: ICI, AMP Capital

While next year will no doubt see a few corrections in shares along the way, the key point is that the broader picture – of reasonable share market valuations, improving global growth and still very easy monetary conditions - suggests the bull market in shares has further to run.

The Australian share market is also likely to benefit from the rising trend in global shares, but is likely to remain a relative underperformer reflecting better valuations globally and a bit more uncertainty over the Australian economy. Sector wise, mining stocks look cheap and best placed to benefit from the global recovery.

In terms of the Australian dollar, Fed tapering may make life a bit easier for the RBA in getting the $A down. While I wouldn’t get too excited as near zero interest rates in the US look like remaining in place for some time, the broad trend in the $A is likely to remain down.

Finally, in the very short term getting the Fed’s taper decision out of the way likely clears the way for the seasonal Santa rally in shares that normally gets underway around this week and runs into early January.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital


Important note: While every care has been taken in the preparation of this document, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) make no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.


Book Review - Dog Days - Australia after the boom

Ross Garnaut - Economic Adviser to the Hawke/Keating Governments and well respected economist has recently published a book that labels Australia as complacent and at the 'cross-road' to its future.

"Here is a brilliant guide to the future of the Australian economy that our prime minister, his cabinet and indeed all members of parliament should study.  We cannot be sure that big problems are ahead for Australia owing to the end of the China boom, but it is highly likely, and our government must be prepared."  Max Corden on the book.

Here is an article extracted from the media recently that outlines some of the aspects of the book that we believe is worth a read.  It's price is $19.99 from bookshops or can be downloaded in electronic version for $9.99.

Australia is enjoying its 22nd year of economic growth without recession – an experience that is unprecedented in any other developed country.

For the first decade of expansion, growth was based on extraordinary increases in productivity, attributable to productivity-raising reforms from 1983. In the early years of this century, reform and productivity growth slowed sharply and then stopped. For a few years, increases in incomes and expansion of output came from a housing and consumption boom, funded by wholesale borrowing overseas by the commercial banks.

Unlike other English-speaking countries and Spain, Australia avoided recession with the end of the housing and consumption boom (earlier in Australia than elsewhere). This was largely the result of a China resources boom. The boom emerged when the exceptional metals and energy intensity of Chinese growth in response to Keynesian expansion through the Asian financial crisis, and again in response to the global financial crisis, took markets by surprise, and lifted prices of iron ore and coal continuously and immensely from 2003 until the Great Crash late in the September quarter of 2008.

China’s fiscal and monetary expansion put iron ore and coal prices back on a strongly rising trajectory in the second half of 2009, and new heights were reached in 2010 and 2011. The high prices for coal and iron ore flowed quickly into state and especially Commonwealth government revenue and was mostly spent as it was received – raising the Australian real exchange rate to unusual, and by 2013, unprecedented levels. The high commodity prices induced unheard-of high levels of resources investment after the recovery of the Chinese economy from the Great Crash of 2008, adding to the expansionary and cost-increasing impacts.

The China resources boom created salad days of economic policy, in which incomes could grow even more rapidly than community expectations. The expansionary effect of the resources boom – taking expenditure induced by high terms of trade, resource investment and resource production together – reached its peak in the September quarter of 2011, when the terms of trade began a decline that continues today. The terms of trade fell partly because Chinese growth fell by about one-quarter within a new model of economic growth.

A bigger influence was the new model of growth, which caused energy and metals and especially thermal coal to be used less intensively. Huge increases in coal and iron ore supplies are also putting downward pressure on prices and will be increasingly important in future.

The dog days of economic policy


The declining impact of the China resources boom ushered in the dog days of economic policy from late 2011, when government revenue and private incomes growth sagged well below expectations and employment grew less rapidly than adult population. The maintenance of high employment and reasonable output growth without external payments problems requires the restoration of investment and output in trade-exposed industries beyond resources. And yet the real exchange rate by early 2013 was at levels that rendered uncompetitive virtually all internationally traded economic activity outside the great mines. A substantial reduction in Australian cost levels relative to other countries is required – a large depreciation of the real exchange rate – to maintain employment and economic growth.

The more that productivity growth can be increased the better. Helpful policy measures include the removal of artificial sources of economic distance between Australia and its rapidly growing Asian neighbours to allow larger gains from trade – removal of remaining protection and industry assistance at the border as the real exchange rate falls, and investment in transport and communications infrastructure.

While China’s new model of economic growth ends the extraordinary growth of export opportunities for iron ore and coal that characterised the first 11 years of this century, new patterns of growth in China and elsewhere in Asia are rapidly expanding opportunities in other industries in which Australia has comparative advantage – education, tourism and other services, high-quality foodstuffs, specialised manufactures based on innovation.

But in contrast to iron ore, coal and natural gas, Australia does not have overwhelming natural advantages over other suppliers of these products. It must compete with the rest of world on price and quality, especially with developed country suppliers with hugely depreciated real exchange rates following the Great Crash.

Even with the return of productivity growth to the world-beating levels of the 1990s, maintenance of output and employment growth would require a large reduction in the nominal value of the dollar, accompanied by income restraint to convert this into a real currency depreciation.

A new economic reform era is required. That requires social cohesion around acceptance that all elements in society must share in restraint as well as commitment to productivity-raising structural change. Achievement of this outcome is blocked by changes in the political culture of Australia since the reform era. Now, uninhibited pursuit of private interests has become much more important in policy discussion and influence.

The new Australian government will succeed in building the political culture that is necessary to deal with the problem only if it is effective in persuading the community of the importance of reform, and in confronting the Australian complacency of the early 21st Century.

This will be hard, as the government will have to change the 21st-century tendency for private interests to outweigh the public interest in policy discussion and choice. Harder still, it will have to disappoint its strongest supporters along the way to leading Australia into a new reform era.

Ross Garnaut is vice-chancellor’s fellow and professorial fellow in economics at the University of Melbourne. This article is based on his book, Dog Days: Australia After the Boom, and is part of a series from East Asia Forum ( in the Crawford School of Public Policy at the Australian National University.


Govt's Super and Tax Plans confirmed

The Coalition Government has reiterated its position on a range of previously announced superannuation and tax issues, as part of the Mid-Year Economic and Fiscal Outlook.

The key take-outs of interest include:

  • The next increase in the superannuation guarantee rate to 9.5% will be deferred for two years.
  • A range of measures relating to the Mineral Resource Rent Tax that were legislated during the previous Government's tenure will be repealed.  This includes the low income super contribution, income support bonus and school kids bonus.
  • The 2015 personal tax cuts will not proceed.
  • Benefits from the Government's Paid Parental Leave scheme will generally be paid by the Department of Human Services, not the person's employer.  Efective 1 March 2014.
  • Deeming will be extended to include allocated pensions from 1st January 2015 (for new pensions only)
  • The tax of 15% on earnings exceeding $100,000pa from assets held by a member in a superannuation pension will not proceed.


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

Common Investor Mistakes from Human Bias - Part One

Efficient investment market theory states that as all investors have access to exactly the same information at the same time, there are many well resourced participants, therefore it is impossible for investors to do better than the market.

Efficient market theory would work it if weren't for one thing - there is human involvement in the investment making decision progress and humans are hard wired differently and have many different personal biases and traps.


Here were begin examining some common investor short comings in a bid to help you reduce the number of mistakes made as an investor.

1. Confirmation Bias - as intelligent people we believe that we make decisions based on researching facts and analysing information.  We tend to suffer from Confirmation Bias where a decision is made and then information is sought from sources that support our pre-conceived ideas.


2. Loss Aversion - Humans are highly loss averse.  Studies have been done that show people are two and a half times more sensitive to loss than they are to gain.  Suppose you had a choice where you can accept a sure $500 or you can face 50-50 odds that you will either win $1,000 or nothing at all.  What would you do?

Or suppose that you are in the unfortunate situation where you have lost $500.  However instead of accepting this loss, you can face 50-50 odds that you either lose $1,000 or you lose nothing.  How would you react?  In a study more than half the students in this situation would take the chance of losing $1,000 instead of accepting a sure loss of $500. Phychologists emphasise that although people generally behave conservatively when it comes to risk, they are much more willing to take risks when they think they might be able to avert a loss.


3. Framing - is a cognitive characteristic in which people tend to reach conclusions based on the 'framework' within which a situation was presented.

This behaviour can result in making poor choices such as selling winning investments rather than realising  a loss on a poor investment.

For example consider a community preparing for the outbreak of an unusual disease which is expected to kill 600 people.


A) If Program A is adopted, 200 people will be saved

B) If Program B is adopted, there is a 33% chance that 600 people will be saved, and 67% chance that no people will be saved.

Which Program would you choose?

Results from a conference where this was asked showed that 72% of respondents would choose Program A, despite the fact that the outcome of both Programs are the same.


4. Anchoring - the use of irrelevant information as a reference for evaluating or estimating some unknown value or information.  When anchoring, people base decisions or estimates on events or values known to them, even though these facts may have no bearing on the actual event or value.

In the context of investing, investors will tend to hang on to losing investments by waiting for the investment to break even at a the price at which it was purchased.  Thus, they anchor the value of their investment to the value it once had, and instead of selling it to realise the loss, they take on greater risk by holding it in the hope it will go back up to its purchase price.


5. Over-reaction and Availability Bias - One consequence of having emotion in the stock market is the overreaction toward new information. According to market efficiency, new information should more or less be reflected instantly in a security's price. For example, good news should raise a business' share price accordingly, and that gain in share price should not decline if no new information has been released since.

Reality, however, tends to contradict this theory. Oftentimes, participants in the stock market predictably overreact to new information, creating a larger-than-appropriate effect on a security's price. Furthermore, it also appears that this price surge is not a permanent trend - although the price change is usually sudden and sizable, the surge erodes over time.

Winners and Losers - example

In 1985, behavioral finance academics Werner De Bondt and Richard Thaler released a study in the Journal of Finance called "Does the Market Overreact?" In this study, the two examined returns on the New York Stock Exchange for a three-year period. From these stocks, they separated the best 35 performing stocks into a "winners portfolio" and the worst 35 performing stocks were then added to a "losers portfolio". De Bondt and Thaler then tracked each portfolio's performance against a representative market index for three years.

Surprisingly, it was found that the losers portfolio consistently beat the market index, while the winners portfolio consistently underperformed. In total, the cumulative difference between the two portfolios was almost 25% during the three-year time span. In other words, it appears that the original "winners" would become "losers", and vice versa.


Investing is both a science and an art.  Keeping controls of ones emotions plays a large part in the outcome.

"Individuals who cannot master their emotions are ill-suited to profit from the investment process"

"The investors chief problem, and even his worst enemy - is likely to be himself"

"To achieve satisfactory investment results is easier than most people realise, to achieve superior results is harder than it looks"

Benjamin Graham (attributed to teaching Warren Buffett)

Emerging Market Risks - How Serious?

Key points

- Concerns about emerging countries on the back of various political problems and trade imbalances that leave them vulnerable as the Fed slows down its monetary stimulus appear to have triggered a correction in share markets.

- However, while it makes sense to be cautious about emerging market shares generally, a re-run of the 1997-98 Asian crisis is unlikely and emerging markets are unlikely to pose a major threat to global economic recovery.


The past week has seen renewed concerns about the emerging world reflecting a combination of political problems in several countries including Turkey and the Ukraine, a currency devaluation in Argentina and ongoing concerns about Chinese growth. Such concerns also reflect the impact of the Fed slowing its monetary stimulus at a time when parts of the emerging world are vulnerable.

This has seen falls in emerging market shares and currencies. Moreover, fears about exposure to the emerging world and a possible threat to global growth have seen share markets in advanced countries fall nearly 4% over the last week. Concern has returned that we may see a re-run of the 1997-98 “Asian-emerging markets crisis”.

Our assessment remains that another “Asian-emerging markets crisis” is unlikely. However, it is even clearer that the secular cycle has now turned against emerging market shares (EMs) relative to developed markets (DMs).

The 1997-98 Asian/emerging market crisis

Economic history reminds us repeatedly about the prevalence of cycles – both short term and long term. Asian and emerging countries and shares are not immune having gone in and out of favour several times over the last few decades. In the mid 1990s there was much talk of an “Asian miracle”. Growth was thought to be assured by high savings and investment rates, strong export growth and a shift in labour from rural areas to cities. However, as is often the case during good times, excesses set in including a growing reliance on foreign capital, current account deficits, excessive debt levels and over-valued fixed exchange rates. Eventually foreign investors had doubts. In mid-1997 Thailand experienced capital outflows that became a torrent and triggered a collapse in its fixed currency, which then led investors to search for countries with similar vulnerabilities (so-called “Asian contagion”) which led to the crisis spreading across the emerging world ultimately contributing to Russia’s debt default of 1998 that briefly dragged down developed market shares in August 1998.

In the 2000s, Asian and emerging countries mostly got their act together thanks to a range of productivity enhancing reforms, less reliance on foreign capital, low and floating exchange rates and high foreign exchange reserves and this along with the industrialisation of China and a related surge in commodity prices (which benefited South American countries and Russia) saw their growth rates improve. The enhanced perception of emerging countries and a secular slump in the traditional advanced economies of the US, Europe and Japan at the same time saw them once more come into favour amongst investors.

This reached a crescendo after the global financial crisis with talk of a “new normal” of poor growth in advanced countries and their rounds of quantitative easing encouraging capital flows to the “stronger” emerging markets leading in fact to talk of “currency wars” as EM currencies rose. The surge in the value of Asian currencies versus the $US over the last decade as a result of strong capital inflows can be seen in the next chart. Recent weakness has only reversed a small portion of the rally from Asian crisis lows, but emerging market currencies generally have been a lot weaker, having been in a down trend since 2011 (just like the $A!).


Back to the future?

Has Asia and the emerging world just gone full circle such that it’s now standing on the precipice once more? Several factors are driving current worries:

  • Fed tapering has led to fears of a reversal in the money flow to the emerging world that may have come from quantitative easing. Transitions in Fed monetary policy often have implications beyond the US, eg the Mexican crisis when the Fed moved to tighten in 1994.
  • This has occurred at a time when the flow of news in developed countries – the US, Europe and Japan - has continued to improve.
  • Some emerging countries face political problems – the Ukraine, Turkey, Argentina and Thailand.
  • Several emerging countries, notably Brazil, India and Indonesia, used the capital inflows that occurred as a result of quantitative easing in the US to finance budget and current account deficits.
  • Slower growth in China has taken its toll on the emerging world generally by putting downwards pressure on commodity prices and dragging on the demand for imports from the Asian region.
  • More fundamentally, the boom years of the last decade allowed several emerging countries to go easy on necessary structural reforms. Poor infrastructure, excessive regulation and restrictive labour laws are key problems. The end result has been inflation and trade imbalances and reduced potential growth rates.

The end result has been for investors to start rethinking the outlook for emerging countries with flows heading back to the advanced countries. The problem for emerging countries in raising their interest rates to support their currencies – as has occurred in several including Brazil, India and Indonesia – is that it further serves to slow economic growth making the investment outlook in such countries even less enticing.

Put simply, there is no easy way out for countries with current account deficits when foreign investors start to withdraw their capital. In the short term domestic spending must fall, interest rates must rise and exchange rates fall to bring this about. The only way to sustained stronger long term growth is to reform their economies, but that takes time.

Still not 1997, but the risks have increased

The next table compares the state of current account deficits & inflation today with the situation before the 1997-98 crisis.

Not as vulnerable as in 1997

  Current account, %GDP FX reserves, $USbn Inflation rate, %
  1996 Now 1997 Now 1996 Now
Indonesia -3.2 -3.9 17 99 7.9 8.4
Thailand -7.9 -1.6 27 167 5.9 2.2
India -1.6 -3.1 20 295 9.0 9.9
Korea -4.4 4.6 20 345 5.1 1.1
Taiwan 3.9 10.0 84 421 3.1 0.3
Malaysia -4.4 5.0 15 136 3.5 2.9
Singapore 13.8 18.5 73 272 1.1 2.6
HK 3.9 2.3 93 309 5.9 4.3
China 0.9 1.9 140 3726 8.3 2.5
Brazil -2.7 -3.7 58 376 9.6 5.9
Russia 2.8 2.3 25 524 21.8 6.4

Source: IMF, Bloomberg, AMP Capital

The overall position of emerging countries remains stronger today. Current account balances are generally in better shape, central banks have much higher foreign exchange reserves, exchange rates are floating rather than fixed and not as high as they were before the Asian crisis and inflation is lower. Having mostly floating rather than fixed exchange rates is a big distinction today because, as IMF research has confirmed, floating exchange rates are less prone to crises than fixed: they create less economic distortions and don't need to be defended from speculative attacks.


Source: IMF, AMP Capital

However, several countries are vulnerable, particularly Brazil, India and Indonesia where current accounts have moved heavily into deficit indicating a now heavy reliance on foreign capital inflows. See the previous chart.
Other emerging markets that are vulnerable thanks to current account deficits and hence a reliance on foreign capital inflows are the Ukraine, Turkey, South Africa and Chile.
By contrast China, South Korea, Taiwan and Russia with large current account surpluses are far less vulnerable.

While we don’t see a re-run of the Asian-emerging market crisis or a sharp collapse in emerging market growth the risks have clearly increased particularly for countries that now have large current account deficits. Emerging market growth generally is likely to be softer in the years ahead than what we got used to last decade.

Implications for investors

There are several implications for investors:
First, while emerging market shares are relatively cheap (with forward price to earnings multiples of around 10 times compared to 14 times for global shares) it’s too early to strategically reweight towards them. Notwithstanding likely bounces in relative performance along the way, the secular underperformance by emerging market shares relative to developed market shares could have a fair way to go yet, particularly given the extent of outperformance last decade.


Second, investors in emerging markets should focus on current account surplus countries as these are less vulnerable to foreign capital flows, eg China and Korea. And in any case Chinese shares are amongst the cheapest in the emerging world.
Thirdly, emerging markets are unlikely to pose a severe threat to growth in advanced countries. Yes the emerging market share of world GDP is now just over 50% compared to around 35% in the mid-1990s, but more fundamentally a sharp slump in emerging market growth is unlikely given the stronger position of many emerging countries today compared to that prior to the Asian-Emerging Market crisis.
Fourthly, emerging market worries appear to have provided the trigger for a correction in advanced country share markets that high levels of investor sentiment had left them vulnerable to. But once investor sentiment falls back to more normal levels the rally in shares is likely to resume.

Finally, while a recession in emerging market countries is unlikely, slower growth than seen over the last decade will act as a bit of a constraint on commodity demand, providing another reason why the broad trend in the Australian dollar will likely remain down. Ultimately I still see the $A heading down to $US0.80.

Dr Shane Oliver

Head of Investment Strategy and Chief Economist AMP Capital


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.


RBA Minutes - rates on hold for now

The minutes of the February 4 RBA Board Meeting confirmed that the Bank now has a neutral bias and has desisted from further talking down the AUD. On interest rates: "the most prudent course would likely be a period of stability in interest rates". Whereas in the December Board minutes the AUD was described as "uncomfortably high" the language used early in 2013 has been restored with "the exchange rates has also depreciated further since the December meeting. If sustained, a lower exchange rate would be expansionary for economic activity and would assist in achieving balanced growth of the economy". Of course that fall has not been sustained with the AUD around US 91c at the time of the December Board meeting falling to US 88c at the time of the February Board meeting but now having rebounded to around US 90.50c, only slightly below the "uncomfortable level" at the time of the December Board meeting.

Commentary around the domestic economy is generally upbeat. Consumption, dwelling investment, business conditions and exports are described as being "more positive". In fact the minutes note that "survey measures suggested that business conditions had improved noticeably in recent months, to be above average levels". Of course the labour market was still described as weak but this was partially dismissed by describing the labour market as a lagging variable. Consistent with that theme, and, in line with the view around spending, the minutes note that the forward looking indicators of labour demand had shown signs of stabilising although were described as "consistent with only moderate growth of employment". There appears to be little consideration in this analysis of the feedback effects from a weak labour market to household confidence and incomes. Indeed the Bank expects that the rise in house prices will boost spending leading to falls in the savings rate.

The unexpected increase in inflation clearly played an important role in discussions. Four different explanations were given for this lift with interestingly the first one mentioned being "an element of noise that occurs in economic data". Other explanations related to: the faster than normal pass through from the lower exchange rate: "a slower than expected pass through from weak wages growth"; and finally the possibility that there was less spare capacity in the economy enabling retailers or wholesalers to increase their margins. The Bank concludes that it was not possible at this stage to distinguish these explanations and it was likely that some combination of these four explanations was at work.

A number of vulnerable remarks appear in these minutes. Firstly, the 3% decline in consumer sentiment back to average levels made the comment "consumer sentiment had recorded a modest decline around the end of 2013" somewhat out of date. A more disturbing issue was around the Bank's forecast for growth of Australia's trading partners which is expected to increase to be above average in 2014. It would be our view that with Chinese growth likely to decelerate this growth outlook seems overly optimistic.


There are no significant surprises in these minutes. If the Bank had decided to continue talking down the AUD possibly with less strident language than "uncomfortably high" then it is likely to have been covered in the Governor's statement accompanying the decision two weeks ago. With no lead from the Governor it was not surprising that the language around the AUD has reverted back that period in 2013 when there was no explicit effort to talk down the AUD. The Governor also made it clear that policy had been moved to a neutral stance and these minutes confirm that view. There are a number of behavioural assumptions in the minutes. Firstly it is assumed that the labour market will lag economic growth with feedback effects from employment to incomes and confidence tending to be overlooked. It is therefore assumed that the rise in house prices will prompt a marked lift in consumer spending through the wealth effect and therefore a reduction in the savings rate. We tend to be more sceptical around that dynamic given the ongoing attitude of households since the Reserve Bank started to cut rates in November 2011. However we do accept the explanation that the unexpected lift in the inflation rate most likely shows some noise; a faster than expected response to the fall in the currency and a slower response to soft wages growth. With the AUD now stabilising and wages growth remaining soft the wages story is likely to be the dominant driver of inflation through 2014.

Our forecast that the RBA will need to cut rates further in the second half of 2014 clearly hinges on the likely outlook, at that time, for growth in 2015 . Factors that will impact on that outlook will include the ongoing downturn in mining; fiscal consolidation; the impact of a fall in the terms of trade; and two important macro dynamics which the Bank appears to be understating. These are the direct feedback effects on confidence and incomes of the weak labour market and ongoing caution amongst business and consumers.

Bill Evans - Chief Economist - Westpac Banking Corp

DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

The US Federal Reserve, Rates and Bonds


As the US economy continues to recover, it was inevitable that investor focus would shift from the need for more stimulus, which has been the dominant issue over the last few years, to when the US Federal Reserve will actually start to reverse the stimulus. This is important because easy monetary conditions on the back of poor growth and low inflation – first low rates and then QE – have helped underpin a fall in bond yields to record lows. This in turn has underpinned strong returns from sovereign bonds and gains in bond-like high yield investments, notably corporate debt, real estate investment trusts (REITs) and high yield shares, such as banks and telecommunications companies in Australia.

Nervousness about a change in direction from the Fed has been building this year, particularly over the last month following Fed Chairman Bernanke’s comments that he is prepared to slow or “taper” the pace of quantitative easing “in the next few meetings”. This would likely mean cutting the US$85 billion a month it is buying in government bonds and mortgage-backed securities to around US$60 billion a month.

Fearing this signals a shift towards the start of US monetary tightening, expectations for interest rate hikes in the US have been brought forward a year or so, bond yields have increased sharply and beneficiaries of easy money in the US, such as non-government debt, REITs, emerging market debt and equities, high yield shares and the A$ have all been under pressure. This has happened at a time when not all US economic data has been strong, leading some to fear a premature tightening by the Fed.

So the Fed’s latest monetary policy setting meeting was much anticipated for greater clarification around these issues.

The message from the Fed

The basic message from the Fed may be summarised as follows.

First, Chairman Ben Bernanke confirmed that the Board may start to slow the pace of QE later this year. He added that the reduction is likely to be gradual and that QE could end by mid next year. However, he also noted that this is conditional on the economy continuing to improve as the Fed expects, with growth projected to accelerate to 3-3.5% next year. While the immediate reaction in share markets has been negative, taking the lead from confirmation that QE is on track to be phased down, the fact it will only be phased down if the economy continues to improve is likely to be supportive for shares going forward, as this means stronger profits. When it does start to taper, the Fed is likely to prefer a meeting after which it has a press conference where it can explain its actions. This would suggest action will be taken at the September meeting at the earliest.

Second, the pace of QE can still be increased or decreased in the future, depending on how the US economy is performing. In other words, just because the Fed might start to taper in say, September, doesn’t mean that all the next moves will automatically be towards a further reduction. In fact, Bernanke appears to have made a steady decline in QE towards ending the program in mid-2014 contingent on expectations being met that the unemployment rate will fall to around 7% by then. For growth-oriented investments, this is effectively what some have called the “Bernanke put”, i.e. either the economy and profits improve (supporting share markets) or QE continues. It’s very different to the first two rounds of QE that automatically ended in March 2010 and June 2011, only to be followed by significant share market weakness.

Third and most importantly, the Fed reiterated that any decision to slow QE does not mean that interest rate hikes are any closer. In fact, 15 of the 19 Fed meeting participants don’t expect the first Fed Funds rate hike until 2015 or later. This is one more than in March. Moreover, the Fed continues to indicate that near zero interest rates will be justified at least as long as unemployment remains above 6.5% and inflation expectations remain low, with Bernanke pointing out that the 6.5% unemployment rate is a threshold, not a trigger. This suggests that the move forward over the last six weeks in money market expectations for the first Fed rate hike from mid-2015 to mid-2014 is premature. Expect rate hike expectations to settle down again and push back into 2015.

Our assessment

Our assessment is that while the Fed will likely start to slow quantitative easing later this year, this will actually be a good thing because it will only occur because the Fed’s mission has been accomplished. In other words, the US economy can start to be taken off life support. Moreover, by the time this occurs it will be a surprise to no one.

However, as the Fed keeps telling us, it is unlikely to want to rush into raising interest rates, given that:

  • Growth is still a long way from booming and is still relatively fragile as the private sector continues to reduce debt ratios. This is evident in bank loans growing at just 3%p.a and fiscal stimulus now being reversed. This is also evident by the mixed tone of recent economic indicators, with a solid housing recovery but soft readings for the ISM and most other manufacturing conditions indices.
  • Spare capacity remains immense as evident by a 7.6% official unemployment rate and double-digit labour market underutilisation and a still very wide output gap (i.e. the difference between actual and potential growth), as shown in the next chart.

Source: Bloomberg, AMP Capital

  • As the labour market continues to strengthen, labour force participation will likely start to bounce back, slowing the fall in the unemployment rate and achievement of the Fed’s 6.5% threshold.
  • Inflation is low and falling, currently just 1.4%.

So short of a sharp acceleration in the US economy, it’s very hard to see the Fed raising interest rates for the next year at least. This is important because the 1994 ‘bond crash’, which saw US 10-year bond yields rise nearly 300 basis points, was triggered and underpinned by an aggressive rise in the US Fed Funds rate (its official short term interest rate). See the next chart.

Source: Bloomberg, AMP Capital

Implications for investors

Despite an initially negative reaction, the message from the Fed remains reasonably market friendly. The pace of quantitative easing will only slow when the economy is stronger and rate hikes are unlikely any time soon.

The bottom line is that at this stage, a 1994-style bond crash still seems unlikely.1 US interest rates are unlikely to rise any time soon and in Japan, Australia and probably Europe, monetary conditions are still in the process of being eased.

However, we remain cautious of sovereign bonds, given that yields remain well below long term sustainable levels, for which potential nominal GDP growth provides a good guide. See the next table.

Bond yields are well below sustainable levels

Source: Bloomberg, AMP Capital

After four years of record inflows, US bond funds are at risk of seeing big outflows as investors start to see lower or poor returns. In fact, they have started to see outflows in the last few weeks and this could have a long way to go if sentiment towards bonds really turns negative. And of course, this in turn will create upward pressure for bond yields.

Finally, periodic bouts of nervousness regarding the Fed will likely continue as the US economy continues to improve. As a result, we remain of the view that sovereign bond yields will continue to gradually trend higher, resulting in poor returns for bond investors.

Against this backdrop, the chase for yield will likely continue as interest rates will remain low, albeit with perhaps less enthusiasm than seen over the last year. However, returns from assets that have already benefitted immensely from low bond yields like credit and real estate investment trusts will likely slow.

Shares have also benefitted from lower bond yields, although it is worth noting that in relation to US shares, gains have been underpinned by record profits. Moreover, they still trade on relatively high forward earnings yields compared to bond yields. See the next chart.

Source: Bloomberg, AMP Capital

This suggests that earnings yields on shares still offer a reasonable buffer as bond yields normalise, albeit a too rapid or great an increase in bond yields will result in more short term volatility as we have seen over the last month.

One final point to note is that a move towards the end of quantitative easing in the US will further reverse the upward pressure seen on the A$ since 2009. This will be good news for the Australian economy as the stubbornly strong A$ has been a key factor holding the economy back recently. Expect the A$ to fall to around US$0.80.

1. See “What’s the chance of a bond crash?” Oliver’s Insights, Feb 2013.


Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital

Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

Do you need to lodge a tax return for 2012/2013?

This is the first year that the tax free threshold has risen to $18,200, and therefore many more Australians now no longer need to complete a full tax return.

Those with investments in Australian shares (owned either directly or through managed funds) should ensure that they claim their entitlement to imputation credits.  But you may not have to complete a full tax return to do that.

We have sourced this article from the ATO to assist you in determining whether you need to complete a full tax return or whether you can simply use the "Application for Refund of Franking Credits" form.

Important Point - Retirees should pay particular attention to "Reason 2"


If any of the following applies to you then you must lodge a tax return.

Reason 1

During 2012-13, you were an Australian resident and you:

  • paid tax under the pay as you go (PAYG) withholding or instalment system, or
  • had tax withheld from payments made to you.

Reason 2

You were eligible for the seniors and pensioners tax offset, and your rebate income (not including your spouse's) was more than:

  • $32,279 if you were single, widowed or separated at any time during the year
  • $31,279 if you had a spouse but one of you lived in a nursing home or you had to live apart due to illness (see the definition of Had to live apart due to illness in T2 Seniors and pensioners (includes self-funded retirees)), or
  • $28,974 if you lived with your spouse for the full year.

To work out your rebate income, see Rebate income or use the Rebate income calculator for seniors and pensioners tax offset.

Reason 3

You were not eligible for the seniors and pensioners tax offset but you received a payment listed at question 5 and other taxable payments which when added together made your taxable income more than $20,542.

Reason 4

You were not eligible for the seniors and pensioners tax offset and you did not receive a payment listed at question 5 or question 6, but your taxable income was more than:

  • $18,200 if you were an Australian resident for tax purposes for the full year
  • $416, if you were under 18 years old at 30 June 2013 and your income was not salary or wages
  • $1 if you were a foreign resident and you had income taxable in Australia which did not have non-resident withholding tax withheld from it, or
  • your part-year tax-free threshold amount if you became or stopped being an Australian resident for tax purposes; read question A2 or phone 13 28 61.

Other reasons

You must lodge a tax return if any of the following applied to you:

    • You had a reportable fringe benefits amount on your:
      • PAYG payment summary - individual non-business, or
      • PAYG payment summary - foreign employment.
    • You had reportable employer superannuation contributions on your:
      • PAYG payment summary - individual non-business
      • PAYG payment summary - foreign employment, or
      • PAYG payment summary - business and personal services income.
    • You did not claim your full private health insurance rebate entitlement as a premium reduction, or a direct payment from Medicare, and your income for surcharge purposes is below $84,000 for singles and $168,000 for families*

* The family income threshold is increased by $1,500 for each Medicare levy surcharge dependent child after the first child.

  • You carried on a business.
  • You made a loss or you can claim a loss you made in a previous year.
  • You were 60 years old or older and you received an Australian superannuation lump sum that included an untaxed element.
  • You were under 60 years old and you received an Australian superannuation lump sum that included a taxed element or an untaxed element.
  • You were entitled to a distribution from a trust or you had an interest in a partnership and the trust or partnership carried on a business of primary production.
  • You were an Australian resident for tax purposes and you had exempt foreign employment income and $1 or more of other income. (Read question 20 Foreign source income and foreign assets or property for more information about exempt foreign employment income. For the 2009-10 income year and subsequent years, there are changes limiting the exemption for foreign employment income.)
  • You are a special professional covered by the income averaging provisions. These provisions apply to authors of literary, dramatic, musical or artistic works, inventors, performing artists, production associates and active sportspeople.
  • You received income from dividends or distributions exceeding $18,200 (or $416 if you were under 18 years old on 30 June 2013) and you had:
    • franking credits attached, or
    • amounts withheld because you did not quote your tax file number or Australian business number to the investment body.
  • You made personal contributions to a complying superannuation fund or retirement savings account and will be eligible to receive a super co-contribution for these contributions.
  • You have exceeded your concessional contributions cap and may be eligible for the Refund of excess concessional contributions offer: see Super contributions - too much super can mean extra tax.
  • Concessional contributions were made to a complying superannuation fund or retirement savings account and will be eligible to receive a low income superannuation contribution, providing you have met the other eligibility criteria.
  • You were a liable parent or a recipient parent under a child support assessment unless you received Australian Government allowances, pensions or payments (whether taxable or exempt) for the whole of the period 1 July 2012 to 30 June 2013, and the total of all the following payments was less than $22,379:
  • You were either a liable parent or a recipient parent under a child support assessment. If this applies to you, you cannot use the short tax return.

Deceased estate

If you are looking after the estate of someone who died during 2012-13, consider all the above reasons on their behalf. If a tax return is not required, complete the and send it to us. If a tax return is required, see Completing individual information on your tax return for more information.

Franking credits

If you don't need to lodge a tax return for 2012-13, you can claim a refund of franking credits by using the publication Refund of franking credit instructions and application for individuals 2013 (NAT 4105) and lodging your claim by mail, or phone 13 28 65.

2013 Company Reporting Season - what lies ahead

The company reporting season is just about to get underway.

Perpetual Funds Management talk about their expectation for the 2013 company reporting season in this 2 minute video segment.


China - is it the next US sub-prime?

Mark Draper (GEM Capital) talks with Andrew Clifford (Chief Investment Officer - Platinum Asset Management) about the stress that the Chinese credit system is under.

Andrew provides his view on whether China is the next US sub-prime crisis waiting to happen and outlines the sectors he would avoid given what is going on in China at the present time.

Andrew manages the Platinum Asia Fund and is in an excellent position to comment on the current situation in China.


Investment Theme - e-Commerce and the Chinese consumer

The rise of mobile computing has truly been astonishing in the last 5 years since the introduction by Apple of the first iPhone in 2007.

Like the rail road industry in the US in the 1800's, that resulted in the rise of many complimentary industries, so too we see the rise of industries that are connected to the massive increase in mobile computing and e-commerce.  Facebook, Twitter, eBay are now household names that did not exist all that long ago.

While acknowledging that the late 1990's saw a share market tech boom that ended badly, we are now seeing a boom of e-commerce that is of a different quality.

Investors can choose to ignore this and focus on traditional companies, however e-commerce is likely to impact all forms of business and it's impact must be considered when making investment decisions.

This growth theme is difficult to play from Australia given our small population by world standards.

We can report however that both Platinum Asset Management and Magellan Financial Group are both well and truly on top of developments in e-Commerce generally and more specifically in China.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.


Is the Australian Share market Overvalued?

Should investors be concerned that the Australian share market has run too far, too fast?

Mark Draper (GEM Capital Adviser) talks with Paul Xiradis (CEO Ausbil) to answer this question.



Paul believes that the share market response is in reaction to the belief that the worst from the Euro Debt Crisis is now behind us (from a financial market perspective).

Australian Banking Sector - Outlook - April 2013

Paul Xiradis (CEO Ausbil Funds Management) talks with Mark Draper (Adviser, GEM Capital Financial Advice) about the outlook for the Australian Banking sector.


Key points:

  1. Bank Balance Sheets are in good shape
  2. Housing downturn concerns overblown
  3. Banks have grown their profits consistently in tough times over past years
  4. Australian mortgage owners are well ahead in their repayment schedules

The Australian Dollar - The best is behind it

Key points

After doubling in value against the $US over the last decade, the best is likely behind for the Australian dollar.

The commodity price boom is starting to fade in response to a moderation in Chinese growth as commodity supply starts to increase, the impact of quantitative easing in the US is being blunted by rate cuts in Australia with the prospect of more to come and the rise in the $A has exposed the high cost base of the Australian economy.

While further gains are likely in the value of the $A against the Yen (to around ¥110 by year end), the $A is likely to remain range bound this year against the $US with the risks on the downside, particularly over the next few years.

For Australian based investors, this means less need to hedge global exposures back to Australian dollars.


The last decade saw a huge surge in commodity prices on the back of rapid growth in demand, as China industrialised, and as the supply of commodities was constrained. This hugely benefitted assets geared to commodity prices including emerging market shares in South America, resources companies and of course the Australian dollar which were all star performers.

For the $A it meant a rise from a low in 2001 of $US0.48 to a high in 2011 of $US1.10 and a 70% gain on a trade weighted basis. However, since 2011 the outlook for the Australian dollar has become more confused: commodity prices are high but have been sliding recently; monetary easing (particularly money printing) in the US and Japan is positive for the $A but has been blunted slightly by rate cuts in Australia and the chance of more to come; safe haven flows from central banks looking to diversify have helped support the $A but I get the feeling that they are late to the party and some would question Australia’s safe haven status; and the damage to Australia’s international competitiveness has become more evident.

Purchasing power parity

One of most common ways to value a currency is to compare relative prices. According to purchasing power parity theory, exchange rates should equilibrate the price of a basket of goods and services across countries, such that 100 Australian dollars would buy the same basket of goods in other countries as it does in Australia when translated into their currencies. A rough guide to this is shown in the chart below which shows the $A/$US rate against where it would be if the rate had moved to equilibrate relative consumer price levels between the US and Australia over the last 110 years or so.

Source: RBA, ABS, AMP Capital

Quite clearly purchasing power parity doesn’t work for extended periods with huge divergences evident at various points in time when the $A was fixed such as in the 1950s and 1960s and/or when other factors come into play. In fact, the $A as has gone from being dramatically undervalued in 2001 to similarly overvalued now on this measure now. However, it does provide a guide to where exchange rates are headed over very long periods of time. Such an approach has been popularised over many years by The Economist magazine’s Big Mac index.

An obvious problem with such measures is that they can give different results depending on the estimation period and the types of prices used. The relative consumer price measures used in the chart above would suggest that the $A is currently around 35% overvalued, whereas according to the Big Mac index it is only about 12% overvalued.

However, the broad impression is that the $A is overvalued on a purchasing power parity basis. This is consistent with current perception and news stories recently appearing about how Australia has gone from being a relatively cheap country a decade ago when the $A was much lower to an expensive country today. This suggests the $A could face downward pressure if some of the factors that have been holding it up reverse.

The major factors on this front are commodity prices, relative monetary policies and perceptions of Australia as a safe haven.

Commodity price boom starts to fray

Over the last forty odd years swings in commodity prices have been perhaps the main driver of the big picture swings in the $A. Rising commodity prices helped the $A into the mid 1970s, falling commodities correlated with a fall in the $A until around 2000 and over the last decade rising commodity prices explained the huge surge in the $A. The logic behind this is simple. 70% or so of Australia’s exports are commodities and moves in commodity prices are key drivers of our export earnings. However, the commodity price story is starting to fray at the edges. The pattern for raw material prices over the past century or so has seen roughly a 10 year secular or long term upswing followed by a 10 to 20 year secular bear market, which can sometimes just be a move to the side.

Source: Global Financial Data, Bloomberg, AMP Capital

The upswing is normally driven by a surge in global demand for commodities after a period of mining underinvestment. The downswings come when the pace of demand slows but the supply of commodities picks up in lagged response to the price upswing. After a 12 year bull run since 2000 this pattern would suggest that the commodity price boom may be at or near its end. Specifically, growth in China remains strong but it has slowed a bit (from 10% plus growth to 7 to 8% growth) just at the time when the supply of commodities is about to surge after record levels of mining investment globally. And a basing in the $US is also not helping: the falling $US helped boost commodity prices from around 2002 as they tend to be priced in US dollars. Now with the $US looking a bit stronger this affect is fading.

The chart below shows an index of prices for industrial metals such as copper, zinc, lead, etc, against the $A and suggest that they have gone from a positive influence, leading on the way up last decade, to potentially a negative.

Source: Bloomberg, AMP Capital

Relative monetary policies

Quantitative easing in the US, Japan and elsewhere should be positive for the $A as it means an increase in the supply of US dollars, Yen, etc, relative to the supply of Australian dollars. And indeed it has been. Various rounds of QE in the US have been associated with $A strengthening, and the heightened efforts by Japan on this front only add to this pressure and have helped to push the $A up 25% over the last six months and the trade weighted value for the Australian dollar up to its highest since early 1985. Our assessment remains that as the value of the Yen continues to fall in response to aggressive monetary stimulus from the Bank of Japan, the $A will see further gains against the Yen, taking it to around ¥110 by year end.

However, against the $US the impact of quantitative easing may be starting to wain a bit. As can be seen in the chart below, while the first two rounds of quantitative easing in the US were associated with strong gains in the value of the Australian dollar, QE3 has just seen the $A continue to track sideways in the same $US1.02 to $US1.06 range it has been in since last July.

Source: Bloomberg, AMP Capital

This may be partly because QE3 has not seen a rise in commodity prices. But the main reason that the impact of quantitative easing may be starting to wain for the $A is that the interest rate differential in favour of Australia has fallen dramatically as the RBA has cut rates. With the Australian economy still struggling this may have further to go.

What about central bank buying and safe haven demand?

Buying by central banks looking to diversify their foreign exchange reserves and by investors allocating to a diminishing pool of safe AAA rated countries has no doubt played a role in boosting the $A. However, one can’t help but think that after a decade long bull market in the $A (or bear market in the $US) central banks are late to the $A party. And with the fading of the mining boom and the Government struggling to bring the budget back into surplus it has to be recognised that Australia is not without risk. So my feeling is that this source of support for the $A will start to fade.

Implications for investors

The bottom line is the best has likely been seen for the $A and the risks are on the downside over the years ahead as the commodity price boom fades, allowing the $A to correct some of its overvaluation on a purchasing power parity basis.

Currency is very important for investors as soon as they invest in foreign countries. Most global investments offered by fund managers come with a choice of being unhedged, ie exposed to fluctuations in the value of foreign currencies, or hedged, where the value of the investment is locked back into Australian dollars.

Over the last decade unhedged international shares returned 2.7% pa whereas hedged international shares gained 9.5% pa. The difference largely reflects the rise in the $A (+4.4% pa), but also the interest rate differential between Australia and the rest of the world (+2.4% pa). But if the $A is likely to go sideways or down there is much less need to hedge and with the interest rate gap between Australia and the rest of the world narrowing there is much less incentive to hedge.

In other words the reward versus risk equation in favour of the $A is diminishing so it makes more sense for investors now to consider taking an exposure to foreign currencies (ideally with the exception of the Yen) beyond the Australian dollar and obtaining the diversification benefits they provide.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.


How low can interest rates go?

We expect the Reserve Bank will complement its May rate cut of 0.25% with a follow up move of 0.25% in June. Rates are expected to eventually
bottom out at 2% by the first quarter of 2014 (that is 0.75% lower than today).

There are ample precedents for a May/June move. Over the last 10 years the Bank has moved rates on four occasions in May with two of those occasions being followed up in June.

The really key new developments over the last few weeks have been evidence
of an even lower than expected trajectory for inflation and, as pointed out
in this note, a Reserve Bank that is clearly open to further action.

Given this scenario we think that the most likely policy option is a follow
up rate cut in June of 0.25% which will be implemented for the same reasons
as we have seen today complemented by further evidence of softening
confidence and weak business investment.

We have also always argued that our assessment of the global economy is
more subdued than the consensus. The IMF is expecting 4% world growth in
2014 – we are closer to 3%. For Australia's terms of trade, the peak to
trough decline in the 2011–12 period was 17%, while we forecast a 2013–14
decline in the region of 10%. We have long maintained that from a world
growth perspective, 2014 will feel like 2012.

The threat of a disruptive event in Europe remains ever present.

The US story does not convince us. We confidently expect that the US
Federal Reserve will persist with its quantitative easing policy through
most of 2014.

China has already begun the process of recalibrating its monetary and real
estate policy settings and the support it received from the export sector
in Q1 is already receding. Indian domestic demand is flagging badly and the
required policy support has not been adequate. Japan is something of a
bright spot, but its gross acceleration will far exceed the net from a
global growth perspective as it takes back market share.

From June we expect the Bank will be patient to assess the impact on
domestic demand of the low rates. However by year's end it will become
clear that further stimulus will be required to offset the impact of a
softening world economy while the response to the low rates in the domestic
economy will be disappointing.

We anticipate two further rate cuts will be required in the December
quarter of this year and March quarter of next year. That would see the
cash rate bottom out at 2% from its current 2.75%. Having driven rates down
to that level we expect rates to remain on hold through the remainder of

Our specific profile for the Australian dollar, which had incorporated a
steady cash rate of 2.75% (with downside risks) and a softening world
economy, saw AUD back at USD 0.97 by June next year, partially due to a
gradual narrowing of the overvaluation premium.

With our lower RBA rate profile there is some modest room for further
moderation in the fair value of AUD with our June 2014 target being lowered
to USD 0.96. However, the key to a more significant fall in AUD is a more
marked reduction in that over valuation premium – something that lies
essentially outside the RBA's influence.


Bill Evans - Chief Economist - Westpac Banking Corporation


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.


Australian Banks - are they in Bubble Territory?

A research report from UBS recently described Australian Bank share prices as a "bubble".

We ask this question of Kerr Neilson (CEO) and Andrew Clifford (CIO) of Platinum Asset Management.

They do not believe that Australian Banks are in a bubble - but believe that there are many other banks globally with superior growth characteristics at far cheaper prices.



$AUD - is this the bottom?

We talk with Kerr Neilson (CEO Platinum Asset Management) and Andrew Clifford (Chief Investment Officer Platinum Asset Management) to discuss the future of the $AUD.


They provide a very candid view on the Australian dollar and how Platinum's portfolio's are positioned to take advantage of the currency.




The Next Big Thing - What Happens When Quant Easing comes to an end?

Mark Draper talks with Hamish Douglass (CEO of Magellan Financial Group) about the next big thing that investors should keep an eye out for, which is - What happens when the  United States stop Quant Easing?

Quantitive Easing has been referred to as the printing of money and involves the US Federal Reserve expanding their balance sheet to purchase US Government Bonds, which in turn has resulted in long term interest rates being kept artificially low.

Watch a 7 minute interview that explains what investors should be paying attention to over the next few years, from one of Australia's best macro-economic thinkers.



Inactive Bank Accounts - Government on the prowl

We all know that the certainties in life are death and taxes.  While technically not a tax, the Government recently changed the rules on inactive bank accounts as a novel way to increase Government revenue.

Bank accounts that have been inactive for 3 years (ie no deposits or withdrawals) will now become the property of the Government after recently introduced changes.

This serves as a reminder that unless you wish to make a donation to our great nation, please ensure that any bank accounts you may own remain active.



Is the Australian Sharemarket Cheap or Expensive

The Australian share market has experienced a strong rally over the past 12 months, although it must be said that this rally was off a low base.

So the question that all investors want to know - "Is the share market expensive now?"

One way of determining this is to consider the Equity Risk Premium.  Equity Risk Premium by definition is "The excess return that an individual stock or the overall stock market provides over a risk-free rate. This excess return compensates investors for taking on the relatively higher risk of the equity market. The size of the premium will vary as the risk in a particular stock, or in the stock market as a whole, changes; high-risk investments are compensated with a higher premium."

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

NAB Business Survey - Australian Business Conditions are tough

The NAB Business Conditions survey released in July confirmed what most already knew, that business conditions remain tough in Australia.  While the economy has not entered recession officially, "it just feels like it" for most of the country.

The Business Conditions survey shows that we have not seen this sort of weakness since 2009 which was during the depths of the GFC.  Business confidence is best described as "shot" and will probably not improve until the result of the Federal election is known.

For this reason we remain very selective about where we would recommend to invest in Australia.  We are tending to favour businesses that have overseas earnings rather than those solely based domestically.

This weakness in business conditions could also convince the RBA to further cut interest rates.  NAB themselves have suggested that the RBA could move again in August following the issue of this survey.  This could further weaken the $AUD.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

Five Reasons I'm Bullish for 2013 by Alan Kohler

This article has been reproduced with permission from Alan Kohler.

I returned to work last week even more optimistic than I was before I went, and not just because I was still glowing from the Bali sun.

While I was away the market rallied 2 per cent and although it’s looking ‘toppy’ and looks due for a pullback, I think we are now in the situation where buying on the dips is the best idea. The global recovery is on and, as I explained before Christmas, money is shifting back into equities around the world.

So bearing in mind Nassim Taleb’s dictum that “the only prediction one can safely make is that those who base their business on prediction will eventually blow up”, there are five reasons I am optimistic about 2013 without exactly predicting anything: China, America, Europe, Japan and Risk.


To start with the last of those, in my view 2013 will be a 'risk-on' year. Well to be honest this started half-way through 2012 when it became clear firstly that the global economy was recovering and secondly that the European Central Bank, with German support, really would do whatever it takes to keep the euro intact. The Fed was already doing whatever it takes to get the US dollar down, and the Reserve Bank was doing whatever it takes to get the Aussie dollar down (not that that’s working yet).

All of which means the returns from cash are miserable and falling. Time to invest then, which means taking more risk, but not too much – thus, bank shares returned 25 per cent in the second half of 2012.

In my view this trend has just begun. For five years investors everywhere have been more concerned with not losing their capital than with making a return and gradually that is changing; they are moving out along the risk curve.  Obviously taking more risk means just that, and the world is not yet a safe place (is it ever?). I think the greatest danger has passed, and while deleveraging will continue to hamper growth there are many positives offsetting that.


Sam Walsh must be the luckiest man alive. Not that he doesn’t deserve to be chief executive of Rio Tinto – of course he does, in fact he probably should have taken over years ago (I’m sure he agrees) – but because he takes over just as China’s economy bottoms and turns around and with $14 billion in writedowns tied to Tom Albanese’s tail. All new chief executives would dream of having their troublesome assets all written off and their main customer on the improve.

The data on China that came out last week contained several positives, apart from the fact that growth, at 7.9 per cent, was better than expected. The transition towards greater consumption and less reliance on investment has continued, with consumption now accounting for 4 per cent of GDP growth in the fourth quarter, higher than gross capital formation (3.9 per cent). Growth in retail sales improved from 11.6 per cent to 12 per cent in 2012 and car sales grew 6.9 per cent (5.4 per cent in 2011). The acceleration in consumption happened because income growth, at 9.6 per cent in the cities, was greater than GDP growth for only the third time in a decade.

So the project of converting China from an export and investment driven economy to one that is based on domestic consumption is intact. Income growth is being helped by the remarkable fact that the working age population actually fell in 2012, by 3.5 million – the first such fall ever.

This brings its own challenges of course. It makes it even more imperative that the Chinese authorities reform the economy to promote the return on capital, otherwise economic growth will stall. The state owned enterprise system is deeply inefficient, as you’d expect, which has never mattered too much while the labour force has been growing so rapidly. As it declines, productivity must rise.

But while the long-term picture is clouded, it’s clear that 2013 will see China’s economy continue to accelerate, which should support the iron ore price – if not at $150 a tonne, then certainly above $120. Happy New Year Sam!


China is recovering and so is the United States, with housing leading the way. The National Association of Home Builders Housing Market Index is at a six-year high and double the level of January 2011. The “prospective buyer traffic” component of the index is at the highest level since January 2006. The median house price is up 10 per cent year on year, as is the volume of sales. Residential construction has bottomed and the vacancy rate is heading down.

Thanks largely to housing, the US private sector is growing at a pretty rapid clip – about 3 per cent if the government sector is removed from GDP calculation. State and local governments are starting to join the private sector in recovery, with only the federal government continuing to shrink. Moody’s expects local and state governments in the US to expand employment by 220,000 in 2013, a huge turnaround from the previous three years of job losses.

Manufacturing has been slow to move, but that seems to be now happening as well. Industrial production expanded 0.3 per cent in December after a rise of 1 per cent in November. But the December number was held back by a fall in utilities generation: factory output jumped 0.8 per cent in December. As for this year, cheap energy is expected to produce a resurgence of US manufacturing.

There’s a lot of talk that the budget deal will create a big headwind, but that seems to be overdone. There are two main elements to the deal that will produce fiscal drag: the payroll tax increase, which will cut
GDP by about 0.7 per cent, and the spending cuts due to be implemented in March – another 0.6 per cent of GDP. That 1.3 per cent of GDP fiscal drag seems large compared to 2.2 per cent average GDP growth since 2010, but as Anatole Kaletsky points out the IMF calculates that US fiscal drag on the economy was 1.3 per cent in each of 2011 and 2012. In other words, fiscal drag in 2013 will be no greater than the previous two years.

That is, as long as the politicians don’t snatch defeat from the jaws of victory by sending the US into default because of the debt ceiling. They have about six weeks to raise the limit, since the government will run out of money on March 1. Surely they will, although as usual it will probably be at the last minute.

Paste the below link into your web browser to read the full article.

By Alan Kohler - from Business Spectator - 23rd January 2013

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.



Life Insurance for young families

New priorities and responsibilities

As a 'young family' you have a natural instinct to care, nurture and protect those you are now responsible for. It isn’t just about you anymore, it is about your responsibilities and knowing that your family is secure in your care. You are thinking about the things you are currently providing but, more importantly, you are already planning for the future-such as education for your children; a safe and comfortable home; and family holidays and recreational activities.

As with all life stages, you like to think that you will always be there for your family, and be able to work and provide a steady income. There is nothing stronger or more compelling than the natural instinct of a parent wanting to ‎protect their family.

Why you need life insurance to protect your family

No one plans to get sick, injured or to die unexpectedly and we all have a tendency to think that it won’t happen to us. ‘I’m too young to get cancer or have a heart attack’ and ‘I’m the safest driver on the road,’ are common misconceptions.

The first step in addressing your family’s financial security is to become aware of the risks you and your family are exposed to. One of the greatest risks you may face in your life is losing your ability to earn an income and to provide a secure and comfortable lifestyle and future for your family. Despite this being the case, many people don’t insure themselves for this risk, whilst almost everyone insures their car!

It’s worth taking a moment to consider what would happen if an extended illness or injury or premature death stopped your ability to work and provide an income. This could have a devastating impact to your family’s financial security and long-term lifestyle choices. It’s hard to imagine losing your health and your ability to go to work or even losing your life, but it is easy to imagine the practical impact the lack of an income would have.

The perfect time to put in place a life insurance plan

It is so important to consider your life insurance needs while you are relatively young and healthy, before you have any health scares and while there are still a range of options available to you. Too many people only realise the need for life insurance once they begin to experience health problems and it is often too late.

US Fiscal Cliff - Should We Be Worried?

Mark Draper talks with Jack Lowenstein (CEO Morphic Asset Management) about the most likely outcome from what is known as the US Fiscal Cliff.

1. What is the US Fiscal Cliff?
2. What is the most likely outcome in the short term?
3. Is this the last we will hear of the fiscal cliff?

Reflating the Japanese Economy

Key points:
  • While it is likely still has more to do,the Bank of Japan is on a path towards major policy reflation for the Japanese economy.
  • This is likely to see further downwards pressure on the yen and strong gains in Japanese shares.
  • It is also positive for the global economy as Japan will likely no longer be a drag on global growth going forward.
  • While Japanese monetary reflation adds to upwards pressure on the Australian dollar, a stronger Japan will be positive for Australia overall as it remains our second biggest export market.
  • Platinum International Fund has significant exposure to the Japanese share market.


The announcement that the Bank of Japan (BoJ) is raising its inflation target to 2% and adopting open-ended quantitative easing is very positive.

Options for further fiscal stimulus in Japan are severely limited
by an already world beating budget deficit and public debt levels. Currently, the budget deficit is running around 10% of gross domestic product (GDP) and net public debt is around 135% of GDP compared to 73% in Europe and 84% in the US. Half-hearted monetary stimulus from the BoJ has played a major role in driving the deflationary malaise the Japanese economy has been in for the past two decades. So, apart from structural reform, it is really all up to monetary policy in Japan to pull the economy out of its long-term malaise.

The BoJ’s move reflects ongoing pressure from the new Japanese Government under Prime Minister (PM) Abe, which received a resounding mandate to reflate the economy at last December’s election. This is now resulting in aggressive action from the BoJ and highlights that Japanese economic policy is undergoing a dramatic turn for the better. Key to this change is PM Abe’s comment that the Japanese economy is not going to change “unless we display a firm commitment to escape deflation.”

While some quibble that the pressure from the new government has violated the BoJ’s independence I view this as entirely appropriate. Central bank independence should be conditional on the central bank achieving stable prices and thereby contributing to economic growth and full employment. However, the BoJ has failed in this regard overseeing years of chronic price deflation. As such, it is entirely appropriate that the Japanese Government intervene to refocus the BoJ on achieving an inflation objective.

More to do

The big news from the BoJ was its adoption of an official ‘target’ of 2% inflation agreed with the government. This is a far more substantive commitment than its previous ‘goal’ of 1% inflation.

Having boosted its monthly asset purchase program (basically buying government bonds and other assets using printed money) for 2013 to levels that matched the US Federal Reserve at its December meeting, it also announced the program would become open ended starting in 2014 with ¥13 trillion in asset purchases a month.

On the downside though, with no increase in the size of its 2013 program and the 2014 program focused on short-term bills and likely to be diluted by redemptions, the BoJ will probably still need to do more if it is to achieve its 2% inflation target.

However, the move by the BoJ should be seen as another step along the way to much more aggressive policy reflation. The first step was the big expansion of its quantitative easing program at its December meeting. This has now been followed by the adoption of a firm 2% inflation target. Further easing is likely once a new more dovish BoJ governor takes over in April and finds that he has little choice but to further ramp up quantitative easing if the agreed inflation target is to be met.

Global implications

The adoption of aggressive monetary reflation in Japan aimed at exiting deflation has a number of mostly positive implications globally:

  • TheJapanese yen is likely to fall another 10-20%,after the current short-term correction runs its course. This would take it to around ¥105 against the US dollar and to around ¥110 against the Australin dollar ( just surpassing its 2007 high of ¥107.8). Such a fall in the yen will be necessary if Japan is to achieve its 2% inflation target in the next few years and this in turn means that Japan will need to continue its open-ended quantitative easing for quite some time.
  •  Japanese shares are likely to perform well. A 30% or so gain is feasible this year. As can be seen in the next chart the relationship between value of the yen and the Japanese share market has been inverse over the last ten years, so a weaker yen will provide a big boost to Japanese shares. This largely occurs because a weaker yen provides a huge boost to Japanese exporters.


  • A strongerJapanese economy helped by a weaker yen and an end to deflationary expectations.
  • Japan will no longer be a drag on global economic growth.
  • Easier monetary policies in Japan will add to ultra easy global monetary conditions.
  • Yen weakness will put more pressure on competitor countries, notably Korea and Taiwan, which may in turn put more pressure on their central banks to further ease policy too.
  • Aggressive easing from the BoJ adds further fuel to the global carry trade of borrowing cheap in Japan and investing in higher yielding currencies like the Australian dollar.While the immediate reaction to the BoJ’s announcement has been for Japanese shares to fall a bit and the yen to rise this looks like a classic example of short-term profit taking after the strong moves in both markets over the past few months. As the pace of BoJ easing continues and probably steps up the rising trend in Japanese shares and falling trend in the yen will likely resume.

Concluding comments

Japan takes 19% of Australia’s exports and is our second largest trading partner, so notwithstanding the risk of more upwards pressure on the Australian dollar, an exit from deflation and stronger growth in Japan will be positive news for Australia.

This year has already seen a number of positive developments for the global economy, including: the avoidance of the fiscal cliff in the US; indications that the US debt ceiling will be extended; the relaxation of the Basel bank liquidity requirements; and solid data releases from the US and China. Aggressive Japanese policy reflation just adds to this list. As such it’s little wonder that share markets have started the year on a strong note.

Investors in Platinum International Fund have significant exposure to the Japanese share market and are therefore potential beneficiaries of this course of action from the Bank of Japan.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

Investment Tips For Each Decade


Many opinion pieces and financial articles have been written with handy tips to help invest your money. An issue with many of these is that the people reading them are, in all likelihood, of different ages and at different stages of life.

With this in mind we’ve broken down each decade to help you understand some of the financial considerations.

20–29 year olds

Many people have just entered the workforce at this stage and most people will still be renting. While some people in their twenties have formed long term relationships many have not had children. For the majority, home ownership and families are still a thing of the future.

The major financial focus for this group is to eliminate debt that may have been accumulated while at university/college (HECS–HELP, credit card debt, student loans etc.), and to start to save for a deposit on a home.

30–39 year olds

By the time most people are in their thirties, they are in long term relationships and a lot have had children. Many people during this period have bought their first home and some would even be considering renovations.

The major financial focus during this stage is usually on reducing mortgages as much as possible.

People in this age bracket need to be careful not to over extend themselves financially, and aim to keep money available for emergencies that are more likely to occur than when they were renting and had no children.

Those without children or a mortgage, who are looking to get ahead at this stage may consider investing in the share market.

40–49 year olds

It may sound obvious but the financial position in this period will be largely determined by how much spending restraint has been shown during the previous decade. For disciplined savers there is a good chance of being able to upgrade to a bigger home at this stage of life.

In saying that, the forties can be difficult for couples who have children in their teens as they generally incur more costs at that age, especially if they attend private schools. Careful budgeting is required for people in this position.

Those that don’t have children and have enough money for their day to day expenses may start thinking about diverting more of their money into superannuation.

50–59 year olds

By this stage many people will start experiencing more sustained wealth creation due to fewer family costs. The reason for this is because most will have children at an age where they are becoming financially independent.

Generally salaries are also higher in this bracket. Putting more savings in superannuation is very common when people are in their fifties given the current tax incentives that come with it. This is also an opportunity for many to start their own individual business.

60 and beyond

For people past 60, the main financial focus is to invest savings to generate a retirement income and maximise the age pension.

In summary

Regardless of which stage you are at, it’s important to make a financial decision based on the assessment of the risks and opportunities that exist in your life. As you can see, these seem to change with each decade.

We can help you find the right investment opportunities for your individual situation and for each life stage.

This document has been prepared by Colonial First State Investments Limited. This document is not advice and provides information only. It does not take into account your individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement available from the product issuer carefully and assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision.

Spain & Italy Are (Probably) Fine

Just as Brussels is finally enjoying a spell of summer sun, there’s more good news for debt-crisis watchers who stayed behind in the European Union’s headquarters: The Peterson Institute for International Economics says the debt loads of Italy and Spain are (most likely) sustainable.

In a new working paper, William R. Cline—a sovereign-debt crisis veteran going back all the way to Latin America’s troubles in the 1980s–calculates different trajectories for the debt loads of the two countries whose financial fate is seen as central to the survival of the euro. The interesting thing about the paper is that it not only examines three typical scenarios (good, baseline, bad) and applies them to five variables (the level of growth, primary surplus, interest rates, bank recapitalizations, and privatization receipts), but also assesses the probability of several of these variables going bad (or good) at the same time. In other words, Mr. Cline calibrated the effect of, say, low privatization receipts on a government’s primary surplus or the interest rates it’s likely to pay on its bonds.

His conclusion–which should delight policymakers in Rome, Madrid, and Brussels alike–is that the most likely outcome by the end of the decade is that “both Spain and Italy remain solvent” and that they won’t need a debt restructuring á la Greece or, even worse, leave the euro zone.

The “probability weighted average,” i.e. the best bet, for Spain is that its debt will be no higher than 92% of gross domestic product by 2020. That’s up quite a bit from the 81% it is expected to hit by the end of the year and slightly worse than the 89% under Mr. Cline’s baseline scenario, but still at a level that is generally seen as manageable for a large, developed economy. On top of that, there’s a 75% chance that the debt load will be below 99% of GDP by 2020. For Italy, the best bet is a debt that declines to at least 109% of GDP by 2020 from 123% this year, with a 75% probability that it will go down to at least 116%.

Now, forecasting debt levels eight years into the future is in itself a tricky exercise. The goal of Greece’s debt restructuring earlier this year was to bring the country’s debt load to a “sustainable” 120% of GDP by 2020. Even back in March some EU officials warned privately that that kind of calculation was more of a political spiel designed to convince parliaments in countries like Germany or the Netherlands to once again open their wallets for Greece than a sound basis for economic policy making. Less than six months on they were proven right–international debt inspectors are currently trying to determine how much the political uncertainty of two national elections have set the country behind in hitting the 120% target, while the International Monetary Fund is arguing that for Greece, really, a level of 100% of GDP is much more suitable.

The biggest challenge with these calculations is of course determining how to fill in the variables, i.e. what’s the good, baseline or bad scenario for growth or interest rates. And it is perhaps here were Mr. Cline’s analysis is most vulnerable. For Spain, for instance, the “good” scenario for bank recapitalizations is that Madrid will have to pick up exactly €0 of the cost of recapitalizing its banks—that would only happen if either the stakes the government acquires in struggling lenders turn out to be unexpectedly valuable or the country succeeds in moving the entire recapitalization costs off its own books and onto those of the euro-zone bailout fund. We explained why either of these two scenarios are unlikely here and here.

The baseline scenario expects bank recapitalizations to add only some €5 billion to government debt (mostly thanks to the European Stability Mechanism taking direct stakes in the saved lenders rather than routing the money through the government, as Mr. Cline explained in an interview). Even under the bad scenario the bank bailouts add “only” €50 billion to the debt load (that’s assuming that the cost cannot be transferred to the ESM). Considering that the euro zone has promised Spain as much as €100 billion and some analysts fear that low growth could push the bailout bill even beyond that, it’s easy to imagine a worse scenario. (Sidenote: the bank recapitalization section in the Spain scenario table on p.15 of the paper also includes €36 billion in debts that the Spanish government may have to take on from crisis-hit regions—a footnote that Mr. Cline says was accidentally dropped in the final version.)

But there are conclusions in the paper that go beyond the exact variables used for the different scenarios. For instance, Mr. Cline’s calculations show that for both Spain and Italy higher interest rates—and even lower growth–have a smaller effect on debt levels than missing budget targets. For Spain, more-expensive bank bailouts set off a similar dynamic: the “bad”(€50 billion) recapitalization scenario drives the baseline debt load from 89% of GDP to 94% by 2020; the full €100 billion, meanwhile, would take it up to 99%, even if all other variables stay in the baseline.

The good news from that if of course that governments may have more influence on their primary deficits—and even the cost of bank bailouts for national governments amid “direct” bank recapitalizations from the ESM–than on interest rates and growth. Or as Mr. Cline summed it up in an email: “The good outcome depends on Spain doing its part on the primary surplus and the euro zone doing its part on the banking union.”

If that thesis holds up, Mr. Cline’s analysis may herald more good news than Brussels weather, where the probability of sustainable summer sunshine is close to zero.

By Gabriele Steinhauser

The Wall Street Journal

Financial Planning and Family Risk

There is an important aspect to Financial Planning we would like to highlight which is the potential risk associated with an illness, injury, or major trauma event occurring to a member in your family ie a son, daughter, their spouse or a grandchild.

 If the unthinkable happened and one of your family members was to suffer from any of these events, would they survive financially, or would you need to step in and offer financial support?
We think it is important that you be honest and ask yourself two questions.
  1. Would you step in and help out your family in the event that one of your children, their spouses or your grandchildren were to suffer a serious illness or injury.  We know the importance of family and think in most cases the answer would be yes.
  2. How would you feel if when you found out they had no or insufficient insurance cover to provide for their would the rest of your family feel?

The financial consequences for you could be a burden too great to bear and drastically affect your future plans and other family members.

Many parents know little or nothing of their extended family’s real financial position, this extends to not knowing how much debt they hold and ongoing financial commitments they have.  In addition, most parents rarely know what insurance cover they have in place and if this is sufficient to meet the circumstance.

This is not unusual as they are adults now and responsible for their own life BUT, if something did happen and only then did you find out, you would potential have to suffer the financial consequences.  This is what we call Family Risk as it affects all members of the family.

We provide a financial planning service to the adult children of our clients.  We would be happy to have a discussion with you about your family and how we could provide this service to them.

New Warning - Serious Investment Fraud

The Minister for Home Affairs and Minister of Justice Jason Clare today urged Australians to protect themselves against the growing threat of serious and organised investment fraud.Minister Clare released a new report from the Australian Crime Commission (ACC) and Australian Institute of Criminology (AIC) which provides a national picture of the nature and threat of serious and organised investment fraud in Australia.

“This is the first unclassified report of its kind. It indicates that more than 2600 Australians may have lost more than $113 million to serious and organised investment fraud in the last five years. That number could be even higher because people tend not to report this kind of crime,” Mr Clare said.

“The targets of this type of crime are primarily Australian men, aged over fifty. They are usually highly educated – and have high levels of financial literacy. They are likely to manage their own super.

“This is what happens. The criminal syndicate cold calls the investor, refers them to a flash website and sends them a brochure promising strong investment returns. After taking their money they string them along for months or even years and then the money disappears.

“People’s entire life savings are stolen by criminals with the click of a mouse. This type of crime destroys wealth and destroys lives. It’s also very difficult to stop.

“These criminal syndicates usually operate from outside Australia. They use front companies and false names. Once they’ve stolen the money the website disappears and the trail goes dead.”

In the next two months every household in Australia will receive a letter warning them about this criminal activity and providing information on how to avoid becoming a victim.

This is the first time Australian law enforcement agencies have undertaken a mail out of this scale regarding serious and organised crime.

“This problem is not going away. Australia’s retirement savings are growing – making us a bigger target every year,” Mr Clare said.

ACC Chief Executive Officer Mr John Lawler said the level of superannuation and retirement savings in Australia made it an attractive target for organised crime groups.

“To combat this growing threat, last year the ACC Board established multi-agency Task Force Galilee to disrupt and prevent serious and organised investment fraud and harden Australians against this type of organised crime,” Mr Lawler said.

“These scams are typically unsolicited ‘cold calls’ used alongside sophisticated hoax websites to try and legitimise the fraud. This type of crime targets the life savings of hard working Australians. Australian and international law enforcement partners stand committed to protecting Australians from these crimes.”

Australian Securities and Investments Commission Chairman, Greg Medcraft said fraudulent investments are incredibly sophisticated and very difficult for even experienced investors to identify.

“Perpetrators of this type of fraud are skilled at using high-pressure sales tactics, over the phone and using email, to persuade their victims to part with their money,” Mr Medcraft said.

“I urge investors to be immediately wary if they are called at random by someone offering an investment opportunity overseas.”

Australians should take the following actions to prevent becoming victims of investment fraud:

  • Visit or call 1300 300 630 for further information or advice.
  • Alert your family and friends to this fraud, especially anyone who may have savings to invest.
  • Report suspected fraud to the Australian Securities and Investments Commission, on or 1300 300 630, or your local police. Remembering information such as company name, location and contact details will assist with subsequent investigations and enquiries.
  • Hang up on unsolicited telephone calls offering overseas investments.
  • Check any company you are discussing investments with has a valid Australian Financial Services Licence at
  • Always seek independent financial advice before making an investment.

To access the report on Serious and Organised Investment Fraud in Australia see the ACC website visit or call 1300 300 630 for further information and to report suspected investment fraud.

Warning letter that was sent to all Australian households

Media contact:  Annie Williams - 02 6277 7290

Positive Developments In The Euro Debt Crisis

There have been some very positive developments with respect to the Euro Debt Crisis over the past few months that many would argue is potentially the turning point of the crisis.

View 3 1/2 minute video by Mark Draper explaining some positive developments in Europe

In summary these developments are:
  1. The European Stability Mechanism, which has funds of EUR 500bn, will be available for operation in the second half of 2012.  This fund was the subject of a legal challenge to the German High court on constitutional grounds and this challenge was dismissed yesterday.  The purpose of this fund is for recapitalising European Banks as well as funds to purchase Government Bonds in countries such as Italy and Spain in order to keep borrowing rates affordable for those countries.
  1. The European Central Bank (ECB) has announced a program that will allow the ECB to purchase an unlimited amount of Government Bonds in the market for countries that seek assistance and accept strict conditions about aspects of their budgets.  The purpose of this is to guarantee access to funding for European Governments at affordable rates.  We have long argued that Spain and Italy are solvent countries, providing their borrowing costs do not become excessive.  This announcement is critical in keeping interest rates low and has seen borrowing costs for Italy and Spain come down significantly as can be seen below:
  Spanish 3 Year Govt Bond Rate Spanish 10 Year Govt Bond Rate Italian 5 year Govt Bond Rate Italian 10 year Govt Bond Rate
Borrowing rate as at November 2011



(as of July 2012)



Borrowing rate now





  1. We continue to believe that there is very little risk of a financial meltdown resulting from the Euro Debt Crisis or Financial Armageddon.

The Head of the European Central Bank recently went on record as saying “We will do whatever it takes to keep the Euro together, and believe me this will be enough”.  He has backed up this rhetoric with the announcement to purchase an unlimited amount of European Government bonds for countries that request assistance.

Does this mean that this is the end of the crisis?  Unfortunately not, however, we see these developments as very important building blocks that should stabilise the Eurozone and allow the Governments to carry out the necessary reforms to put their economies on a sustainable path.  These reforms include tax, welfare, spending and labour market reforms.

In addition to these the other steps that the leadership of the European Union will need to take is to formulate plans for a Banking Union, and a closer Political union, which would result in individual countries surrendering some degree of control over their budgets in exchange for access to funding at cheaper rates and other economic benefits.

Currently the European Union is a currency union, arguably put together for political reasons, now they must bring together other aspects of their economies.  This is not something that can be done quickly given the political pressures.  The ECB however appear to have provided the necessary time for the politicians to get on with the job as the ECB alone can not resolve this crisis.  This is where we see the main risk – with politicians and potential for the balance of power to shift over time.

The other main source of risk would seem to be with the very high levels of unemployment in countries such as Spain where overall unemployment is around 25% and youth unemployment is around 50%.  This has potential to create social unrest which is difficult to predict.

Overall, we believe that the most recent steps are very positive moves forward that can provide the building blocks for the Euro Debt Crisis to be brought under control and financial markets have welcomed these moves in the form of lower borrowing costs for Italy and Spain.

There is an excellent video we produced earlier this year called “Fire Wall for the European Debt Crisis” that discusses the firewalls that have been created to ensure European Governments continue to have access to funding at affordable rates.  This can be found by clicking the YouTube icon on our website at and is well worth viewing.  It runs for 6 minutes.

We trust you find this update useful and helps you put into context some of the information you are hearing in the media.


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

To My Dear Dead Husband Tom........


To My Dead Husband Tom,

Why were you so against insurance? You always chuckled and laughed that you would never die and I would just remarry. Well guess what? You died one year later! It’s now two years later, all our money is gone and I have some real physical and mental challenges.

I am left with our daughter Susan, NO HOME, working two jobs, and bills coming from everywhere.  The doctor bills for your heart attack alone were in excess of $90,000.

The fun and laughter is now gone and we are really hurting! When I really think about it, I believe I am as much to blame as you are. I should have opened my mind and imagined the alternative picture that my Financial Planner was painting. Instead I chose to laugh about it and assumed it would never happen to us.

The joke is on me! I am not remarried and most likely will not get married ever again. When someone dies it is amazing the sorrow and pain that comes to the surface.

I want to let you know that I now have a policy on myself, and I make sure it is the first bill paid. If something ever happens to me, I want Susan to be protected. You know what kills me the most? For approximately  $650 a year, we could have been protected.


US Housing Market - the recovery has begun

Warren Buffett (one of the world's best investors) previously stated that he believes the recovery in the US Housing market will be a defining moment for the US economy.

It is considered that the annual underlying demand for houses in the US is 1.5 million houses per year due to immigration and family formation.  For example, since the Global Financial Crisis the US population has increased by over 10 million.  The chart below shows the number of new houses being currently built as around 600,000 per year which is well below annual demand.  At the moment this does not represent a problem as there is as oversupply of housing due to the housing boom leading up to 2007.  During that time many more houses were built than the underlying demand, which lead to surplus housing stock (and let's face it you can only live in one house at a time).

The key message here is that in time the surplus housing stock will be soaked up by demand that is not being met with new home building currently.  This explains Macquaries research which shows (in blue bars) the likely trend for US Home Building over coming years as ultimately the US will have to build houses to keep up with demand.

The question for Australian investors is how can you take advantage of this?


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.






Global Investment Update May/June 2012

Please click on the link below to view an informative video presentation from Hamish Douglass (Magellan Financial Group CEO) that discusses the uncertainties facing the global economy including Greece, Spain, Portugal, United States and China.

Click here for Global Investment Update with Hamish Douglass

The key points from this update are as follows:

  • A spectacular Greek exit from the Euro is very unlikely irrespective of which party wins the June 17th 2012 election.  Greece deciding to leave the Euro now is best described as “suicide”.  If polls can be believed, 80% of Greeks wish to remain in the Euro.
  • Financial issues within Europe are well understood by the authorities including the European Central Bank (ECB) which has made substantial moves already to deal with liquidity in the European Banking system.  This sends a signal that the ECB will not idly sit and let the European financial system fail.
  • Spanish Banks require additional capital to restore their balance sheets following a property market bubble, possibly as high as EUR 100 billion.  The European Stability Mechanism (ESM) is to commence operating in July 2012 and has EUR 500 billion at its disposal and in Hamish’s view, if required could be used to recapitalise Spanish Banks.  The French are suggesting methods to increase the ESM financial firepower.
  • Low probability that the Spanish Banking system will cause a financial meltdown.
  • ECB is in a position to provide assistance to keep borrowing rates affordable for Spain to ensure that Spain does not become insolvent.
  • A gradual United States recovery is underway, and on a 3 year view, US housing will lead a sharp recovery in the US economy.
  • Chinese economy on track for a “soft landing” (meaning that Chinese economy unlikely to fall off a cliff) and is likely to slowdown gradually.
  • Volatility in financial markets is likely to be a feature of the landscape for months to come.

8 Common mistakes made by investors


Mistake 1: Excessive Buying and Selling

A study of more than 66,000 households found that investors who traded most frequently underperformed those who traded the least. For the study, investors were split into five groups based on their trading activity. The returns achieved by the 20 percent of investors who traded the most lagged the least active group of investors by 5.5% annually. Another study showed that men trade 45 percent more than women, and consequently, women outperformed men.

Mistake 2: Information Overload

Those who monitor the market too closely have a tendency to undermine their portfolios with self-destructive behavior. Richard Thaler, a professor at the University of Chicago, conducted a 25-year study where he divided investors into three groups: one group who checked their investment performance every month, one that checked performance once per year, and one that checked performance every five years. The study concluded that individuals who check performance the most obtain the lowest investment return and are most likely to sell an investment immediately after a loss. Of course, selling low is not a good strategy for making money.

Mistake 3: Market Timing

History has shown that the market rises about 70 percent of the time.

Market timers tend to find themselves out of the market during the 70 percent of the time that it is going up because they are trying to avoid the 30 percent of the time the market is falling.

Market timing is typically driven by emotion. Investors tend to buy stocks when they feel good and sell when they feel bad. Unfortunately, investors tend to feel good once the market has run up 20 percent and feel bad when their portfolio is down 20 percent. With the feel good/bad strategy, investors will always buy after the market has already gone up and sell when the market has already fallen.

Mistake 4: Chasing Returns

Guess which managed funds attract the most new money each year? Money flows into managed funds that have just enjoyed the greatest performance in the previous year. Unfortunately, investors are often late to the party with this strategy. It shouldn't be surprising that chasing returns is a very common mistake. The entire financial media industry is built around a common theme: Don't Miss Out on the Ten Hottest Stocks. When the fine print says past investment performance is no guarantee of future returns, believe it!

Mistake 5: Poor Diversification

You may have seen this mistake coming. Investors tend to be concentrated in one or two companies or sectors of the market.

Over-concentration can hurt a portfolio, whether the market is performing well or poorly. Poor diversification leads to excessive volatility and excessive volatility causes investors to make hasty, poor decisions.

Mistake 6: Lack of Patience

Most managed fund investors hold their funds for only two or three years before impatience gets the best of them. Individual stock investors are even less patient, turning over about 70 percent of their portfolios each year. It's difficult to realize good returns from the stock market if you invest for only weeks, months, or even a couple of years. When investing in stocks or funds, investors must learn to set their investment sights on five and ten-year periods.

Mistake 7: Not Understanding the Downside

When you buy an investment, you should plan on worst-case scenarios occurring when you invest. It is true that past performance isn't guaranteed to repeat, but it does give us an indication of what to expect on the downside. Know how your investments performed during recessions, wars, terrorist attacks, and elections. If you don't understand the risks at the outset, you are more likely to react poorly during periodic market setbacks and get scared out of the market.

Mistake 8: Focusing on Individual Investment Performance Rather than Your Portfolio as a Whole

One way to know you are diversified is that you will always dislike a portion of your portfolio. If you are properly diversified, I can guarantee you that each year some of your investments will lag behind others in your portfolio. If you look at investments in isolation rather in context of your overall portfolio, you will be tempted to make poor decisions. You can get yourself into trouble by getting rid of investments when theyr'e low in value and replacing them with those that just experienced a nice run.


Most of these mistakes can be avoided by having a clearly defined, long term investment strategy. Before investing, develop a proper diversification strategy, a system for evaluating the performance of investments, and solidify your long term investment goals. Then, turn off the TV and refer back to the systems and principles of your strategy when it is time to make investment decisions.

This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. RI Advice Group Pty Limited ABN 23 001 774 125  AFSL 238 429.


Don't trip up when Chasing Income Yield

With official interest rates hovering at 3.5% and residential property income yields typically running at between 4-5%, investors are clamouring for investments that pay a higher rate of income.

Is it as simple as running a ruler over the dividend yield column in the Financial Review to select your investments?

The table below highlights the top 20 dividend payers from the Australian share markets based on forecast dividend payments for the current financial year.

What are some of the questions investors should ask themselves when considering high income investments?

What is the likely profit growth trend that can support future dividends?

What proportion of company profits are being paid out as dividends?  A high proportion doesn't leave the company much room to maintain dividends if profit drops.

Is the dividend being artificially inflated by asset sales, debt or financial engineering?

What is the outlook for the sector in which the company operates within?

These points are best illustrated comparing the highest ranking dividend payer in the chart above, Metcash with its larger rival Woolworths.  Woolworths dividend is not as high as Metcash but the share price chart below shows that Woolworths has been a better performing investment despite paying a slightly lower dividend.  (Woolworths is the blue line and Metcash the red line)

Woolworths vs Metcash Share Price Performance

There is no doubt there are some juicy dividends to be enjoyed by investors in the current market, but care must be taken to avoid what is referred to as a value trap.  (where an investment appears good value - but performs as a dog)  We encourage investors to look beyond the headline dividend yield when considering an investment.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.

Related Party Off-Market Asset Transfers to be Banned for Self Managed Super Funds

18 April 2012 – Off-market transfers of certain assets, such as shares, between related parties and self managed superannuation funds (SMSFs) will cease to be allowed under Tax Office rules.

Frequently referred to as in-specie contributions, the government announced in 2011 that from July 1, 2012, non-market transactions that result in a contribution being made to an SMSF in the form of an asset will no longer be permitted.

The government's move came as a response to the growing trend of SMSF members making in-specie contributions of property into their SMSF, as on a practical level many people may not have had spare cash but may have had valuable assets they could contribute.

However there are restrictions imposed on the assets that can be acquired by funds from related parties (such as fund members or family members). The asset must be:

  • business real property (property used exclusively in one or more businesses)
  • listed securities (shares)
  • certain in-house assets acquired at market value (where the value of those in-house assets do not exceed 5% of the value of the fund's total assets).

Off-market transfers that make in-specie contributions to an SMSF are, however, generally made without actually selling and re-purchasing the securities on the open market. Hence the government believed that such non-market transactions were not transparent, and were open to abuse — through transaction date and/or asset value manipulation to achieve more favourable results with regard to both contribution caps and capital gains tax outcomes.

Keeping such asset transfers at arm's length was also seen to more closely meet the sole-purpose test for SMSF activities.

Part of the Stronger Super package, the legislation was formed to ensure that related party transactions be conducted through a market, or accompanied by a valuation if no market exists. In the latter case, transactions must be supported by a valuation from a suitably qualified independent valuer.

For equities, for example, the underlying formal market is the Australian Securities Exchange. So if SMSF trustees want to contribute listed shares to their fund, these will be required to be sold onto the market and then subsequently repurchased.

For business real property, there is no underlying formal market, so transferring these assets will therefore require validation by a valuation from a qualified valuer. Under the existing rules, a real estate appraisal of the value is sufficient.

Speaking at the SMSF Professionals Association of Australia's 2012 conference in February, Tax Office assistant commissioner Stuart Forsyth said the Tax Office will provide guidelines, probably before the end of the financial year, to help trustees and their advisers with the valuation problems they may encounter.

'They'll promote a consistent approach to valuations across the sector and support the proposed new requirement for SMSFs to value their assets at net market value,' Forsyth said. 'We'll also talk directly to auditors and other stakeholders as we develop this product which will build on existing guidelines focused on taxation compliance.'

Source: Taxpayers Australia INC latest news


Review Salary Sacrifice Agreements

The beginning of the financial year is an ideal time to review salary sacrifice arrangements.  This is especially important for individuals likely to be close to their contribution caps, or wishing to maximise their concessional contributions to superannuation.  As a reminder, the concessional contributions cap is $25,000 (or $50,000 for individuals who are aged 50 or over on the last day of the financial year).

Exceeding Contribution Limits can lead to additional tax which effectively taxes your excess contributions at 46% or possibly higher depending on other contributions.

When reviewing or creating a new salary sacrifice agreement, consideration should be given to:

  • the terms of the agreement specifying the amount(s) and timing of salary sacrifice contributions, e.g. whether additional items will be sacrificed, such as end of year bonuses.
  • the number of pay cycles in the coming financial year. In 2011/12, for employees who are paid on a Friday, there will be 53 weekly pay cycles in the year or there may be 27 pay cycles in the year if paid fortnightly.  You may have an extra pay cycle during the financial year and possibly additional superannuation guarantee (SG) and/or salary sacrifice contributions, depending on when your employer makes these contributions and your level of income.
  • factoring in concessional contributions from all sources that will be paid in coming financial year, even if they relate to the previous financial year.   This includes items such as SG and insurance premiums paid by your employer or you for cover effected through superannuation.  For details about contributions that count against the concessional cap contact your Financial Adviser.
  • capturing SG and salary sacrifice contributions made in situations where you changes job, and
  • factoring in a reasonable buffer for pay rises or bonuses received that may occur during the financial year or unexpected employer contributions.
  • understanding your employer's policy regarding SG contributions and whether your employer pays 9% on employee earnings in excess of the maximum quarterly earnings base of $43,820 (2011/12 year).

While the above planning may help avoid an excess contributions problem, it would be wise to review the actual concessional contributions made before the end of the financial year.  This way you can ensure any changes in your employment, income or superannuation contributions since 1 July don't derail your plans.


Sound confusing?  Contact us for more information about salary sacrifice and contribution caps or to arrange a, no-obligation first consultation, please contact:


GEM Capital

Phone: 08 8273 3222


Note: Advice contained in this flyer is general in nature and does not consider your particular situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser. While the taxation implications of this information have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at July 2011.

Small Business CGT Concessions Overview

In many cases, proceeds from the sale of a business form a large part of a small business owner’s retirement funds. Maximising the return on sale is therefore important to ensure a comfortable retirement

Tax concessions are available to small business owners who are selling business assets if certain basic conditions are met. A summary of these tax concessions and the basic criteria that must be met is summarised below.

As this is a complicated area, we recommend individuals obtain tax advice specific to their business structure and arrangements..


The four CGT concessions.

The four small business capital gains tax (CGT) concessions are:

  • 15-year exemption – this concession totally exempts any capital gain made upon sale of the business asset. To be eligible, a small business entity must have continuously owned the CGT asset for a minimum of 15 years and, at the time of disposal, the individual is 55 or over and the disposal is connected to their retirement, or the individual is permanently incapacitated. If the business operates as a company or under a trust structure then the entity must have a ‘significant individual’ for any period or periods totalling 15 years during the period of ownership.
  • The 50% active assets reduction – a 50% reduction of a capital gain.
  • The retirement exemption – an exemption of capital gains up to a lifetime limit of $500,000. If the recipient is under 55, the amount must be paid into a superannuation fund and normal preservation rules apply.
  • The rollover concession – a deferral of a capital gain if a replacement asset is acquired. The deferred capital gain may later crystallise when the replacement asset is sold or its use changes.
  • If an asset is being sold by an individual and the asset has been held for more than 12 months, the capital gain must first be reduced using the 50% discount before applying any of the above mentioned small business CGT concessions.



The eligibility conditions?

To be eligible to use the small business CGT concessions, an individual (or entity) must first satisfy several basic conditions:

  • the $6 million net asset value test or the $2 million • aggregated turnover test
  • the active asset test, an
  • if the business operates as a company or under a trust structure, it must also meet the 20% significant individual test.


$6 million net asset value test?

A business that meets the $6 million net asset test is considered a small business by the ATO. To meet this test, the net value of CGT assets of the individual and certain related entities must be less than $6 million.

The net value of CGT assets is the market value of those assets less any liabilities relating to those assets.

Certain assets are excluded from the test, such as assets held for personal use and enjoyment, superannuation entitlements and the value of life insurance policies.


$2 million aggregated turnover test

A business that fails the $6 million net asset value test can still be considered a small business by the ATO if it meets the $2 million aggregated turnover test.

To meet this test, the aggregated turnover of the individual plus any affiliated or connected business entities must be less than $2 million.

There are three methods for determining aggregated turnover:

  • using the previous year’s aggregated turnover
  • estimating the current year’s aggregated turnover, or
  • using the actual current year’s turnover


Active asset test

A CGT asset is an active asset if it is owned by the individual (or entity) and it is used, or held ready for use, in a business carried on by the individual (or entity), the individual’s affiliate, their spouse or child, or a connected entity.

The asset does not need to have been active at the time of disposal, but it must have been active for the lesser of 71/2 years or half of the period of ownership.

If the asset being sold is a share in a company or unit in a trust, an 80% look-through test applies, meaning that the shares or units will be considered active assets if at least 80% of the market value of the underlying assets of the company or trust are active assets.



Significant individual test

If a business is run through a company or trust structure, one of the following additional basic conditions must be satisfied just before the CGT event:

  • the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
  • the CGT concession stakeholders in the company or trust together have a small business participation percentage in the entity of at least 90% (the 90% test).

An individual is a CGT concession stakeholder of a company or trust if they are a significant individual, or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust. This participation percentage can be held directly or indirectly through one or more interposed entities.

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. The 20% can be made up of direct and indirect percentages.


Note: Any advice contained in this flyer is general in nature and does not consider your particular situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser. We are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent.


For more information about the Small Business CGT Concessions or to arrange a no-cost, no-obligation first consultation, please contact:


GEM Capital

Phone Number: 08 8273 3222

Dummies Guide to the Debt Crisis

What's the debt crisis really about? Why is everyone panicked and what should you do about it?


John Addis from Intelligent Investor offers a salutary guide for the worried.


What is sovereign debt?

Sovereign or public debt is the term used to describe money owed not by a nation but by a nation’s government.

Governments issue bonds to finance their debt. Those purchased by its own citizens constitute a domestic debt whilst those borrowed overseas from non-residents are an external debt.

The distinction is important, especially if you happen to be Greek. At the end of 2009, Greek sovereign debt stood at 113% of GDP, 82% of which was external. Interest payments on that debt leave the country, depressing economic activity and making further repayments more difficult.

Italy on the other hand had public debt of 115%, of which only 19% was external. Italy’s interest burden is largely paid to Italians, which is why its problems aren’t as serious as other PIIGS.

The other consideration is the currency in which debt is issued. Whereas most countries have to issue bonds in a foreign currency (typically the US dollar), the United States does not. If the US gets into trouble, it can simply print more dollars to repay debt (something it’s busy doing right now).

Countries carrying a large percentage of external debt don’t have that option, which is why Portugal, Ireland, Greece and Spain are in more serious trouble.

Is sovereign debt bad?

It depends. Societies’ religious background colours views; many see debt as a moral failing. In Sanskrit, Hebrew and Aramaic, the word for debt and sin are essentially the same so discussions of the subject can sound like a morality play—Debt is bad, we have sinned, we should pay it all back and suffer. We can see the political expression of that in the Tea Party.

But government debt is different. It’s constantly refinanced and investors accept it because the money is invested in health, education, infrastructure and wars, which tend to be economically beneficial. But that’s not to say countries don’t get into trouble from too much debt; they do, quite a lot.


So countries do default on their debt?

Conventional wisdom suggests debt defaults are infrequent. History suggests the opposite. In This time it’s different, Carmen Reinhart and Kenneth Rogoff examine ‘default episodes’ over eight centuries and establish that, especially among emerging economies, defaults aren’t exceptional at all.

Between 1300 and 1799 the emerging economies of France and Spain defaulted eight and six times respectively. In the 19th century alone Spain defaulted seven times. From the Great Depression of the 1930s to the 1950s, nearly half of all countries were in default or ‘restructuring’—a euphemism for default—representing almost 40% of global GDP.

More recently, there was a wave of defaults in the 1980s and 90s, including Russia in 1998 then Argentina, which defaulted on part of its external debt in 2002. Countries default all the time, even in Asia and Europe.

Ominously, Reinhart and Rogoff remark that ‘whereas one and two decade lulls in defaults are not at all uncommon, each lull has invariably been followed by a new wave of default.’ The period between 2003 and 2007 was one such lull. We all know what happened next.

Also, we should remember that most defaults aren’t about an inability to pay but, at least in a democracy, a lack of political will to do so. The alternatives to default are austerity measures—cutbacks on government services—and tax increases. Neither are big vote winners. It’s much easier for politicians to punish those (non-voting) horrible, dirty foreigners stupid enough to lend them money in the first place.

What are the consequences of default?

Let’s take Argentina as an example. After its $132bn default in 2002, investors fled the country, causing a currency collapse (in fact, in anticipation of default they were leaving in droves before it). The value of the countries’ exports plummeted despite the currency falling. Without financing, the government was forced to cut expenditure, slashing state pensions. Private sector wages fell, too.

Unemployment soared to 20%, inflation skyrocketed as the cost of imports rose and the government printed money, debasing the currency further. In a year, the economy shrunk by an incredible 13% and about a quarter of the population resorted to bartering. Bartering!

The long term consequences are most evident in the credit ratings and rates on Argentinean bonds. Japan is carrying debt of 225% of GDP, the highest in the world. It pays 1% on its 10-year bonds. Argentina, with debt standing at 52% of GDP, pays 10%. Argentina has a credit rating of B; Japan AAA. Much of that differential is explained by Argentina’s default. Investors want a higher return for trusting them again.


Why the panic now?

Firstly, no one’s panicking about Australia—quite the opposite in fact. The problems are in the largest economies of the developed nations. And it’s not debt per se that’s the problem—it’s the extent of it and what it’s been used for.

In 2006 the average debt level of the G7 nations (Canada, France, Germany, Italy, Japan, the UK and the US) was 84% of GDP—not bad enough to send us all to the great margin loan in the sky. By 2010 it was 112%, the highest level since World War II.

Those averages disguise some alarming figures. In the United States debt has risen from under 60% of GDP to well over 100% in 2010. According to the IMF, in 2010 Japan, Greece, Italy, Belgium, Singapore, Ireland, the US, France, Portugal, Canada, the UK and Germany carried government debt of 75% or more, far greater than economic powerhouses like Malawi (40%) and Uzbekistan (10.4%).

For debtor countries especially, the GFC made matters far worse. Bank bailouts resulted in private debt being made public and, in an attempt to kick start slumping economies, massive fiscal stimulus packages were undertaken. Government debt increased hugely as a consequence.


How can countries fix their debt problems?

The first option is economic growth. If GDP is increasing at a rate faster than the increase in national debt, although the debt is rising in absolute terms, as a percentage of GDP it’s falling. That’s good.

Countries like the United States, the UK and Japan, which can take on more debt cheaply, have this option. For Spain and Italy, with 10-year bond rates around 5%, it’s a remote possibility. For Greece, with a 10-year bond rate of 17%, it’s out of the question.

Reducing debt by cutting government expenditure and increasing revenues is the second policy choice. The UK in particular is following this strategy, favouring cutbacks over tax increases.

The trouble is that increasing taxes and cutting back on government expenditures at a time when economic conditions are already shaky can make things worse. In that sense, these two options conflict.

The third policy option is to inflate the problem away. Inflation reduces in real terms the debt owed, which is why indebted governments have a big incentive to encourage inflation. Although governments won’t admit to it, policies like quantitative easing (see Quantitative easing made easy) have this as one of their aims.

Currency devaluations have much the same effect, which is why the US dollar and UK pound are at historically low levels. Lower exchange rates also benefit economic recovery, making exports cheaper and imports relatively more expensive. In the aftermath of the GFC, Iceland, as well as letting private banks collapse, used a currency devaluation to great effect.

Unfortunately, indebted European countries tied to the Euro at a rate set largely by Germans aren’t able to do this. That’s why the situation in Europe, where the problems are structural and immediate, is more pressing than in it is the United States.

Remember also that a currency’s value is relative; countries can’t all devalue at the same time. With a troubled US and Europe, and half of the rest of the world pegged to the US dollar, devaluation is unlikely to do the trick.


We’ll be okay because of China, right?

Not necessarily. The United States and Europe are China’s two biggest markets. If things take a turn for the worse in those economies, China will be affected.

China is an export-driven nation; domestic consumption is insufficient to compensate for another deep recession in the US and Europe. If that were to occur, we could expect to see a rapid fall in commodity prices, the local currency and our terms of trade.

China also has its own problems, including massive (and under-reported) local government debt, social unrest and inflation concerns. It’s not the beacon of economic stability it’s made out to be.


What are the chances of a double-dip recession?

The global economy is three years into a debt recession, which tend to last longer and are more severe than normal recessions. Charles R Morris in The Trillion Dollar Meltdown said, ‘A credit bubble is different. Credit is the air that financial markets breathe, and when the air is poisoned, there’s no place to hide.’

We’re all breathing toxic air and it needs cleaning. That takes time. Look at the Japanese and their lost decade. We can expect a few more problems yet, although that doesn’t mean we’re going to face Japan-style problems.


How does this affect my investment strategy?


First, don’t panic. Corporate debt is much lower, corporate profits much higher. The banks have been recapitalised. This might feel like 2007 all over again but it doesn’t look like it.

Second, understand that the local currency isn’t the safe haven it appears. A weak US dollar and an unsustainable and risky Chinese stimulus program make it look that way. Australia remains a small economy heavily reliant on the financial and resources sectors. That's why investors should consider overseas exposure.

Pricing power is also going to be important. That means—and we’re going to sound like a broken record here—that you should buy best of breed companies and hold some cash—volatile markets are likely to be the norm.

Also, be more demanding with your valuation estimates. If a company reaches fair value then consider selling it for cheaper stocks (it's sensible to swap cheap for cheaper still). As we’ve already seen, a volatile environment offers plenty of opportunities for patient investors.

Nevertheless, prepare for a world of lower growth. Dividends will become more important and low interest rates more prevalent. That should influence the stocks you buy and sell. In the latest Platinum Quarterly Report, Kerr Nielson posits that more than two thirds of the total real return from equities in the period 1900 to 2008 came from dividends. There’s no reason why the next 90-odd years won’t follow a similar pattern.

Finally, acknowledge that humans have an amazing capacity to muddle through. Crises pass and problems are solved, after which we forget they existed in the first place, thus creating the conditions for them to happen all over again. We are indeed a strange mob.

This article has been reproduced with permission from Intelligent Investor – their website is


Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at August 2011.




Make Money From Shares - Dividends From Australian Shares In A Rising Trend

In a financial world that is currently light on for good news, largely courtesy of Europe and the US, it may surprise you to know that almost 50% of the top 200 Australian companies increased their dividend last financial year.

There are clearly two parts to determining the return from investing in shares.  The first is movement in the share price and the second is the dividend paid each year by the company.  Dividends are often overlooked as an important reason to invest in shares, but Platinum Asset Management recently reminded that from 1900 – 2008 the average return from shares was over 6% above the inflation rate and that  dividends contributed 4% of this figure.  (Platinum were quoting figures from the US share market, where dividends are generally lower than Australia)

Total dividends from the Australian market rose by over 9% last year and here is a selection of companies to show the increase in dividends.  This information has been sourced from IRESS.


Company 2010 Dividend 2011 Dividend % Increase 2011 Dividend Yield ** Dividend Yield adjusted to include tax credit
Wesfarmers $1.25 $1.50 16.6% 5% 7.1%
CBA $2.90 $3.20 10.3% 7% 10%
Woolworths $1.15 $1.22 6.1% 5% 7.1%
Platinum Asset Mgment $0.22 $.0.25 13.6% 6.75% 9.6%
NAB $1.47 $1.62 10% 7.2% 10.3%
Telstra $0.28 $0.28 No Increase 9.4% 13.4%
QBE $1.28 $1.28 No Increase 10.1% 10.5%


** Based on closing price of company as of 12th September 2011.

Not only are the dividends being paid by these companies significantly higher than the current cash rate of 4.75%, but dividends are bankable and can be spent or saved by investors.  Companies that pay fully franked dividends means that the tax has already been paid at a rate of 30% on that dividend.  The right column titled  “Dividend Yield adjusted to include tax credit” includes the value of tax paid by the company on a fully franked dividend.

While share values fluctuate daily, it is the dividend stream that investors can rely on over time paid from rising profits.



Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at September 2011.


Safe As Houses???

How would Australians feel if the house that they bought in 1979 was worth almost 10% less today?  It’s fair to say they wouldn’t be too happy.  But this is the scenario that homeowners in the United States, who are experiencing the effects of plummeting wealth, are putting up with.  From 1991 to 2005, US house prices rose at a rapid rate but, adjusted for inflation, prices are now almost 40% off their peak, or roughly US$100,000.  Those who stumped up to buy a house in 1979 are now down about 8.5% - and that’s more than three decades later.

Jeremy Grantham, who is a well respected Investment Analyst from GMO suggests that the Australian property market is well and truly overvalued, when compared with rental income yields, long term historic averages and relative to incomes in Australia.



Investing is a rising inflationary environment

The Reserve Bank has a formal inflation target in place and most investment commentators regularly talk and discuss the threat inflation may have on investors.  This article explains why inflation should be considered by investors and some tips on protecting an investment portfolio in a rising inflationary environment.

For many years there have been deflationary pressures, particularly from 1. an increasing Australian dollar which lowers the cost of imports, and 2. cheap Chinese labour (translating to cheap imports).

In the past 12 months, Chinese wages have increased 30% for average workers, while Chinese construction workers have received about 100% wage increases (source Platinum Asset Management).  Food and energy shortages around the world are also putting upward pressure on prices of basic essentials for daily living.  We believe that the days of deflationary pressures are over for now.

Why is this important?

Consider a business that sells widgets.  It sells 1,000 widgets for $100 each, while the cost to produce the widgets is $50 per widget.  The gross profit for this business is therefore $50,000.

If however the cost to produce widgets due to rising energy prices, increased wages etc goes up to $60, the gross profit falls 20% to $40,000.  Of course the business could raise the sale price of widgets to protect their profits, or sell more widgets if the market will bear, but this is easier said than done. So inflation hurts business profits (read share prices) as well as making the cost of living higher.

Share Market Investments

Seek to invest in companies that have the ability to pass on price increases to their customers.  These companies typically have the following attributes:

  • Well recognised brand and a dominant market position  (meaning they can pass on increased costs)
  • Management with experience from previous inflationary cycles

If using managed funds, ensure that the fund manager responsible for investment selection is on top of the threat of global inflation.  Evidence of this could come in the form of commentary from the fund manager in recent communications.  Your adviser could also have direct contact with the fund managers’ investment personnel and can confirm this for you as well.

Fixed Interest Investments

Exercise extreme care when investing in long dated fixed interest investments.  Consider an investor who invested $100,000 into a 10 year bond paying 5% interest.  Interest received is $5,000pa.  If interest rates rose to 10%, in order to receive $5,000 of interest the investor would only require $50,000 of capital.  The point here is that if this investor wished to sell their 10 year bond, before the 10 year period was due, it would be unlikely that they would receive anywhere near $100,000.  It is possible to lose capital in fixed interest investments in a rising interest rate environment.

Instead, look at fixed interest investments that are linked to interest rates.  So as interests rates go up, the payment received goes up as well.  Your financial adviser can help you with investments that have these characteristics.

Other suggestions

Property (particularly commercial property) can provide protection in an inflationary environment as lease agreements normally contain an inflation adjustment each year.

Infrastructure investments such as toll roads also contain clauses in the legal agreement, where the toll paid by consumers is increased by inflation each year.

Talk to your adviser to ensure that your portfolio is prepared for the threat of a global inflationary environment.

5 Tips For Combating Everyday Stress

HALF of Australia is so stressed out that it is making us sick, according to an annual poll taken for the past four years.

Lifeline spokesperson Brendan Maher said the problem is growing every year with 93 per cent of 1201 respondents said to be stressed as compared to 90 per cent in 2010.

"This year we can put some of it down to the natural disasters affecting our nation, but much of it will be due to poor stress management," he said.

Supporting partner Bupa said the poll identified work as the number one stresser and research that they have done have backed this claim.

5 tips for combating everyday stress are:

1. Get active: exercise programs have been proven to help reduce anxiety and exercising for as little as 30 minutes a day, as recommended in the National Physical Activity Guidelines, may help to combat stress while keeping you in good physical condition.

2. Eat a healthy, balanced diet: a healthy diet is one of your best tickets to good health. Good health means one less thing to stress about.

3. Get good, quality sleep: lack of sleep affects both our mental performance and our mood. Bupa Healthwatch research found that sleep-deprived people reported feeling more stressed, sad, angry, mentally exhausted and less optimistic about their lives as a whole.

4. Stop smoking and limit caffeine: Nicotine in cigarettes and caffeine in coffee, cola and energy drinks are stimulants that may increase your stress levels.

5. Be smart about how much alcohol you drink: it's likely that drinking too much may negatively affect how well you perform, increasing the stress you're under.


Late June and early July saw a surge in market sentiment, as various European Union entities and the International Monetary Fund apparently cobbled together yet another rescue package for Greece. Slightly more positive data also emerged from the US and Japan, where the post „quake recovery seems to be proceeding better than originally expected.

Some emerging markets are also taking comfort from the fall in the price of oil, even if this may itself be a symptom of weaker growth in developed economies.

However, we note that most of Asia has inverted to flat yield curves and that these have traditionally been good indicators of economic slowdowns and often recession.

We remain cautious and maintain relatively high levels of cash and bullion in our portfolios. We are sensitive to the degree of hedging  we have in  the VGT, ASV and  GDG, with some expectation  that the long  period of Australian dollar out performance may soon come to an abrupt end. Our problem is that it is not clear what currencies would outperform the A$ given the threats to developed world currencies.

Looking at another area of potential instability, the Europeans‟ political commitment to the Euro project seems increasingly untenable on economic grounds. Greece faces a significant restructuring of its debts, as the economy continues to shrink, while government debt spirals despite an unprecedented austerity programme. We doubt the Greek populace will have stomach for much more hardship, especially when it fully grasps that the current multilateral  so-called  rescues  are  more  focussed  on  protecting  bank  lenders  from  France  and  Germany  than helping the Greeks themselves. The real solution to Greece‟s problems is a default and withdrawal from the Euro allowing the restoration of the drachma and dirt cheap holidays in Greece for hard-working Northern Europeans.

We are no more optimistic on the prospects for two other sick small countries in Europe: Portugal and Ireland. The real test of the Euro and the European Central Bank will be bail outs for Italy and Spain, both of which have come under attack in the bond markets in recent days with soaring yields. Sovereign defaults by these two countries will have systemic impacts on the solvency of many European banks and probably the European Central Bank itself, and would put an end to what many commentators deride as the current “Extend and Pretend” routine in continental Europe.

Europe‟s problems do not end at the English Channel. Britain has the balance sheet of “Club Med” but the interest rates of the thrifty Northern Europeans. It still looks vulnerable, even before it feels the effects of the long overdue, but still painful impact of cuts in its bloated public sector. Given the shrivelled nature of its manufacturing sector, it is also not clear how much benefit it is getting from continued falls in the pound sterling.

The theme of weakening government tax revenues exceeded by rising government spending is evident in most developed economies. This is perhaps in its most extreme form in Japan, but it is increasingly apparent in Australia too, despite the well rehearsed, but increasingly unconvincing pledges to bring the Commonwealth budget back to surplus.

Where Australia stands out, and indeed looks more like an emerging market, is its willingness to use monetary policy to offset the fiscal laxity. Like developing Asia, Australia is seeing inflationary pressures. Unlike Asia, these relate more to labour shortages in WA and Queensland and rising government charges than raw material costs. Unfortunately structural inefficiencies in Australia prevent labour in the struggling Brisbane to Melbourne corridor flowing to the growth states as they have in previous resource booms. In the meantime the Reserve Bank of Australia‟s tough monetary stance is pushing up the Australian dollar, which adds to the pain in the mortgage belts of the large cities of eastern Australia through the destruction of traditional blue collar manufacturing jobs.

Increasing doubts about the sustainability of China‟s investment intensive economic growth model have seen many raw material prices plateau or dip. While it would be wrong to underestimate the capacity of China‟s central planners to keep the growth engines firing, signs are emerging that the conflicting need to put a cap on inflation through tougher monetary policy is putting the country‟s financial system under strain. What is clear is that if China does catch a cold, Australia, most of Africa and much of South America will get influenza.

The potential vulnerability of Australia‟s position is exacerbated by the increasingly apparent frailty of its housing market, which could have significant impacts on the country‟s banks, due to their high level of dependence on the sector. Australian banks have managed to slightly reduce their reliance on foreign borrowing, but still have high levels of loans to their core deposit bases. As well as having a huge traded sector, Australia is connected to the rest of the world‟s economy through our banking sector‟s reliance on wholesale funding to bridge the gap between loans and deposits. And if interest rates go up internationally Australian banks will be squeezed.  Any uncertainty about their financial strength will hurt the Australian dollar – and put the focus on the effective blank cheque the Commonwealth has written to protect Australian bank deposits.

How equity markets perform in this environment is not clear. We believe the 20 year bull-run in developed country government bonds is coming to a close and the inflationary impacts of lax fiscal and monetary policies in most developed economies are reaching an inflexion point. Rising costs of doing business in China will also remove the biggest deflationary force of this period caused by cheap manufactured imports. In our view, long term fixed interest investments are likely to do badly while equities are likely to do less badly.

We are of the view that the long swing of outperformance of Australian shares over foreign shares, especially when measured in Australian dollar terms is petering out. To this end, it is our present strategy to cut our hedges on our foreign holdings in the VGT, GDG and ASV as soon as we gain confidence in a decisive break in Australian dollar strength, and gradually cut our exposure to Australian stocks in the VGT as well.

At the country level we are still nervous about China, and fundamentally more bullish about India, especially if, as we believe, the recent monetary tightening phase is coming to an end, and recent oil price weakness is sustained.

The paradox of Europe is that great export companies from Germany, France, Scandinavia, the Benelux region and even northern Italy are benefiting from the currency weaknesses caused by the stresses at the heart of the Euro project. Japan contains elements of both the US and Europe so far as the prospects of individual companies are concerned, but seems frozen in even greater apathy at the political level, and in far too many cases companies there still treat shareholder as passengers rather than owners.

Meanwhile in the US, signs of a recovery in the housing market remain at best tentative, and even record company profits are not prompting much new hiring. At the same time most US governments seem incapable of cutting spending, with the only hurdle to increased indebtedness coming from mandatory debt limits at the federal, state and municipal level, increases in which typically require legislative approval.

Nevertheless, we do feel the US could be the one market that provides upside surprise potential. The one level where we have confidence is the ingenuity of corporate management, especially in companies with international sales, which are more likely to profit than lose from a weak currency and a soft labour market.

This is now being joined by an expansion in consumer credit in Q1 (the first since 2005); an improvement in US credit scores (which hit their highest level in four years in May); and senior loan officers willingness to lend is increasing markedly.

What if the best place to invest is the US and not Asia as many people think? This is not our base case given the sharp rises already seen in the market, the fiscal incontinence and coming budget issues, but food for thought if these can be addressed in a timely manner.

As our portfolio managers go about their work however the key remit remains unchanged from our inception nearly 20 years ago: to find stocks that are not just cheap, but cheap despite the quality of their businesses and managements and their prospects for growth.

Please  be  advised  that  Monthly  Performance  Reports  for  the  Funds,  as  well  as  other  relevant  marketing information can be emailed to you. If you would like to subscribe to this service, or have any further queries regarding Hunter Hall, please contact our Investor Relations Department by email at This email address is being protected from spambots. You need JavaScript enabled to view it. by calling 1800 651 674 (0800 448 305 for New Zealand callers).


Financial Ruin awaits those failing to register their car

South Australia recently reported an alarming increase in the number of motorists driving an unregistered car.  Around 2,000 motorists per month are now being detected in South Australia driving an unregistered vehicle.  We can only imagine similar statistics exist in all states.

What does this have to do with Financial Planning I hear you say?

The answer lies with the fact that motorists driving an unregistered vehicle run the risk of losing everything, including their house.

One of the components of motor registration is the premium of compulsory Motor Injury Insurance.  This is the insurance coverage that pays compensation to people injured in a motor vehicle accident.

Those who do not register their vehicle, do not have this insurance cover.  This could mean that in the event of a motor vehicle accident, where another person was injured, the owner of the unregistered motor vehicle could become liable for the compensation amount that would normally be paid by the Motor Injury Insurance provider.

To put some perspective on this subject we highlight the accident in 1986 involving high profile Australian actor John Blake.  He was ultimately awarded $7.7 million in compensation as a result of a car accident.

If this compensation could not be paid by the Motor Injury Insurance because the offending vehicle was not registered, the liability would most likely fall to the vehicle owner which would more than likely result in bankruptcy for most.

Risk management is a key plank of any good financial strategy.  Failure to register a motor vehicle puts at risk an individual’s assets.

As part of your overall financial health, we recommend that you double check to ensure that your vehicles are registered.


Note: Advice contained in this article is general in nature and does not consider your personal situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.  While the taxation implications of this strategy have been considered, we are not, nor do we purport to be registered tax agents. We strongly recommend you seek detailed tax advice from an appropriately qualified tax agent before proceeding.  The information provided is current as at August 2011.







Notwithstanding the considerable uncertainty in financial markets we remain calm and comfortable with the risk profile of the Magellan Global Fund.

Since the inflection of market sentiment in early April, the Magellan Global Fund unit price has remained stable.

In our view the portfolio is well constructed to deal with these events and is focussed on extremely high quality businesses that continue to excel in the current environment. Almost without exception the companies in the Magellan Global Fund which have recently reported have delivered outstanding operating performance with improved competitive positions, strong revenue and earnings growth.



Performance 1 April  to 5 August 2011:

Magellan Global Fund        -1.7%

S&P/ ASX 200 Index    -14.7%

MSCI TR Net World AUD       -10.6%


The sovereign debt issues in Europe and recent poor economic data out of the United States have led to considerable market volatility in recent days and months.  The sovereign debt issues in Europe cross two complex and associated issues.

The first issue is a solvency issue. In our view Greece is effectively insolvent and Portugal and Ireland have potential solvency issues. The good news is that the European Union and the European Central Bank have finally recognised the insolvency issue in Greece. The new Greek bailout package is a fundamental step in the right direction. The package materially reduces Greece’s financial burden via the extension of loan terms and the reduction in interest rates; these measures were also extended to Ireland and Portugal. The proposed involvement of private sector creditors to swap Greek sovereign debt for longer duration lower interest debt will also materially reduce the present value of Greece’s outstanding debt. This reduction in Greece’s debt burden is a fundamental step in putting Greece on a path to sustainability. We suspect that more still needs to be done, however we are optimistic that the tools and policies are now in place to address Greece’s solvency issues.

The second issue engulfing Europe is a potential sovereign debt liquidity crisis affecting larger European countries, particularly Italy and Spain. We do not believe that either of Spain or Italy are insolvent, however a collapse in bond market confidence could push yields on sovereign debt to levels that create a true liquidity crisis. In our view monetary union presents particular challenges to addressing this situation. For a country that has its own currency and an independent central bank able to readily print money this situation would be addressable. In such circumstances the central bank could print money and buy bonds on the open market to drive down yields and monetise government funding requirements. The current policy path potentially involves the European Stability Fund (which is constrained in size) and the ECB buying affected bonds (with necessary offsetting asset sales) on the market to stabilise yields.

Unfortunately if this situation continues to escalate and in the absence of a dramatic and possibly unlimited increase in the size of the European Stability Fund, this policy path is akin to bringing a pea shooter to a gun fight.

We do believe that there are two potential policy options which would address these liquidity difficulties; either allowing the ECB and EU central banks to print money or allowing the EU to issue Eurobonds to finance the struggling economies.

We feel it is unlikely that these liquidity issues will result in a financial Armageddon scenario and that correct policies will eventually be pursued. However there are divergent views on the correct path of action and thus we could have a sustained period of considerable volatility until this is resolved.

We remain realistic and relaxed about the difficulties facing the US economy.The recent decision to raise the US debt ceiling has removed considerable risk in the short term and we are confident that the US will take action over the next few years to ensure it is on a sustainable long term fiscal path.

Magellan continues to focus on the preservation of investors’ capital and our disciplined approach to investing in the world’s highest quality companies and we are confident of delivering the portfolio’s objectives over the long term.

Kind regards,

Magellan Asset Management

Important Information: Units in the Magellan Global Fund are issued by Magellan Asset Management Limited (ABN 31 120 593 946, AFS Licence No 304 301). This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement (PDS) available at or by calling 02 8114 1888.


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Brief Update on Investment Perspective of Japan’s Earthquake

Last Friday’s earthquake in Japan has bought massive human misery. It will also have economic consequences for the global economy as well as Australian Companies.
Here is our first pass at identifying some industries and companies that are likely to be impacted in some way (either positively or negatively).

Insurance Companies
Insurance risk modelling group AIR Worldwide estimates that the total insured losses could be up to US$34.5bn excluding tsunami damage. QBE updated the market yesterday with a preliminary estimate that claims from the earthquake and tsunami would be around US$125 million, which is not financially significant to QBE. Other Australian insurers are not likely to have any exposure to this event.

Uranium Miners
The market is questioning the future strategy of nuclear energy following the threat of meltdown of several nuclear reactors. We have no exposure to uranium miners at GEM Capital and do not recommend pursuing this area.

Australian Inbound Tourism
Japanese and New Zealand tourists make up a large volume of inbound tourism to Australia. Listed companies that could be negatively impacted by earthquakes in both countries include Tabcorp (hotels and casino’s), Qantas and Virgin Blue. GEM Capital has very little exposure both directly and via managed funds to these sectors.

Japanese Property Groups
GEM Capital has no exposure to listed Japanese Property Companies which include Astro Japan Property Group and Galileo Japan Trust. In any case, both of these companies have stated that their properties were not significantly impacted.

Potential Beneficiaries
Australia’s coal industry and Liquefied Natural Gas producers could be a beneficiary if increased demand for these sources of energy over nuclear eventuates. Coal industry could suffer from a proposed carbon tax. Origin Energy has exposure to energy and in particular LNG.
Suppliers of construction materials, such as steel and concrete. This is likely to be short term in nature though.
We will provide a further update of this information on our website as we develop our thoughts and gather additional information, particularly to do with the banking system.
At this stage however we stress that this event does not alter our fundamental view of investments as it is likely that most of the impacts from an investment perspective (rather than human perspective) will be at the margin.
I trust that you have found this information useful.

Kind Regards
Mark Draper CFP, Dip FP
Authorised Representative

Australian Sovereign Wealth Fund Debate – if only our leaders knew what one was

Last weekend, Bill Shorten (Assistant to the Treasurer) stated that he does not support the creation of a Sovereign health Fund for Australia.

Firstly I searched on Wikipedia to come up with a definition of a Sovereign Wealth Fund and here is the result:

“A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. There are two types of funds: saving funds and stabilization funds. Stabilization
SWFs are created to reduce the volatility of government revenues, to counter the boom-bust cycles' adverse effect on government spending and the national economy. Savings SWFs build up savings for future generations.”
Australia is currently enjoying is highest level of national income for decades courtesy of the mining boom. Some in the Reserve Bank and many leading business people are calling for Australia to establish a Sovereign Wealth Fund to save some of the money that the country is making from its resources boom while commodity prices are high and put it aside for the time when the commodity boom subsides.
Put simply the idea of a Sovereign Wealth Fund is putting money aside for a rainy day as the old cliché goes. Instead it seems that the current Government wants to spend additional revenue earned during the boom times and assume that the commodities boom and current income will last forever. I fear that when the resources boom subsides, that Australia will have little to show for it.
What is even more disturbing is that Bill Shorten was quoted as saying that he didn’t think Australia needed a Sovereign Wealth Fund as we already have one in the form of Superannuation. With all due respect, Bill’s statement here is rubbish. Last time I looked at my superannuation statement I didn’t see any reference to my savings being used to reduce the volatility of government revenue.
While clearly criticising the ALP’s view on a Sovereign Wealth Fund here, it must be remembered that I also publicly criticised the Coalition’s stance on Banking policy last year. The purpose of this article is to encourage Australian’s to support a sensible and
informed debate on important issues such as the establishment of a Sovereign Wealth Fund rather than tolerate the daily rhetoric of trash that is currently coming from Canberra.
The views in this article are my own personal opinions, produced for the interests of the future well being of Australia and do not reflect the views of the dealer group.
Mark Draper

Political Risks of Investing in Australia are Rising

July 2011 is shaping up as a pivotal moment for the Frankenstein Government (unrelated parts cobbled together) that has been installed in Australia.  This is when the balance of power in the Senate will shift and the balance of power held by the Greens.

We have seen the Greens attempt at banking reform policy already which must have been taken from a text book from around the same era as their industrial relations policy.

On top of this we have witnessed the debacle surrounding the resources tax, the introduction of the notion of a carbon tax and of course the NBN which is becoming more and more intriguing with every resignation from senior NBN management.

Banking Reforms and the Telstra Bill are other examples of Government intervention over business.  Robert Gottliebson recently wrote an article on how Australian business is being attacked by the Gillard Government which can be found at


Our point here is that the political landscape has changed materially in Australia and 2011 could well see the political risks of investing in Australia rising further.  Business investment thrives on certainty.  With the high Australian Dollar and the uncertainty of the political scene in Australia there are some signs that International investors are putting their money elsewhere rather than investing in Australia.

There are good reasons to have investments spread geographically outside of Australia given the current political environment, not to mention the high Australian Dollar which leads us to our view to invest part of an investment portfolio internationally.  There are some excellent fund managers who are investing in leading global companies that are taking advantage of buoyant economies in emerging companies.  On our website there is an excellent presentation from Magellan Financial Group outlining this in more detail – check it out at



Mark Draper  CFP, Dip FP

Authorised Representative


GEM Capital Financial Advice

Superannuation and the Co‑contribution Scheme

One government incentive to increase our retirement savings is the super co-contribution scheme – the government will contribute $1 for every $1 you personally contribute, up to $1,000. The information below will help you find out if you can use the co‑contribution scheme to boost your retirement savings.

What is the co-contribution scheme?

If your income is less than $31,920, the government will contribute $1 for every dollar you personally contribute, up to a maximum of $1,000. If you earn between $31,920, and $61,920, the government will contribute an adjusted amount.

Who is eligible?

To qualify for the co-contribution you have to meet the following criteria in the financial year:

• receive an assessable income of less than $61,920;

• make a personal contribution to your superannuation account out of your after-tax income;

• receive 10 per cent or more of your total income from employment or carrying on a business or attributable to activities that result in the person being treated as an "employee" for superannuation guarantee purposes, or a combination of both;

• lodge an income tax return; and

•be less than 71 years of age at the end of the financial year.

Only personal contributions from your after-tax income qualify for a co-contribution. Superannuation payments from your employer and contributions for which a tax deduction has already been claimed (for example under a salary sacrifice arrangement or if you are self-employed) are not eligible.

What are the current levels of co-contribution payable?

The maximum co-contribution that will be made by the government is $1,000, and is available if you have an assessable income of less than $31,920 a year. The maximum co‑contribution is reduced at a rate of 3.33 cents in the dollar if you have an income of between $31,920 and $61,920.

The following table highlights the level of co-contribution the government will make to superannuation, if you make a personal contribution of $1,000.

Income                         Co-contribution

$31,920 or less         $1,000

$35,000                       $897

$40,000                       $731

$45,000                        $564

$50,000                        $397

55,000                            $231

$61,920                          $0

How to apply for the co‑contribution If you qualify for the co-contribution payment, you don’t need to apply. The only actions required from you are to make the extra contribution to your super fund before 30 June and lodge an income tax return. The Australian Taxation Office (ATO) will work out if you are entitled to a co-contribution using information from your tax return and your super fund. If you are eligible, the ATO will then pay the co-contribution directly into your super account where it must remain until you retire. You need to supply your super fund with your tax file number so it will be easier for the ATO to link your personal contribution to your taxable income.

If you feel that you qualify and no payment has been made, you should contact the ATO to find out what has happened.

When will the co-contribution payment be made?


The ATO anticipates that the co-contribution will be paid late in the year. The ATO firstly has to collect information from your super fund about contributions (due 31 October). The ATO also has to wait until you lodge your tax return before they can determine if you are eligible.

Remember you must make your personal super contributions before 30 June to be eligible for a co‑contribution within the current financial year.

The government’s co-contribution scheme is a great incentive to grow your super savings. If your own salary is above the threshold, consider boosting the super of someone in the family who works part time such as your spouse or child. Take full advantage of this scheme if you can.

The co-contribution scheme at a glance

What is it?

The government will make super contributions (up to a maximum of $1,000) for low-income earners who make personal super contributions.

To be eligible you must:

  • receive income of less than $60,342;
  • contribute to super (from post-tax income);
  • receive 10 per cent or more of your total income from employment or carrying on a business;
  • be under 71 years of age; and
  • complete an income tax return.

How much will be paid?

An amount up to $1,000 (if income less than $31,920). An adjusted amount, if income less than $61,920.

When will I receive the money?

Late in the year.

How do I apply?

You don’t need to apply. Make a contribution and the ATO will deposit the co-contribution automatically.

Note: Advice contained in this flyer is general in nature and does not consider your particular situation or needs. Please do not act on this advice until its appropriateness has been determined by a qualified adviser.

For more information about the co-contribution scheme or to arrange a no-cost, no-obligation first consultation, please contact the office on 08 8273 3222.


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In the last 5 years Telstra shareholders have had little to cheer about as they have watched the NBN punch a hole in earnings, resulting in a share price slide and dividend cuts.  That is now changing.

In the recent profit result, not only did Telstra forecast earnings growth for the first time in 5 years, but also outlined a timetable to change its legal structure by splitting the company into 4 parts.

The proposed legal structure within the Telstra Group, expected to be completed by December 2021, includes:

  • InfraCo Fixed, which would own and operate Telstra’s passive or physical infrastructure assets: the ducts, fibre, data centres, and exchanges that underpin Telstra’s fixed telecommunications network.
  • InfraCo Towers, which would own and operate Telstra’s passive or physical mobile tower assets, which Telstra is looking to monetise given the strong demand and compelling valuations for this type of high-quality infrastructure.
  • ServeCo, which would continue to focus on creating innovative products and services, supporting customers and delivering the best possible customer experience. ServeCo would own the active parts of the network, including the radio access network and spectrum assets to ensure Telstra continues to maintain its industry leading mobile coverage and network superiority.
  • International, will be established under a separate subsidiary within Telstra Group and includes subsea cables

Testra ORG chart


After being negative on Telstra for years, Gaurav Sodhi (Analyst, Intelligent Investor) believes the new structure is a good move.  He says that there are a lot of assets within Telstra that aren’t being adequately valued.  Separating them will recognise the value of infrastructure style assets that can generate stable, recurring revenues, resulting in a far higher valuation than the present share price.  Sodhi’s sell trigger of $5 on Telstra provides some guidance on the value he sees.

The Towers business carries a modest asset value of just $300m on Telstra’s balance sheet after heavy depreciation.  Once towers are in place and connected to the fibre backhaul, they are expensive to replicate and therefore extremely valuable.

Experience overseas shows that Telstra is following a well trodden path as it seeks to increase shareholder value.  Will Granger (Analyst, Airlie Funds Management) says that mobile tower companies can trade at EBITDA multiples (earnings before interest, tax, depreciation, amortisation) ranging between 21-27 times earnings.  Telstra by comparison currently trades on an EBITDA multiple of around 8 times.  Granger believes through a partial or full sell down of these assets, Telstra can realise this valuation arbitrage and increase shareholder returns.

Gaurav supports this view by referencing American Tower which is listed in the US.  It is the largest tower business in the world which bought AT&T’s long distance phone lines years ago and used them to host mobile infrastructure and are today valued at over US$100bn.  American Tower trades at over 20 times EBITDA while AT&T trades at just 7 times.

Granger adds that Vodafone spun off its mobile tower assets in March of this year on an EBITDA multiple of around 20 times.

Granger sees few downsides for the proposed restructure other than Telstra risking their network advantage if the mobile towers separation is not properly structured.

Sodhi agrees and said that American Tower and Crown Castle have been so successful because they host multiple networks from a single piece of infrastructure.  They have been able to scale nicely.  For Telstra’s tower businesses to do the same, Telstra would have to allow other networks access to those sites.

There is a clear trade off here.  In order to maximise the value of its infrastructure, Telstra needs to allow other networks access to it.  If it does that, it risks its network superiority.  Sodhi believes that Telstra is likely to opt for a lower value for its infrastructure to protect its network superiority.

The ACCC is another risk to this restructure.  Sodhi says that while its been hard to predict the reaction of the ACCC in recent years, he doesn’t believe there would be too many objections.  A split of the towers and infrastructure assets potentially opens the door to other networks also utilising those assets which could even the playing field.

Telstra has been a serial underperformer over the past 5 years, but investors must be forward looking and responsive to new information.  The split is new and its happening this year, and investors may do well to reconsider Telstra.

This article was written by Mark Draper and appeared in the Australian Financial Review during the month of April 2021.

Bell Potter - Special report - outlook for Coronavirus

Bell Potter have produced a special report on developments of COVID-19 focussing on the virus itself with particular reference to Europe and the US.

The report looks at infection rates and death rates, comparing the first and second waves.

The analysis considers the likelihood of reaching herd immunity.  Complete with statistics and graphs the report is designed to assist investors reach their own conclusions about what may be in store for the world with COVID-19.

Download your copy of the report by clicking on the report below.


Best of the Best - August 2020

The Investment Team at Montgomery Investments have produced their bi-monthly "Best of the Best" report.

This edition focuses on:

- Why it's time to focus on quality businesses

- Optum - Hidden GEM in US Healthcare

- Nanosonics has a long runway for growth

- Three reasons we continue to like Woolworths


Sustainable returns from Telco sector

Telecommunication companies (Telcos) have been central to many of our activities during the COVID-19 crisis, ranging from virtual wine tasting nights with friends, working from home, Netflix binges or simply ringing family.

In recent years Telco’s have been challenging for investors with falling margins from mobiles and the NBN crushing broadband margins.  The worst of this may be behind the sector now and investors are now presented with an investment opportunity that may be COVID-19 proof.

An investment into a Telco company typically involves two main segments, infrastructure and retail/business operations which includes broadband, mobiles and services. .  

In Australia the three major players are Telstra, Optus and TPG which recently merged with Vodafone.  Telstra and TPG are listed on the ASX.

According to Andrew Peros (Deputy Head of Research, Ausbil) “infrastructure is probably the most attractive on the assumption that it can be successfully separated from the retail assets.  Telecommunications infrastructure provides a long term steady cash flow which is highly valued by the market.  Unfortunately, in Australia, there are no pure play communication tower investments.  Telstra’s communications infrastructure are currently part of the overall business and have not yet been demerged as a separate business, similarly with TPG’s cable infrastructure”

That may be about to change following a restructure announced last year which resulted in Telstra splitting its infrastructure assets into a separate business segment called InfraCo.  InfraCo consists of exchanges, ducts, data centres, subsea cables, fibre and 8,000 towers that host networking equipment.

Towers and other parts of InfraCo currently generate revenue from servicing Telstra alone.  If this division were separated from Telstra, these assets could increase revenue by servicing other Telcos.  A tower that currently services only Telstra could service all three mobile networks.  Competitors would have to supply their own networking gear, but the infrastructure owner could earn three times as much revenue. Mobile network towers are a natural monopoly and it makes little sense to duplicate a network once it has been constructed.  We don’t duplicate water pipes or electricity wires and the same can apply to mobile towers. This is an important opportunity for investors to grasp.

Annabel Riggs (Telco Analyst, Airlie Funds Management) is “attracted to the mobiles market, with the sector transitioning into a more rational pricing environment after a period of intense competition between network operators.  We are beginning to see evidence of a more rational market with Telstra lifting prices a couple of weeks ago across its post paid mobile plans.  This is positive for earnings and returns.”

5G is the next battle ground for the Telco’s.  Riggs believes that “network operators will selectively compete with the NBN in some areas by using a fixed wireless product.  The margins and returns on this product work if the customers are relatively low usage.  We have seen in New Zealand that about 20% of their broadband base is now on Fixed Wireless and bypassing their own version of the NBN.”

Peros adds “telcos are likely to hesitate on fixed wireless if competition between operators is expected to lower returns on capital, and there is a risk in Government support firming to protect the value of the NBN.”

Government regulation would seem one of the key risks to investing in the Telco sector.  The relatively high access costs the NBN charges the telco resellers for broadband is a good example.  Riggs points out that the NBN has improved its pricing model however the total cost of accessing the NBN for telcos is still much higher than the copper network.  The higher access costs to the NBN has put huge pressure on earnings of the telco sector.

The decision to ban Huawei from providing 5G equipment in Australia was another big decision.  Huawei was a lower cost equipment provider which will ultimately increase expenditure for TPG which was planning their 5G build around Huawei equipment.

Peros flags the economies of scale in a geographically large country with a small population as another important risk.  

Investors should also pay attention to some interesting new entrants.  Riggs points to Uniti Group who has recently acquired Opticom as having an interesting opportunity to challenge the large players in the fibre market.  Peros likes NextDC which owns data centres which will benefit from the increased demand for data now that a greater proportion of the workforce are working from home.

It would seem that Telco’s revenues are largely COVID-19 proof, but the growth story could come from the demerging of infrastructure and new entrants.

This article was published in the Australian Financial Review online on Monday 3rd August 2020

Note:  Mark Draper, Shannon Corcoran and their entities own shares in TPG and Telstra.

What we learned from reporting season

The only thing certain about the future right now is that the future is uncertain.  So as we complete one of the strangest company reporting seasons we have ever seen, investors should reflect on the company profit announcements to see what they can learn about what may lie ahead 

Matt Williams (Portfolio Manager, Airlie Funds Management) says that while overall profits were down 20% compared to the previous year, the dire predictions in late March proved to be too bearish and there are now more profit upgrades than downgrades.  He said “The economy has strongly outperformed the accepted bearish scenarios of late March, retailers have produced phenomenal numbers”.

“The COVID-19 pandemic has not been uniformly bad for all Australian companies.  Travel related companies and listed property trusts with shopping centre assets have had a tough 6 months, while electrical retailer JB Hifi, hardware and office retailer Wesfarmers, AfterPay and Domino’s Pizza all saw record revenue over the past 6 months, benefitting from consumers being quarantined at home” according to Hugh Dive (Senior Portfolio Manager, Atlas Funds Management).

Nathan Bell (Head of Research & Portfolio Management, Investsmart) picked up on the travel sector which saw airlines and travel retailers at the epicentre of the COVID-19 storm.  “You could hear the desperation in Alan Joyce’s voice as he pleaded for state borders to reopen after announcing a $4bn loss”.  Bell also highlighted the almost 100% drop in passenger numbers since COVID-19 emerged for listed Sydney and Auckland airports.  He is of the view that leisure travel ultimately recovers and even if business travel only recovers to 70% of past highs due to a permanent shift to online meetings, both airports represent good value at current prices.  “People are once again going on holidays in the northern hemisphere, which is another good omen for this pair of airports.  Vietnam, Taiwan and Korea recently reopened their domestic borders and passenger numbers are now 10 – 20% above 2019 levels, suggesting pent up demand” he adds in support of the investment case for a rebound in airports.

Food and alcohol retailers (such as Woolworths and Coles) reported solid results as they benefitted from changing consumer purchase patterns, but they now trade at huge valuations.  Their valuations suggest future returns are likely to be far more muted if not negative should the impact of Job Keeper payments and people raiding their super funds wear off.

Dive points to the fact that “cash flows from the government were a significant feature of the August results season, albeit one that was understandably not highlighted by management when they presented their results.  JobKeeper and higher JobSeeker payments have helped companies such as JB Hifi and Afterpay as cash flows from the Government have supported retail sales despite the significant rise in unemployment”.  Investors would be wise to resist extrapolating the impact of these Government payments over the past 6 months into the future.

While the Telco sector reported earnings hits from lower global roaming charges and reduced retail sales during lockdowns, the 5G networks will cover the majority of the population in the next 12 months which represents revenue growth opportunities.  More rational mobile pricing should also help the Telco’s.

Banks reported much lower profits due to a mix of low credit growth, low interest squeezing margins and increasing bad debts.  Bell says of the banks “the bull case for Australia’s largest banks rests on them trading at large premiums to book value despite reporting single digit return on equity figures.  If this happens, Australia will be the exception to the rest of the world.  We don’t see why Australian banks are an exception as more people deleverage in the years ahead and property investors look beyond property for large capital gains”.  Ultimately the loan repayment deferrals will also need to be bought to account as well.

Williams said that in his discussions with company management, the key themes about the future were:

-       What happens at the end of the Government stimulus where retailers would appear most exposed.  

-       Opening up of state borders

-       Economic reform

With around 70% of companies either not issuing future earnings guidance or withdrawing earnings guidance, coupled with some market sectors trading on extremely high valuations, the job of assessing investment value is difficult.  The best opportunities ahead are less likely to be found in this years’ reporting season stars.  


This article was published in the Australian Financial Review during the month of September 2020.

Best of the Best report from Montgomery's - April 2020

The investment team at Montgomery Investments have put together another informative report that covers various aspects of the current investment landscape.

In this report the team looks at:

- Is it time to get back in

- How should you think about cash?

- Looking through market volatility for opportunity

- 4 criteria to consider before buying shares in this market


To download your copy of this report, click on the report below.


COVID-19: Demystifying this Frightening Disease

The COVID-19 (coronavirus) pandemic has shaken the global population to its core. The personal toll is enormous, and the fear, immense. In this special feature I will explain what the virus is, what makes it unique and the progress that has been made in developing a treatment and vaccine. The collaboration between pharma, biotech and medtech companies, as well as researchers has been astounding and gives me great confidence that we will win this fight.

Within a very short period of time, the world has shifted its focus to a virus that measures roughly 50-200 nanometres1. Suddenly, we have all become familiar with scientific terms such as viral spread, PCR testing capacity, antibodies, viral shedding and many more. Economists have become epidemiologists hoping to model the outbreak, while we have also witnessed the limitations of many healthcare systems.

Viruses are a part of life. There are plant viruses, animal viruses and viruses that infect bacteria. Over time, outbreaks occur and can be devastating. Polio was an example of a seasonal, frightening viral epidemic in the 1940s and 1950s that was eventually eliminated by vaccination. There is no reason to believe that we will not be successful combating SARS-CoV-2, the new coronavirus.

SARS-CoV-2 is a member of the Coronaviridae family, a rather large clan with two subfamilies (Coronavirinae and Torovirinae) that can infect humans as well as animals. These subfamilies have several members and there are four coronaviruses that we have all most likely had exposure to. They cause mild symptoms, such as the common cold and require no diagnostic testing. However, occasionally we see a coronavirus that causes very unpleasant diseases, such as SARS (2002/2003), MERS (2012/2015) and now COVID-19.

This latest virus outbreak will change our view about this viral family, vaccination, pandemic preparedness and antiviral therapeutics. It is highly plausible that we may require vaccination against this culprit with additional booster shots annually. Given what we are seeing today, this new coronavirus is here to stay.

Viruses are simple but sophisticated creatures. They have an outer shell and sometimes an inner one as well. Inside, is the viral genome, often with some viral functional proteins attached to it. The outer shell tends to have family-specific characteristics that determine which and how the virus infects its host. Coronaviruses like respiratory and gastrointestinal tracts. So-called spike proteins that sit on the outer shell of the virus have a high affinity for proteins localised in our throat, lungs and gut. It is this outer shell that disintegrates when it contacts soap, hence the reason why washing our hands is so crucial. Similarly, we as the host, are crucial for the survival of the virus. Viruses cannot replicate by themselves, they need the host’s ‘machinery’ to multiply. Viruses are masters at exploiting the host’s machinery and they know how to adapt, so it is essential we deny them any opportunity to find another host by practising social distancing. Some viruses are very clever, they have worked out that causing mild disease is better as the host keeps socialising, which guarantees survival of the virus, while the more aggressive (not so clever) viruses cause devastating diseases and hence eliminate themselves quickly. SARS-CoV-2 falls into the sophisticated category as it replicates in the upper respiratory tract (e.g. throat), causing mild symptoms vs. its cousin SARS-CoV that settles deep in the lungs. Transmission from the throat is much easier and hence requires drastic actions to slow it down and stop its spread. Scientists are closing in on this virus a lot faster than we have ever seen before.

What we learnt from HIV

Thanks to the advanced scientific tools we use today in the laboratory, we have been able to identify and study SARS-CoV-2 and its lifecycle at a rapid speed. It is worthwhile revisiting the AIDS/HIV epidemic in the 1980s to understand how far we have come. In 1981, the US Centres for Disease Control and Prevention (CDC) started to see patients with diseases that occurred due to a malfunctioning immune system. However, nobody knew what was causing this immune deficiency. A year later, the disease was called AIDS (Acquired Immune Deficiency Syndrome). In 1983, French scientists postulated that a retrovirus could be the cause of AIDS, which was confirmed by US scientists the following year. In 1985, the US Food and Drug Administration (FDA) approved the first commercial HIV blood test that detected antibodies in a patient’s blood. A molecular test, similar to what is being used today to detect SARS-CoV-2, was only available for HIV in the mid-1990s. The first antiviral drug was approved in 1987. Compare this timetable to the current pandemic. Late last year, news emerged from China about a respiratory disease that did not test positive for any known respiratory pathogen. It quickly emerged that it was due to a new coronavirus. The genome of the virus was rapidly sequenced and distributed to scientists globally and molecular tests were established. Biotechs and pharmaceutical (pharma) companies quickly looked inside their drug cabinets for potential therapies as well as how their technologies could be applied to make specific drugs and vaccines for this new virus. It has been a phenomenal global effort. Currently, we are awaiting clinical trial data for the first repurposed antiviral therapy (Gilead Science’s Remdesivir, which was originally developed to treat Ebola), while the first vaccine is also already being tested in humans. It may feel like a long time but it has only been months.

The virus itself is being studied intensely by several groups around the world. The spike proteins that make up the outer shell have been analysed and scientists have elucidated the structure of one of the viral functional proteins called protease, which is immensely important, as it will allow scientists to develop anti-protease inhibitors, which were crucial in treating HIV.

Scientists are simultaneously studying the immune system’s response to the virus and have identified Interleukin-6 (IL-6) as a key mediator, hence Roche’s IL-6 Antibody Actemra is being used to treat COVID-19 in some hospitals, while clinical trials are ongoing. Meanwhile, Sanofi/Regeneron’s IL-6 antibody has also just entered clinical trials for COVID-19.

We know from previous viral outbreaks that patients who have recovered from a virus will have produced antibodies that neutralise the virus, so Japanese pharmaceutical company, Takeda has started collecting plasma from patients who have recovered from COVID-19 to give to patients currently suffering from the disease. CSL has recently joined Takeda to work together on such a plasma-derived product.

Regeneron, a US biotech, is using its antibody engineering capability to find antibodies that target the virus. Those antibodies should move into human testing later this year. Alnylam and Vir Biotechnology are working on a long-acting small interfering RNA (siRNA) therapeutics targeting the virus. Vir is also working on antibodies with GSK.

The ability to explore and investigate so many different drug modalities was not possible during other viral outbreaks as we did not have the technological capability.

Global collaboration

There has been a lot of debate about the lack of testing capacity, but overall, the scientific community, including biotechs, pharma and medtechs, have all shown great leadership in this pandemic. The collaboration and sheer speed in detecting the virus and developing a treatment have been unprecedented. Not that long ago, pharma and biotechs were in the political crossfire regarding high drug prices. In this pandemic, the industry has the opportunity to set the record straight and show their full capabilities. In years to come, this industry, along with the medical profession, will be viewed through a very different lens.

Vaccines, the holy grail to combat infectious diseases, are also experiencing immense activity by traditional vaccine companies and also by biotechs who use new transformative technologies, such as messenger ribonucleic acid (mRNA).

The concept of a vaccine is simple. A venture capitalist recently described it in the easiest possible way; likening a vaccine to sending a “wanted criminal dossier” to the immune system, that shows the immune cells what to look out for and prepare to capture the ‘criminal’. Sometimes, the immune cells are able to see the picture of the criminal just once to ensure the immune cells can fight off the criminal, other times, they need to be reminded again i.e. get a booster.

The criminal dossier can come in different forms. It can be very detailed (a weakened form of the virus) or it may only have some very poignant features of the criminal (parts of the virus that are very immunogenic).

It takes time for laboratories to make a virus that replicates the criminal dossier. Firstly, scientists need to figure out how best to make it, or which part of the virus they should focus on. Manufacturing then has to be scaled up, which all requires a significant amount of money. The vaccine then needs to be tested at length and many millions/billions of dosages have to be manufactured. Today, four companies dominate the vaccine industry (GSK, Pfizer, Sanofi, Merck) with Australian company, CSL a distant fifth and Johnson & Johnson always keen to participate.

The potential long lead times and significant upfront costs have, however, not deterred Sanofi and Johnson & Johnson from applying their more traditional vaccine-making approach. Both companies are actively working on the criminal dossier and Johnson & Johnson is due to start trials later this year.

Platinum has followed the vaccine space for more than a decade and we have long hoped that technology advances would one day change the way vaccines are made. Using cell lines (where a permanently established cell culture multiplies indefinitely) has been one significant step along this path, but overall, the vaccine industry has remained a tight oligopoly.

In recent years, the potential to use mRNA as a therapeutic treatment and as a vaccine has emerged. We have been following the progress closely and invested in two companies in this space, Moderna and BioNTech, some time ago. The pandemic has placed mRNA and both companies firmly in the global spotlight. US-based Moderna was able to start clinical trials within 63 days of receiving the genomic sequence of the new virus. BioNTech has been slightly slower, but recently expanded its partnership with Pfizer and also entered a partnership with Chinese company, Fosun to develop its vaccine candidate. Curevac, another privately- owned German mRNA biotech backed by SAP co-founder Dietmar Hopp, is also busy developing a vaccine, while Sanofi recently expanded its alliance with biotech, Translate Bio.

Using mRNA for vaccine development is quite an elegant approach and Moderna and BioNTech have invested considerable effort in designing and selecting the best possible mRNA molecule for a respective protein of interest. It remains to be seen if it works, however, both companies have received support from the Bill and Melinda Gates Foundation and have large partners for various pipeline products. Some established vaccine makers are sceptical, but Moderna has been the first to take their mRNA to the clinic.

mRNA explained

mRNA is a molecule that functions naturally in our bodies as an intermediary between our genes and our proteins. It is the blueprint for our proteins and essentially a copy of the gene encoding the protein. If designed and delivered correctly, cells will recognise the mRNA and start making the protein. For vaccines and therapeutics alike, the mRNA can be quickly designed (by the right team of scientists) in the lab once the scientists know which is the correct viral particle to make. Usually, several mRNAs are made and scientists quickly assess which one is the most suitable. Manufacturing these chemical molecules (or information molecules, as Moderna calls them) can be done with a much smaller manufacturing footprint and also at a fraction of the cost of making traditional vaccines or protein therapeutics, as it is not a protein, it is the information to make the end product. In the end, the 'active’ product, the vaccine or the therapeutic protein, is made by the person who receives the mRNA injection. Humans essentially function as the manufacturing site for the mRNA vaccine.

We are convinced that these multiple vaccine efforts (traditional and modern) will result in a product, potentially as a first-generation product that will give companies time to refine their efforts and develop the next generation of longer-lasting vaccines.

A global logistical exercise

Apart from the scientific approach that is being undertaken to combat the virus, this pandemic is also witnessing large- scale crisis planning and management in different countries.

Molecular testing has been a key pillar in managing the viral spread. It is clear, however, that the supply of these tests cannot fulfil demand. Each country has taken slightly different approaches to testing. Some countries are actively looking for asymptomatic infected individuals, while others are struggling to keep on top of the symptomatic patients. Testing guidelines will undoubtedly change over time and serological testing, whereby a test determines antiviral antibodies in a patient's blood, will complement molecular testing in the future.

In a pandemic, facts determine your management plan and as the facts change so should the plan. Many people worry when plans change, but in the crisis we are experiencing today, it is paramount that countries adjust their plans to address the changing dynamics.

Our knowledge of the SARS-CoV-2 virus and the COVID-19 disease has rapidly grown and changed as physicians in different countries gained first-hand experience. Throughout this pandemic we have drawn on a number of sources, including the New England Journal of Medicine (NJEM), a weekly medical journal published by the Massachusetts Medical Society, Dr Anthony Fauci, one of the lead members of the White House Coronavirus Task Force in the US, the German federal government agency and research institute, Robert Koch Institute, along with a German virologist Professor Drosten (coronavirus specialist) and several of his colleagues.

These learnings and the exchange of these experiences is vital to form response plans. One of the key learnings in recent months has been the fact that this coronavirus can spread very quickly. This is due to its preference for residing in the upper respiratory tract, as highlighted above. This means it often causes milder symptoms that can go undetected. The biggest challenge is to break this rapid spread and protect vulnerable individuals. In an ideal world, everyone would be tested. A swab kit would arrive in your mailbox (similar to the bowel cancer test kit), you would take a swab, it would be collected by a courier and the results emailed to you in a matter of hours. What would be even better though, would be a molecular test that people can do themselves at home. This would quickly identify who is infected and who needs to self-isolate.  Unfortunately, these tests are not available to us today, so the next best option is what is currently being practised in many countries; quarantine, social distancing, drive-thorugh testing facilities, and tracing potential infections practively.  Sophisticated piont of care testing that could be done at home or at the local medical centre is emerging rapidly, with companies such as Roche, Qiagen (soon to be part of Thermo Fisher) and Cepheid (now part of Danaher), key platers developing this technology.

At the core of this pandemic, due to the rapid spread of the virus, is the ICU capacity of hospitals. In the current phase of the pandemic, the focus hence needs to be on ensuring we have enough ICU beds and ventilators. Globally, we are seeing different ICU capacities and thankfully we are seeing a move to central ICU bed co-ordination. Germany, for example, is moving to real-time monitoring of its ICU beds as well as transporting patients from neighbouring countries. All hospitals have to work together, which has been a challenge, particularly in the US. We have learned from Italy’s experience that it is important to have COVID-19 treatment centres protecting non-COVID-19 patients. This pandemic is as much a logistical and planning exercise as it is a scientific endeavour. It will highlight very quickly the shortcomings of our healthcare system along with our past desire to be as supply chain efficient as possible.

However, there will be a next phase to this pandemic, and that will be when we start to return to our offices and gradually begin to socialise again.

During the next phase it will be about recovered patients and keeping on top of regional outbreaks and next-generation diagnostic tests that identify antibodies to the virus. Many of these tests are currently receiving media coverage, however, I would caution that these tests are not yet ready to be used widely. The potential for false negatives is not a risk we want to take currently; it takes days to develop antibodies and hence molecular tests remain the best approach to detect an infection early.

However, the presence of anti-SARS-CoV-2 antibodies in the blood means the person has been infected sometime in the past and hence are now regarded as being immune, which will be important when we are ready to return to work. In Germany, for example, the debate is currently about issuing “immunity certificates” for those who show positive antibody titres in their blood. It is still unclear, however, how long this immunity will last. In the months to come, detection of the virus and our immunity will remain paramount until we have therapeutic options and a vaccine.

At Platinum, we have long believed that diagnostic tests will become a key pillar of healthcare, be that in oncology, inflammatory diseases or infectious diseases. The aim in healthcare should be prevention, which requires tools to detect changes in our body early with precision. This is the same with the current virus, if we can detect it quickly, we can prevent it spreading. This pandemic challenge has placed the healthcare industry squarely in people’s minds. It has shown how limited our arsenal of antiviral therapies is and highlighted how our approach to vaccine development has to be overhauled. In the world we are living today, with all the digital factory technology that is available, manufacturing vaccines strikes us as 'old style’. Given we have seen several coronavirus outbreaks in the last 18 years, it is more likely than not, that this coronavirus family will continue to cause us harm and hence having a vaccine, or possibly an annual coronavirus vaccination booster would be worthwhile investing in. We are firm believers that current events will change healthcare systems and most importantly, will highlight what a vital role biotechs play today.

The biotech industry is relentless in its search for new technologies and new therapeutics. Bankruptcies are rare and failure does not demotivate them, to the contrary, it motivates them.

For now, as Germany’s chancellor Angela Merkel recently said, the best therapy we have for SARS-CoV-2 is to stay at home.


This article has been reproduced with permission from Platinum Asset Management.  The article is written by Dr Bianca Ogden (Healthcare Portfolio Manager Platinum Asset Management).  

Dr Bianca Ogden, MBio (Tübingen), PhD (University College London), has been the portfolio manager for the Platinum International Health Care Fund since 2007 and leads the healthcare sector team. Molecular biology was Bianca’s first love before she discovered the joys and challenges of investing. After spending some time at Swiss pharmaceuticals company Novartis researching new HIV drugs (one of which has been approved and is in use today), Bianca went on to complete a PhD at UCL, investigating Kaposi’s sarcoma-associated herpesvirus. She then migrated to Australia and joined Johnson & Johnson as a molecular biologist, researching new drug targets in oncology. Bianca embarked on a career change and joined Platinum as an investment analyst in 2003. Her rich knowledge base in molecular biology and first-hand insights into the pharmaceutical and biotech industry give her a unique ability to delve deeply into the fundamentals of healthcare companies and identify those with a solid foundation in scientific research.


Solvency and Debt in time of crisis

This article was written by Hugh Dive - Atlas Funds Management and he has generously authorised its reproduction ..... Thanks Hugh!


Alongside the worldwide devastation as healthcare systems struggle to cope and deaths are well into the tens of thousands, the COVID-19 crisis is having a chilling impact on Australian corporates. Many companies are removing profit guidance given less than a month ago, cancelling dividends, raising debt, and in the last five days attempting to raise capital. Eleven years ago during the GFC many companies raised equity, often at deep discounts to their share price, as nervous bankers put pressure on management to shore up weakened balance sheets. In some situations, companies were forced to raise equity as their bankers were unable to refinance loans that had become due in a frozen credit market. 
In this week’s piece we are going to look at the various debt measures that we examine to assess a company’s solvency. These measures provide insight into whether management will be forced to raise equity during times of stress.


Gearing is the most commonly discussed measure of a company’s debt. It indicates the degree to which a company’s business is supported by equity contributed by shareholders, as opposed to debt from banks and bondholders. Gearing is measured by dividing net debt by total equity (assets plus liabilities).  During times of buoyant business conditions, companies with a high level of gearing generally deliver higher returns to investors. However, when the tide turns, highly geared companies have a riskier financial structure and have an increased chance of going into administration or having to raise equity to retire debt.

Most companies on the ASX have a gearing ratio between 25% and 35%. However, the level of gearing needs to be assessed in the context of the industry in which the company operates.  Utilities such as Spark Infrastructure with regulated revenues can “safely” have a higher level of gearing than a highly cyclical stock such as Myer or Qantas. The latter two have more variable earnings and thus a variable ability to meet interest payments.

The key weakness in using gearing alone to measure a company’s solvency is that it assumes that the company’s assets can be realised for close to what they are valued on the balance sheet. The shortcomings of this approach are especially apparent for companies with a large proportion of intangible assets on their balance sheet, such as goodwill stemming from acquiring other businesses at prices above their net asset backing. In 2019 AMP’s gearing increased rapidly after the financial services company wrote down the asset value of its troubled wealth management and life divisions by $2.5 billion. Shortly after writing down the value of its assets, the highly geared AMP both cancelled its dividend and conducted a $650 million equity raising at a 16% discount to the share price at the time.

Companies such as Medibank PrivateJanus Henderson and A2Milk are in the fortunate position in 2020 of having no net debt on their balance sheet. As a result, each has a negative gearing ratio and is facing no anxious discussions with their bankers. By contrast AMP, Pact and OohMedia (which raised $167 million last week) all have high levels of gearing.

Short-Term Solvency

Short-term solvency ratios, such as the current ratio, are used to judge the ability of a company to meet their short-term obligations. The current ratio divides a company’s current assets by their current liabilities (i.e. liabilities due within the next 12 months). Firms can get into financial difficulties despite long term profitability or an impressive asset base if they can’t cover their near-term obligations. A current ratio of less than one would indicate that a company is likely to have trouble remaining solvent over the next year, as it has less than a dollar of assets quickly convertible into cash for every dollar they owe. A weakness in using this measure to assess the solvency of a company is that the current ratio does not account for the composition of current assets which include items such as inventory. For example, winemaker Treasury Wine reports a robust current ratio. However, a large proportion of current assets are inventories of wine which may be challenging to convert into cash at the stated value during times of distress (panic buying of wine notwithstanding).

A further limitation of the current ratio in assessing a company’s financial position is that some companies such the ASX, Coles and Transurban which have minimal inventories or receivables on their balance sheet. This occurs as they collection payment immediately from their customers, but pay their creditors 30 or 60 days after being invoiced. These companies will tend to report current ratios of close to 1. Alone, this figure would indicate that these companies may be in distress. Indeed Coles has a current ratio below 1, which far from being alarming is due to the nature of the grocery business. Suppliers such as Kellogg’s and Coke are paid on terms between 60 and 120 days after they deliver their goods which creates a large current payables balance, while the receivables balance is small when customers pay for their cornflakes or Diet Coke via direct debit. This favourable mismatch between getting paid and paying their suppliers allows Coles and Woolworths to report an alarming current ratio that is effectively a loan from their suppliers to fund the grocers’ working capital.

Interest Cover

A debt measure that we look at more closely than gearing is interest cover, as this measures cash flow strength rather than asset backing. Interest cover is calculated by dividing a company’s EBIT (earnings before interest and taxes) by their interest cost. The higher the multiple, the better. If a company has a low-interest cover ratio, this may indicate that the business might struggle to pay the interest bill on its debt.

Before the GFC, I had invested in a company that had significant asset backing held in the form of land and timber. Using gearing as a debt measure alone, Gunns appeared to be in a robust financial position. However, interest cover told a different story. The combination of a rising AUD (which cut demand for its woodchips) and weak economic conditions resulted in Gunns having trouble servicing their debts despite their asset backing, and the company ended up in administration.

As interest rates have trended downwards over the past decade, it has become easier for companies to pay their declining interest bills, so in general, the interest cover ratio for corporate Australia has increased. Across the ASX companies such as JB Hi-Fi, Goodman Group, Wesfarmers and RIO Tinto all have an interest cover of greater than ten times. At the other end of the spectrum Nufarm, Viva Energy, Boral and Vocus all finished 2020 with interest cover ratios less than three times, which is likely to result in some worried discussions with their bankers. Nufarm has since sold its South American crop protection business with the proceeds going to pay down debt.  

Tenor of Debt

A very harsh lesson learned on debt during the GFC was not on the absolute size of the debts owed by a company, but the time to maturity – known as the tenor of the debt. The management of many ASX-listed companies sought to reduce their interest costs by borrowing on the short-term market and refinancing these debts as they came due. While this created a mismatch between owning long-dated assets that were refinanced yearly, it was done under the assumption that credit markets would always be open to finance debt cheaply. This strategy worked well until global credit markets seized up in 2008 and a range of companies such as RAMS and Centro struggled to refinance debts as they came due.

When looking at a company’s solvency during times of market stress, one of the critical items to look at is the spread of a when a company’s debt is due. If the company’s debt is not due for many years, management teams may not be forced by their bankers into conducting dilutive capital raisings during a period of difficult economic times. In the ASX over the next year Seven West Media, Downer and Southern Cross Media all have significant levels of debt to refinance, which may prove challenging in the current environment.

After the GFC many of the larger ASX-listed companies have sought to limit refinancing risks by issuing long-dated bonds in the USA and Europe. Toll road companyTransurban does carry a large amount of debt, but as you can see from the table below, the maturities of these debts are spread over the twenty years with an average debt to maturity of 8.4 years.

Similarly, at the smaller end of the market, the supermarket landlord SCA Property has minimal debt due over the next three years after issuing long-dated bonds in the USA. While COVID-19 is disrupting SCA Property’s business in March 2020, this spread of debt maturities positions this property trust better to ride out the current storm.



Covenants refer to restrictions placed by lenders on a borrower’s activities and are contained in the terms and conditions in loan documents. These are either affirmative covenants that ask the borrower to do certain things such as pay interest and principal, or negative covenants requiring the borrower not to take on more debt above a certain level – for example; gearing must stay below 60% or an interest cover above three times. For investors, covenants can be difficult to monitor since, while companies reveal the maturity, currency and interest rate of their debts in the back of the annual report, disclosure on debt covenants is generally relatively weak.

Debt covenants were something that received little attention before the GFC when a covenant linked to Babcock & Brown’s market capitalisation triggered the collapse of the company. In June 2008, Babcock & Brown’s share price fell such that the company’s market capitalisation fell below $2.5 billion, and this triggered a covenant on the company’s debt that allowed its lenders to call in the loan.  After this experience, very few borrowers will include a market capitalisation covenant in their debt, as this leaves the company vulnerable to an attack by short-sellers. More recently in 2019 when Blue Sky Alternatives breached covenants, bondholders called in the receivers to protect their loan.

In 2020 amid the COVID-19 crisis, debt covenants are once again in the minds of investors, particularly in the hard-hit media and listed property sector. In the media sector, a fall in TV advertising revenue of 10% is likely to trigger Seven West Media’s debt covenant of 4 times EV/EBITDA (enterprise value divided by earnings before interest, depreciation and tax).

In listed property, the embattled shopping centre trusts have more breathing room, as they entered 2020 with a lower level of debt. The key covenants for Scentre are gearing (less than 65%) and interest cover (higher than 1.5 times). For the gearing covenant to be breached, the independent valuation of Scentre’s assets would have to fall by 60% from December 2019; for the interest cover to be breached, earnings would have to fall by 60% assuming no change to Scentre’s cost of debt.


In the context of debt, hedging refers to the addition of derivatives to limit the impact of movements in either interest rates or the currency in which the debt is denominated. Many Australian companies borrow in Euros, US dollars and yen – both to take advantage of the lower interest rates in these markets, but more importantly to borrow money for a longer-term.  In 2020 the Australian dollar has fallen 12% against both the Euro and the US Dollar.

Companies that have significant un-hedged debt – such as building materials company Boral – will see their interest costs increase, especially if the company does not have enough foreign earnings to service their debt. This situation occurred in 2010 for Boral and required a dilutive $490 million to keep the company within their debt covenants. In December 2019 Boral’s debt was A$2.8 billion, but currency movements over the past 90 days have added $340 million to the struggling building materials company’s debt pile.

Our take

The upcoming year  will be tough for Australia’s companies as the sudden step change in demand is very different to the falls in 1987,1991,2000 or 2008/09. While demand for goods and services fell during these previous times of stress, some companies are now facing a government mandated shut-down in their businesses.

On a more positive note businesses are also likely to find more sympathetic bankers in 2020 than they faced in previous recessions, as well as massive government support. During the GFC,  the banks themselves were not well placed to help businesses, as issues with the global banking sector were at the heart of the crisis. The banks were de-levering their own balance sheets, while struggling to explain collapsed credit markets and the problems created by complex financial instruments to hostile politicians. Given that the shutdowns from COVID-19 are a temporary state of affairs and in light of the massive fiscal stimulus, we would expect the banks to give many struggling firms a degree of leeway over the next year.



Alibaba - why the smart money likes it

With the Chinese middle class population forecast to double to over 600 million over the next 5 years, which in turn increases consumer spending, it is not difficult to see why the ‘smart’ money is investing in Alibaba, one of China’s largest companies that is likened to Amazon, eBay, Paypal and Google all rolled into one.

Alibaba was founded during the 1990’s by Jack Ma who realised at that time China lacked technology in the business world.  Alibaba, now one of China’s largest companies, listed in 2014, and today is highly profitable with a market capitalisation of over US$580bn.  This is about 6 times larger than Australia’s largest company CSL.

Alasdair McHugh (Product Specialist Baillie Gifford) is attracted to Alibaba due to their very strong position in ecommerce transactions in China where their market share is over 60% by gross merchandise value and likely to rise further.  He also likes the fact that the original co-founder and visionary Jack Ma is still involved in the business.  

According to the China Ministry of Commerce, total retail sales across China increased 8% in calendar 2019, for a total of RMB 41 trillion (AUD $9 trillion).  Consumption contributed over half of China’s economic growth.  Online retail sales for the year was RMB 8.5 trillion (AUD $1.87 trillion) up 19.5% from the year before.  It is clear that consumption is now a major driver of economic growth in China, and online retail is an important driver of consumption growth. Alibaba’s dominant position means it is well placed to capture this growth.

The scale of the opportunity is extraordinary and underestimated by certain investors, particularly some from the west who still consider China as a risky emerging market.  But McHugh suggests that those who still treat China as an emerging market are overlooking the fact that the addressable market for Chinese consumer spending is 1.3 billion people.  

Illustrating this point was the recent ‘Singles Day’ held in November 2019 where another record was broken with total sales of RMB 268.4bn (approx. AUD $59.2bn).  Almost 1.3 billion packages were delivered by Alibaba from ‘Singles Day’ orders and of those 960 million were delivered within one week.  This is equivalent to 2.3 times the combined online sales of Black Friday and Cyber Monday in the US.  It reflects the strength of Alibaba’s digital economy and of Chinese consumers consumption power.

Joe Lai (Portfolio Manager Platinum Asset Management) says that “mobile monthly average users on Alibaba’s retail marketplaces in China reached 824 million in December 2019, an increase of 39 million from the previous quarter”.  

Beyond the ecommerce business, Alibaba operates the largest cloud computing business in China, Alibaba Cloud.  Many believe that this business can ultimately become the largest division within the company despite it presently representing less than 10% of overall revenue.  Revenue from Alibaba Cloud grew by 62% over the year to December 2019.

A fascinating aspect of Alibaba’s recent quarterly earnings update related to the company’s involvement in procuring and delivering 40 million units of medical supplies worth around AUD$100 million to Wuhan which has been impacted by Covid-19.  This shows a company that is so much more than an online retailer. 

Lai points out that “The Alibaba ecosystem keeps delivering new sources of value to shareholders.  Amid the Covid-19 lock down in China, Alibaba’s new enterprise communication app, DingTalk, has achieved new prominence.  Alibaba introduced a new digital health check in feature on DingTalk, which as at February 2020, had recorded more than 150 million daily health check ins.”

While currently investors are obsessing over Covid-19, Alibaba management said “17 years ago, the ecommerce business experienced tremendous growth after SARS.  We believe the adversity will be followed by changes in behaviour among consumers and enterprises and bring ensuing opportunities.  We have observed more and more consumers getting comfortable with taking care of their daily living needs and working requirements through digital means.” 

With the huge growth in China’s middle class and online commerce in coming years, combined with Alibaba’s dominance across retail, financial and computing businesses it’s clear to see why the company is in Platinum and Baillie Gifford portfolios.  Investors can of course buy Alibaba directly either on the Hong Kong or US exchange and can also gain access to it through managed global funds.


This article appeared in the Australian Financial Review during March 2020 - written by Mark Draper GEM Capital

Montgomery's Best of the Best - February 2020

The investment team from Montgomery's are pleased to bring you their latest edition of "Best of the Best".

 In this edition they discuss: 

  • Have low interest rates made assets too expensive?
  • Why Infigen should profit from our decabonising economy
  • What should we expect from the big 4 banks in 2020? 

Download your copy by clicking on the report below. 

Coronavirus - increasing economic threat - what to watch for and what should investors do

Article written by Shane Oliver - Chief Economist AMP Capital

Coronavirus continues to rattle investment markets as the number of new cases outside China continues to rise posing increasing uncertainty over the impact on economic activity. And its impact has intensified following the collapse of OPEC discipline causing a further plunge in oil prices raising concerns about debt servicing for oil producers. From their highs global shares and Australian shares have had a fall of around 20%.

Source: PRC National Health Commission, Bloomberg, AMP Capital
Given the extreme uncertainty this note looks at various scenarios in relation to global and Australian economic growth and what signposts to look at in relation to how it may unfold.

Much ado about nothing or a major global catastrophe

It seems there are two extreme views on coronavirus. Some see it as just a bad flu and can’t see what the fuss is all about. Others think that it will trigger a major humanitarian and economic catastrophe killing millions and triggering a major global recession as excessive leverage is finally exposed. The optimist in me wants to lean to the former:

  • So far over 114,000 people are reported to have contracted the virus of which nearly 4000 have died. Of course, this number is still growing but in China where the number of new cases has collapsed (see the first chart) the number is 80,754 cases and 3136 deaths. In the 2017-18 US flu season alone 44.8m Americans got sick and 61,099 died.
  • The actual death rate from Covid-19 may be 1% or lower, rather than the currently reported rate of 3.5% because many of those who get the virus don’t get sick enough to seek medical help and so won’t be included in the case count. The Diamond Princess episode may provide a rough guide – all 3711 passengers and crew have been tested with 705 contracting the virus of which seven have died and most of those are believed to have been over 70. This would suggest a death rate of around 1% which is only just above that for regular flu for those over 65.
  • It appears to be less contagious than regular flu.
  • China’s experience shows it can be contained. Maybe this is due to extreme containment measures in Hubei that are not possible in other countries. But the case count in the rest of China has also been contained with less extreme measures and Singapore and Hong Kong have had some success in slowing new cases without extreme quarantining.
Source: PRC National Health Commission, Bloomberg, AMP Capital
  • Alternatively, at some point authorities outside China may just conclude that containment is impossible and, as the death rate is not apocalyptic, shift from containment to just treating those who get very sick. This could enable life to return to normal, albeit with a change in behaviour - less handshaking, frequent handwashing and wearing a mask. 

But I also must concede I just don’t know. There is much that is unknown about the virus itself and how long it will continue to spread. And even if there is a switch to just treating the very sick it’s unclear there will be enough hospital beds. And there is also the human or behavioural overlay which is intensifying the economic impact. Just look at the toilet paper frenzy to see that this can have a real economic effect even before the virus has really taken hold in Australia. While there may be a boom in demand for hand sanitisers, toilet paper and long-life food, this will be a temporary boost as the spread of the virus globally and the disruption that containment measures are causing is continuing to increase the risk of a longer and deeper hit to economic activity. And there is a risk of secondary effects as the short-term disruption risks leading to business failures and households defaulting on their debts if they can’t keep up their payments and so causing a deeper impact on economic activity. The secondary effects of the coronavirus outbreak and its flow on is highlighted by the 45% collapse in oil prices since mid-January. Ultimately lower petrol prices will be a good thing as this will boost consumer spending when the virus goes away but for now all the focus is on the downside of lower oil prices – debt problems and less business investment by producers.

Base case versus global recession and beyond

Given all these uncertainties it’s still too early to say that shares, commodity prices and bond yields have bottomed. The following charts present three scenarios for the global economy: 

  • How we saw global growth panning out prior to the virus. Basically, we were expecting a mild pick-up in growth.
  • A sharp downturn centred around the March quarter as the Chinese economy contracts sharply but rebounds in the June quarter offsetting recessions in developed countries including in the US. This is our base case.
  • A worse case downturn that sees global growth contract in the March quarter (led by a sharp contraction in China) and the June quarter as (as developed countries get badly hit) resulting in a global recession to be then followed by a rebound as life returns to normal led by China.

Note: the scenarios show quarterly annualised growth. The key is to focus on the pattern of growth rather than the precise level.

Source: Bloomberg, AMP Capital
The next chart shows three scenarios for Australian growth:
  • How we saw global growth panning out prior to the virus.
  • Mild downturns in the March and June quarters driven initially by the lockdown in the China and then the coronavirus flow on to the rest of the world and Australia, followed by a second-half rebound. This is our base case.
  • A worse case downturn that sees deeper downturns in the March and June quarters then followed by a rebound as life returns to normal.
Source: Bloomberg, AMP Capital
Last week we moved to forecasting a recession for the Australian economy in our weekly report. We were already expecting a negative March quarter on the back of the bushfires and the hit to tourism, education exports and commodity exports from the slump in China. But the spread of coronavirus globally and in Australia has made it likely that we will also see a contraction in the June quarter too. As with the global outlook this should really be “a disruption” that will pass once the virus runs its course - hopefully at least as the Northern Hemisphere heads toward summer. The worse case scenarios would likely see a deeper decline in shares and bond yields.

What to watch?

Shares will bottom when there is confidence that the worst is over in terms of the economic impact from the virus and its largely factored in. So, the debate is largely now about how big the hit to growth will be and this relates to how long the virus will weigh on global growth and any secondary effects it may cause. In this regard the key things to watch are as follows:

  • A peak in the number of new cases – as per the first chart.
  • News of successful vaccines or anti-virals.
  • Whether governments switch from containment.
  • Timely economic indicators, eg, jobless claims and weekly consumer confidence data in the US and Australia.
  • Measures of corporate stress, eg, spreads between corporate bond yields and government bond yields. 
  • Measures of household stress, eg, unemployment and non-performing loans.
  • Measures of market stress, eg, bank funding costs as measured by the gap between 3-month rates and central bank rates. These have risen but are well below GFC levels.
Source: Bloomberg, AMP Capital

  • The monetary and fiscal policy response – this will be critical in terms of minimising the impact on vulnerable businesses and households from the coronavirus disruption, ensuring financial markets remain liquid and driving a quick recovery once the threat from the virus is over. So far so good with policy makers moving in the right direction (rapidly so in Australia it seems) – but there is a fair way to go. 

What does it all mean for investors?

The rapidity of the fall in share market has been scary. In our view the key things for investors to bear in mind are as follows: 

  • periodic sharp falls in share markets are healthy and normal. With the long-term trend ultimately remaining up & providing higher returns than other more stable assets. 
  • selling shares or switching to a more conservative investment strategy after a major fall just locks in a loss. 
  • when shares fall, they are cheaper and offer higher long-term return prospects. So, the key is to look for opportunities the pullback provides. It’s impossible to time the bottom but one way to do it is to average in over time.
  • while shares have fallen, dividends from the market haven’t. Companies like to smooth their dividends over time – they never go up as much as earnings in the good times and so rarely fall as much in the bad times. 
  • shares and other related assets bottom at the point of maximum bearishness, ie, just when you feel most negative towards them. 
  • the best way to stick to an appropriate long-term investment strategy, let alone see the opportunities that are thrown up in rough times, is to turn down the noise.  

Best of the Best - December 2019

The Investment team have provided their final "Best of the Best" report for 2019.

In this issue they discuss the insanity of negative interest rates and what investors should do about it.

Other topics in the report include:


1. Why valuation still matters

2. Implications for asset prices from low rates

3. The anatomy of the Small Company market


Download your copy by clicking on the report below.

Waste Management - turning trash into profit

Investors seeking an industry sector  - that is almost certain to grow would be wise to take a look at the Waste Management sector.

Andrew Mitchell (Ophir Asset Management) is attracted to the sector because “Waste is a huge industry which will increase with population growth.”  He also likes the high barriers to entry in particular segments of the waste sector such as municipal collections and commercial waste.

The chart below shows the growth in core waste in Australia over a decade with a compound annual growth rate of 1.2%pa.


There are three main segments of the waste industry:

  1. Municipal (council kerbside household waste)
  2. Commercial / Industrial waste
  3. Building and demolition (construction and infrastructure)

Municipal and Commercial waste is generally considered ‘recession proof’ among professional investors while building and demolition waste is more cyclical.

Waste Management companies of the future are increasingly focussed on recycling, particularly following the introduction of the Chinese ‘National Sword’ policy last year.  China used to be the biggest importer of recyclable materials globally.  It took 30m tonnes of the world’s waste each year, including Australia’s.  Put simply, China used to buy the world’s recyclable waste, and it largely banned it overnight.  Australia will need to build its own recycling facilities to dispose of the waste appropriately.

Mitchell believes that “it’s becoming a social imperative that more is done with waste.  The call for more to be done on sustainability and recycling is growing louder within the community.  We believe Australians are becoming more accepting now of paying for the cost of sustainability.”

Emma Goodsell (Airlie Funds Management) says “the waste management industry is increasingly focused on building out critical recycling infrastructure.  The issue for the whole waste supply chain is that the cheapest way of doing things is usually the worst for the environment (ie landfill).  So it requires government intervention, in the form of levies on the cost of disposing a tonne of waste into a landfill, to adjust the playing field and allow for investment in recycling assets.”

The graph below shows the growth in recycling over a decade, with compound annual growth of 2.4%pa.

Landfill levies collected by the NSW government alone are approaching $1bn per year and are increasing.  Australia recycles or converts waste to energy for around 50% of waste according to Mitchell, so is considered middle of the pack by global standards compared with the US or developed European peers where this figure is around 80% plus.  Mitchell sees Government landfill levies as a potential revenue pool for Waste Management companies who are able to divert waste from landfill.

Goodsell points to Cleanaway’s joint venture with Macquarie’s Green Investment Group for a Western Sydney plant that will convert waste to energy as an example of business diverting waste from landfill.  This plant is likely to have the capacity to cut landfill volumes by 500 kilotonnes per year.

The biggest risks of investing in this sector would seem to be regulatory.  There is a lack of cohesion between State Governments which results in the waste industry being effectively different in every state.  Landfill levies can vary significantly from state to state and until recently Queensland didn’t charge a landfill levy which saw large movements of NSW waste shipped across the border.  Lack of uniformity in bin sizes across states increases costs as trucks need to be designed differently for each state.

Mitchell believes that Governments are slowly realising that more needs to be done in the waste sector, particularly with more national cohesion noting that there is now a Federal minister for waste reduction.

The ASX is home to one of the worlds’ largest listed waste management companies,  Cleanaway (formerly Transpacific Industries), and Bingo Industries is a relatively new addition to the ASX.  Mitchell is attracted to Cleanaway as “we like the more stable and defensive earnings streams of Cleanaway (mainly municipal and commercial) whereas Bingo operates in the more volatile/cyclical building and demolition space.  There are also a lot lower barriers to entry in that part of the market (Bingo Industries)”.

Most investors would associate waste management with garbage collection, where as the future lies with the recycling of waste.


This article was written by Mark Draper (GEM Capital) and appeared in the Australian Financial Review during October 2019

Best of the Best - October 2019

The team at Montgomery Investments produce a magazine "The Best of the Best".

In the latest edition they discuss:

1. Five Global Investment Themes

2. Reliance Worldwide

3. Flight Centre

and much more.


Click on the report to download your copy

Best of Best image Oct 19

Retail Property - apocalypse or rebirth?

Every month Mark Draper (GEM Capital) writes a column for the Australian Financial Review.  Here is the column that featured in the month of September 2019. 

Often investors accept a simple thematic to determine their investment view on an entire sector.  Amazon’s entry into Australia was to be the death of our retailers, but JB Hi-Fi and Super Retail Group’s recent good results have defied this theme.

A common investment theme is that the internet will turn shopping malls into museums and investors in retail property will be left with a worthless asset.  Those who believe such a simple thematic without further investigation could well be passing up high investment income from some attractively priced retail property assets.

The bears of retail property will refer to the US experience of shopping malls being closed and 5 – 6,000 shops going out of business last year as reasons to avoid the sector entirely.

While it is true that US shopping malls are closing, Hugh Giddy (Investors Mutual) and Hugh Dive (Atlas Funds Management) believe that it is dangerous to extrapolate these closures across the entire global retail property sector as the US retail property market is over supplied.  This was due to overbuilding of malls between 1970 and 2015 where the number of malls in the US grew twice as fast as the population.  The chart below shows the level of commercial retail space in the US per person, compared with other countries.

Dive says “the thesis that all shopping malls are ruined and are going down, doesn’t account for the changing composition of tenancies”.  The better shopping centres are changing their tenancy mix to include more services and experiences.  This is likely to appeal to a wider audience including the Millennials who are less focussed on “things” and more interested in experiences.

Dive adds that “the good shopping centres are placing more emphasis on dining, entertainment, fitness, massage, healthcare and education services – things that can’t be easily delivered online”

Giddy says that “traditionally shopping centres were anchored with department stores and fashion apparel shops but those tenants are reducing space which is being taken up by medical centres and other service providers.”  Cinema admissions are still strong, and consumers are attracted to the shopping centres to watch movies.  Giddy asks “why are people still going out to the movies?, because they don’t want to only watch a movie on DVD or Netflix, it’s a social experience”.

Giddy points out that the shopping centre sector is turning into ‘the haves and the have-nots’.  The ‘haves’ are the centres that are well located in densely populated catchment areas, near transport hubs offering a diverse range of shopping and entertainment experiences.  He quotes Chadstone, Bondi Junction, Westfield London and Pitt Street Mall as examples of ‘the haves’ which are very high quality centres that have no problem filling their locations with shoppers and tenants.  This provides investors with high occupancy rates and rental income certainty.

The ‘have-nots’ which should be treated with caution, are typically located in regional locations with low catchment population, offering a narrow range of shops and services.

The strong shopping centres are also building residential apartments over them to capture value from the air rights over their centres.  Dive said that “Vicinity plans to build 900 apartments over the Chatswood shopping centre to capture value from the air rights.  In 2017 Vicinity also sold the air rights to a developer for $60m over their Melbourne shopping centre, and this development should be completed by 2020.”  Not only are the shopping centres capturing value from selling air rights, but they are also capturing additional shoppers who will reside within the shopping centre complex.

Investing into retail property can be through owning individual listed property trusts such as Scentre, Vicinity and Unibail Westfield or via managed funds and ETF’s.  Unlisted property trusts are unlikely to offer access to the type of retail properties described as ‘the haves’.

The risks to retail property investors include prolonged economic downturns that result in reduced consumer spending although Giddy says “during the GFC the Westfield Group held up quite well”.  Continued online competition will put pressure on the amount of bricks and mortar retail space required but Giddy argues that consumer brands are still going to want to have physical presence in the premium shopping centres as a branding opportunity.

Cloud computing the global growth opportunity

Mark Draper (GEM Capital) writes a column for the Australian Financial Review every month.  Here is his column that featured during the month of September 2019.

What do Amazon, Google and Microsoft have in common?  They are all huge players in the world of global cloud computing.  Most would associate Amazon with online shopping and yet Amazon’s cloud business generates more than 50% of group income at a margin of 28%, and the most recent quarterly revenue grew by 37% from the previous year .  Very few large businesses have the capacity to grow at this rate.

Cloud computing is defined as using a network of remote servers to store, manage and process data, typically delivered via the internet rather than using a local server or personal computer.

The simplest example of cloud computing is business email.  Many businesses used to run their own email servers where they would buy the server hardware, buy the email exchange software and then pay an IT specialist to install and manage the email service.  That can all now be replaced by using Microsoft’s Office 365 which is a cloud based solution.  In essence cloud computing results in businesses and consumers renting services rather than owning the hardware and software.

The benefits of using cloud computing are that consumer and business users do not need to incur a large upfront cost to buy hardware and software and instead access these services more quickly, reliably and securely than traditionally.  It is often less expensive for users to access services from the cloud.  It is these reasons that provide optimism for the continued growth in the cloud.

From an investors perspective, it is important to identify 3 key segments of cloud computing.  Infrastructure as a Service (IaaS) delivers computer infrastructure on an outsourced basis.  Typically IaaS provides the hardware, storage, servers and compute services.  Secondly, Platform as a Service (PaaS) includes application development, security, databases, analytics and tools that the applications depend on to work.  Differentiating between IaaS and PaaS is difficult as they are often provided by the same company.  The 3 dominant players in these segments are Amazon, Microsoft and Google.

Scale is important for IaaS/PaaS players to support the operation of large, globally distributed data centres and the development of complex software underlying the rapidly expanding functionality of IaaS/Paas.  Kris Webster, (Portfolio Manager Magellan Financial Group) believes that the market outside of China will be dominated by Amazon, Microsoft and Google for that reason.  He says that the current annual revenue from cloud computing infrastructure is below US $100bn but forecasts the addressable market by 2030 to be US $800bn per year.

Finally, Software as a Service (SaaS) is also known as cloud application services in which end user software is rented on a subscription basis and is centrally hosted.  Common examples of SaaS are Adobe Creative Cloud and Dropbox.  Before the cloud, Adobe Professional suite of software would attract an upfront cost of well in excess of $1,000.  The high upfront cost often led consumers to pirate the software.  According to Webster, “Adobe has done a terrific job at bringing in the pirates to its network and thereby generating additional revenue, by charging a more affordable $50 monthly subscription”.

Other common examples of SaaS are music subscription services and video on demand services such as Spotify and Netflix.

Andrew Clifford (CEO Platinum Asset Management) highlights that many SaaS companies trade in the range of 15 – 25 times sales (not earnings).  He believes that the likelihood of any company growing fast enough for long enough to justify such valuations is very low.

Platinum are instead investing in companies that produce memory chips for computers and data centres that stand to benefit from the growth in cloud computing.  Some of these businesses can be purchased on single digit earnings multiples.  Platinum are also significant investors in Alphabet which owns Google.

Risks to the investment case for cloud computing exist if the switch to cloud computing is slower than forecast due to security or other concerns.  Counter to this point NAB’s IT executive Steve Day said recently “the cloud providers have realised they are so large, they can invest in the sort of security a bank like NAB could only dream of”.

With forecast growth of cloud computing of over 20%pa over the next decade, investors can not afford to ignore this sector.

Demergers - the hidden treasure

Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.

This column was published in the month of August 2019 in the AFR.

There have been many Australian demergers in the last 15 years and well known US investor Joel Greenblatt says “there is only one reason to pay attention when they do; you can make a pile of money investing in spin offs”.

A spin off, created from a demerger, is the establishment of a separate independent company through the sale or distribution of new shares of an existing business or division of a company. Generally the reason behind demergers is the belief that the demerged company will be worth more as an independent entity rather than being part of a larger business.  

Unrelated businesses may be separated via a demerger so that the separate businesses can be better appreciated by the market. Sometimes the motivation for a demerger comes from the desire to separate out a ‘bad’ business so that an unfettered ‘good’ business can shine through to investors.  There are many other reasons why a company would pursue a demerger, but broadly the idea is to create the environment where 1+ 1 = more than 2.

Paint company Dulux is the poster child for the demerger Fan Club according to Matt Williams (Portfolio Manager Airlie Funds Management).  He quips he is the founder, president and treasurer of that club.   “The simple fact is that demergers have a higher probability than not, of adding considerable value. In 2010 Orica shareholders received one Dulux share for each share they owned in Orica. Dulux shares closed at $2.54 on its first day as a stand-alone company. Nearly 10 years later shareholders will receive $9.75 as giant Nippon Paints adds Dulux to its stable. The total shareholder return for Dulux over this period was more than 20% p.a.” said Williams.

Goldman Sachs analyst Matthew Ross in a research paper on the value of demergers showed that Australian ASX100 demerged entities on average have outperformed the market by 18.5% in the first year post demerger.

That same study found that one of the significant drivers of value for the shareholders in the companies involved in demergers, was that they typically increased the prospect of a takeover of either business.  Shareholders in demerged companies Dulux, Recall, Sydney Roads, and Rinker can attest to this assertion.  Demergers where the parent company still owns a stake such as Coles lessens this likelihood.

Williams said that “like all good things its pretty simple, demergers work because:

-      They allow good businesses previously trapped inside a conglomerate to be valued more precisely by investors.

-      Management can be properly incentivised and rewarded thereby driving positive outcomes and

-      Companies are able to be taken over, or if not at least a ‘control premium’ can start to be factored into the share price”

Investing in spin offs is not smooth sailing immediately following demergers however as quite often the spin off company is initially sold by investors.  This is because spin offs can often represent a small holding in the context of an investors’ portfolio and therefore sold as nuisance value.  Alternatively institutional investors sell as they are either not allowed to own stocks below a certain market size or they simply do not understand the new spun out business.  After the initial period when this wave of selling is done, an investment in a spin off can be lucrative.

Joel Greenblatt says that “both spin offs and merger securities are generally unwanted by those investors who receive them. Both spin offs and merger securities are usually sold without regard to the investment merit”.  This often results in the immediate performance of a spin off post demerger being poor.  He adds “as a result, both spin offs and merger securities can make you a lot of money.”

So enthusiastic about demergers is Greenblatt that he dedicates an entire chapter to the subject in his book “You can be a stock market genius”, which is well worth a read.

The next demerger that is proposed for Australian investors to consider is Woolworths spinning off their drinks division, good luck in the treasure hunt.



The Best of the Best - August 2019

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.

The impact of China's growth on the world economy - Ray Dalio

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.

Afterpay - the elephant in the room

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 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.

India - the next big growth opportunity

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.

Roadsigns to Recession

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.  

Montgomerys' Best of the Best Report - April 2019

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

Inside the minds of Australia's best global investors

Livewire recently interviewed arguably two of Australia's best Global Investors.  They are Andrew Clifford (CEO Platinum Asset Management) and Hamish Douglass (CEO Magellan Financial Group).

The interview discusses their current views on the financial landscape and is a must see for investors.



Knowing when to sell

Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.  In his January 2019 article he outlines some of the triggers investors should look for that provide clues for when to sell.


7 flags to tell you ‘it’s time to sell’

The days of the ‘buy and hold’ strategy has long been a ‘dinosaur’ and probably always was. Regular changes to technology, regulation, consumer tastes not to mention competitors can turn today’s hero investments into tomorrows dogs. 

Successful investing involves not only buying assets for a reasonable price, but also knowing when to sell.

The term ‘red flag’ is referred to by professional investors as events that take place that act as an early warning signal to sell.

Here are 7 red flags to help investors sell before ‘it hits the fan’:

  1. When directors sell shares in their own company, particularly when more than one director sells in a short period of time, investors should be nervous.  History is littered with examples of director selling followed by dramatic falls in share prices.  In August 2016 the CEO and Chairman of Bellamys both sold a combined total of 365,000 shares at around $14.50 per share.  In June 2018 two directors of Kogan sold 6,000,000 shares at $7 per share. The share price charts below tell the rest of the story.  INSERT Bellamy’s and Kogan charts (attached PDF’s)
  2. Crowded trades takes place when consensus opinion on an investment is universally positive which usually coincides with excessive valuation.  The ‘investment that can not lose’, verbalised by cab drivers and instant experts at barbecues  is usually a place to avoid.  Crowded trades could also be referred to as fads.

Who can forget the mantra in 2007/2008 about peak oil theory, when the oil price was around $150 per barrel.  Investing in energy was a one way bet according to common beliefs of the day, providing an excellent example of the crowded trade.  Oil today of course trades today at around $60 per barrel.  

  1. Poor behaviour from management which include directors/management using company assets for private use, related party transactions such as the company renting premises from directors and excessive management remuneration.
  2. A google search of Nepotism reveals “the practice among those with power or influence of favouring relatives or friends, especially by giving them jobs”.  Whether employing a relative or friend of management, or the company expanding into an unrelated business, so that a relative can run it, rarely results in getting the best person for the job.
  3. Most investors appreciate that a company’s share price follows the earnings.  Earnings should follow cash flow, so when earnings rise without a corresponding rise in cash flow, investors should beware.
  4. My father always said to me ‘everything comes from the top’, and how true this is with respect to investing.  Changes to management can play a big role in share holder returns.  A Financial Services executive employed to run a healthcare company?  A Milkman running a Childcare company?  True situations that didn’t end well for shareholders.  Investors should consider the background and experience of new management that is appointed to satisfy themselves that they are fit for the role.
  5. Valuation is the ultimate red flag. Buy low and sell high sounds simple but the only way an investor can do this is to first hold a view of what an asset is worth.  While this seems elementary, I continue to be surprised by investor behaviour which clearly demonstrates no regard for valuation.

Let us pay tribute to the poor souls who invested in Cisco Systems at the height of the bubble paying well in excess of 100 times earnings.    Almost 20 years later, the share price is still not back to its level at the peak of the boom.

And there were many examples of this behaviour in Australian technology stocks in the boom that didn’t even have a price earnings ratio due to the fact that the company’s didn’t have any earnings to show.  Crypto currency is possibly the most recent example of investors chasing returns from an asset without regard for intrinsic value.

7 flags to help investors keep from trouble.  As the great Kenny Rogers song said, “you gotta know when to hold ‘em, know when to fold em’, know when to walk away and know when to run.  Happy investing!

Generational Investment Opportunity in Chinese middle class

Mark Draper (GEM Capital) writes a monthly column for the Australian Financial Review.  This article outlines the generational opportunity that is before investors in the doubling of the Chinese middle class in the next 5 years.  It was published during February 2019.


The growth in Chinese middle class is one of the strongest demographic opportunity for investors in a generation.  Most investors however, including the Global indices, have little in the way of exposure to this theme.

Chinese middle class is forecast to double from around 300 million to 600 million people in the next 5 years.  While the definition of middle class varies widely, it is commonly characterised to include those but the poorest 20% and the wealthiest 20%.  It is natural as more people enter the middle class they will have more disposable income to spend on discretionary purchases.  Buying cars, property, healthcare, mobile phones and a change of diet are all examples of the opportunities that exist for investors from this demographic trend. 

Vihari Ross, Head of Research at Magellan Financial Group points to coffee consumption in China as a long term opportunity. Those with even modest discretionary income can afford this ritual.  Chinese annual coffee consumption is less than 1 cup per year per capita, versus the US consumption of around 300 cups per year per capita.  

Growth in Chinese coffee consumption is one of the key drivers behind Magellan’s investment into Starbucks according to Ross. There are currently 3,400 Starbucks stores currently in China,  the company is forecast to open 600 new stores in China each year for the next 5 years, which equates to annual growth of 15%.  With a pre-tax return of 85% on investment from these stores the investment case seems compelling.

Source: Magellan Financial Group

Andrew Clifford, CEO Platinum Asset Management says “China is the world’s largest physical market – not just for iron ore and copper but everything imaginable:  aeroplanes, autos, mobile phones, semiconductors, running shoes and luxury handbags.  Indeed, it is hard to imagine a physical market for which China is not the largest customer.”

Source: Platinum Asset Management

With growing car ownership in China, comes the need for insurance.  This helps explain Platinum’s investment into Ping An Insurance Group, the number 1 global insurance company on the 2018 Forbes Global 2000 list.  Ping An, which trades on a price earnings multiple of around 11 is growing rapidly and boasts a technology-first mindset.  Its Fintech capabilities are world class and its health business and life insurance businesses are also booming.  Needless to say, there are very few listed companies in Australia trading on a price earnings multiple of 11 that are growing their earnings.

To help put further perspective on what the next 5 years might look like for Chinese middle class, we look back 5 years. Dinner party conversations will be enriched by wheeling out some of these Chinese growth statistics.  In 2014 there were 25 million motor vehicles sold in China and in 2018 the number was 28 million.  Chinese box office revenue in 2014 was $5bn and in 2018 it took in $9bn. There were 640 million internet users in 2014 and in 2018 there were more than 800 million.  109 million overseas visitors entered China and in 2018 the number of tourists was over 150 million.  14 billion express post parcels were delivered in 2014 and in 2018 parcel delivery grew to over 50 billion parcels.  32 million Chinese passengers flew domestically every month in 2014, rising to around 50 million passengers per month in 2018.  (statistics courtesy of Platinum Asset Management)

To cope with the surge in air travel, China plans to build over 70 new civil airports by 2020 to make the total 260. That’s up from 175 in 2010.  The opportunity for inbound tourism into Australia is enormous (and bolsters the investment case for Sydney Airport).

The numbers are phenomenal and difficult to grasp for many Australians.  More importantly, investors who base the majority of their investments domestically are ignoring this generational tailwind.

Clearly there will be peaks and troughs in the Chinese economy, although it is still growing at around 6% per year, good by Western measures.  Just the growth of the Chinese economy each year is larger than the entire Australian economy.

Investors would be wise to look through the short term economic cycles and embrace the extraordinary opportunity that is before them.

AMP - two bagger or falling knife?

Mark Draper wrote this article which appeared in the Australian Financial Review during the month of December 2018.

After spending the last 20 years despising AMP and selling any shares we ever came into contact with, it is interesting that we find ourselves potentially interested in buying AMP shares now that they are trading at an all time low.

Every investor dreams about picking the turnaround story that doubles in value.  Is AMP a two bagger or a falling knife?

It’s hard to find much in the way of positive news flow around AMP at present, which is normally a good place for investors to start as it can imply most investors have already headed for the exits.  The recent sale of AMP’s life insurance division was the last instalment of poorly received news with some in the market labelling it a ‘fire sale’ or ‘AMPutation’.

After the sale of AMP’s Life businesses, consensus earnings estimates are around 25 cents per share according to Skaffold software, which puts AMP on a current price earnings multiple of 10.

Skaffold which models intrinsic value based on assumptions of future cash flows currently has the share price trading at a small discount to intrinsic value.  

Source: Skaffold

What is often overlooked by investors is that AMP still has 3 key divisions, which are Wealth Management (platforms and advisers), AMP Capital (funds management) and AMP Bank.

AMP Capital has assets under management of $192.4bn, with around two thirds of this coming from their internal channels such as AMP aligned financial advisers.  This division is currently in fund outflow.  The key question for investors is whether AMP can regain the trust of investors and stem fund outflows, or whether fund outflows are permanent?  

AMP Bank has a lending book of around $20bn and the loan book saw a small decline for the first time since 2015.  This division carries the same risks of the other retail banks in the event of potential for bad debts.

Nathan Bell, portfolio manager at Intelligent Investor says “within a few years after the recent AMP Life disposal and the sale of its New Zealand wealth management business slated for next year, AMP could have around $1.5bn of capital that could either be returned to share holders or reinvested to grow earnings. Incoming CEO De Ferrari (who starts on 1st Dec 2018) needs to increase the company's return on equity to 15% to earn all his bonuses, so theoretically investing the money would increase earnings by $225m, which in turn could see earnings per share move closer to 30 cents per share”.

Bell then suggests that if AMP was subsequently re-rated to 15 times earnings, assuming no deterioration or improvement from other divisions, the share price could be $4.50 (15 X 30 cents per share earnings). The dividend yield for investors with an entry price of $2.50 would also be attractive under this scenario according to Bell. 

The problem with finding investments that can produce such a high return at the tail end of a bull market is that these opportunities often come with ‘warts’, and AMP’s business units are under immense pressure, which is why Bell is eager to hear De Ferrari's strategy. There are also suggestions De Ferrari will renegotiate his contract, as his bonus targets will be very difficult to achieve following the board's widely condemned deal announced recently to sell its AMP Life business.

It is always useful to understand how senior management is incentivised and the incoming CEO receives a large incentive if the share price reaches $5.25.

Matt Williams, Airlie Funds Management is watching AMP closely but has rarely invested in the company over his career. He cites a revolving door of management and a business with high fixed costs that is not really a leader in any of its market segments as reasons to be cautious.  Airlie have recently met with AMP management but remain on the sideline at this stage.

Risks for AMP include De Ferrari not being able to restore the company’s reputation, continued fund outflows, financial market downturn which decreases fee revenue from funds under management, bad debts from the banking division not to mention the outcome from the Royal Commission with respect to vertical integration among other issues.

The best investment decisions are often the ones which make investors feel the most uncomfortable and on that count AMP rates highly, given the uncertainties.  The strategy from the incoming CEO is the next piece of the puzzle for investors to help determine whether AMP is a turnaround in the making or a falling knife.

Why Buffett likes Apple

Mark Draper writes a monthly column for the Australian Financial Review - this article was published in September 2018


Apple has not only featured in the media for its latest range of iPhones and Watches, but also because it is Warren Buffett’s largest investment.

Warren Buffett owns around 5% of Apple shares (via Berkshire Hathaway) which recently became the first company to crack the US $1 trillion market capitalisation level.  ($AUD 1,400,000,000,000)  To put this in perspective, the market capitalisation of the entire ASX200 is only about 25% higher than that of Apple alone. 

Even though technology is the one of fastest growing sectors globally, local investors are starved of IT opportunities in the ASX200 with technology comprising less than 4% of the index. Local investors with a focus on the domestic market may be missing out on Buffett’s wisdom.

Composition of the ASX 200

Buffett does not have a natural leaning toward technology manufacturers but at his recent annual meeting described Apple as a “very, very special product, which has an enormously widespread ecosystem, and the product is extremely sticky”.  So what is behind the investment case for Apple?

The best place to start is to ask, how many of your friends and family own an iPhone?

The iPhone is important to Apple as its sales represent around 60% of revenue, but what has changed in the last 5 years is the composition of iPhone sales.  Magellan Asset Management estimate that in 2012 around 45% of iPhone sales were to new users.  In 5 years this changed so that only 20% of iPhone sales are to new users, with 80% being sold as replacement handsets to existing users.

For investors, this means more consistent earnings in the form of recurring earnings, rather than one off handset sales.  Magellan portfolio manager, Chris Wheldon describes the iPhone sales figures “as a subscription that Apple users are willing to pay every 2- 3 years, to remain in the Apple ecosystem”.

While revenue from iPhone sales YTD to 30th June 2018 is up an impressive 15%, what is more impressive according to Wheldon is the growth in the ‘Services’ business which is up 27% YTD.  The Services business comprises of revenue from digital content and services including the App Store, Apple Music, iCloud, Apple Care and Apple Pay.  Apple Music is now the most popular paid streaming service in the United States. 

The Services business was the second largest division within Apple contributing over $27bn in revenue for the 9 months to 30th June 2018, which represents almost 15% of total revenue.

The Services business is largely recurring in nature and its strength relies on the number of Apple devices connected to the ‘ecosystem’.  Earlier this year, Apple CEO Tim Cook stated in January 2018 that its active installed base of devices had reached 1.3bn, which includes iPhone, iPad, Mac and Apple Watches. 

The ‘Wearables’ division which includes products like Airpods and Apple Watch is also growing strongly.  In the last quarter of 2017, for the first time, Apple shipped more Apple watches than the entire Swiss Watch Industry, making Apple the largest watch maker in the world.

Wheldon believes the market may not yet fully appreciate the quantum and growth in the Services and Wearables businesses which could account for 35% of the total business in the future.

The technology bears would point to the high valuations of the boom at the turn of the century.  To this end it is interesting to note that Apple currently trades on a forward looking 2019 price earnings ratio of around 16 (less if adjusted for cash holding), which for a business whose earnings are growing at a double digit rate does not seem excessive.

Investors can invest in Apple through many avenues, either by owning it directly or via listed invested companies/trusts from leading managers including Magellan, Platinum and Montgomery Investments.  Some ETF’s also provide an entry point to technology companies.

Using technology is second nature in our everyday lives, so why wouldn’t investors make it second nature to their investment strategy as Warren Buffett has done?

Best of the best - August 2018

Every two months Montgomery Investment Management prepares a report for investors that contains information about today's financial markets.


This issue has several interesting articles including:


1. US Market Overpriced, but is it a problem?

2. Rising rates, a falling $AUD put the squeeze on mortgagees

3. Catalysts that ended prior bull markets


To download your copy, click on the image below.


Learning to be a better investor from a billionaire


This article appeared in the Australian Financial Review during August 2018 and was written by Mark Draper (GEM Capital).  The article was sourced from a 30 minute interview with Kerr Neilson (Platinum Asset Management).  The audio track can be heard at the bottom of this article.





What can private investors learn from one of Australia’s best investors?  I recently spent 30 minutes privately with Kerr Neilson, founder of Platinum Asset Management and Top 100 Global investor, with a view to share his wisdom.

Think about how the world is likely to be

Neilson suggests investors should spend time “conjuring up an image of the world as it is will be, rather than what is now”. This focuses on forward looking rather than relying on the past to develop an investment playbook.  “Investors need to remain agile to cope with the idea of new possibilities rather than reverting to the ways of the old”

Australian investors should be reminded of this by the current position Telstra finds itself in, and they should also be thinking now about to what extent Fintech companies including Apple and Google may disrupt the banking sector.

It is the competitor response that matters most

It is not just the behaviour of the company you are investing with that matters.

One of Neilson’s signature thought processes centres around “It is how the competitors respond that matters most”.  

Investment Research into retailing for example, would be incomplete without reference to Amazon.

Deal with the media overload.

Neilson believes the biggest problem investors face is dealing with the media overload.  This can create huge biases in behaviour of investors.  The most common is ‘availability bias’ where there is an obsession about the current news item which encourages investors to limit their scope to the most recent news and potentially lack perspective.  This can lead to either pain or opportunity.

Neilson quotes China as the perfect example of Availability bias.  “Certainly the country has too much debt, as do many countries, and yet we can find companies with attractive valuations that are growing at 15 – 25% per year and we are paying around 12 times earnings.  He adds “it is not as if all these companies are going to be forced to do things by their Government.  To the extent that this is a threat, we adjust the price we are willing to pay.”

Anchor decisions on fact, not momentum

Investors need to understand the reasons for owning particular assets and be clear about their expectations from them.  It is only then that an investor can take comfort in the face of an upset.  One of the problems he sees with passive investing (via index funds and ETF’s) is investors are simply buying momentum and the belief that ‘it has worked so well since the crash, why should we not do it’.  He believes investors should question passive investment from the perspective of “what are the circumstances that have created this and why should they persist”?  

Be aware of limitations of financial modelling 

While the rise of Artificial Intelligence is already at work in investment management, Neilson is of the view that financial modelling of companies has its limitations.  “It’s easy to observe winners in retrospect” he says. Recognising real talent, such as Bill Gates (Microsoft), before it is priced to perfection is where the real investment opportunities exist.

Great investors continually build their knowledge

The sources of available information has exploded with the internet.  Neilson highlights that if he wants to learn about computer chip design he can attend a lecture on YouTube.  “I agree with Buffett, it’s all about reading extensively and broadly” Neilson said. He also recommends investors should visit the website of companies they are investigating and listen to (or read the transcript) the quarterly/half yearly investor calls.  The Q & A section of these calls where management is put to the test by analysts is an excellent source of insight. 


The final take away from my time with Kerr Neilson was humility.  When asked what are the greatest mistakes he sees investors make, he came back with “We all make mistakes so we should be careful not to point the bone too eagerly”. When pressed on his proudest moment in investment management, Neilson’s response after a long pause was “pride comes before a fall, we don’t spend a lot of time on pride.  We at Platinum spend a lot of time on thinking about how many mistakes we have made and how to reduce those”.  

From my personal experience meeting with Institutional investors for over 20 years, the best investors are humble.


Below is a podcast of the interview.  Alternatively a full transcript can be seen by clicking on this link Full Transcript 


The damaging visible hand

This article is written by Hugh Giddy, Investors Mutual and has been reproduced with their permission on our website.


Students of economics learn early on that ‘there is no such thing as a free lunch’, an expression of the scarcity of resources. Those resources include things like labour and time as well as physical resources such as arable land.  Given that resources are not unlimited, much of early economic theory was devoted to the optimal and most efficient allocation or use of resources, as well as their valuation.  

Classical economics provides a foundation for much of our understanding of the economy.  Adam Smith, in The Wealth of Nations of 1776, describes the benevolent workings of the invisible hand of the market. Self-interested competition in the free market tends to benefit society in general by keeping prices low, while still building in an incentive for a wide variety of goods and services to be produced and supplied.  
The workings of the free market break down where there are monopolies, where prices would not remain low without some supervision or restraint, and where there are negative externalities that are not naturally priced or costed such as the quality of the environment.

The poor performance of planned economies in general (leading to the fall of the Soviet block and evidenced in the disparity in wealth between North and South Korea) is generally attributed to the removal of useful price signalling and incentives that exist in free markets.  Free markets and the invisible hand undoubtedly have flaws, but history has shown price controls and manipulation inevitably lead to shortages, inefficiencies and distortions.

Over time most economies have begun to adopt several measures to mitigate against some of the undesirable or politically unpalatable effects of free markets including minimum wages, universal minimum healthcare, and public housing, as well as competition bodies to ensure that industries do not become so concentrated that the markets no longer operate effectively.

Modern economies have one outstanding characteristic that is different to traditional economies: there is potentially no scarcity in money that is not backed by something physical like gold. Furthermore, interest rates and therefore the credit markets are explicitly manipulated by governments or their agencies.  It is one of many areas where the visible hand is quite dominant, and the influence is far from benign.

We are living in a period where growth is much slower than it was before the GFC, arguably because some of the credit excesses pre GFC have not been erased by an extended recession, and a proper reset did not occur.  Despite quite high levels of overall prosperity and high material standards of living across much of the developed world, rising income inequality and upheaval in traditional service and manufacturing industries has contributed to political polarisation and a rise in populist parties and leaders.  This in turn has made politicians in general more populist and likely to meddle in markets and more reluctant than ever to embrace any necessary but unpalatable economic policies.

Examples of poor policies abound and three Australian examples are discussed below: the insulation scheme, energy policy and the NBN. The focus will then turn to interest rates and credit.

Insulation scheme

The Rudd government, as part of a package designed to combat the economic effects of the financial crisis of 2007-8, announced a home insulation programme in February 2009.  By the time the scheme was abruptly abolished in February 2010, four installers had died and a Royal Commission was then set up to investigate the deaths.  By artificially boosting demand for insulation in a very short period, against the advice of the companies who made insulation, the government ensured huge distortions in the market.  The local producers, CSR and Fletcher Building, had to step up production and import product to keep up with soaring demand.  Knauf, a private German company saw the demand bonanza and set up in Australia for the first time using imports from the USA.  Insulation is a product one would normally not ship between distant continents as it is bulky and of low value, but the policy led to significant higher cost imports.  When the scheme was aborted:

  • huge excess inventories of insulation had to be destroyed at considerable cost to the producers (as insulation has a shelf life because it is packaged tightly to minimise space at the end of the production process)
  • a new competitor was introduced who arguably would not have spent the money setting up distribution, warehousing and sales channels
  • four people had died in the rush to take advantage of subsidies without reference to safety and training.  

Energy Policy

In Australia we have had a very inconsistent approach to energy policy in the area of renewables and carbon emission minimisation. Going through all the history in detail would no doubt be an insomnia cure for readers, the intention is simply to highlight that government meddling has distorted normal business economics.  

Renewables have needed subsidies to make them economically viable, particularly in Australia where we have traditionally had abundant cheap coal and gas.  Gas drilling has been outlawed in several states creating a shortage.  Elsewhere new coal power plants are currently being built delivering electricity at much lower cost than power prices in Australia, while locally coal would not be considered as a new source of power.  
Over time renewables will come down in cost, and in the distant future we might conceivably get all our electricity from hydro, wind and solar combined with battery storage, but that is some time away. In the meantime, Australian manufacturing is struggling, shrinking in an environment of very high power prices. Because we have disincentives for power from our cheapest and most reliable base fuel source, the consequence is higher power prices. Of course many people disapprove of coal and the carbon emissions, but at present we can’t have the luxury of being green and having the cheap power manufacturers require to be competitive internationally.

At present, owners of coal and gas generation have little incentive to invest in new generation or allocate capital to existing power plants.  Not only do renewable power sources receive subsidies, renewable plants have priority in supplying electricity to the grid, and it is expensive for baseload power to turn generation up and down depending how much wind there is.  Unsurprisingly, coal fuelled Hazelwood has closed in Victoria, almost all generation except renewables closed in South Australia and Tasmania, and Liddell (coal) is scheduled to close in NSW in 2022.  The previous excess supply of electricity has disappeared, and electricity prices have increased.  We have built renewables but of course renewables need the sun to shine or the wind to blow at the same time as there is demand for electricity.  Gas peaking plants are used to supplement renewables but are more expensive.  

The Government, wearing a populist hat, does not like the higher electricity prices which have resulted from uncertainty and their policies, and hence is seeking to restrain prices.   This will remove incentives to invest in the sector and possibly lead to shortages and emergency measures as happened in South Australia, and in Tasmania which had to buy expensive diesel generators because the rainfall was insufficient to provide all the required hydro power.  It is almost certain that government intervention in recent years has destroyed effective market signals, and politicians don’t welcome the unintended consequences.


In the telecommunications sector, the newly elected Federal Government decided in 2007 that Australia should have a national fibre optic network to carry broadband telecommunications, in a spirit of “nation building”. Tenders were submitted by various private parties including Telstra but none were accepted and overnight the Government Telcommunications Minister Stephen Conroy instead decided to form the NBN Corporation as a monopoly and to use Government funding to construct and operate the new network.  Estimates of the build cost quickly rose from tender levels (less than $10bn) towards $30 and $40bn, with the final number (over $50bn) still outstanding for a network that is not going to consist of as much fibre as originally claimed and speeds that have so far disappointed most users. The sorry tale of this white elephant will no doubt be material for a lengthy book in future.

The effect of the NBN has been to decimate the fixed line revenues and earnings of incumbent operators from Telstra and Optus to TPG and Dodo.  Unsurprisingly, companies reacted to mitigate the loss.  In particular, TPG has sought to cherry pick sites that would ordinarily be profitable for the NBN such as CBD buildings and apartment blocks where density makes for excellent economics in the context of pricing that is set with a view to cross subsidizing costly services to remote areas.  TPG has also bought spectrum to allow it to offer mobile services in the densely populated east coast cities, with the principal intention of offering mobile broadband as an alternative to the NBN (circumventing the NBN’s charges) rather than to become a major mobile player in itself.  The Government’s visible hand has greatly disrupted the industry, and few could argue that the project has been or will be an economic success.  It is certainly not living up to the fanfare with which it was announced.

In a low growth environment where many companies face challenges to maintain and increase profits, dealing with government interference can create significant unforeseen headwinds.  It is also hard for investors to anticipate these headwinds because they not only create market distortions; it’s often hard to find any beneficiaries other than lawyers and lobbyists as neither consumers nor businesses benefit over time, and hence such irrational policies are difficult to forecast.

Interest rates and credit

The greatest influence on the corporate and investment landscape by the visible hand of government is through interest rates and money.  Over time governments and their agencies have effectively devalued money through years of inflation which would not have been possible with disciplined monetary policies.  Inflation effectively favours borrowers over savers and therefore redistributes income without growing the value of the pie.  In recent decades credit growth has vastly outstripped income growth as banks have competed to lend to customers with increasingly poor creditworthiness, as lower interest rates have improved the affordability of the interest portion of loan service.

Because interest rates are effectively set or at least manipulated by governments, the huge expansion of credit is a direct result of government policy or at least government complicity.  Since the GFC the deliberate expansion of money and credit has been very explicit as Quantitative Easing has been pursued in many developed countries despite there being little or no evidence of any efficacy other than boosting financial asset prices.

Credit tends to support both asset values and consumption as many people now buy things they cannot immediately afford whereas a few decades back people only could buy what they had already saved up for.  Easy liquidity has driven up many asset values such as real estate, shares, commodities and bonds of varying quality.  Very low and even negative interest rates have destroyed useful market signals that would normally occur as investors have been pushed to take on risk beyond their usual preference in a desperate hunt for yields greater than the near zero safe yields.  

This in turn has allowed highly speculative companies and start-ups to prosper because they have had access to unusually cheap funding, in turn creating problems for their established competitors who may be relatively disadvantaged by having a more traditional and conservative approach to funding.  As Amazon has proved, it is very difficult to compete with a business that is very well funded by investors and lenders without having to deliver profits or cash flows for years.  A business that can sell things very cheaply and offer great service overall will virtually always succeed assuming that a lack of profits in the medium term is not a problem for the lenders and backers.  These are unusual times in that a lack of profitability is not necessarily perceived as a problem.  Abnormally low interest rates may have assisted consumers by creating competition in the short term but will not have helped should the disruptors become so strong they are effectively monopolies.

Governments’ visible hand in fostering the huge build up in debt and very loose credit conditions globally has also created a great deal of vulnerability for the economy.  High debt levels mean anything that changes perceptions of risk and therefore the willingness of private lenders to extend credit could have a major negative impact on the economy.

At IML we are very cognisant of the heightened risks in the economy and therefore continue to favour more defensive companies with more reliable and steady earnings.  This style has underpinned returns for our investors through a number of booms, busts and fads, and will continue to do so.

Short Sellers - can they help retail investors avoid 'bombs'

 DSC8761This article was written by Mark Draper and appeared in the Financial Review in the month of July 2018.

Mark writes a monthly column for the Australian Financial Review.


Good investors are rewarded for not just what they purchase, but just as much by what they let pass.  Could it be that much maligned short sellers could actually help investors avoid some of the stock market ‘bombs’.

Short selling is defined as the sale of a security that is not owned by the seller or that the seller has borrowed.  Short selling profits when the value of an asset decreases in price, enabling it to be bought back at a lower price.  By examining what short sellers typically look for as their targets can help retail investors avoid investment traps.

With this in mind I spoke with Andrew Macken, Portfolio Manager at Montgomery Investments who spent several years working with world famous short seller Jim Chanos.

Short sellers are sophisticated investors looking for weaknesses in businesses and business models.  Macken believes “there are 4 key characteristics that make a great short”.

  1. Structural decline at industry level.  These are structural headwinds within an industry that are likely to last for years not quarters.  Technological obsolescence is a good example of this characteristic such as video rental stores being disrupted by online content providers.
  2. Divergent Expectations.  This exists where market expectations built into the share price are overly optimistic.  Dominoes Pizza is currently one of the most heavily shorted stocks in the Australian market as short sellers question whether future growth may be at a lower level than what is currently reflected in the share price.
  3. Asymmetric risks.  This is when the downside risk is unequal, or greater than the upside risk.  These characteristics can lead to waking up one morning and seeing a share price down 30%. A stretched balance sheet is a good example of this, where one day the business is fine, and the next day the business fails to meet a debt covenant or refinance commitment.  Centro Properties was a high profile case study of this.
  4. Misperceptions.  These are instances of aggressive or creative accounting.  There are numerous ways in the accounting world that a business can be portrayed in a manner that is more flattering than the reality.  This can commonly occur during acquisitions where adjusting items such as goodwill can result in overstating future earnings. Fraud is the ultimate misperception. The Dick Smith IPO, which was labelled the “Greatest Private Equity Heist of all time” by Forager Funds Management is a classic example of a misperception and a detailed analysis on this can be found on their website.

Andrew’s ideal approach is to consider shorting companies that exhibit all four of these characteristics.

Those who own shares in a company that is being heavily shorted, means that sophisticated investors are flagging that some or all of these problems may exist in that company.  An increase in short selling activity could be an early warning signal that a problem exists.  So how can investors determine the level of short interest in a company.

ASIC provides a daily list of short positions on Australian listed companies on their website.  This information should also be available from a stock broker or financial adviser.  The information expresses how much of the company’s shares in percentage terms have been short sold.

Investors may be alerted to potential issues by watching trends of short selling activity and establishing whether the short positions are increasing.  

Clearly short sellers do not always get their calls right, just ask those who recently got burned being short in the Healthscope takeover offer.  But investors would be wise to keep an eye on short activity.  This could allow investors time to reconfirm (or otherwise) the investment case for a stock they own, or intend to buy, that is subject to material short interest.  As they say in sport, the team that makes the fewest mistakes wins, and maybe short sellers can help retail investors make fewer mistakes.

Australian Sharemarket Outlook - July 2018

GEM Capital recently hosted a client function with John Grace (Deputy Head of Equities - Ausbil Investment Management).  Ausbil are excellent investors who have enjoyed a very good track record over a long period of time.  They have enjoyed a very good investment return in the last 12 months as well.

The function was relaxed and conducted on a "Question and Answer" basis.

Here is the video of the function, together with a summary of the key topics discussed, together with the approximate time stamp in the video.

Topics covered:

0. Introduction to Ausbil and fund performance (1.00)
1. Overview of Macro Economic themes (2.30)
2. Banking Royal Commission (6.30)
3. One stock that has been our best call .... Bluescope Steel (10.00)
4. Telstra (and Telco sector) (12.00)
5. Question - Impact of Trade War threat (20.00)
6. Thoughts on household debt levels (30.00)
7. Benefits of Company Tax Cut (34.00)
8. Flight Centre (40.00)
9. Bionomics (46.30)
10. China - how is it changing (53.00)
11. Gold (56.00)
12. View on Australian Interest Rates (58.30)
13. Woolworths and Coles and Retail sector (59.30)



How to profit from Market Myths

In 1962, President John F Kennedy delivered Yale's graduating class of 1962 a piece of advice that all investors should hold dear:

"The great enemy of truth is very often not the lie - deliberate, contrived and dishonest - but the myth - persisent, persuasive and unrealistic .... We enjoy the comfort of opinion without the discomfort of thought"

All too often, investors rely on conventional wisdom.  Ideas that may have been true one dday, which are perhaps not relevant today. For those investors who fail to question the myths they have always believed, danger lies ahead.  On the other hand, great investment opportunities can stem from the continual questioning of conventional wisdom and the dispelling of myths.

This article has been reproduced on our website with the permission from Montgomery Investment Management.

Is discussed the myths surrounding Consumer Packaged Goods, and why they may be a dangerous place to invest.


Click on the image below to download your copy of this report.


China - What just happened?

Reproduced with permission from Charlie Aitken - Aitken Investment Management


This article is written by Charlie Aitken, founder of Aitken Investment Management.


Substantial outflows from emerging markets ETFs, driven by US Dollar strength, triggered large and relentless selling in the largest index weightings in Hong Kong (Chinese equities). Fears of a “trade war” have also weighed on China sentiment.

The Hang Seng China Enterprises Index (HSCEI) fell -7.6% in June, while the Chinese mainland benchmark, the Shanghai Composite Index (SHCOMP) fell -8.0%. From mid-January peak both indices are now down over -20%, triggering a technical “bear market”.

It has been a brutal and indiscriminate technical sell-off in Hong Kong. However, we remain confident in the investment case for Chinese consumer facing companies and the major technology platforms which have pulled back to what we consider compelling investment arithmetic. We will explore that investment arithmetic later in this note.

While Chinese stocks listed in China had a very poor month, it seems somewhat odd to us that China facing stocks listed on developed market exchanges such as the NYSE or ASX proved broadly immune to any price falls. That most likely suggests this is a violent emerging market to developed market rotation, rather than a wholesale de-rating of all things China facing.

We believe this is a technical ‘clearance sale’ in leading Chinese equities and we want to emerge from this rotational correction holding the very best fundamental portfolio of tier one Chinese structural companies we can.

Outflows from Emerging Market equities

The US dollar rally that began in May has seen significant outflows from Emerging Market equities. We can use the IShares MSCI Emerging Market ETF (“EEM.US”) as a good proxy to illustrate this point. EEM has seen a 20% redemption of units on issue since April (approx. $7.7bn of outflows at today’s prices). China is the biggest weighting in this ETF at 30% and Tencent is the biggest single stock weighting at around 5.5%, so redemptions from this ETF and all other products like it lead to direct selling of Tencent and other large cap Hong Kong Listed equities.

The following chart shows the number of units outstanding in EEM (the blue line) versus the DXY USD Dollar index (the red line) which we have inverted. In simple terms USD strength has seen an exodus from Emerging Market equities. For context the outflow in EEM over the past 8 weeks is greater than the outflow for the entire of 2015 when the world was in a China-centric deflationary spiral.

In 2015 evidence of a fundamental slow-down in China was obvious everywhere from Chinese economic data, to global PMIs, trade data, commodity prices and even Australian listed China facing equities. The most obvious example is BHP shares which have historically had a very strong correlation to H-Shares. The chart below shows the HSCEI Index (H-shares) versus BHP. One of these 2 is sending us the wrong message on Chinese economic fundamentals. The gap in this chart will close one way or another in the second half of this year. Note the divergence started around the same time as the EM exodus (BHP is not part of EM equities).

Is China grinding to a halt?

Relative to the strong-growth seen in 2017 we are definitely seeing a moderation of growth in China. This was evident in our recent trip to China and can been seen in monthly data series such as the YoY change in Industrial Enterprise Profits and the Li Keqiang index (which measures YoY change in rail freight data, power consumption and bank lending). However as can be seen below the picture at this stage is fundamentally different to what we saw in 2015. The key question is, are HK equities pre-empting a move in fundamentals or is this a market driven panic? 

What are markets pricing in?

Whilst the 2015 bear market in Chinese equities saw a combination of very high starting valuations and badly deteriorating economic fundamentals the picture today is quite different. The market PE for domestic Chinese equities is already below the trough of 2015. 

We see plenty of inconsistencies in global cross asset market prices at the moment. It feels like Hong Kong listed Chinese equities are pricing in a harsh slow-down in global growth whilst other equity markets (and other asset classes such as gold and commodities) are taking a more optimistic view. 

Below we present a snapshot of AIM’s four biggest Chinese holdings.

We believe all these businesses have very bright futures and are very attractively priced at current levels. They are the leaders of their industries, have expanding moats, have massive addressable markets, and are all platform businesses or benefitting from technology. We believe their earnings growth outlook is unchanged, we have recently met with management teams, and we have great confidence in their business strategy and execution abilities.

While it was a disappointing end to the financial year for those of us who are structurally bullish on China, we remain of the view that the potential for strong total returns remains in FY19 particularly given the entry points and highly attractive valuations of our core high conviction Chinese investments above.

Don’t run away from the clearance sale: take advantage and buy the best Chinese consumer brands while they are cheap.

The Best of the Best - June 2018

The Investment Team at Montgomery Investment Management regularly produce a report "Best of the Best".

We bring you the June 2018 edition.

This report is put together by the investment team, and not a marketing spin doctor.


Click on the image below to download your copy.


Let's take a look at the Banks results

Article reproduced with permission from Montgomery Investment Management.


In the midst of the Royal Commission into Misconduct in Financial Services, the major banks have released their latest half yearly results. The market headed into the reporting period with a high degree of apprehension given the public backlash emanating from the revelations coming from testimony at the Royal Commission to date.  In a number of articles over a long period of time, we have discussed our concerns about the outlook for revenue growth given the impact on loan book growth, that is likely to result from the turn in the long term structural decline in interest rates globally. Expected is a slowing of loan book growth, as volume growth is no longer boosted by the falling cost of debt, which has allowed households and businesses to sustain progressively higher levels of debt.

The first half results showed signs of this playing out, with loan book growth, based on the average balance for the period, continuing to slow on a sequential basis.




Screen Shot 2018-05-14 at 5.24.13 pm
Source: Company Data *CBA data represents the 3 months to 31 March 2018

Slowing loan growth has been offset in recent periods by rising net interest margins, as a result of the repricing of interest only and investment property mortgage rates. In 1H18, the banks benefited from some easing in the level of competition for deposits.

However, over the last couple of months, the banks have been exposed to rising benchmark short term wholesale interest rates (BBSW and LIBOR) relative to official central bank rates. This is expected to see the funding costs of the banks shift from being supportive for net interest margins to now presenting a headwind.

Net interest margins were down for three of the four majors, with negative mix in mortgages (switching to lower rate principal and interest mortgages) and a full period impact of the bank levy offsetting any residual repricing benefit.

The other factor to take into account is the impact of trading and markets activity on the net interest margin. This is a very volatile part of the equation. For ANZ (ASX:ANZ) and National Australia Bank (ASX:NAB), a weaker trading performance relative to 2H17 reduced net interest margin (NIM) in 1H18, while for Westpac (ASX:WBC) it boosted NIM materially.

Given the volatility of this income, this is a low value driver of NIM and should be looked at in a historical context when projecting into forward periods due to the likelihood of mean reversion. This is particularly relevant for WBC’s result in which the Markets and Trading component of the NIM is well above historical levels and therefore should be treated with a degree of caution when forecasting from this base.

The chart below shows the annualised rate of growth in net interest revenue for the four major banks in 1H18 relative to 2H17. Growth, excluding the impact of trading, provides a better indication of the underlying sustainable rate of growth in the period as it strips out the volatile impact of trading activity on NIM.

Screen Shot 2018-05-14 at 5.25.26 pm
Source: Company Data *CBA data represents the 3 months to 31 March 2018

Non-interest income was similarly soft, particularly once trading revenues and one-off profits from the sale of investments and businesses are excluded. This resulted in total revenue growth in the low single digits. We note that the Commonwealth Bank of Australia (ASX:CBA) trading update provided limited detail on the underlying drivers.

However, according to CLSA Australia’s banks team, net interest revenue was negatively impacted by a restructuring charge on a hedge from a funding issue last year, as well as a reduction in trading revenue and a proportionally more significant impact from the increase in Bank Bill Swap Rate (BBSW) in March given CBA’s announcement was for three rather than six month earnings.

Operating cost growth was mixed with higher growth from NAB and CBA while ANZ continues to reduce its cost base. The Royal Commission resulted in elevated cost growth in the period, and this will continue into the rest of this calendar year and potentially beyond. Excluding this, revenue would have increased in the March quarter.

Screen Shot 2018-05-14 at 5.26.58 pm

Source: Company Data *CBA data represents the 3 months to 31 March 2018

NAB’s increase excluding the upfront redundancies and write downs from its cost reduction strategy reflects an uplift in investment in the near term to assist the transformation of the business over the next few years. However, based on its guidance for flat operating costs between FY2018 and FY2020, aggregate costs over this three years period will be higher than average analysis forecasts prior to the announcement of the cost reduction programme in November last year.

Screen Shot 2018-05-14 at 5.28.04 pm

Source: Company, UBS, JPM, CS, DB, CLSA, Citi

Slowing revenue growth is continuing to turn up the heat on management to reduce operating costs as an offset.

Provisions for bad debts were once again a positive for the net profit outcome.

Unlike in recent results, the main source of surprise came from lower new individual provisions rather than write backs of prior period charges. This is despite a continuation of the modest increases in mortgage arrears. Of most concern was CBA’s comment that “there has been an uptick in home loan arrears, influenced by a small number of customers experiencing difficulties with rising essential costs and limited income growth”. This could be the first signs of a squeeze on household budgets that has been a core part of the bear thesis for those warning about the outlook for the bank stocks.

While ANZ and Westpac (ASX:WBC) continued to reduce their collective provision balance as a proportion of credit risk weighted assets (meaning these banks have less of a buffer against a downturn in credit quality), NAB actually increased its collective provision balance.

Screen Shot 2018-05-14 at 5.29.06 pm

Source: Companies

Bank capital levels were generally in line with market expectations, with ANZ surprising to the upside. CBA highlighted the future impact of the Prudential Inquiry by APRA which will require it to increase its operational risk regulatory capital by A$1billion from 30 April 2018. The introduction of AASB 9 will also see CBA increase its collective provision balance by A$1.05 billion. These two issues will reduce CBA’s Common Equity Tier 1 *(CET1) ratio by 53 basis points. CBA expects a 70 basis point increase in its CET1 ratio from the sale of its Australasian life insurance operations in the next 8 months, but this will also reduce CBA’s sustainable earnings and capital generation in future periods.

The Montgomery Funds own shares in Westpac and Commonwealth Bank  This article was prepared 15 May 2018 with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade Westpac or Commonwealth Bank you should seek financial advice.

The Rise of Asia (podcast) - Joe Lai Platinum Asset Management

Mark Draper (GEM Capital) recently spoke with Joe Lai who is the portfolio manager of Platinum Asia fund.

We are pleased to bring you the podcast from this discussion and for those who prefer it, here is a transcript of the interview.


Joe specifically talks about why he believes China is unlikely to experience a debt crisis despite the constant media attention it receives and he outlines the magnitude of the investment opportunity in China.




Speakers:  Joe Lai (Platinum Asset Management) and Mark Draper (GEM Capital)

Mark:  Joining us here is Joe Lai from Platinum Asset Management and in particular, Platinum Asia, who Joe runs the listed investment company, Platinum Asia, as well as the unlisted version of Platinum Asia that you find across the spectrum. Thanks for joining us, Joe.

Joe:  Hi, Mark, thanks.

Mark:  We’ll start with the Asian markets because they’ve had a big run, albeit from the low base.

Joe:  Yeah.

Mark:  18 months ago, 2 years ago. So, is this run—sustainable is not the right word, but is this as good as it gets or can investors expect decent returns from the Asian sector going into the future?

Joe:  Yeah, look, I mean, what we believe the opportunity in Asia is one of a long-term opportunity because the growth rate in Asia is going to be, you know, robust, and going forward for quite a long time. And also, the scale of opportunity is just unparallel compared to anything else we’ve seen for a very, very long time.

Growth rate on China, even we’re saying that China is growing at—slowing a bit from the heady days of 8 or 9% growth, to about 6 to 6-1/2% growth, that would be still one of the fastest growing regions of the world.

And outside of China, we’ve got countries like India and also the ASEAN countries. I mean, these are countries with, you know, collectively, more than a billion people and for the region itself, it’s close to three billion people. They are going to grow in a way—in excess of 3-4% on average. Again, the scale is huge.

Mark:  And compare that to the American market, the American population I think is somewhere between 3-400.

Joe:  Yes, about 300 million people and it’s growing much slower.

We look at that long-term trajectory, I think, is very, very good. And then we look at the markets. I mean, there’s a lot of concern about valuations and whether we’ve peaked. I mean, the U.S. market is definitively expensive if we look at price to earnings multiple or price to book multiple. In fact, if we look at a lot of EPS growth that the American market has been able to generate, a lot of it has been through financial engineering.

What I’m talking about is borrowing money, companies borrowing money, and do share buy-backs, to reduce the number of shares outstanding to—

Mark:  Which then increases earnings per share.

Joe:  Yeah, absolutely. But in the case of Asia, that has not been the case. Perhaps the Asian corporates or CFOs are a little bit behind in terms of doing engineering, engineering the balance sheets. But certainly a lot of the upside in Asia has been a result of actual earnings growth in the last few years as opposed to EPS growth or a great deal of market re-rating or the PE ratio going up.

Mark:  You talk about 6-1/2% growth, but I think—and which is less than 9% growth—but the reality is that China’s been growing at a big rate for a long period of time. Is it possible to put some perspective on the size of the economy? Say compared to where it was historically? Because 6-1/2 might not sound great, but 6-1/2 on a big number is a big number.

Joe:  Yeah. I mean, the size of the Chinese economy is by no means small. At the moment, it’s probably slightly more than 10 trillion U.S. dollars and U.S. is probably 16, 17. On an aggregate basis, it is still smaller, but however, when we look at many of the industries in China, they’re already bigger than that of the U.S. I mean, these may be an interesting fact which a lot of people may not realize, if we look at the passenger car market in China, they’re running at about—selling about 28 million passenger cars a year. U.S. is about 20 million.

That market alone, which is a big part of the economy really, it’s already about 40% bigger than that of the U.S. or Europe. 

The other part of it is this: That market is still growing. I mean, still growing at about 5% to 10% a year and most people buying cars in China are not reliant on car financing. That’s very different to, I guess, the more developed markets. Eventually, how big this market will grow into, it’s hard to estimate. That’s one.

But when we look at the property market clearly, the Chinese market is a lot bigger than anything else in any other parts of the world, literally, two, three, four times the size of Europe or U.S. If we look at the smart phone markets—I mean, I’m talking the smart phone here which is, I’m sure are made in Taiwan or Mainland China. China domestic smart phone market is about half a billion. 

Mark:  It’s about 500 million.

Joe:  It’s 500 million.

Mark:  New handsets every year.

Joe:  New handsets a year. U.S. is about a 150 million, so even that market, which is—you wouldn’t say is a back water, sort of like—we’re not talking about sports shoes or T-shirts, we’re talking about a smart phone. Sure, some parts are coming from Japan or Taiwan or U.S. to make the smart phone, but they’re producing a lot of these parts domestically in China as well, as they climb the technological ladder.

The smart phone market it literally  two, three times the size of U.S. or Europe and the car market is 50% bigger than U.S. or Europe. That is the scale already. We’re talking about when the economy is about, probably two-thirds the size of the U.S., officially. So, I guess, that’s how far they’ve come and they’re going to—the aim for them is to climb the technological ladder and to clean up the environments going forward.

Undoubtedly, I mean, they will continue to progress further. Compared to where they started, I guess, since liberalization, the GDP per capita of China, if we look back 35 years ago, it would be very close to that of North Korea. I mean, it’s amazing. This country has taken off where some of the countries haven’t moved on at all. That’s, I guess, the scale and opportunities there.

Mark:  And part of that is driven by population growth, but it’s more than population growth. It’s the rising wealth in middle class here, so you’ve spoken about car ownership, you’ve spoken about mobile phone and internet access.

Joe:  Yeah.

Mark:  What are some of the other things that you’re seeing in China that as middle class develops, they’re spending money on, that by extension creates investment opportunity, clearly.

Joe:  Okay. I mean, that’s a lot of stuff—which a lot of things which are changing for the better. I guess if we sort of go back one step. I mean, what is underpinning sort of this growth in income and all productivity is because they’ve done the appropriate amount of investment in various things. If you travel to China these days, you’ll see that they’ll have first class infrastructure in roads, telecommunication, a 4G network. The high-speed rail, which just completely opened up the country. Even the smaller cities offer a few million people.

So, you mentioned you’re doing business that you can actually ship things around and things just work.

Mark:  Yeah.

Joe:  And also, the investment in education is actually quite interesting. Each year there’s about 8 million university graduates that China produces.

Mark:  8 million is a third of the population of Australia every year as your graduates. [Laughs]

Joe:  Yeah. And this number actually has ramped up in the last five or six years, so there has been some effort to increase the supply of skilled labor into the economy where because there has been a desire for the economy to lift productivity, to climb the technology ladder, they knew that they needed people. And of the 8 million, half of which are actually engineers and scientists. I mean, it’s actually what they need. That’s very different, I guess, to other countries which actually haven’t grown their university graduates or the focus on engineering and science may have actually gone backwards in the last 5 or 10 years.

Investment in infrastructure and education are key for—to sort of the strong underpinnings for economic development for the country.

So, looking forward, we mentioned about cars and we mentioned about smart phones. These are markets which are already bigger than in the U.S. compared to—sorry, bigger in China, compared to I guess developed countries in those market size.

There are some areas which China is still smaller in aggregate than Western countries. And we sort of have experienced some of it in this country, like things relating to consumption of insurance, healthcare, some of the luxury goods, some of the—I guess things which are more, I guess, differentiated or tastes which they’ve yet to acquire.

I guess in this country we’ve seen the vitamins doing well. Perhaps some of the milk stuff from New Zealand and also wines going well. These are some of the stuff, I mean, we’re not directly involved in those because these are sort of, I guess, local companies. But the markets which I mentioned, insurance and healthcare, and some of the technology companies, I mean, the insurance market in China is small compared to that of Western countries on a per-capita basis.

Even if you go to places like Shanghai, the insurance penetration is literally a fraction of that of Hong Kong or Taiwan, but you know that it is an essential product that people would want, once they have money and they want to protect their wealth, they want to protect their family’s livelihood.

Mark:  You’re talking life insurance or you’re talking car insurance, house insurance, etc.?

Joe:  Yeah, yeah. So that’s interesting. And we’re seeing private companies in China doing very interesting things. Some of these industry leaders are doing things which are leading, I think, most of the world. For example, we own one of our biggest, or bigger, positions is a company called Ping An Insurance. I mean, they’ve actually applied artificial intelligence in a big way. I mean, literally spending literally billions of dollars over the last, about three or four years, on improving their ability to serve the customers by using AI. They’ve got a voice recognition product that when you call up, they can, I guess verify your identity without you telling them anything. I mean, you know, when we call up Telstra and ask you for date of birth or address to certify that’s who you are, but here they’ve got technology to go to Mr. A and then we know this voice and then if this voice matches, that’s him. 

So, that’s something like that. And also, when the people have car accidents, they’ve got this thing on the smart phone, this app on the smart phone where they can launch their claim. I mean, they can photo of the car, where the damage is, and actually utilizing artificial intelligence to work out what is the damage and also the cost of repair. Then this is, I guess, good for controlling fraud. It’s good also for customer experience.

I mean, these are just some of the things which are happening very rapidly in China because it’s the investment cycle in China of experimentation, try something out. If it works, use it. If it doesn’t, let’s move on. It’s much faster than most other countries.

And then of course healthcare. The next area is healthcare. So the market in China is more and in fact, we’re seeing this to be growing rather quickly because—

Mark:  Have they got a national healthcare scheme at the moment?

Joe:  Absolutely, Mark. I mean, that’s been ramping up. The desire from the government is to improve the livelihood of those people who sort of didn’t share as much in the fruits or dividends on economic growth in the last 20 years. Over the last few years there’s been progressive rollout of coverage in terms of health insurance. I mean, it’s not perfect. But nowadays, most people in China are covered by one kind of insurance or another, mostly public based and then some are local government based. But what it means is that going forward, we think that the consumption of healthcare will continue to grow, almost irrespective of the growth or GDP growth of the country.

And as the people get more discerning in terms of their healthcare, they will start to use some of the drugs which Western countries are used to. Like if you actually look at the top 10 selling drugs in most Western countries, including Australia, these days, most of those drugs are what are called biologics and they’re actually quite expensive. Expensive drugs which can target specific diseases very accurately. Gone are the days of using one drug to treat everything. It’s almost very titled medicine.

I mean, I was a medical doctor before I did this, working in this industry and the type of drugs I’m seeing today is truly amazing and China is starting to adopt these drugs as well. We own some companies which are producing some of these biologics in China. They’re not the easiest to produce and these drug are not even in the top hundred in the Chinese league of drug sales, whereas some of these drugs are already top 10, including these countries.

That to us is very interesting and it’s going to grow multiples the pace of the economy.

Mark:  Are you seeing homegrown healthcare companies compete with the West?

Joe:  Yes.

Mark:  Or are you seeing Western healthcare going to Asia?

Joe:  Yeah, I mean, that’s an interesting question, Mark. I mean, it has certainly been a mix of the two. And the fact is, I mean, it would go to the issue of scale and accountability. I mean, China is almost unparalleled compared to most other countries. But bottom up work suggests that in early days, foreign companies would go into China and sell their drugs or medical devices and actually at a quite high price, because it’s seen as like a luxury good. You know, they can charge—the prices we pay in Australia would be literally a fraction of how much these local Chinese people paid previously.

As you can see, the dynamic, together with sufficient capability, but domestic eyes and capital to invest in R&D, what have you, creates this dynamic where the pressure for the locals to actually substitute for the imports is very high because they can see that if they do well, first of all, they’ll make a lot of money. Second of all, there is some government support for the locals. Thirdly, it is—they also, I think, recognize that they’re doing a benefit for the local people who may not be able to afford imported drugs.

In the case, just some examples, in the case of insurance, I mean, I think some listeners may know insulin, basically it’s used to treat diabetes. There’s different types of insulin and in most parts of the world, this market isn’t only. It’s dominated by four or five, probably four companies. Sales are different, the same kind of insulin, but at a very high price.

In China, there’s already drug companies making insulin, which is actually very uncommon. I mean, it’s almost happening nowhere in the world, so we’re sort of investing in one of them to provide, I guess, cheaper version of high-quality insulin in the country. 

The other element, the other example I can cite, is cardiac stents. These are things which are used to treat blockage of the arteries, in the heart. Again, this is, in the rest of the world, is an oligopoly, controlled by a few big U.S. and European companies. In China, more than half, in fact, maybe 60% or 70% of the cardiac stents are made domestically, by domestic companies. 

Mark:  Right.

Joe:  And some of them are trying to sell it overseas. They’re very successful. We are sort of invested in one of the companies there as well which makes cardiac stent for the locals. They’ve actually gone around the world in acquiring the second player globally, or third player globally, of pacemakers…what else? Orthopedic prosthesis, to bring it back to the country. To maybe make it at a lower price, but huge market. But the product itself is—the products themselves are superior to what the locals have been making previously.

So, I mean, we find that to be rather a prospective area to have some money.

Mark:  One of the perineal things that seems to be around the Australian media is the expectation of a Chinese credit crises or a banking collapse over there. Can you give us a feel for whether that’s reality or misguided?

Joe:  Yeah, look. I mean, okay, I think it’s misguided. It is understandable why there has been a concern because China has ramped up as a country, rammed up its debt load since the global financial crises. And a lot of it is the stimulus which they implemented. But the good news is this is something that everyone knows about. I mean, if there’s anything that we can trust the local Chinese authorities to do, is to count. They can actually calculate and count where the problems are. I mean, it’s been like literally six, seven years since even Western countries or people outside the country started to talk about geez, there’s debt. You can imagine and I think you can believe that the local authorities who are interested in a 30, 50-year future for the country or more, to want to diffuse any problem that may have arisen as a result of the stimulus.

What are we looking at today? China’s debt to GDP is actually about 250%. And okay, to put it into context, that is actually similar to most developed countries. I mean, USA is about 250, 260. European area is about 250. Japan is about 400% to GDP, so it’s a lot higher and it shows that a country with a trade surplus actually can sustain very high level of debt, because it means that they’re not relying on foreign capital to fund their debt when they run the trade surplus. And Japan is the case, is a good example.

If the absolute accurate good level is high and it’s ramped up quickly, but it’s not disastrous and in fact, it’s manageable. And the second thing is, almost all the debt in China is domestic. In other words, they’re not reliant on foreign countries or people or corporations to keep buying their bonds. They can actually buy their bonds themselves with the savings.

Mark:  Like its self-funded.

Joe:  And the other benefit of having all the debt in domestic currency is that if really push comes to shove, they can print money, which I guess most countries have done in the last five—or since the GFC. There’s all these levers they can pull. 

The next thing is, as we mentioned before, this problem is not unrecognized and if you Googled—I mean, there has been some—basically its getting managed and that’s been, I think, increasingly recognized by people. The Bridgewater guy, Ray Dalio, I think he recently did an interview, mentioned about that. It’s interesting, he said, well, you know, in the GFC, we have I guess developed countries, central banks reacting to the problem. But here we actually have a forthright regulator trying to deal with the problem and in fact, he thinks they’re doing a good job. But anyhow, that’s just an aside.

But what I believe is that China is already trying to reduce the growth of the loan and they call this process deleveraging, which means slow down the growth of loan and then look where the problems are. They’re probably more than halfway through this process and I think at the end of it, the banking system will actually look rather nice. And then after that, even now, you ask the question: What else can we say that’s wrong with the country? I mean, it’s actually a difficult thing to come up with. [Laughs]

Mark:  Donald Trump has helped in that respect because he’s, through his Twitter account, talked about potential trade wars. Is that something that is concerning you guys?

Joe:  Look, I mean, the fact is, I mean, I find it so hard to predict what Trump—what Mr. Trump is going to say or do. But if we—I guess put it this way, if we go down the path of an all-out trade war, it’s clearly not good for markets, and particularly, I think, it may change the way how people assess the U.S. market, especially given the valuation of that market because put up tariffs and whatever, it is going to harm them just as much as harm everyone else. Just increasing inflation, reduce the ability of people’s real—or reduce real income for the people.

But I think if one, I guess, try to rationalize it, everyone knows that it’s a bad outcome for all and so it makes—it actually makes no sense for anyone to want to go down this path in a big way. There may be skirmishes and there may be some people making statements to actually have across the board withdrawal basically of globalization. I just don’t see how anyone can effectively support that.

The reaction from, I guess, the key countries, interesting. We see these aluminum steel tariffs, which, Trump talked about. China actually didn’t say much about it. They actually said, it’s not good.

Mark:  Canada was vocal.

Joe:  Yeah, and the reason is, as you know, Mark, that the percentage of Chinese imports into U.S. in these two products is literally less than 5%. I think the percentage of Chinese imports or steel imports in the U.S., China constitutes maybe 2% or something like that. It’s very low percentage. Certainly, it’s a very, like less than 1% output of Chinese steel industry. So, they go, okay. 

But whereas Canada is a much bigger part and Mexico and also Brazil and maybe even Korea or Japan.

They’re not too worried but I guess if we go down this path, then it would be something. But also last week, I mean, China sent one of the leaders—this is a guy below the presidency—over to the States to talk to the people in the White House about this issue. It is something that, in a way, they don’t want to—

Mark:  It’s not the steel and aluminum and such, it’s the bigger issue of whether it’s more widespread.

Joe:  Yeah. It becomes more widespread and because everyone—and so they do want to stave off this—Mr. Trump going down this path by, I think they will announce some things to try to appease him. Whether it’s enough or not, I think it will, I guess, calm down the situation somewhat. But of course, if there is real impact made to the various economies, particularly in China, they would retaliate in the form of maybe tariffs on some of the agricultural imports from the States and maybe cars. I mean, the truth is, most car companies—a lot of foreign car companies, from China’s perspective, are reliant on the Chinese market for profits.

Mark:  GM, Ford. They’re all there.

Joe:  GM, Ford, yeah. And it is the biggest car market in the world. It makes no sense to go down this path, but I can’t really predict one way or another.

Mark:  It’s a good answer. And sorry to drag down the tone actually of this conversation about Asia with Donald Trump.

Joe:  That’s all right.

Mark:  But that’s just something to cover off. 

Joe:  Yeah.

Mark:  It is a generational opportunity to invest in the Asian region and thanks very much for your time to explain some of how you guys are going about harnessing this opportunity for investors. Thanks, Joe.

Joe:  Thanks, Mark.

[End of Audio]


Telstra - Good Value or Value Trap?

Mark Draper (GEM Capital) is writing a monthly column for the Australian Financial Review.  This article will appear in the print edition of the Financial Review on Wednesday 13th June 2018.

At the time of writing, Mark did not own Telstra shares.


If you have any story ideas that you would like us to write about, we would love to hear from you.


 Here is the article.


Telstra look’s cheap on a valuation model (see chart below), but is it a value trap?

The trouble with valuation models is that they rely on assumptions.  We are of the view that it is better for investors to spend time thinking about what is likely to alter the inputs of valuation models, such as margins and competition rather than finessing the model itself.

Telstra has a dominant market position, the best infrastructure in the country and receives high margins for its services and yet trades on a Price Earnings ratio on a historic basis of less than 9 times. 

The latest trading update from Telstra showed deteriorating earnings and falling margins.  The bright spot for Telstra was that free cash flow was at the upper end of forecasts, while earnings was at the low end.  The dividend at 22 cents per share for this year was confirmed, putting the stock on a juicy yield of over 7% fully franked. The dividend on a medium term view however is under a cloud, particularly once the one off NBN payments stop.  It is important for investors to look beyond todays yield and to concentrate on the future earnings of Telstra in order to determine value.

Telstra earns most of its money from broadband and mobile divisions, so it is critical that investors understand what is happening in these divisions well.

The core earnings of the Mobile division are under pressure.  After years of customers flooding to Telstra’s mobile network, a recapitalised Vodafone is growing market share and TPG will turn on their network later in 2018, initially offering free service for 6 months and then offering plans at a jaw dropping rate of $9.99 per month.  Average revenue per user in Telstra’s mobile division is around $65 per month today, but TPG and other competitors are likely to force this to below $50 per month according to analysts at Intelligent Investor. Telstra currently enjoys margins from its mobile business of around 40% but this margin as well as customer numbers are under threat.  

The NBN offers no comfort for Telstra share holders either, as around 180 NBN resellers are fighting for market share.  The economic model of the NBN looks challenged, but even if access charges to NBN resellers were to fall, there is no certainty that the price cut to access charges would improve margins, or simply be competed away.  As the NBN grows it transforms Telstra from an asset owner into a reseller.

5G, which is to be launched next year, potentially makes parts of the NBN redundant according to several institutional investors.  That is a potential positive for Telstra as they would receive income directly from their 5G customers, most likely at a higher margin than reselling the NBN.  The unknowable question however is how much will Telstra need to spend to buy 5G spectrum.  

Roger Montgomery from Montgomery Investment Management currently believes the ability for Telstra management to cut costs is under-appreciated by the market.  Telstra has already announced cost savings of $1.5bn, but if larger savings can be made, this could help fill an earnings blackhole of around $3bn.

Telstra is an outstanding mobile operator with infrastructure advantages, but the risky thing is its ambition to offset declining broadband and mobile margins with a plan to become a global technology business.  If management can execute this strategy well, shareholders would be rewarded, but it carries material execution risk.  

Telstra management plan to provide a critical update to the market during June 2018 about their future plans for business.

It seems that there is universal agreement that Telstra’s earnings decline in the foreseeable future. So despite the share price having some valuation appeal we are likely to wait until the June update from management before making our next move.

Souce: Skaffold



Why investors should be wary of rising long term interest rates?

Why investors should take notice of rising bond rates

Are the Bond market ghosts of 1994 coming back to haunt, or is this as high as long term interest rates rise?  That’s unknowable at this stage, but investors should ensure their portfolio’s can weather rising interest rates.

Investment strategies that worked well while interest rates fell, are unlikely to be rewarded when rates rise.  

Long term interest rates, particularly the 10 Year US bond rate (also known as the risk free rate of return) is important to investors as an anchor point against which asset prices such as property and shares, are measured.  Generally speaking a higher long term interest rate results in lower asset prices, in the absence of earnings growth.

Future inflation expectations are filtering into long term interest rates following stronger than expected US wage growth in the first few months of 2018.  This has resulted in the total returns for Investment Grade (IG) bonds having their worst start to a year in 20 years.

Chart provided courtesy of Intelligent Investor

US 10 Year Rates have doubled since July 2016 from under 1.5% to currently around 3%.  This has seen long term bond prices fall (price of bonds fall as rates rise). Assets considered bond proxies including infrastructure and property have also come under pressure during this time.

Long term bonds, which feature in many investors portfolio’s under the labels of “Fixed Interest”, “Bond” or “Conservative” funds/ETF’s are vulnerable to rising interest rates, particularly those with longer duration.  While rising interest rates increase the income from bonds, rising rates can be devasting to the capital value of a bond portfolio owned in managed funds, ETF’s and super funds.  The chart below shows the capital destruction of US Bonds and Australian 10 Year bonds in the event of rates rising by 2% and 4% respectively from current levels.  Not exactly a defensive investment in a rising interest rate environment!

Source: Bloomberg


Bond proxies such as infrastructure and property are generally considered to be negatively impacted by rising long term rates, but caution is required before dismissing these assets during periods of rising rates.

Assets such as toll roads can offer some protection from rising inflation and increasing interest rates as toll revenue is usually linked to inflation.  Therefore rising inflation (which generally feeds higher interest rates) can result in material earnings growth for toll roads.  Citylink tolls as an example are linked to inflation.

Infrastructure businesses can see an increase in the cost of debt funding as rates rise, and these businesses generally carry high levels of debt.  While higher interest rates obviously increase the cost of debt servicing, good infrastructure businesses have used the extended period of low interest rates to secure long term debt at low rates which means that the impact of rising interest rates may not be seen for many years.   During 2017, Zurich Airport, raised debt for a 12 year term at 0.6214% interest. 

Property investors where rents are linked to CPI can offer some protection against rising inflation and rising rates, but there are some property sectors where rents are under pressure, such as retail property.

While clearly there are potential losers from rising interest rates, there are also potential winners.  Companies that hold large fixed interest portfolios of short duration, such as insurance companies stand to earn materially higher levels of investment income.  Computershare is another listed company in Australia whose earnings stand to benefit from rising rates from client funds it holds.

For other parts of the share market, rising company profits are the best defence against the negative valuation effects of rising rates.  Earnings growth for the ASX200 is forecast to remain at high single digits for financial years 2018 and 2019 (source Ausbil Roadshow) and Asian company earnings are forecast to grow at double digits this year.  This should cushion share prices against the valuation impact of rising rates.

With the unwinding of Quantitative Easing (money printing) in the US, and with the Euro region likely to follow suit soon, it seems that the interest rate environment has changed.  Investors should check their investment strategy is positioned for a rising interest rate environment.

Trump and Trade War Risks

Written by Shane Oliver - Chief Economist AMP



After the calm of 2017, 2018 is proving to be anything but with shares falling in February on worries about US inflation, only to rebound and then fall again with markets back to or below their February low, notwithstanding a nice US bounce overnight. From their highs in January to their lows in the last few days, US and Eurozone shares have fallen 10%, Japanese shares are down 15% (not helped by a rise in the Yen), Chinese shares have fallen 12% and Australian shares have fallen 6%. So what’s driving the weakness and what should investors do?

What’s driving the weakness in shares?

The weakness in shares reflects ongoing worries about the Fed raising interest rates and higher bond yields, worries that President Trump’s tariff hikes will kick off a global trade war of retaliation and counter retaliation which will depress economic growth and profits, worries around President Trump’s team and the Mueller inquiry, rising short-term bank funding costs in the US and a hit to Facebook in relation to privacy issues weighing on tech stocks. The hit to Facebook is arguably stock specific so I will focus on the other bigger picture issues.

Should we be worried about the Fed?

Yes, but not yet. The risks to US inflation have moved to the upside as spare capacity continues to be used up and the lower $US adds to import prices. We continue to see the Fed raising rates four times this year and this will cause periodic scares in financial markets. However, the Fed looks to be tolerant of a small overshoot of the 2% inflation target on the upside and the process is likely to remain gradual and US monetary policy is a long way from being tight and posing a risk to US growth.

What’s the risk of a global trade war hitting growth?

In a nutshell, risk has gone up but is still low. This issue was kicked off by Trump’s tariffs on steel imports and aluminium and then went hyper when he proposed tariffs on imports from China and restrictions on Chinese investment into the US and China threatened to hit back. It looks scary and is generating a lot of noise, but an all-out trade war will likely be avoided.

First, the tariff hikes are small. The steel and aluminium tariffs relate to less than 1% of US imports once exemptions are allowed for and the tariffs on Chinese imports appear to relate to just 1.5% of total US imports. And a 25% tariff on $US50bn of imports from China implies an average tariff increase of 2.5% across all imports from China and just 0.375% across all US imports. This is nothing compared to the 20% Smoot Hawley tariff hike of 1930 and Nixon’s 10% tariff of 1971 that hit most imports. The US tariff hike on China would have a very minor economic impact – eg, maybe a 0.04% boost to US inflation and a less than 0.1% detraction from US and Chinese growth.

Second, President Trump is aiming for negotiation with China. So far the US tariffs on China are just a proposal. The goods affected are yet to be worked out and there will a period of public comment, so it could be 45 days before implementation. So, there is plenty of scope for US industry to challenge them and for a deal with China. Trump’s aim is negotiation with China and things are heading in this direction. Consistent with The Art of the Deal he is going hard up front with the aim of extracting something acceptable. Like we saw with his steel and aluminium tariffs, the initial announcement has since been softened to exempt numerous countries with the top four steel exporters to the US now excluded!

Third, just as the US tariffs on China are small so too is China’s retaliation of tariffs on just $US3bn of imports from the US, and it looks open to negotiation with Chinese Premier Li agreeing that China’s trade surplus is unsustainable, talking of tariff cuts and pledging to respect US intellectual property. While the Chinese Ambassador to the US has said “We are looking at all options”, raising fears China will reduce its purchases of US bonds, Premier Li actually played this down and doing so would only push the $US down/Renminbi up. It’s in China’s interest to do little on the retaliation front and to play the good guy.

Finally, a full-blown trade war is not in Trump’s interest as it will mean higher prices in Walmart and hits to US goods like Harleys, cotton, pork and fruit that will not go down well with his base and he likes to see a higher, not lower, share market.

As a result, a negotiated solution with China looks is the more likely outcome. That said, trade is likely to be an ongoing issue causing share market volatility in the run up to the US mid-term elections with Trump again referring to more tariffs and markets at times fearing the worst. So, while a growth threatening trade war is unlikely, we won’t see trade peace either.

Australia is vulnerable to a trade war between the US & China because 33% of our exports go to China with some turned into goods that go to US. The proposed US tariffs are unlikely to cause much impact on Australia as they only cover 2% of total Chinese exports. The impact would only be significant if there was an escalation into a trade war.

Should we worry about Trump generally?

Three things are worrying here. First, it’s a US election year and Trump is back in campaign mode and so back to populism. Second, Gary Cohn, Rex Tillerson and HR McMaster leaving his team and being replaced by Larry Kudlow, Mike Pompeo and John Bolton risk resulting in less market friendly economic and foreign policies (eg the resumption of Iran sanctions). Finally, the Mueller inquiry is closing in and the departure of John Dowd as Trump’s lead lawyer in relation to it suggests increasing tension. The flipside of course is that Trump won’t want to do anything that sees the economy weakening at the time of the mid-term elections. But it’s worth watching.

What about rising US short term money market rates?

During the global financial crisis, stress in money and credit markets showed up in a blowout in the spread between interbank lending rates (as measured by 3-month Libor rates) and the expected Fed Funds rate (as measured by the Overnight Indexed Swap) as banks grew reluctant to lend to each other with this ultimately driving a credit crunch. Since late last year the same spread has widened again from 10 basis points to around 58 points now. So far the rise in the US Libor/OIS spread is trivial compared to what happened in the GFC and it does not reflect credit stresses. Rather the drivers have been increased US Treasury borrowing following the lifting of the debt ceiling early this year, US companies repatriating funds to the US in response to tax reform and money market participants trying to protect against a faster Fed. So, it’s not a GFC re-run and funding costs should settle back down.

Source; Bloomberg, AMP Capital  

Is the US economy headed for recession?

This is the critical question. The historical experience tells us that slumps in shares tend to be shallower and/or shorter when there is no US recession and deeper and longer when there is. The next table shows US share market falls of 10% or greater. The first column shows the period of the fall, the second shows the decline in months, the third shows the percentage decline from top to bottom, the fourth shows whether the decline was associated with a recession or not, the fifth shows the gains in the share market one year after the low and the final column shows the decline in the calendar year associated with the share market fall. Falls associated with recessions are highlighted in red. Averages are shown for the whole period and for falls associated with recession at the bottom of the table. Share market falls associated with recession tend to last longer with an average fall lasting 16 months as opposed to 9 months for all 10% plus falls and be deeper with an average decline of 36% compared to an average of 17% for all 10% plus falls.

Our assessment remains that a US recession is not imminent:

  • The post-GFC hangover has only just faded with high levels of confidence driving investment and consumer spending.
  • US monetary conditions are still easy. The Fed Funds rates of 1.5 - 1.75% is still well below nominal growth of just over 4%. The yield curve is still positive, whereas recessions are normally preceded by negative yield curves.
  • Tax cuts and increased public spending are likely to boost US growth at least for the next 12 months.
  • We have not seen the excesses – debt, overinvestment, capacity constraints or inflation – that precede recessions.

We have not seen the excesses – debt, overinvestment, capacity constraints or inflation – that precede recessions.

Falls associated with recessions are in red. Source: Bloomberg, AMP Capital.

What should investors do?

Sharp market falls are stressful for investors as no one likes to see the value of their wealth decline. But I don’t have a perfect crystal ball so from the point of sensible long-term investing:

First, periodic sharp setbacks in share markets are healthy and normal. Shares literally climb a wall of worry over many years with numerous periodic setbacks, but with the long-term trend providing higher returns than other more stable assets.

Second, selling shares or switching to a more conservative investment strategy or superannuation option after a major fall just locks in a loss. The best way to guard against selling on the basis of emotion after a sharp fall is to adopt a well thought out, long-term investment strategy and stick to it.

Third, when shares and growth assets fall they are cheaper and offer higher long-term return prospects. So the key is to look for opportunities that pullbacks provide.

Fourth, while shares may have fallen in value the dividends from the market haven’t. So the income flow you are receiving from a well-diversified portfolio of shares remains attractive.

Fifth, shares often bottom at the point of maximum bearishness. And investor confidence does appear to be getting very negative which is a good sign from a contrarian perspective.

Finally, turn down the noise. In periods of market turmoil, the flow of negative news reaches fever pitch. Which makes it very hard to stick to your well-considered long-term strategy let alone see the opportunities. So best to turn down the noise.

Andrew Clifford (Platinum Asset Management) talks about CEO change

Mark Draper recently met with Andrew Clifford (Platinum Asset Management) to talk about the change in CEO at Platinum Asset Management and what it means for investors in Platinum funds.

Below is a podcast of the discussion and also a transcript. 


Speakers:  Mark Draper (GEM Capital) and Andrew Clifford (Platinum Asset Management)

Mark:  Here with Andrew Clifford, Chief Investment Officer, or currently Chief Investment Officer of Platinum Asset Management, soon to be Chief Executive Officer of Platinum Asset Management.

Andrew, thanks for joining us.

Andrew:  Good morning. It’s good to be here.

Mark:  Shooting this in Adelaide, too, by the way. So, welcome to Adelaide, Andrew.

It was announced to the market recently that the joint founder of the business, alongside of you, Kerr Neilson, who is the current CEO of Platinum Asset Management is going to step down as CEO, still stay within the business.

I just want to talk about that this morning for our Platinum international investors.

Are you able to give us an overview? What does this actually mean for the business?

Andrew:  I think what people should understand is that we’ve built over the last 24 years, a very deep and experienced investment team. I think also it would be good for people to understand just exactly how the process works internally to understand the role, how Kerr’s changing role affects us.

Across that team, one of the things that we think if very important in coming up with investment ideas is that there’s a very thorough and constructive debate about investment ideas. If you put someone in the corner of a room and leave them to their own devices for four weeks to look at a company, on average through time, they’re not going to come up with good ideas, they’re going to miss things.

Part of our process is that the ideas, even from the very beginning, should we even be looking at this company or this industry, is something that is thoroughly debated all the way along.

We have five sector teams and also our Asia team. These are teams of sort of three to five people and they’re working away, coming up with ideas, debating them internally before they’d even presented to the portfolio managers for a potential purchase.

Then what happens is we have a meeting around that and you get all the portfolio managers for whom that is relevant and the idea is further debated and one of the things to understand about the process is we’re not trying to all come to some lovely agreement about whether this company is a good idea. We’re trying to work out what’s wrong with it.

Then ultimately, what happens after all of that, invariably there’s more questions to follow up and work to be done, but what happens is then each of the portfolio managers make their own independent decision on whether to buy that company or not.

The important role of the portfolio manager, as I see it, is everyone always thinks of them as these gurus who are making a decision about buying this stock or investing in this idea, and certainly they have that final responsibility. But I actually think their most important role is leading that discussion and debate.

Indeed, what happens in the places, that you can see that if an idea comes through to buy a certain company, if I buy it and Clay Smolinski doesn’t or Joe Lai doesn’t, when it’s an Asian stock, or Kerr does, but he buys 3% in the fund and I buy half a percent, there’s some kind of difference of opinion there that needs to be further debated and discussed. We have particular meetings where we do that.

I give this all as a background to say that there’s a very—

Mark:  It’s a bigger process.

Andrew:  —deep and proper process there.

Mark:  It’s not one person pulling the strings.

Andrew:  That’s right, absolutely. When it comes to Kerr and his role, Kerr will continue to be part of the investment team, he will continue to work away on investment ideas, which is his love. When you do this job, you’re never going to stop doing that.

He’ll still be there working away on this idea or that, as pleases him. Also, he will be looking at the ideas other people are putting forward because that’s what excites him.

He will still be part of our global portfolio manager’s meeting, which is the meeting of the most senior PMs, where we actually debate those ideas, where those differences of opinion are occurring amongst the PMs.

He’s still there going to be doing that and as Kerr would say, the demands of being a—of running a global portfolio, are not inconsequential in terms of the time and effort. What he is hoping to be doing is then being able to take that time where he doesn’t have to think about absolutely everything we’re doing to focus on what he believes are the really good ideas.

It is a change, but it may not be as significant as it sounds to people.

Mark:  I think the interesting thing from my perspective is that it’s not like Kerr is resigning from the company, selling all his shareholdings and just walking away. This is very much—sounds like a planned event. He is still going to be in the business, he’s just moving out of the CEO role so he can focus on the investment side and still remain contributing to the company. Is that…

Andrew:  Yeah, I mean, absolutely. Because I think it’s one of these things is that you, as I said, you can’t really retire from investing. You’re going to be doing it one way or the other. This is a great way for him to continue to do what he loves doing and it’s great for the rest of the organization to still have that input from him. It’s something that the younger members of the team will value because he will, as he does today, he’ll walk across the floor to talk to someone about what they’re working on and be quizzing them on that idea.

Because along with that idea, all those sort of more formal processes of how an idea comes to life, there’s also the discussions in the kitchen when you’re making a cup of tea and what have you.

He’s going to remain there as a full-time employee and part of the investment team.

Mark:  What’s he likely to do with his shareholding? Because he does own a significant amount of Platinum Asset Management. I think he said publicly in the press that he’s just retaining them. Is that—

Andrew:  Yes, so it’s hard for me to talk for him, so I can really only repeat what he has said, which is that I think at the moment there’s no intention to sell any of the stock at this stage.

Mark:  Going back to the funds for a second, what are the changes to the management of the funds and with a particular focus on the Platinum International Fund, which is the flagship fund, and also Platinum Asia. Probably the easiest one to start with is Platinum Asia.

Andrew:  Really, for Platinum Asia, there’s no changes in the management of that. Joe Lai has been running that in its entirety for a number of years now.

What you would expect with what we’ve done with Asia previously, with myself and Joe, when I used to run that, he started at 15% of the fund and progressively moved up to half and then the whole fund. That’s something—this is all part of both the development of individual members of the team and also building in that succession planning across the firm.

While there’s no intention to change that today, at some point in the future, you would expect that we will bring in another portfolio manager to run a small part of that fund and then build that up through time.

Mark:  I think that’s really interesting because Joe started out having a smaller amount of that fund, got built up, and then is now running all of it. The Platinum International Fund is not too dissimilar to that, in that Clay Smolinski, who has been with Platinum for quite some considerable time and is a very high quality investor, he’s currently managing 10% of the Platinum International Fund.

Andrew:  Yes.

Mark:  What’s going to change in that respect?

Andrew:  Clay’s also been running the un-hedged fund for a number of years now.

Mark:  Which has performed really, really well.

Andrew:  It’s performed very well, as the European Fund did, or continued to, even after Clay left, but is also—he did a very good job running that.

What’s going to happen is Clay will take 30% of that fund and what you again might expect at some point in the future, that is a third portfolio manager will be brought in there. One of the reasons for not doing that—a lot of people ask us why we’re not doing that today and it’s simply that these types of changes now, five years ago, didn’t attract a lot of attention, these days, the research houses are very focused on these changes. We’ve already given them quite a bit to think about in the last month. So, rather than make yet another change at that point, we want to leave that for a point in the future.

But people might be interested, across the range of our funds, that besides moving to that 30%, we will essentially bring—

Mark:  And then you manage 70%?

Andrew:  I manage 70%.

Mark:  You’re currently managing around half?

Andrew:  40.

Mark:  40, so you got a lot and so does Clay.

Andrew:  But some of our other funds that are similar mandates, this is not so much relevant for Australian investors, but our offshore uses product will also be 70/30. I will take over the management of Platinum Capital, whereas Clay will take over the management of—

Mark:  Platinum Capital being the listed investment company?

Andrew:  Listed investment company, yes.

Mark:  We have some invested in it.

Andrew:  But then also there are funds, the Platinum Global, which is the in fund, that its mandate is much more similar to the un-hedge fund, so Clay will take over that.

Mark:  Right.

Andrew:  They’ll be changes in other funds as well.

Mark:  Yeah. You touched on research houses. One of the things—and this is probably more relevant for Platinum Asset Management investors, rather than investors of the funds, but it strikes me that one of the key things is what the research houses say about you in their capacity as acting as a gatekeeper between you and financial advisors, like us.

What’s been the reaction of the research houses, Morningstar, Lonsec, etc.? What’s their reaction been to this, Andrew?

Andrew:  As you can imagine, we were on the phone to them, in for a meeting within 24 hours.

Mark:  You’re very much on the front foot, I must say, with that.

Andrew:  Yes. Both Morningstar and Zenith have reaffirmed the writings across our fund, so there’s been no change there. I don’t really want to speak for them either. They’re very independent in their views and their positions can be read. But essentially, I think, this was not unexpected in their minds and they’ve reaffirmed those writings, but as always, they’re watching carefully to see how we go.

Mark:  As always.

Andrew:  As it stands today, while we’ve had feedback from Lonsec, we don’t know what their final decision is at this stage.

Mark:  I do know Morningstar were out in the press last week, I think, saying they think that the management of Platinum Funds just continues as is. They were actually quite supportive in the press.

Andrew:  Yes. And I think that came on the back of the one that had that we won the Morningstar, not just the fund manager, the International Fund of the Year, but we also got the Fund Manager of the Year Award, which means that’s won against the entire, you know, all comers who are doing product across the range. And they assured me that was decided before any of the decisions anyway, but it was actually very nice timing to win that at that point for the organization and the investment team because it really recognizes what has been a period of very strong performance.

Mark:  Yes.

Andrew:  After a period where actually we didn’t think our performance was that poor, but in a relative sense, we had lagged the market for a while, by a very small margin, but I think that it was very nice to win that aware at that point.

Mark:  Absolutely.

Andrew:  We stuck to doing things the way we’re doing and the end result has been good. As I say, I’m not one to normally get too excited about awards, but it was a lovely time to get it and at this point in time as well.

Mark:  Congratulations, by the way for that. The track record, so Clay and yourself are running the flagship fund. There’s no changes to Platinum Asia. The track record of Clay and you has been really good over a long, long period of time. Are you able to provide any context around that? I know that’s actually a hard question.

Andrew:  This is the thing, I go back to where we started and talk about the process that is there, and I don’t want to take away from Clay’s excellent record, but here’s the thing, over our 24 years of history, we’ve had 14 different portfolio managers running money. Every one of them, their long-term record was one of out performance. That’s quite extraordinary. I don’t think you find that many easily, in any market.

Now, of those 14, 10 are still with us. 2 of them were other founders who have stepped aside. But I look at this say, this is the system. If I have a flippant response to people when they worry so much about the role of the portfolio manager because if I’m sitting here, I have 30 people in the office bringing me great ideas. If they only bring me great ideas, because they’re well thought through and well argued out,  then all I need to do is buy every one of them or flip a coin and buy every second one, whatever it is.

Now, there’s more to it than that. But the job of running money becomes easy when you’re supported by a strong team.

Mark:  The main message really here is that. This is very much a team business and it’s a big team. You’re probably one of the deepest teams in the country, in international equities.

Andrew:  I think in the country, very easily and across probably all investment teams in terms of depth of experience and what have you, I mean, there will be other people globally who have similar histories.

But, you know, I think the thing that we see when we talk to clients overseas, is that the things that differentiate us very strongly, not any one of these things, but a collection of all of them, is that we’ve been going for a while, 24 years. We’re managing a substantial sum of money with 27-odd billion Australian dollars. Very defined investment approach and extraordinarily deep team, and a long-term record of out performance. You’ll find that people who have got four of the five or three of the five, but there aren’t many.

What I should say, I think one of the things that stands out with overseas clients is when we say we construct our portfolios independently of the MSCI Index, is that we genuinely do. There are many other people who say they do.

Mark:  Say they do and they don’t. [Laughs]

Andrew:  But they still end up with—and some of those who’ve got great records, but they still end up with 45% in the U.S., even though they say they’re not doing that, which interests us. We genuinely are—

Mark:  You’re true to label though, aren’t you? You’re very much true to label. What you say you’re going to do, you do.

Andrew:  We do. I think that maybe sometimes in Australia that’s not valued quite as much as it could be because we’ve been around a long time and people know us. But I think it is—there’s no one else we know of that can show all those attributes.

Mark:  Our position, Andrew, is that we know the depth of your management team at Platinum Asset Management, and you individually have been managing that team for the last five years officially, I believe, in any case.

Andrew:  Officially, yes. Unofficially, for longer than that. [Laughs]

Mark:  Yeah, that’s right. [Laughs] From our perspective, nothing has really changed other than it’s a change of role for Kerr, but he’s still in the business. We’re still positive on Platinum Funds, clearly.

Have you got any last thing that you would like to say for our Platinum investors or PTM shareholders?

Andrew:  I think the other thing that people ask about is, I’m taking on this additional role of CEO and what are the—how much of a workload, how does that—I guess the fair concern is how does that detract from the investing side of things?

Again, I think that not everyone will be aware of just how strongly our organization, that investment team is supported by the other functions. Liz Norman, who was there on day one and I think most clients and financial planners in this country know her. I make the joke, I walked into the Morningstar Awards and everyone is saying, “Hi, Liz. Who are you?”

Mark:  [Laughs]

Andrew:  But you know, he’s run all of that part of the business for 24 years, does an extraordinary job. On the other parts of the business, the accounting, legal, compliance, tax, we had a great founding CFO, Malcolm Halstead. He left the business a few years ago, but he built an extraordinary team of people. There’s all these boring things people wouldn’t know about, portfolio accounting and registry, but these are very important functions because when they go wrong, they can create havoc and they can cost—well, they never cost the clients money but they’ll cost—

Mark:  They cost the business and it’s a management distraction.

Andrew:  It costs the business money and a lot of distraction and we have an incredibly strong team there, now led very well by Andrew Stannard, our current CFO.

When it comes to the role of CEO, the reality is that Liz and Andrew and their teams, they run the business. We want an investment person as CEO because ultimately the CEO makes the final, critical decision on important things and we want those decisions taken from a perspective of is this going to impact the investment process? You can have all these great ideas, we should have this product, we should do this, we should open an office in New York, we can have all the great ideas in the world, but ultimately, they need to be run through the filter of how does this impact the way the investment team functions.

All of those things, those sort of decisions, can impact and hurt that and that’s why I’ve taken on that role. In reality, yeah, there will be times where there’s more to do, but in fact, the way it’s worked, is Kerr and I have already long divided those responsibilities. So, most of the accounting and compliance-type discussions where it’s come through to the management committee, which is Andrew Stannard, Liz, Kerr, and myself, they’ve tended to be my area and Kerr is focused more on the client side of the business. I’ve been part of those discussions for 24 years, so it’s not like I have to all of a sudden get on top of, or how does this work or how does that work? I’ve been there the whole time.

There will be some time into that, but I don’t believe that it will be substantial.

Mark:  Good answer. Andrew, all the best for the new role as CEO and I know you’ve been there forever [laughs], so all the best for the transition. Thanks very much for making the time to talk to us about it.

Andrew:  Thank you.

[End of Audio]

Transcription by bethfys

Best of the Best Report - Montgomery Investment Management - December 2017

We are planning to add Montgomery Investment Management to our recommended list of investments early in 2018.  In particular we are impressed by their Global Investment team who have had an impressive track record since the fund began a few years ago.

The Montgomery Global Fund is listing on the ASX on 20th December 2017 and is a portfolio of high quality global companies aiming to pay a half yearly income distribution of 4.5%pa.  We will have further details on this fund in the new year.

In the meantime, here is a sample of how Montgomery Investment Management think about investing in a comprehensive report that makes excellent reading over the Festive Season.  The articles are written by the investment team at Montgomery Investment Management, rather than a marketing spin doctor and are very informative. 


To read the report simply click on the picture of the report below.

Some of the content in this edition include:

1. How the changes in the $AUD impact global facing businesses

2. Why do Montgomery's own Facebook

3. Should you own Wesfarmers?

And many more articles.


Bubbles, Busts and Bitcoin

Shane Oliver - Chief Economist AMP


The surge in bitcoin has attracted much interest. Over the last five years, it has soared from $US12 to over $US8000; this year it’s up 760%. Its enthusiasts see it as the currency of the future and increasingly as a way to instant riches with rapid price gains only reinforcing this view. An alternative view is that it is just another in a long string of bubbles in investment markets.

Nobel Economics Laureates Daniel Kahneman, Robert Shiller and Richard Thaler and many others shown that investors and hence investment markets can be far from rational and this along with crowd psychology can drive asset prices far from fundamentally justified levels. This note provides a refresher on the psychology of investing before returning to look at bitcoin.

Irrational man and the madness of crowds

Numerous studies show people suffer from lapses of logic. In particular, they:

  • Tend to down-play uncertainty and project the current state of the world into the future – eg, resulting in a tendency to assume recent investment returns will continue;
  • Give more weight to recent spectacular or personal experiences in assessing probabilities. This results in an emotional involvement with an investment – if it’s been winning, an investor is likely to expect it to keep doing so;
  • Tend to focus on occurrences that draw attention to themselves such as stocks or asset classes that have risen sharply or fallen sharply in value;
  • Tend to see things as obvious in hindsight – driving the illusion the world is predictable resulting in overconfidence;
  • Tend to be overly conservative in adjusting expectations to new information – explaining why bubbles and crashes normally unfold over long periods; and
  • Tend to ignore information conflicting with past decisions.

This is magnified and reinforced if many make the same lapses of logic at the same time giving rise to “crowd psychology”. Collective behaviour can arise if several things are present:

  • A means where behaviour can be contagious – mass communication with the proliferation of electronic media are perfect examples of this as more than ever investors get their information from the same sources;
  • Pressure for conformity – interaction with friends, social media, performance comparisons, fear of missing out, etc;
  • A precipitating event or displacement which motivates a general investment belief – the IT revolution of the late 1990s or the rapid industrialisation of China which led to talk of new eras are examples upon which were built general believes that particular investments will only go up.

Bubbles and busts

The combination of lapses of logic by individuals and their magnification by crowds goes a long way to explaining why speculative surges in asset prices develop (usually after some good news) and how they feed on themselves (as individuals project recent price gains into the future, exercise “wishful thinking” and receive positive feedback via the media). Of course this also explains how the whole process can go into reverse once buying is exhausted, often triggered by bad news.

The chart below shows how investor psychology develops through a market cycle. When times are good, investors move from optimism to excitement, and eventually euphoria as an asset’s price moves higher and higher. So by the time the market tops out, investors are maximum bullish and fully invested, often with no one left to buy. This ultimately sets the scene for a bit of bad news to push prices lower. As selling intensifies and prices fall further, investor emotion goes from anxiety to fear and eventually depression. By the time the market bottoms out, investors are maximum bearish and out of the market. This sets the scene for the market to start rising as it only requires a bit of good news to bring back buying.

The roller coaster of investor emotion

Source: Russell Investments, AMP Capital

This pattern has been repeated over the years. Recent examples on a globally-significant basis have been the Japanese bubble and bust of 1980s/early 1990s, the “Asian miracle” boom and bust of the 1990s, the tech boom and bust of the late 1990s/early 2000s, the US housing and credit-related boom and bust of last decade and the commodity boom and bust of late last decade into this decade. History may not repeat but rhymes and tells us asset price bubbles & busts are normal.

Where are we now?

Our assessment in terms of global share markets is that we are still around “optimism”. Investor sentiment is well up from its lows last year and some short-term measures are a bit high, warning of a correction (particularly for the direction-setting US share market) but we are not seeing the “euphoria” seen at market tops. The proportion of Australians nominating shares as the “wisest place for savings” remains very low at 8.9%.

But what about bitcoin? Is it a bubble?

Crypto currencies led by bitcoin and their blockchain technology seem to hold much promise. The blockchain basically means that transactions are verified and recorded in a public ledger (which is the blockchain) by a network of nodes (or databases) on the internet. Because each node stores its own copy, there is no need for a trusted central authority. Bitcoin is also anonymous with funds just tied to bitcoin addresses. Designed to work as a currency, bitcoin therefore has much to offer as a low-cost medium of exchange with international currency transfers costing a fraction of what, say, a bank may charge.

However, bitcoin’s price in US dollars has risen exponentially in value in recent times as the enthusiasm about its replacement for paper currency and many other things has seen investors pile in with rapid price gains and increasing media attention reinforcing perceptions that it’s a way to instant riches.

However, there are serious grounds for caution. First, because bitcoin produces no income and so has no yield, it’s impossible to value and unlike gold you can’t even touch it. This could mean that it could go to $100,000 but may only be worth $100.

Second, while the supply of bitcoins is limited to 21 million by around 2140, lots of competition is popping up in the form of other crypto currencies. In fact, there is now over 1000 of them. A rising supply of such currencies will push their price down.

Third, governments are unlikely to give up their monopoly on legal tender (because of the “seigniorage” or profit it yields) and ordinary members of the public may not fully embrace crypto currencies unless they have government backing. In fact, many governments and central banks are already looking at establishing their own crypto currencies.

Regulators are likely to crack down on it over time given its use for money laundering and unregulated money raising. China has moved quickly on this front. Monetary authorities are also likely to be wary of the potential for monetary and financial instability that lots of alternative currencies pose.

Fourth, while bitcoin may perform well as a medium of exchange it does not perform well as a store of value, which is another criteria for money. It has had numerous large 20% plus setbacks in value (five this year!) meaning huge loses if someone transfers funds into bitcoin for a transaction – say to buy a house or a foreign investment – but it collapses in value before the transaction completes.

Finally, and related to this, it has all the hallmarks of a classic bubble as described earlier in this note. In short, a positive fundamental development (or “displacement”) in terms of a high tech replacement for paper currency, self-reinforcing price gains that are being accentuated by social media excitement, all convincing enthusiasts that the only way is up. Its price now looks very bubbly, particularly compared to past asset bubbles (see the next chart – note bitcoin has to have its own axis!).

Because bitcoin is impossible to value, it could keep going up for a long way yet as more gullible investors are sucked in on the belief that they are on the way to unlimited riches and those who don’t believe them just “don’t get it” (just like a previous generation said to “dot com” sceptics). Maybe it’s just something each new generation of young investors has to go through – based on a thought that there is some way to instant riches and that their parents are just too square to believe it.

Source: Thomson Reuters, Bloomberg, AMP Capital

But the more it goes up, the greater the risk of a crash. I also still struggle to fully understand how it works and one big lesson from the Global Financial Crisis is that if you don’t fully understand something, you shouldn’t invest.

At this stage, a crash in bitcoin is a long way from being able to crash the economy because unlike previous manias (Japan, Asian bubble, Nasdaq, US housing in the chart above) it does not have major linkages to the economy (eg it’s not associated with overinvestment in the economy like in tech or US housing, it is not used enough to threaten the global financial system and not enough people are exposed to it such that a bust will have major negative wealth effects or losses for banks).

However, the risks would grow if more and more “investors” are sucked in – with banks ending up with a heavy exposure if, say, heavy gearing was involved. At this stage, I think it’s unlikely that will occur for the simple reason that being just an alternative currency and means of payment won’t inspire the same level of enthusiasm that, say, tech stocks did in the late 1990s (where there was a real revolution going on).

That said, it’s dangerous to say it can’t happen. There was very little underpinning the Dutch tulip mania and it went for longer than many thought. So it’s worth keeping an eye on. But as an investor I’m staying away from bitcoin.

What does this mean for investors?

There are several implications for investors.

  1. The first thing investors need to do is recognise that investment markets are not only driven by fundamentals, but also by the often-irrational and erratic behaviour of an unstable crowd of other investors.
  2. Investors need to recognise their own emotional capabilities. In other words, investors must be aware of how they are influenced by lapses in their own logic and crowd influences.
  3. To help guard against this, investors ought to choose an investment strategy which can withstand inevitable crises & remain consistent with their objectives and risk tolerance.
  4. If an investor is tempted to trade they should do so on a contrarian basis. Buy when the crowd is bearish, sell when it is bullish. But also recognise contrarian investing is not fool-proof – just because the crowd looks irrationally bullish (or bearish) doesn’t mean it can’t get more so.
  5. Finally, while crypto currencies and blockchain technology may have a lot to offer bitcoin’s price is very bubbly.

Gerard Minack - what's in store for 2018

Well known investor Gerard Minack, who also sits on the board of Morphic Asset Management recently produced this video on this thoughts for investment markets for 2018.

This video was produced for the Morphic Asset Management roadshow and has been reproduced with their permission.



Cryptocurrencies - The next big thing? or the next tulip?

Investment research mouseEvery bull market has it's pin up boy.  In the early 2000's, it was the technology stocks where we witnessed companies 'reinventing' themselves by adding .com to their name, accompanied by large share prices increases.

Today, the Technology companies that are rising rapidly are underpinned by significant growth in revenue and profits, something that was missing from much of the tech sector early this century.

But there is a new 'Next Big Thing' that is attracting investment, probably from many who have not seen market cycles before, or fads come and go.  We are of course referring to Crypto currencies, led by Bitcoin.

At this point we wish to make the point that when discussing crypto currency it is important to separate the technology behind crypto currency from the currency itself.

The technology behind Bitcoin and other crypto currencies, known as Blockchain, is real and likely to influence the financial system around the world as banks, stock exchanges and share registries are investing heavily in the technology.  Put simply “The blockchain is an incorruptible digital ledger of economic transactions that can be programmed to record not just financial transactions but virtually everything of value.”

Picture a spreadsheet that is duplicated thousands of times across a network of computers. Then imagine that this network is designed to regularly update this spreadsheet and you have a basic understanding of the blockchain.

Information held on a blockchain exists as a shared — and continually reconciled — database. This is a way of using the network that has obvious benefits. The blockchain database isn’t stored in any single location, meaning the records it keeps are truly public and easily verifiable. No centralized version of this information exists for a hacker to corrupt. Hosted by millions of computers simultaneously, its data is accessible to anyone on the internet.

So the technology behind Bitcoin and others is real and is likely to materially impact the global financial system, particuarly to reduce processing costs and times and 'cut out the middle man'.

Our concern in this article revolves around the trading of Bitcoin and other crypto currencies by those seeking to get rich quickly.  The chart below tracks the rise of some of history's great bubbles, including Bitcoin.

What prompted us to write about this is when I began seeing a friend of mine uploading a Bitcoin market report everyday on Facebook and scoffing at those who invest in "old world" sectors like fixed interest and the share market.  I can remember these type of conversations during the tech boom of early 2000's.


We are not professing to be experts on Bitcoin, or cryptocurrencies, we simply wish to highlight the issues that we would want to satisfy ourselves with before investing.  You can then make your own conclusion.

Cryptocurrency is a form of digital money that is designed to be secure and, in many cases, anonymous, making it ideal for money laundering, organised crime and drug/arms dealers.

It is a currency associated with the internet that uses cryptography, the process of converting legible information into an almost uncrackable code, to track purchases and transfers.  There are new cryptocurrencies being issued every week, and these are known as Initial Coin Offerings.

It is being suggested by enthusiasts that cryptocurrency will become the global currency benchmark, replacing paper money and the existing financial system.  We would caution against such a view as one of the key differences between cryptocurrency and say $USD, is that there is a Government standing behind the $USD.  So unless the Government were to default, the currency has value.  There is no Government support behind cryptocurrency.  In fact recently the Chinese Government  announced that public cryptocurrency exchanges would be shut down.

Our other questions include:

1. Why are cryptocurrencies not being embraced by larger insitutional investors, often referred to as 'smart money'?

2. What legal protections are available to investors who trade cryptocurrency in the event of fraud or other online mischief?

3. What is the intrinsic value of what investors are buying?  (ie the intrinsic value of buying a company is the future cash flow a company generates)


We leave this article quoting two famous investors (made famous for different reasons).  

Jordan Belfort, the original "Wolf of Wall Street" says that initial coin offerings "are the biggest scam ever" and "are far worse than anything I was ever doing".

Howard Marks, one of the worlds most famous investors, from Oaktree Capital talked about cryptocurrencies in his recent investor newsletter.  His word of caution was "They're not real".



Business model disruption has only just begun

From a presentation by Hamish Douglass (CEO Magellan Financial Group) in October 2017


There’s a lot of business model disruption in the world and many companies will be left behind by the changes. There will be winners and losers in the years ahead, but sometimes business model disruption isn’t obvious. There are first-order effects when you have changes to business models, but when new technology and new businesses develop, it affects other businesses and other industries and it’s often not foreseeable. This is Part 1 of a two-part transcript.

Watch for second-order effects

If you look at a photograph of the Easter Parade in New York in the year 1900, it is full of horses and carriages. If you fast forward to 1913, the photograph is full of petrol-powered automobiles. Think about what had to happen, such as rolling out petrol stations. Transportation fundamentally changed in 13 years. In 1908, Henry Ford rolled the first Model-T Ford off the production line which enabled an automobile to be mass-produced at an affordable cost.

Many first-order effects are fairly obvious. If you manufactured buggy whips, you effectively went out of business. If you collected manure in the streets, you went out of business. There were 25 million horses in the United States in 1910 and 3 million in 1960.

The second-order effects aren’t as knowable. The second-order effects are what the automobile enabled to happen. An entirely new industry could move goods around far more efficiently. People could start the urban sprawl and move further away. We developed regional shopping centres due to the automobile.

Consider a simple change in technology, the automated checkout, such as in Woolworths and Coles in Australia. Walmart started rolling out these automated checkouts in around 2010 at scale and the other major retailers started doing the same. The first-order effects were a loss of jobs of the people working the checkouts, and retailers reduced their costs. And if one major competitor does that, other competitors follow, otherwise their cost structure is out of line.

But what of the second-order effects? Chewing gum sales have lost 15% of their volume since the introduction of automated checkouts in the US. The checkouts have disrupted the business model of impulse purchases. People do not drive to the supermarket to buy chewing gum, but when you used to stand in those checkout lines, you would pick up some chewing gum. I think mobile phones have had a bit to do with it too, because you now do other things when you’re standing there.

Our job as fund managers is to try and spot the next Wrigley. In 1999, at the peak of the technology bubble, Warren Buffett was asked by a group of students why he doesn’t invest in technology. He said he could not predict where the internet was going but investing in a business like Wrigley will not be disrupted by technology. And look what’s happened. Wrigley sales had gone up for 50 years, every year, before this change happened.

The pace of change is accelerating

Technology adoption appears to be accelerating. The chart below shows the number of years it takes to reach 50 million new users. We saw the rapid adoption with smart phones, and it only took Facebook five years to move from 1 billion to 2 billion users. These new technology-related businesses can scale at an incredibly fast rate.

I think there’s a whole series of factors explaining why this is happening, and a lot of things are starting to come together.

First, globalisation and the internet have enabled products to spread rapidly to much larger audiences around world. A second factor is the digitalising of goods and services. We have digitalised books, newspapers, music and videos. With Facebook, Google or Netflix, all their services are digital goods. Instead of spreading atoms around the world, we’re now spreading bits around the world where an identical copy of a digital good is produced at zero cost.

Third, the mobile phone today is more powerful than the world’s most powerful super-computer in 1986, in the year I left school, which is absolutely incredible. And now we’re connecting all these devices in ‘cloud computing’, where massive data farms don’t need computers to sit locally, and you can share all this information. So there’s a whole lot of infrastructure and change that’s enabling very rapid change.

The incredible power of two digital platforms

Consider the ‘GAF effect’ from Google, Amazon and Facebook. I don’t mean specifically those companies, but how they are affecting industries and important business models. First is the advertising industry. Google and Facebook know an enormous amount about their users. Anyone who uses Google has something called a Google timeline (unless you’ve opted out of it). On your Google timeline, in your user settings, you can go back five years and it will tell you exactly what you did five years ago if you carried your mobile phone, and most people do.

It tells you what time you left your house, whether you walked to the bus, which bus you boarded, if you went to work or not because it knows the address. If you take any photos on a day, it will put those photos on the timeline. It will tell you where you went for lunch, when you went home and if you went to dinner, it will tell you the restaurant. And this goes for every other day of your life for the last five years. It’s collecting enormous amounts of data about you, as are Facebook and others. That enables these platforms to start highly-targeted advertising and make it incredibly efficient.

In the last decade, traditional print advertising has lost about 24% market share, and I predict this will go to zero. It is extraordinary that outside China, two companies (Facebook and Google) have taken nearly the entire market share of a global industry that had many, many players in the world – magazine producers, newspapers producers, classifieds producers. All this revenue has ended up with two digital platforms that have this massive network effect. Television advertising, which is the largest pot of advertising money, has not yet been disrupted. We’re starting to see the rise of YouTube but it is still relatively small, as shown below. It’s probably got between US$6-8 billion of revenue at the moment, but it’s an industry with US$150-180 billion of revenue outside China.

Television is next

The television advertising business model is the next to fall due to two big factors. We’re experiencing the rise of these streaming video services. Think of Netflix, Amazon Prime, Stan, and Hulu, and Apple wants to enter this game. These businesses are spending enormous amounts of money on content creation. Amazon and Netflix this year will spend US$10 billion creating original content. They are far outspending anyone else on the planet. Facebook just bid US$600 million for the Indian cricket video streaming rights and were outbid by News Corp’s Fox. I think that’s one of the last-ditch efforts to protect sporting rights and there’s a battle going on between the television and the movie networks. Apple and Netflix are bidding for the next James Bond.

They are taking viewers away from television and pay TV which reduces advertising revenues. Then on the other side, the costs of producing the content and buying the best shows is being bid up. It is not a great business model if your revenues go down and your costs go up.

We’re also seeing the advent of new video advertising platforms. The streaming services are not advertising businesses, they are subscription businesses. But YouTube and now Facebook (and they’ve just launched Facebook Watch) are advertising business models, and I believe that a huge amount of the revenues that are currently in television and pay TV are at risk. It’s fundamentally different, because this is targeted advertising. These platforms know so much about the users that advertisements can be delivered specifically to what the users are watching on these new platforms.

The television advertising model as it currently stands gives a number of companies in the world a huge advantage because there are massive barriers to entry to promote products on television if you want to advertise at scale. It will be much easier to enter one of these new platforms. You can do very specific programmes if you are developing a new brand on Facebook, YouTube or Google compared with advertising on television.

The Amazon effect

Amazon is a business with an estimated US$260 billion in sales (including Whole Foods), the second largest retailing business in the world after Walmart. It’s a fascinating company. They run a ‘first-party’ business, where Amazon buys the goods, stores them in their warehouse and then sells them to their users via the Amazon website or mobile apps. Then they have a ‘third-party’ business called Fulfillment by Amazon, where other retailers put their own inventory into Amazon’s warehouse and then Amazon sells that inventory to their customers as well. So customers suddenly have a much greater selection, and Amazon charges other retailers rent for having their goods in the Amazon warehouse, then charges a commission for selling to the user base.

Amazon also is a massive logistics company. They are expanding warehouse space by about 30% a year and they are incredibly advanced from a technology point of view. They have developed with a robotics company something called the Kiva robot, with about 45,000 of these robots in their warehouses at the moment. Humans are good at putting goods in a package, adding a label and sending them off. But it’s inefficient for the human picker to run around the warehouse to find the shelf where that good is stored in these massive, multiple football field-sized spaces. So these robots automatically go around the warehouse and bring the shelves holding the product to the packers.

The loyalty scheme called Amazon Prime started out with two-day free shipping, then same-day and 2-hour free shipping in a number of cities around the world. Amazon Prime members receive free video, free music and free ebooks with the service.

Amazon is a also a data analytics company. They understand enormous amounts of information about what the customer wants to buy. Amazon members see web pages that look different to anybody else’s. There are 50 million goods available in Amazon so customers receive a particular look into the world.

Amazon’s Jeff Bezos wants to fulfil all of his customers’ shopping needs. He worked out that if you want to be in their everyday shopping, you need to be in the grocery shopping habit. They started with Amazon Fresh, an online grocery shopping business that’s very niche. But if you want chilled vegetables or meats or ice cream, it’s inconvenient to have them delivered on the verandah if you’re not there for two hours. A lot of people want to look at their fresh fruit and vegetables and not have anyone else choose that for them. So Bezos bought Whole Foods, the largest fresh food retailer in the US. It had a reputation for expensive produce, lots of organics, incredible displays. On the first day Bezos took control, on the key lines people are interested in, he dropped the prices 35-45%. People shop for incredibly good, fresh groceries then everything else can be put together.

He wants to connect your home by the ‘Internet of Things’. Many goods like washing detergent and milk will have computer chips on them that will connect to the internet to know when you are running out. Washing machines and fridges will automatically generate shopping lists. He’s adopting a voice platform for your house with a digital personal assistant.

What’s next?

There’s a massive number of these revolutions. You may think Amazon and Facebook and Google are big at moment, but we’re in the early stages of where this technology and these businesses are heading. Advertising and retailing is the start. Next week, I’ll discuss which large companies will suffer, and bring in the perspectives of Warren Buffett and Charlie Munger.


Rocket Man Kim - Keep calm and BUY shares

by Jack Lowenstein (Morphic Asset Management)


A few weeks ago, US Ambassador Nikki Haley to the UN intoned that “the North Korean can couldn't be kicked any further down the road because there was no more road”. But a few weeks seems to be a long time in rhetorical road building because the can has just had another boot applied, and is still on terra firma. 

Meanwhile after brief jitters when North Korean missiles were flying and the dust from underground nuclear tests was settling, global stock markets reached new all-time highs again last week, and several major central banks confirmed they were moving ahead with monetary policy tightening. 

Many investors ask us why we don’t tend to get more nervous about potentially catastrophic geopolitical events.

This note is a brief description of why we try to stay calm even in the face of potentially devastating instability on the Korean peninsula, and what might make that wrong. For the record, we used recent jitters to slightly top up our investment in Korea’s largest company Samsung Electronics, which makes it now the largest holding in our portfolios.

I first had to contemplate the implications of tensions on the Korean Peninsula and their potential resolution in 1990. In most regards, nothing has changed. That doesn't mean it never will - but probably not for some time. 

That year, when I was still a journalist at Euromoney magazine, I was sent to Seoul to write about the financial consequences of the Koreans copying Germany and reunifying. It must have looked like a smart idea from the distance of London, where people were still excited about the end of the Cold War and the demolition of the Berlin Wall. 

In Seoul, it quickly became apparent the proposition was laughable. 

The South, with its population of 45m or so had a per capita income generally estimated at eight times as much as that ‘enjoyed’ by the 25m in the North. Having only just escaped extreme poverty, itself, however it could little afford the cost of investing in the North to bring it up to its level quickly or cope with an influx of starving northerners moving south. So few in the leadership had any real interest in reunification, even if they had to go through the motions of aspiring for it in public. 

In North Korea, the ruling elite would lose all their privileges if not their lives if their regime collapsed, so they would never support reunification. 

The other four interested parties also had no real interest in demarche. China didn't want a western-leaning democracy on its doorstep. Russia didn't want to lose a distracting irritant to the other superpower, the US. The US didn't want to lose valuable forward bases in Korea and Japan that were nominally justified by a belligerent Pyongyang. And Japan didn't want to lose a fully engaged US military in the region. Nor did it have much appetite for a larger northeast Asian economic competitor.

Today similar factors apply. 

Pyongyang has buttressed its position through nuclearisation. “Rocket Man” Kim, as President Trump has undiplomatically dubbed him, would know his chances of preserving power, wealth or indeed his life would be negligible under a united regime.

South Korea could probably afford to integrate the North now, but the challenge from internal migration would be acute, given per capita GDP in the south is now at least 20 times higher than the north. 

Japan might worry less about Korean reunification than in the past, given the greater threat the present situation poses than in the past. The increased challenge from China now also justifies the retention of US bases in Japan to both Washington and Tokyo. A resurgent Russia, however, would probably be more opposed.

The Chinese dilemma is exquisite. Many in the Beijing leadership probably hate being held hostage by Rocket Man. But to give him up, would entail a loss of face. There would still be no interest in a country with a western orientation being directly on the border, even if it was agreed US bases would be closed.

Sadly the most likely way this impasse changes is by accident. And it is almost impossible to manage money in preparation for that kind of discontinuous event. 

Challenger superpowers like China are highly prone to start wars. Sometimes this is to distract from temporary economic setbacks, like the three wars Germany fought against Denmark, Austria and France between 1860 and 1870. Sometimes, like emerging Japan prior to WW2, wars can happen because a field commander can make a blunder and no one at the capital wants to lose face by bringing him into line. 

Pyongyang has too much to lose from deliberately attacking anyone, but what if a rocket veers off target and lands in Japan or South Korea? Or someone in the line of fire erroneously believes a rocket attack is under way?

My old friend Jonathan Allum of SMBC Nikko today drew my attention to the story of Stanislav Petrov who has died at the age of 77. On the 26th September 1983, he was the duty officer at a Soviet military facility that monitored the threat of missile attacks. The following is condensed from the BBC version of what happened that day.

In the early hours of the morning, Soviet early-warning systems detected an incoming missile strike from the United States. The protocol for the Soviet military would have been to retaliate with a nuclear attack of its own. But duty officer Stanislav Petrov decided not to report it to his superiors, and instead dismissed it as a false alarm.

"If I had sent my report up the chain of command, nobody would have said a word against it… The siren howled. All I had to do was to reach for the phone; but I couldn't move. I felt like I was sitting on a hot frying pan…Twenty-three minutes later I realisedthat nothing had happened. If there had been a real strike, then I would already know about it. It was such a relief”

A subsequent investigation concluded that Soviet satellites had mistakenly identified sunlight reflecting on clouds as the engines of intercontinental ballistic missiles… 

A salutary tale. Let’s hope the world stays this fortunate. But these really don’t seem to be risks we can hedge.

North Korea and investment markets

Written by Shane Oliver - Chief Economist AMP
Tensions with North Korea have been waxing and waning for decades now but in recent times the risks seem to have ramped up dramatically as its missile and nuclear weapon capabilities have increased. The current leader since 2011, Kim Jong Un, has launched more missiles than Kim Il Sung (leader 1948-1994) and Kim Jong Il (1994-2011) combined.

Source: CNN, AMP Capital
The tension has ramped up particularly over the last two weeks with the UN Security Council agreeing more sanctions on North Korea and reports suggesting North Korea may already have the ability to put a nuclear warhead in an intercontinental ballistic missile that is reportedly capable of reaching the US (and Darwin).

US President Trump also threatened North Korea with “fire, fury and, frankly, power” only to add a few days later that that “wasn’t tough enough” and “things will happen to them like they never thought possible” and then that “military solutions…are locked and loaded should North Korea act unwisely”. Meanwhile, North Korea talked up plans to fire missiles at Guam before backing off with Kim Jong Un warning he could change his mind “if the Yankees persist in their extremely dangerous reckless actions”. 
This is all reminiscent of something out of James Bond (or rather Austin Powers) except that it’s serious and naturally has led to heightened fears of military conflict. As a result, share markets dipped last week and bonds and gold benefitted from safe haven demand, although the moves have been relatively modest and markets have since bounced back.
At present there are no signs (in terms of military deployments, evacuation of non-essential personnel, etc) that the US is preparing for military conflict and it could all de-escalate again, but given North Korea’s growing missile and nuclear capability it does seem that the North Korean issue, after years of escalation and de-escalation, may come to a head soon. It’s also arguable that the volatile personalities of Kim Jong Un and Donald Trump and the escalating war of words have added to the risk of a miscalculation – eg where North Korea fires a missile into international waters, the US seeks to shoot it down, which leads to a cycle of escalating actions. This note looks at the implications for investors.

Shares and wars (or threatened wars)

Of course there have been numerous conflicts that don’t even register for global investors beyond a day or so at most if at all. Many have little financial market impact because they are not seen as having much economic impact (eg the war in Afghanistan in contrast to 1991 and 2003 wars with Iraq, which posed risks to the supply of oil). As such, I have only focussed on the major wars/potential wars since World War 2 and only on the US share market (S&P 500) as it sets the direction for others (including European, Asian and Australian shares).
  • World War 2 (September 1939-September 1945) – US shares fell 34% from the outbreak of WW2 in September 1939, with 20% of this after the attack on Pearl Harbour, and bottomed in April 1942. This was well before the end of WW2 in 1945. Six months after the low, shares were up 25% and by the time WW2 had risen by 108%.
  • Korean War (June 1950-July 1953) – US shares initially fell 8% when the war started but this was part of a bigger fall associated with recession at the time. Shares bottomed well before the war ended and trended up through most of it.
  • Vietnam War (1955-1975) – For most of this war US shares were in a secular bull market but with periodic bear markets on mostly other developments. Rising inflation and a loss of confidence associated with losing the Vietnam war may have contributed to the end of the secular bull market in the 1970s – but the war arguably played a small role in this.
  • Cuban Missile Crisis (October 1962) – Shares initially fell 7% over eight days as the crisis erupted but this was part of a much bigger bear market at the time. They bottomed five days before it was resolved and then rose sharply. This is said to be the closest the world ever came to nuclear war 
  • Iraq War I (August 1990-January 1991) – Shares fell 11% from when Iraq invaded Kuwait to their low in January 1991 but again this was part of a bigger fall associated with a recession. Shares bottomed 8 days before Operation Desert Storm began and 19 days before it ended and rose sharply.
  • Iraq War II (March-May 2003) – Shares fell 14% as war loomed in early 2003 but bottomed nine days before the first missiles landed and then rose substantially although again this was largely due to the end of a bear market at the time.

Source: AMP Capital
The basic messages here are that:
  •; padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Shares tend to fall on the initial uncertainty but bottom out before the crisis is resolved (militarily or diplomatically) when some sort of positive outcome looks likely; 
  •; padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">Six months after the low they are up strongly; and
  •; padding-left: 11px; margin-bottom: 5px; background-position: 0px 8px; background-repeat: no-repeat no-repeat;">The severity of the impact of the war/threatened war on shares can also depend on whether they had already declined for other reasons. For example, prior to World War 2, the Cuban Missile Crisis and the two wars with Iraq, shares had already had bear markets. This may have limited the size of the falls around the crisis.

Possible scenarios 

In thinking about the risks around North Korea, it’s useful to think in terms of scenarios as to how it could unfold:
  1. Another round of de-escalation – With both sides just backing down and North Korea seemingly stopping its provocations. This is possible, it’s happened lots of times before, but may be less likely this time given the enhanced nature of North Korea’s capabilities.
  2. Diplomacy/no war – Sabre rattling intensifies further before a resolution is reached. This could still take some time and meanwhile share markets could correct maybe 5-10% ahead of a diplomatic solution being reached before rebounding once it becomes clear a peaceful solution is in sight. An historic parallel is the Cuban Missile Crisis of 1962 that saw US shares fall 7% and bottom just before the crisis was resolved, and then stage a complete recovery. 
  3. A brief and contained military conflict - Perhaps like the 1991 and 2003 Iraq wars proved to be, but without a full ground war or regime change. In both Iraq wars while share markets were adversely affected by nervousness ahead of the conflicts, they started to rebound just before the actual conflicts began. However, a contained Iraq-style military conflict is unlikely given North Korea’s ability to launch attacks against South Korea (notably Seoul) and Japan.
  4. A significant military conflict – If attacked, North Korea would most likely launch attacks against South Korea and Japan causing significant loss of life. This would entail a more significant impact on share markets with, say, 20% or so falls (more in Asia) before it likely becomes clear that the US would prevail. This assumes conventional missiles - a nuclear war would have a more significant impact.
Of these, diplomacy remains by far the most likely path. The US is aware of the huge risks in terms of the likely loss of life in South Korea and Japan that would follow if it acted pre-emptively against North Korea and it retaliates, and it has stated that it’s not interested in regime change there. And North Korea appears to only want nuclear power as a deterrent. In this context, Trump’s threats along with the US show of force earlier this year in Syria and Afghanistan are designed to warn North Korea of the consequences of an attack on the US or its allies, not to indicate that an armed conflict is imminent. Rather, comments from US officials it’s still working on a diplomatic solution. As such, our base case is that there is a diplomatic solution, but there could still be an increase in uncertainty and share market volatility in the interim. Key dates to watch are North Korean public holidays on August 25 and September 9, which are often excuses to test missiles, and US-South Korean military exercises starting August 21.

Correction risks

The intensification of the risks around North Korea comes at a time when there is already a risk of a global share market correction: the recent gains in the US share market have been increasingly concentrated in a few stocks; volatility has been low and short-term investor sentiment has been high indicating a degree of investor complacency; political risks in the US may intensify as we come up to the need to avoid a government shutdown and raise the debt ceiling next month, which will likely see the usual brinkmanship ahead of a solution (remember 2013); market expectations for Fed tightening look to be too low; tensions may be returning to the US-China trade relationship; and we are in the weakest months of the year seasonally for shares. While Australian shares have already had a 5% correction from their May high, they are nevertheless vulnerable to any US/global share market pull back. 
However, absent a significant and lengthy military conflict with North Korea (which is unlikely), we would see any pullback in the next month or so as just a correction rather than the start of a bear market. Share market valuations are okay – particularly outside of the US, global monetary conditions remain easy, there is no sign of the excesses that normally presage a recession, and profits are improving on the back of stronger global growth. As such, we would expect the broad rising trend in share markets to resume through the December quarter.

Implications for investors

Military conflicts are nothing new and share markets have lived through them with an initial sell-off if the conflict is viewed as material followed by a rebound as a resolution is reached or is seen as probable. The same is likely around conflict with North Korea. The involvement of nuclear weapons – back to weapons of mass destruction! – adds an element of risk but trying to protect a portfolio against nuclear war with North Korea would be the same as trying to protect it against a nuclear war during the Cold War, which ultimately would have cost an investor dearly in terms of lost returns. While there is a case for short-term caution, the best approach for most investors is to look through the noise and look for opportunities that North Korean risks throw up – particularly if there is a correction.

New Magellan listed trust - with a loyalty bonus

Magellan Financial Group have announced a new listed investment vehicle, the Magellan Global Trust.

This ASX listed trust will commence trading on 18th October 2017, targetting an income yield of 4%pa and will be invested similarly to the Magellan Global Fund which has been established since 2007.

Existing investors in Magellan funds (both listed or unlisted) can apply for units in a priority offer and receive 6.25% worth of bonus units on the first $30,000 applied for.  Bonus value is up to $1,875, and to be eligible the Magellan Global Trust must be held until 11 December 2017.

The Priority Offer is open to any person who has a registered address in Australia or New Zealand and who, as at 5.00pm (Sydney time) on 1 August 2017, was a direct or indirect holder or investor in any one of the following (each an "Eligible Vehicle"):

  1. a)  Magellan Financial Group (ASX: MFG);

  2. b)  Magellan’s Active ETFs: Magellan Global Equities Fund (Managed Fund) (ASX: MGE), Magellan Global Equities Fund (Currency Hedged) (Managed Fund) (ASX: MHG) and Magellan Infrastructure Fund (Currency Hedged) (Managed Fund) (ASX: MICH);

  3. c)  Magellan’s unquoted registered managed investment schemes: Magellan Global Fund (ARSN 126 366 961); Magellan Global Fund (Hedged) (ARSN 164 285 661); Magellan Infrastructure Fund (ARSN 126 367 226); Magellan Infrastructure Fund (Unhedged) (ARSN 164 285 830); and Magellan High Conviction Fund (ARSN 164 285 947); and

  4. d)  at Magellan’s discretion, any fund or investment strategy for which Magellan is the investment manager or adviser.


GEM Capital will be flagging this issue to its clients directly, but in the meantime we attach a fact sheet about the offer.


Download Magellan Global Trust Fact Sheet


Download Magellan Global Trust Product Disclosure Statement


Company reports can mislead investors

We tracked how investors read company reports and here's how they're misled

File 20170828 27564 jnov8i The study used an eye-tracking device to ensure that all information included in the management report was read and considered in light of judgment formation. Andreas Hellmann, Macquarie University

Investors would have spent a fair amount of time over the last few weeks poring over financial documents, as listed companies report their earnings and plans for the year to come. But our research shows they could have been misled just by the order of information in these reports.

We found that investors place more emphasis on the last piece of information in the management report included in company documents. Non-professional investors also ranked the performance of the company higher on more occasions, if the last piece of information is positive.

We invited 66 non-professional investors in our laboratory to read a management report of a fictitious mining company containing a short series of complex and mixed information. The positive information contained in the report told of increases in financial profitability and a strong operating cash flow. Negative information included a declining share price and increases in costs.

We randomly assigned the participants to two groups. The first group read the textual information included in the report in a sequence of positive information first and negative last. The second group read exactly the same information, but for them it was presented in the opposite way, negative before positive. We used an eye-tracking device to ensure that all information included in the management report was read and considered in light of judgement formation.

The investors we studied actually used the fictitious information in their investment decisions. Over 60% of participants were less inclined to invest in the fictitious company when negative information was presented last.

Easily mislead

Research into the behaviour of investors shows that the presentation order of financial information influences their judgements on company performance.

Because of the limited attention span and working memory capacity of the human mind, investors give more weight to information received later in a sequence.

So although financial information is often regarded as objective, neutral and value-free, the deliberate presentation ordering of information is able to influence non-professional investors. Companies could use this to try and hide negative information in the middle sections of a narrative and disclose positive information at the end of a sequence for the greatest effect.

Presentation ordering is not the only trick companies may use to influence the perceptions of annual report readers.

Graphs can attract investor’s attention and can be more easily retained in their memory than other narratives. Because of this, companies use significantly more graphs highlighting favourable rather than unfavourable performance.

One concern that arises from our findings is that readers of financial information may be mislead into believing there is more objectivity in practice than actually is the case. With regulatory efforts largely related to quantitative information, companies have much more flexibility in terms of how they present narrative information accompanying the financial statements in their reports.

Perhaps further guidance on the presentation of the management commentary is required by the global regulators to restrict the possibility that companies may influence the impressions conveyed to users of accounting information.

The ConversationMaybe next reporting season investors should take another look at what information companies include in their reports.

Andreas Hellmann, Senior Lecturer in Accounting, Macquarie University

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

Is Telstra good value after the dip?

Written by Tim Kelley - Montgomery Investment Management


Telstra (TLS) is not high on the list of businesses we would most like to own. Having said that, it is not a terrible business, and at the right price it makes sense to own it, particularly given its steady dividend stream. So, with TLS’s share price down around 20 percent over the past year, we decided to assess its value.

One of the appealing features of TLS is its stability. Over many years, the company has delivered consistent revenues at consistent margins for consistent earnings. On the face of it, this should allow us to value the company fairly readily.

However, for several reasons the future for TLS looks different to the past: Firstly, migration to the NBN will take a large bite out of TLS’s fixed-line business, offset somewhat by a series of one-off and recurring payments it will receive from NBN Co. for handing over its copper and HFC networks. Secondly, there is the matter of TPG Telecom (TPM) planning to become Australia’s fourth mobile network operator.

Given this, we think it makes sense to split the valuation into four components:

A “business-as-usual” valuation of TLS based on historical financial metrics; A valuation of the earnings “hole” left by the migration to NBN; The present value of payments TLS will receive from NBN Co; and An adjustment for the impact of increasing competition in mobile.

We consider each of these in turn.


As noted above, TLS has historically been a very stable business, and the “business-as-usual” valuation is a relatively straightforward extrapolation of historical financials. Using an 8% cost of capital and a 1.5% p.a. growth rate, we arrive at an estimated value of just under $50 billion for the equity in TLS, or around $4.20 per share.

NBN earnings hole 

We then come to the NBN earnings hole. TLS has provided guidance as to the EBITDA impact it expects when the migration is complete, and our “business-as-usual” valuation gives us an implied EBITDA multiple with which we can capitalise this impact. We estimate that this amounts to a fairly meaningful $17.4 billion of equity value, equivalent to around $1.46 per share.

Payments from NBN Co.

Happily, this earnings hole is largely compensated for by one-off and recurring payments it expects to receive from NBN Co. TLS has provided estimates of the value of these payments, but we believe the discount rate applied to these payments should be lower than the one TLS has used (which is generally 10%). We have evaluated TLS on the basis of an 8% WACC, and we see these payments as having somewhat lower risk than the overall TLS business, and so we apply a 7% discount rate. On this basis, we estimate the value of payments yet to be received from NBN Co at around $16.9 billion after tax – a larger figure than quoted by TLS, and one that substantially makes up for the value lost from TLS’s fixed line business.

Increasing competition

Finally, we consider the impact of TPM’s entry into the mobile market. As a point of reference, we note the impact of the 2012 entry into the French market by low-cost operator, Free mobile. In that example, ARPUs for the leading player, Orange, declined by 10-15% over several years, as the new entrant moved to take market share of 15%.

This sort of outcome would imply a very material loss of value for TLS. However, for a range of reasons, we expect TLS to experience a less dire outcome. These reasons include:

Free benefitted from a roaming agreement with Orange. However, the ACCC has indicated it does not support roaming in Australia. This is an important constraint on TPM which plans to spend relatively little on its network build and will achieve relatively limited population coverage; Approximately 53% of TLS mobile subscribers are outside the major cities, and therefore less vulnerable to competition, as TPM focuses its network spend on the major cities; A large part of TLS’s mobile revenues are derived from business subscribers, who would also be less susceptible to a TPM offering; and Across its entire customer base, TLS maintains a price premium position in the Australian market due to perceptions of coverage and quality. TPM’s low-cost offering will more directly impact Optus and Vodafone (and is thought to potentially be a strategy to pressure Vodafone into a consolidation).

Our valuation of Telstra

Taking these factors into account, we anticipate a couple of percentage points of lost market share for TLS, and perhaps a 5% decline to ARPUs. On this basis, we estimate that the value of TLS falls by around $4.3 billion, or around $0.36 per share – still a material impact.

We then assemble the different valuation components into an overall picture, as follows, to arrive at an estimated value for TLS equity of around $44.8 billion, which equates to around $3.77 per share.

Against today’s share price of $4.42, this makes TLS look around 15% expensive, although it should be noted that we consider large sections of the Australian equity market to be expensive, so this conclusion perhaps comes as no surprise. It is also worth noting that different judgements around discount rates might lead other analysts to a different conclusion.

The Montgomery Alpha Plus Fund – which is fully-invested and uses a machine learning model analysing many different variables to drive investment decisions – holds a modest position in TLS in its long portfolio. For the Montgomery Fund, however, we are particular about valuation and are happy to hold cash when value is scarce. Accordingly, TLS does not find its way into our long-only funds at the current price, regardless of its dividend-yielding appeal.

The next French President - Emmanuel Macron - Euro political risks subside

Written by Richard Watt - Fidelity Investments
Political risks subside 
Perceived political risks in Europe have detracted from European equity performance over the past year, with around US$100bn flowing out of European markets in 2016. With the election of Emmanuel Macron as the next French President, much of that risk has been reduced and investors may now focus on the performance of European companies.
Here we look at the key benefits that the Macron win may bring to the European economy and its equity markets.
Pro-reform, pro-integration 
Macron is a reformist and pro-European. He is in favour of greater integration in Europe, the strengthening of European institutions and a common Eurozone budget that would protect from future economic shocks. He has campaigned on reforms of the labour market in France, reforms of the tax system and tax cuts, and raising the retirement age, which is currently one of the lowest in Europe. 
Along with this, he plans to invest EUR50bn into the French economy. This would be funded by reducing the size of the French state - by far the largest of any European country.
All of this would be hugely beneficial to what is a relatively uncompetitive French economy, and to the future strength and stability of the Eurozone.
Political risks diminishing 
Sentiment towards Europe has been particularly strong since the first round of voting in France two weeks ago, seeing European and French markets up 7-8%. With either the upcoming UK or German elections representing an existential risk to Europe, much of the political risk is behind us. Investors will likely focus on corporate fundamentals and earnings. 
Earnings turn
Since the financial crisis, while US companies have seen margins and earnings recover, European earnings are still below their peak. The underperformance of European stocks relative to US stocks has been exclusively driven by the lack of earnings delivery of European companies. 

European earnings revisions turning positive 

Source: Fidelity, Datastream, Morgan Stanley , data as of 6 Apr 2017. N12M ERR (%) = 12-month earnings revision ratio. 3MA = 3-month moving average.

What we are now seeing is a strong recovery in European stocks, with earnings starting to come through. Margins are recovering and the most recent earnings season in Europe has been the strongest in more than 10 years. 

Particularly compelling for European equities is their valuation. As they have been out of favour for much of last year they are trading at a multi-year discount relative to the US on a price-to-book basis. And today, record high numbers of European companies have a dividend yield that exceeds their bond yield.

European P/B vs US P/B

Source: Datastream, GS Research, data as of 31 March 2017. 

Percentage of stocks with dividend yield > bond yield

Source: Datastream, Goldman Sachs Global ECS Research, December 2016. Stoxx Europe 600.  

Europe has been significantly out of favour for some time due to political risk. The French result today puts much of this behind us and European equities are looking attractive compared to the US and other markets and asset classes. We are now starting to see companies deliver strongly on earnings, removing another key detractor from investor sentiment. 
This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets. 

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser.  You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise. 

French election in 3 charts

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.



Trump's election as US President - has it changed the world that much?

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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Why we don't like Telstra

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.


Can ethical investing and good returns co-exist?

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.

Plato Income Maximiser - New Listed Investment Company

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.

Morphic Ethical fund to list

Jack Lowenstein and Chad Slater formerly from Hunter Hall are about to list the Morphic Ethical Equities fund.  Morphic was established in 2012 and has managed the Global Opportunities fund in that time which has generated a 17%pa return for investors since its inception.

Morphic Graph


Morphic is 30% owned by Westpac, and 70% owned by management, an ownership structure that we like.  Jack Lowenstein will be putting in significant money of his own into the listed investment company which is further evidence that management's interests are aligned with share holders.

The Morphic listed investment company will be aiming to pay out a steady stream of franked income once it has built up a profit reserve account and will invest ethically by not being to invest in companies that engage in:

Environmental Damage 

Oil and Gas




Uranium Mining

Old Forrest logging

Morphic Ethical Equities fund will also have the ability to short stocks, (take a position to profit from a falling share price) and interestingly may short companies that fail it's ethical screen.

Investors who apply for shares in the IPO will receive a share of $1.10 in addition to an option for each share they purchase.  The option allows them to purchase an additional share at the same price of $1.10 in the next 18 months, or alternatively the option will carry some value and may be traded on the market.

We have spoken to the managers of the IPO - who have received good support from investors and they are anticipating that Morphic is likely to raise around $100m in this offer.

Management fee is 1.25%pa of net asset value of the fund which is reasonable for a global fund, plus a performance fee if the fund returns better than the international market.

GEM Capital is likely to receive an allocation of shares in this fund and the advisers will be co-investing into the fund too.

CEO Jack Lowenstein recently spoke on Sky Business News to Peter Switzer and we bring you that interview below.


Of course before investing, investors should seek professional advice and read the prospectus which can be downloaded below by clicking on the "Download" icon.



download button 1



China - It's better than you think

Mark Draper and Shannon Corcoran (GEM Capital) recently spoke with Joseph Lai (Portfolio Manager Platinum Asset Management) about China and the current state of the economy.

Joseph believes that the Chinese market is cheap and that the risks of a banking crisis in China are overblown.

You can listen to the podcast here.



Apple Inc - is more than simply a device manufacturer

Apple RainbowApple is among the largest companies in the world.  The company enjoys strong brand recognition globally and extensive market penetration for its flagship products, most notably the iphone.  While speculation around the success of Apple Watch, Apple TV, iPad, or even the likelihood of an Apple Car often captures headlines, we estimate that iPhone and iPhone related services represented around 70% of Apple's revenue and 80% of Apple's gross margin in 2016.  Despite its relatively high price, there is strong demand for the iPhone in both developed and emerging markets, with China now contributing 21% of Apple's total revenue.

We recently met with Dom Guiliano (Chief Investment Officer, Magellan Financial Group) who outlined the investment case for Apple Inc, which is a major holding in Magellan funds.  You can listen to the podcast below.  You can also download the paper that briefly outlines the Investment Case for Apple, which clearly is far more than an electronic device manufacturer.  This can be downloaded by clicking on icon below.


Donald Trump - the policy agenda


The biggest event for global financial markets in 2017 is likely to have taken place on 20th January - when Donald Trump was sworn  in as the 45th President of the United States.

The implications for the US economy and financial markets from President Trump is likely to involve three phases.

Phase one was 'risk off', with the unexpected election victory by Trump seeing the US equity market and the US dollar sell-off and US bond yields rally.  This phase, however, lasted less than 24 hours, with the market quickly moving into the second phase.

The second phase, which ies expected to be the dominant factor throughout 2017, is supported by the view that Trump's policies will be expansionary and stimulatory - especially his company and income tax cuts, increased infrastructure spending and reduced regulatory environment.

This phase has already seen a strong rally in equity markets, the US dollar, a sell off in bond markets and is expected to be the primary factor driving markets throughout 2017.  A noticeable increase in both business and consumer confidence has taken place since the election.

Further out, however phase 3 may not be as positive.  Although the timing for phase three is very difficult to determine, it could be anywhere between 2018-2020, this phase is likely to involve an increase in inflation and a more aggressive monetary policy tightening cycle from the US Federal Reserve resulting in higher than expected interest rates.

In terms of the main policy agenda for President Trump, the following is expected (+, - and ? symbols indicate the direction of impact on the economy and markets)

+ Significant fiscal stimulus through a) large income tax cuts (3 rates 12%, 25% and 33%) b)company tax cuts (to 15% or 20% from 35%) and c) a 10% repatriation tax for cash currently held offshore by US corporates

+ Increase in infrastructure spending ie $300bn government spending, with private sector involvement potentially up to $1 trillion.

+ Increase in military spending - current and veterans

+ Reduce regulatory burden, especially on energy to achieve "complete American energy independance"


- Strongly protectionist stance - name China as a 'currency manipulator' and impose 45% tariffs on selected imported goods

- No support for TPP and change / withdraw from NAFTA - both important trade agreements

- Scale back climate change regulations

- Critical of US Federal Reserve policy, pro-audit, Chair Janet Yellen to be replaced in early 2018

- Isolationist stance of foreign policy - critical of NATO / some allies and China.  Closer to Russia.

- Tough stance on immigration - building a wall


? Repeal and replace Obamacare.


It has been estimated that Trump's policy agenda will increase the level of US Government debt by around 20% of GDP over the coming decade. 




The key question for investors over 2017 and beyond is wil this be money well spent?  Will President Trump's policies lead to a permanent shift higher in US's potentional economic growth rate?

This information is an extract from a presentation we attended by Stephen Halmarick (Chief Economist Colonial First State)

We will be producing a podcast that explores more about Trump's policy agenda in March with Dom Guiliano (Chief Investment Officer - Magellan Financial Group)

What the "Dumb" money is doing - Sportsbet on Trump

Investing is a game of probabilities.  So is politics.

With the leading global book makers being wrong on Brexit and Donald Trump, they are now providing punters an opportunity to win their money back with Donald Trump, providing odds on Donald Trump being impeached, to visiting North Korea in his first term.

We provide screen shots from that highlight what's on offer.



















Following OPEC Oil Production Freeze - supply demand in balance during 2017

Late last year OPEC announced that it will cut oil production by 1.2 million barrels per day to 32.5 million.  To put this number in perspective, OPEC represents around one third of global oil production.  These cuts will take effect in January 2017, lasting for 6 months and is the first time since 2008 that OPEC has cut production.  Currently although Iraq is producing more than agreed, the compliance from other OPEC members has been very high.

Already there has been some reaction in the oil markets with the price of oil rising in the last quarter of 2016.

Around 12 months ago, we shot a video featuring Clay Smolinski (Platinum Asset Management) who suggested that the oil markets would likely come into balance where supply meets demand during 2017.  This of course was well before the OPEC production cuts were announced, as the balancing of the oil market was underway at that stage.  The OPEC production cuts simply speed up the process.  The graph below confirms his prediction.

What stands out from the above chart is how close supply and demand tend to be.  Even when the oil market was in dramatic oversupply during 2015, the oversupply was around 2 million barrels per day.  The over-supply gap at the end of 2016 was small which underscores the significance of a production cut of 1.2m barrels per day.

It was also suggested at that time, that the oil price was likely to recover to around $70 per barrel as it is at this level that oil companies can make sufficient profit to reinvest into exploration to ensure supply can be maintained.  Currently the oil price remains in the $50 - $55 per barrel range, but the production cuts, providing they are maintained are only starting to be reflected in oil inventories now.

Higher oil prices are positive for companies who derive income from oil or products referenced to the oil price such as LNG.

At GEM Capital we have been investing in companies that can benefit from a rising oil price, and with fund managers who also share this view such as Ausbil and Platinum Asset Management.

Hunter Hall Global Value - Business as usual

James McDonald (interim Chief Investment Officer for Hunter Hall) recently spoke with Commsec about the resignation/departure of Peter Hall from the business.

James talks about the depth of the Hunter Hall team, the current fund positioning as well as the future dividend policy.



10 themes to watch in 2017

This time last year, JCB Advisory Board Economist, Saul Eslake warned of the risks of a Yuan devaluation: “A large devaluation of the Yuan would add renewed impetus to the deflationary pressures that policymakers in advanced economies are hoping will ebb this year.” This proved prescient as markets saw a sharp risk-off correction in the first months of the year. By contrast, inflation is a key theme to watch this year, as headline inflation, core inflation, and producer price inflation all begin to show signs of life. This is just one of ten themes identified in this year’s ‘What to watch.’ Livewire and Jamieson Coote Bonds are pleased to provide exclusively for readers the top themes to watch this year from one of Australia's pre-eminent economic minds, Saul Eslake. 

By Saul Eslake, Jamieson Coote Bonds Advisory Board Member & Senior Economist. Saul Eslake was Chief Economist of ANZ Bank from 1995 to 2009, Chief Economist at National Mutual Funds Management in the early 1990s, and acted in various advisory roles to the Howard, Rudd, and Gillard governments.


"Over the first few weeks of the year, I’ve been thinking about the issues that I’m likely to find myself talking about at conferences and events in the coming year. Here are ten things that I think are likely to shape the global and Australian economies during 2017.

1. What Donald does (or says) next: This time last year I wrote that Donald Trump was ‘odds on’ to be the Republican nominee for President of the United States, but I also found it ‘hard to conceive’ that he could be a ‘serious contender for what used to be called Leader of the Free World’. Moreover, I thought that financial markets around the world ‘may well take fright’ if they began to think that he and Melania ‘could be moving into the White House’. Well, Melania isn’t moving (yet) – but Donald Trump is now ensconced in the White House; and although they didn’t predict his victory either, they haven’t been at all troubled by it (so far). Since the election, investors seem to have assumed that President Trump will only seek (or be allowed by Congress) to implement the items from his campaign platform which markets believe will boost economic growth (such as cutting taxes and boosting infrastructure spending), and that he will back away from (or Congress will block) items from his campaign platform which would harm growth (such as launching trade wars). However, Donald Trump’s inaugural address casts a lot of doubt on those convenient assumptions. I think his assertion that ‘protection will lead to great prosperity and strength’ is complete and utter balderdash – but it’s also a clear signal that he means to implement the protectionist agenda he repeatedly outlined during last year’s election campaign. And, as a result, we are likely to see much more volatility in market pricing of the outlook for the US and global economies – and, eventually, if the Trump Administration is able to implement this protectionist agenda, weaker growth, higher unemployment and higher inflation.

2. European voters: There are a number of important elections in Europe this year – including in the Netherlands on 15th March, in France on 23rd April and on 7th May, and in Germany sometime between late September and late October. Each of these will provide some insight into the extent to which the wave of right-wing populism which gained global attention in the ‘Brexit’ referendum and then during the US election campaign continues to appeal to voters. The Dutch Parliamentary and French Presidential elections, in particular, could add to the number of countries seeking to exit the European Union. And then of course there are the various formal steps which Britain needs to undertake in order to give effect to last year’s referendum verdict. All of these represent potential sources of market volatility.

3. The clash between demography and economic policy: Markets – and many policy-makers – seem to be paying scant regard to the constraints which demographic change has been having – and will increasingly have – on the rates of growth which can be sustained by advanced (and some emerging) economies. Across the OECD area, the growth rate of the 15-64 year old population has slowed from 0.75% pa in 2006-08 to just 0.2% pa in 2016- 18. This largely explains why OECD area real GDP growth averaging just under 2% pa since the trough of the ‘Great Recession’ in early 2009 – a rate some two-thirds of a percentage point below the average between the global recessions of the early 1990s and the onset of the financial crisis – has nonetheless been sufficient to allow the average unemployment rate across the OECD area to fall by more over the past three years than over any other three-year period, bar one, in the last five decades. That fall in unemployment is of course a Good Thing. But now that the unemployment rate in the OECD’s four largest economies is down to levels traditionally regarded as consistent with ‘full employment’ – while in those OED countries where unemployment hasn’t fallen by very much, it’s mostly ‘structural’ rather than ‘cyclical’ unemployment, which faster economic growth alone can’t help – ongoing efforts to procure a return to pre-crisis economic growth rates are more likely to trigger higher inflation than faster growth. That’s especially so if productivity growth remains as anaemic as it has, in virtually all advanced economies, since the financial crisis. And in this kind of world, protectionist policies amount to a fight over shares of a shrinking economic pie – they do nothing to make the pie bigger.

4. The end of deflation fears: Largely because the four major advanced economies are now effectively at full employment, the fears of falling into deflation which have periodically gripped financial markets since the financial crisis should evaporate. ‘Headline’ inflation rates have picked up (in some cases out of negative territory) since the middle of last year, aided by the rebound in oil prices. ‘Core’ inflation rates also appear to be edging higher in most advanced economies, especially in the UK (as a result of the post-referendum fall in sterling) and in the US. Producer price inflation across Asia also moved back into positive territory towards the end of last year, something which will filter into advanced economy consumer prices during 2017. This should eventually see an end to negative interest rates around the world.

5. The Fed: The Fed repeatedly baulked at raising interest rates last year, eventually doing so only at the last opportunity, in December. This left the Fed open to accusations from Donald Trump that it was ‘artificially’ holding rates down in order to favour his political opponent. As President Donald Trump is now in a position to reshape the Fed, with two vacancies on the Fed’s Board of Governors able to be filled immediately, and the opportunity to appoint a new Chair and Vice-Chair early next year when Janet Yellen’s and Stanley Fischer’s terms in those offices expire (although they could complicate matters by electing to serve out some or all of their remaining terms as Governors). During last year’s election campaign Donald Trump also appeared sympathetic to proposals to water down the Fed’s independence from political interference. At its December meeting the Fed foreshadowed its intention to raise interest rates three, or possibly four, times during 2017. The Administration’s reaction to such moves, as well as the calibre of its appointees to the Fed, may have an important bearing on market perceptions of the Fed’s credibility as the year unfolds.

6. China: The ‘Chinese authorities’ succeeded in shoring up China’s growth rate, staunching the outflow of capital, and stabilizing the currency during 2016. Nonetheless, uncertainty about the future trajectory of the Chinese economy, and the response of the ‘Chinese authorities’ to the various policy dilemmas which they face, will remain throughout this year. The form taken by last year’s monetary policy stimulus – whereby banks were encouraged to borrow in wholesale money markets in order to fund purchases of local government securities and loans to non-bank financial intermediaries – has introduced a new element of risk into the Chinese financial system. For the first time, the ratio of loans to deposits of Chinese banks has dropped below 100% - and is continuing to fall – implying that the Chinese banking system is starting to become exposed to liquidity risks of the sort (albeit not yet on the same scale) that were at the heart of the Asian financial crisis of 1997-98 and the global financial crisis of 2007-09. The ‘Chinese authorities’ may be fearful of allowing the yuan to depreciate further against an appreciating US dollar for fear of further inflaming the protectionist instincts of the Trump Administration. And of course they may have to decide whether, and if so how, to retaliate to any specific protectionist measures directed at China by the Trump Administration. Outside of the purely economic sphere, tensions between China and the US over the former’s activities in the South China Sea, and the latter’s relationship with Taiwan, could also prove unsettling for financial markets.

7. Australia’s on-going economic transition: Australia’s economy is continuing its hesitant and uneven transition away from growth driven by the mining investment boom (which peaked in 2013) to growth driven by a variety of other, often less visible, sources. The upswing in dwelling construction, which has accounted for more than one-third of the non-resourcesexports-related increase in real GDP over the past two years, appears to have peaked – and although there is still plenty of work left in the residential building ‘pipeline’ this sector is unlikely to provide much further impetus to economic growth in 2017. The renewed upswing in lending to investors is potentially worrisome (since the main effect of domestic property investors is to inflate housing prices, rather than to add to housing supply), and may require further attention from APRA. There’s still not much sign of any imminent pick-up in other categories of investment. Consumer spending should continue to grow at a modest pace, given subdued growth in both wages and employment, and the on-going absence of fiscal stimuli of the type that became routine during the commodities boom years

8. Domestic politics and the Budget: The Turnbull Government is in a much weaker position than seemed likely this time last year – with a wafer-thin majority in the lower house, a fractious assortment of cross-benchers holding the balance of power in the Senate, and an ill-disciplined and restless backbench, all as a result of the Government’s poor showing at last July’s election. The Government lacks any kind of strong mandate for economic reform – with its signature initiative, the ten-year staged reduction in the company tax rate, unlikely to gain legislative approval, and there being no readily apparent ‘Plan B’. Moreover, despite Malcolm Turnbull’s promise to preside over a ‘thoroughly liberal government’, his Government seems surprisingly beholden to protectionist and other right-wing influences, both from within and without. This tendency will only increase if Pauline Hanson’s One Nation party does well in the State elections to be held in Western Australia on 11th March and Queensland most likely later this year. Another key milestone will be the Budget on 9th May – where the Government will again be under pressure to re-assure credit rating agencies and others that the budget really is on a credible path back to a sustainable surplus, and not one reliant on accounting policy changes.

9. The RBA: It will take a lot to get the Reserve Bank to move Australian interest rates – in either direction – this year, although no-one should doubt their willingness and ability to do so if they think it’s warranted. Newly-installed Governor Phil Lowe’s previous writings have prompted some to think that he places more weight on financial stability considerations than his predecessors, and hence will be less inclined to cut interest rates and further – and possibly more willing to raise them. However to date he hasn’t really said or done anything to justify that conclusion. He appears to share the (sensible and pragmatic) view held by his predecessor, in his final year as Governor, that monetary policy was approaching the limits of what it could do to improve Australia’s economic growth prospects, and that fiscal policy and productivity-enhancing structural reforms should play a greater role. Global developments suggest that Australia’s inflation rate should edge higher, in line with the RBA’s own forecasts, from its late 2016 levels – in which case there shouldn’t be any need for further rate cuts. On the other hand, it’s also hard to see Australia’s economic growth performance picking up so strongly as to warrant one or more rate hikes this year.

10. Property prices: No discussion of the Australian economy, or Australian interest rates, would be complete without at least some reference to the residential property market. Actually to speak of ‘the’ residential property market as if it were a single homogeneous entity is even more misleading than usual under current circumstances, with Perth and Darwin prices down 8% and 6%, respectively, from their peaks but Sydney and Melbourne prices putting on more than 15% and nearly 14%, respectively, last year. There is, to be sure, a lot of new supply hitting the Melbourne, Sydney and Brisbane markets over the next few years, which in theory should put a lid on further price appreciation: but there is also quite strong population growth, particularly in Melbourne, to absorb at least some of that new supply. And there is absolutely no political will on the part of the present Government to do anything to restrict the scope for domestic investors to continue inflating existing property prices. The renewed upturn in lending to investors towards the end of last year will, if it continues, be of some concern to the RBA, but they’re unlikely to raise interest rates for that reason alone, and will instead likely leave that problem to APRA. A US-, Irish- or Spanish-style ‘meltdown’ in Australian property prices won’t happen without a specific trigger, and it’s hard to see one on the near-term horizon: but the more prices keep going up, the greater the risk of either some kind of ‘accident’ (which could emanate from somewhere outside of Australia, such as China) or, alternatively, a growing social and political backlash against the ongoing deterioration in housing affordability."

Saul Eslake, Jamieson Coote Bonds, Advisory Board Member & Senior Economist.

23rd January 2017

Shane Oliver - What the Trump win means for investors and Australia

 Key points



After a seemingly long and difficult campaign Donald Trump has been elected president of the United States with the Republican Party retaining control of the House, and the Senate, in Congress. Just as we saw with the Brexit vote, the combination of rising inequality, stagnant middle incomes and the disenchantment of white non-college educated males has seen a backlash against the establishment and helped deliver victory for Trump. This note looks at the implications.


Trump’s key policies

Taxation: Trump promises significant personal tax cuts including a cut in the top marginal tax rate to 33% from 39%, a cut in the corporate tax rate to 15% from as high as 39% and the removal of estate tax.

Infrastructure: Trump wants to increase infrastructure spending.

Government spending: Trump wants to reduce non-defence discretionary spending by 1% a year (the “penny plan”), but increase spending on defence and veterans.

Budget deficit: Trump’s policies are likely to lead to a higher budget deficit and public debt.

Trade: Trump wants to renegotiate free trade agreements and has proposed various protectionist policies, eg; a 45% tariff on Chinese goods, 35% on Mexican goods.

Regulation: Trump generally wants to reduce industry regulation, which would be good for financials and energy.

Immigration: Trump wants to build a wall with Mexico, deport 11 million illegal immigrants, put a ban on Muslims entering the US and require firms to hire Americans first.

Healthcare: Trump wants to repeal Obamacare and allow the importation of foreign drugs.

Foreign policy: Trump wants to reposition alliances to put "America first" and get allies to pay more, would confront China over the South China Sea and would bomb oil fields under IS control.

Risks and uncertainties

A problem for Donald Trump and America is that he will start his Presidency as extremely unpopular – in fact he is the least popular candidate on record and the election campaign has also highlighted a deeply divided America.

Source: Gallup, BCA Research, AMP Capital

He also faces a difficult time negotiating with his Republican colleagues in Congress given many distanced themselves from him during the election campaign.

Trump’s victory, like the Brexit vote, adds momentum to a backlash against establishment economic policies and specifically a move away from economic rationalist policies in favour of populism and a reversal of globalisation which could be a negative for long term global economic growth. The shift away from globalisation could also add to geopolitical instability (Russian President Putin was a supporter of Brexit and Trump!). More positively though, a greater focus on using fiscal stimulus could help reduce the burden on monetary policy and policies to reduce inequality could help support longer term economic growth.

Economic impact

Some of Trump’s economic policies could provide a boost to the US economy. The Reaganesque combination of big tax cuts and increased defence and infrastructure spending will provide an initial fiscal stimulus and, with reduced regulation, a bit of a supply side boost to the economy. The downside though is that this will blow out the budget deficit and the risk is that his protectionist policies will set off a trade war, and along with much higher consumer prices and immigration cut backs will boost costs. All of which could ultimately mean higher inflation and bond yields and a faster path of Fed rate hikes in the US (apart from any initial delays associated with uncertainty around his policies).

There may also be negative geopolitical and social consequences - tensions with US allies, reduced inflows into US treasuries in return, a more divided America - if Trump follows through with policies on these fronts.

Australia being more dependent on trade than the US (exports are 21% of GDP in Australia against 13% in the US) will be particularly vulnerable if Trump were to set off a global trade war.

The ultimate impact will depend on whether we get Trump the populist (determined to push ahead with his protectionist policies and steam roll Congress) or Trump the pragmatist (who backs down on his more extreme policies, eg. around protectionism) leading to a smoother period for the US and global economies. If we get Trump the pragmatist there is a good chance the US will see a sensible economic stimulus program combined with long needed reforms in areas like corporate tax.

Likely market reaction

The last few weeks – with shares and other risk assets falling when developments favoured Trump and rallying when developments favoured Clinton – indicates Trump’s victory will not go down well with markets. In fact we have already seen this with the initial reaction in Asian markets:

  • Trump’s victory is seeing a resumption of “risk off” with shares likely to fall 5% or so (both in the US and globally – although Asian and Australian shares have already reacted to some degree) and safe havens like bonds and gold rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares are particularly vulnerable to this given our high trade exposure. The “global shock” of a Trump victory will likely see the Yen and the Euro rally further against the $US but the $US rise further against the Mexican peso and trade exposed countries in Asia.
  • While the Fed will be a bit less likely to hike in December with a Trump victory, the $A will likely suffer from the threat to trade and the initial “risk-off” environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war, may also increase the chance of another RBA rate cut in Australia – but not until next year.
  • Beyond the initial reaction, share markets are likely to settle down and get a boost to the extent that Trump’s stimulatory economic policies look like being supported by Congress, but much will ultimately depend on whether we get Trump the pragmatist or Trump the populist. Congress, along with economic and political reality, can probably be relied on to take some of the edge off Trump’s policies to some degree, but this would take time. But a more pragmatic approach by Trump to economic policy would probably see the initial market reaction present investors with a buying opportunity.

Historically since 1927 US total share returns have been weakest when Republicans controlled the presidency and Congress with an average return of 8.9% p.a.

Source: Bloomberg, AMP Capital

Concluding comments

While Trump’s victory will come as a bit of a shock to many, there is a good chance that economic realities and the checks and balances provided by Congress will see his policies become more pragmatic. A good initial guide to this will be what sort of advisers Trump appoints around him. And remember there was much concern a Yes Brexit vote would be a disaster for shares and the global economy. What actually happened was an initial knee jerk sell off but after a few days global markets moved on to focus on other things and shares rallied. So there is a danger in making too much of the US election. It’s also worth noting that recent global growth indicators have been improving – both business conditions PMIs and profit indicators – and this along with continuing ultra-easy global monetary policy provides support for investment markets in the face of short term political uncertainties. 

Finally, while the Presidential election is an important political event, investors should remain focused on adhering to their financial objectives, ensuring that their portfolios are well diversified across asset classes and geographies, and continuing to take a long-term view.

Should investors participate in IPO's

This article was written for SMSF Adviser online magazine.


With the avalanche of new listings coming to market, we consider the issue should investors participate in IPO’s (Initial Public Offers)?

When it comes to investing we all aspire to Warren Buffett, and yet at times investors act more like Gordon Ghecko, the fictional character portrayed by Michael Douglas in the 1987 film “Wall Street”. This is how it seems with the love affair investors have with IPO’s.

Every investors dream of course is to buy into a float, and then sell day one for a handsome profit, otherwise known as a ‘stag’.

We acknowledge how easy it is to fall in love with a new IPO, after all the prospectuses produced usually come complete with stunning pictures of celebrities such as Jennifer Hawkins who made the Myer prospectus worth flicking through. When Pacific Brands pitched to investors the images of Pat Rafter and others in their underwear may have been visually appealing, but certainly not instructive.

Aside from the pictures though, the prospectus almost always outlines a rosy outlook for the business.

The first question we would suggest investors ask themselves is – would they want to have this in their portfolio in 5 years time? If the answer is a clear no – then we suggest extreme caution.

Other than the normal set of investment considerations that investors think about when investing, such as price, management, gearing etc here are a series of additional points when thinking about investing in an IPO.

  1. Investors need to understand who is the vendor of the IPO. Private Equity funds have established a poor reputation for taking over businesses, loading them up with debt after stripping the company of other assets before selling back to unsuspecting investors via an IPO. Dick Smith comes to mind as a perfect example. We are not opposed to buying from Private Equity funds as such, but investors must understand that the vendors in an IPO have a far greater understanding of the business than the investor can gather from reading the prospectus, which puts the vendor at a significant advantage. Conversely the history of Government IPO’s has been a little friendlier for investors, other than of course Telstra II, which is still significantly underwater from its $7 plus offer price.
  2. Once investors have established who is the vendor, it is important to also understand whether the vendor is retaining any part of the company or if it is a full sale. If the vendor is retaining part of the business, investors need to understand if there are any time limitations around this ownership. We also believe that it is also crucial to understand what the IPO proceeds are being used for. Is the IPO simply to reduce debt, or for the vendor to sell out? Or are the proceeds being used to grow the business?
  3. Brokers are remunerated for selling the IPO. While this may sound obvious, it reminds us of the phrase “never ask a barber whether you need a haircut”. Brokers have to sell their services to the IPO vendor, which results in a research blackout on the IPO company. This simply means that it is virtually impossible to obtain unbiased investment research from the broking firm that is handling the IPO. And of course as the experienced brokers will tell you – “the best IPO’s you can never get enough of, and the IPO that you receive your full allocation for is generally the one you don’t want”
  4. One of the best pages of the prospectus is the “Investment Risks” section. In our experience, very few investors read much in a prospectus at all, and in particular do not read or understand the investment risks section. If it is one section of a prospectus that investors read, it should be this section.

So, should you invest in IPO’s? Our view is that while some IPO’s offer good opportunity, greater caution should be exercised by investors when considering IPO’s due to the lower level of information usually available.


Why Deutsche Bank is no Hindenburg

This article is an extract from Platinum Asset Management's September 2016 quarterly review


Bank's fail because they are 1) illiquid 2) insolvent or 3) both.

Deutsche Bank does not have a liquidity problem.  They hold EUR 200bn of highly liquid assets (12.5% of the balance sheet) which are enough to withstand a serious bank run.  But ultimately is doesn't matter, because the ECB can and will provide unlimited liquidity support to the bank, if needed.

The solvency question in more nuanced.  Normally banks become insolvent because they can't recover money from borrowers or counterparties, they don't have as many assets as they thought.  But the value of Deutsche bank's asset isn't being questioned.  Rather, its the value of their liabilities that has the market in a spin.

According to its latest disclosure Deutsche Bank faces 14 sets of legal actions.  These are contingent liabilities because Deutsche only has to pay if it loses a case.  Both the probability of losing those cases and the amount they would have to pay are unknown today.  Deutsche makes an estimate and has set aside EUR 5.5bn for these contingencies.  It recently emerged that the US Dept of Justice (DOJ) has offered to settle the largest of these actions for EUR 13bn.

Of the EUR 5.5bn Deutsche has provisioned for these contingent liabilties, EUR 3.5bn is thought to be ear-marked for this particular case.  This leaves Deutsche Bank EUR 9bn short.  It also raises the question of whether the EUR 2bn of reserves set aside for the remaining 13 cases is sufficient or if more will be needed.

Answsers are not forthcoming, most likely because they are unknowable.  Remember, this is a proposed settlement, not a penalty awarded by a court.  And the DOJ has a history of 'high balling' and then negotiating down.  For example Goldman Sachs was hit with a similar figure and ultimately settled for US $5bn.  EUR 9bn is therefore a worst case scenario.

Against this EUR 9bn claim and 13 other outstanding cases, Deutsche Bank has EUR 120bn of loss absorbing capital and, under basic assumptions, around EUR 4bn in annual earnings.  There is simply no reasonable chance that these litigation costs will cause a loss to the bank's depositors, clients or counterparties, let alone trigger a systemic crisis.

It is possible, however, that shareholders and the holders of some equity-like instruments may end up taking a hit.  This relates to a second problem.  While Deutsche meets its capital requirements today, the required level of capital will ratchet up each year until 2019, its a moving target.  By the end of 2019 the bank will need EUR 49bn of capital, and it currently has EUR 43.5bn.  This leaves a EUR 5.5bn shortfall that has to be progressively closed over three and a half years.

There are a lot of moving parts.  They may end up settling for well under EUR 13bn with the DOJ.  But equally, earnings are volatile in this business and may end up being significantly lower than EUR 4bn.  There is little in the way of a margin of safety, particularly where fear-driven clients choose to close accounts or cut relationships because of bad press.

However this is reflected in the stock price.  The shares are curently trading at roughly a 75% discount to book value.  This indicates that the market is pricing in a reasonably high likelihood of a dilutive capital raising.

Holders of some hybrid instruments are at risk if the bank's capital falls below a certain trigger level, which would trigger the automatic conversion of these bonds into equity.  This seems unlikely under current circumstances as it is hard to see how the issues described above would erode capital so much as to trigger a conversion.  However they are now vulnerable should the bank experience a second or third unexpected shock.

3 Macro Issues that matter - Hamish Douglass - CEO Magellan

Hamish Douglass (CEO Magellan Financial Group) talks about 3 macro economic issues that investors should be thinking about at the moment.

Hamish believes that investors need to be thinking about rising long term interest rates, Italian financial system and China.

He is considered one of the best investors in Australia and his views are widely sought after.

He also talks about recent moves he has made in the fund he manages - Magellan Global Fund.


Inghams IPO - we've chickened out!

GEM Capital has considered applying for stock in the soon to be listed Inghams IPO, and had the opportunity through its investment bank contacts, but have decided not to proceed after careful consideration.

This article is simply to communicate the evaluation process that is undertaken when assessing investment opportunities.

Inghams is one of the largest vertically integrated chicken manufacturers in ANZ with a #1 market share in Australia (40% share) and #2 in New Zealand (34% share). Inghams runs its own stockfeed operations and controls every aspect of chicken growing and processing. Its closest competitor has a 33% market share in Australia and 48% in NZ.

Inghams Group sells to supermarkets (53% of revenue), fast food restaurants (17% of revenue), food distributors (8% of revenue), and ‘wholesale’ providers (butchers, etc, 7% of revenue). Although Inghams has a large number of customers, the top five accounted for 55%-60% of revenue in 2016. We have seen with companies like Coca-Cola Amatil Ltd that large supermarkets like Woolworths Limited and Wesfarmers Ltd have the ability to pass on a fair amount of pricing pressure to suppliers and Inghams will not be immune.

One of the most important aspects of assessing a new listing, commonly referred to as an IPO (Initial Public Offering) is to understand who you are buying from.  In the case of Inghams, the family has previously sold to a Private Equity firm, TPG Capital.  In our experience, rarely do private equity firms pass on gifts to retail investors. (or any investors for that matter)

It is interesting to note that TPG paid the Ingham family close to $900m for the business in 2014, and have since sold all the properties and leased them back, realising around $600m.  Now, two years after acquisition, TPG are selling up to 70% of the business to investors and are hoping to raise around $1.1bn at the upper end.  That means for an outlay of $900m, TPG will receive up to $1.7bn, pocketing a tidy profit of $800m while still owning 30% of the Ingham business.  TPG's remaining 30% stake is escrowed for 6-12 months, but it is unlikely they will be a long term owner of  this business.

If investors take a look at the sensitivity analysis from the prospectus, they will see that small movements in sales and pricing can have material impacts on profitability.










For a company forecast to increase profit by 18.9% to $98.8m in 2017, movement in average selling prices represents a significant risk should the supermarkets wish to use chicken in a discounting war.

While the price at the upper end of the IPO pricing would appear OK at 15.5 times forecast earnings, the price is higher than its smaller rival across the Tasman, Tegel Foods.

This is a low margin, high turnover business.  We don't mind the food production sector and quite like the chicken story, particularly with it's price advantage for consumers over beef.

We just feel that the easy money here has been made by private equity.  Therefore we are not participating in the IPO and will watch Inghams in the aftermarket, in the months ahead.


 This information is of a general nature only and neither represents nor is intended to be personal advice on any particular matter. We strongly suggest that no person should act specifically on the basis of the information contained herein, but should obtain appropriate professional advice based upon their own personal circumstances including personal financial advice from a licensed financial adviser and legal advice. Fortnum Private Wealth Pty Ltd ABN 54 139 889 535 AFSL 357306




European Refugee Crisis - last straw for the EU?

Germany has taken in 1 million refugees in the last 12 months, and there are plenty of signs that the refugee crisis is taking its toll on social harmony in Europe.

A couple of months ago we spoke with Clay Smolinski on how the European refugee crisis is impacting investment decisions.


Here is a transcript of the video for those who prefer to read the interview.


Mark Draper: Here with Clay Smolinski from Platinum Asset Management and the Europeans have been through a lot really in the last decade and they’ve got plenty of coming up.

One of them has to do with the refugee crisis  there. So we just want to spend a couple of minutes looking at the investment aspects of the European refugee crisis. Can you just take us through your thinking on that?

Clay Smolinski: Yeah, absolutely. So the refugee crisis for me, the issue is – the risk of it is that it’s another challenge that the political will of the European Union needs to face.

For me the crisis alone probably wouldn’t be a huge deal for the union but the issue is that it comes on top of a lot of the problems, those individual – the union of countries has had to face over the last few years.

So we think about the union. Through the sovereign crisis, they got through the major battle, which was the economic battle needing to cut the budget deficits, needing to where – you know, that higher unemployment that that caused. From the economic perspective, we can fairly definitively point that that battle has been won. The economy is now recovering but that has left that political will far weaker.

Since then we’ve seen that in subsequent elections, more radical left or right wing parties have been voted in. Examples of this would be Podemos in Spain or Syriza in Greece. We now have major members like the UK going to referendum on deciding whether it’s an exit or not and now we have the refugee crisis and immigration is always a very politically-charged issue and it’s clear that the member countries have differed in their views on how to exit, on how to handle it. That just creates – it’s another issue. It’s another reason for people to get upset, the voting populous and maybe vote for an exit.

What is interesting for us as well and is a bit of mitigant to that is how Germany is – has behaved through this and certainly through the sovereign crisis, the response to that crisis was very much dictated by Germany and that has forced a lot of the other member countries to go through a lot of pain.

Now with the refugee crisis, they’ve really stepped to the fore and said, “We’re going to do more than our fair share to handle this. We’re going to take a lot of these people on to our soil. We’re going to provide additional funding to the others to work through this,” and I think it’s their way of standing up and saying, “Look, we know you’ve done your part and now it’s our time to really give back and to show solidarity in the union.”

Mark Draper: So a major risk here would seem political for that in terms of the uprising of hard left or hard right – well, probably hard right in this situation.

Clay Smolinski: It’s very hard to factor that back into a definitive investment decision but it’s certainly something that we need to keep in mind and often when you compare the European market to the US market, the European market does trade at a valuation discount. But I think at least some of that discount is warranted given the – I guess the more uncertain political outlook for that region.

Mark Draper: So be alert, but not alarmed at the moment. It’s a work in progress.

Clay Smolinski: That’s how we’re viewing it.

Mark Draper: Thanks for your time Clay.

Clay Smolinski: You’re welcome.

Bull thesis on Woolworths

Woolworths is "long on assets and short on market capitalisation" says Vince Pezzullo, Portfolio Mananger, Perpetual Equity Investment Company.

Perpetual started accumulating shares late last year and picked up the buying following first half results. Pezzullo believes management have shifted their focus from sales growth to efficiencly, with sales per square metre now a key metric.

Despite widespread investor concerns about losing market share to Aldi, Aldi recently lost East Coast market share for the first time.  "Our view is that Coles is run particularly efficeintly, if Woolworths is run particularly efficiently, which we think they're on that journey it will be hard for Aldi to grow."

With loss making Masters now closing, and the possibility of a spin-off of ALF Pub Group, the situation is also improving for Woolworths non-core busineses.

"We still like Woolies, we think it's a $30+ stock at some point".

Here are Vince's views on Woolworths, presented in September 2016.



New Technological and Machine Age

Sir John Templeton famously said "The four most dangerous words in investing are 'this time it's different'."  As investors, we need to question whether we are entering a new technological and machine age over the next 10-25 years that could disrupt most businesses and possibly society as we know it.  In this regard, the new technological and machine age may be more important than The Industrial Revolution.  Quite possibly, this time it is different and whilst heeding Sir Templeton's advice, as prudent investors we believe it would be neglectful to ignore the technological developments that are almost certain to provide substantial threats and opportunities to business.

In a recent TED interview, Charlie Rose asked Larry Page (co-founder of Google) what is his most important lesson from business.  He said that he has studied why many large businesses fail and he concluded: "They missed the future".

According to Magellan Financial Group founder, Hamish Douglass, there is mounting evidence that we are approaching a tipping point of exponential technological advancement, particularly through accelerating improvements in artifical intelligence, 3D printing, genomics, computing power and robotics.

In his annual newsletter to investors he outlines what the future technological changes may look like and puts forward several challenges about how they may impact our lives, business and investment.

Click on the newsletter below to download your copy to read.



Germany - Powerhouse or Powderkeg?

Despite signs of economic recovery, Europe, indeed the developed world, has been engulfed by a wave of anti-establishment movements over the past year. What is going on? And why?

Charles Weule's on-the-ground report from Germany, the heart of Europe's immigration crisis, may help shed some light.  Charles was a former analyst at Platinum Asset Management.  We have reproduced this article with permission from Platinum Asset Management.

Preface - by Kerr Neilson (CEO Platinum Asset Management)

The present decade has been a tumultuous one for Europe. More than a handful of countries in the European Union went through a sovereign debt crisis in the aftermath of the 2008-09 global financial crisis and, at least for now, fiscal austerity and unprecedented monetary expansion continue to sit side by side as the twin pillars of economic policy.

A region that was already apprehensive from economic uncertainties was further shaken by the series of Islamic terrorist attacks and the influx of millions of immigrants and refugees en masse from the other end of the Mediterranean Sea and beyond.

The angst and frustration culminated in the vote of the British people on 23 June 2016 to leave the EU, but the chaos that ensued at Westminster suggests that ‘solutions’ and stability, if there were such a thing, are still some distance away.

Of these continual crises, last year’s refugee crisis has been one of the most trying on the cohesion and strength of the EU and was arguably a key factor that shaped the outcome of the Brexit referendum.

While politicians and bureaucrats wonder at the intensity and spread of anti-establishment sentiments and mainstream media busy themselves with denouncing the re-emergence of far-right nationalism, an on-the-ground, first-hand account of the daily interactions between the locals and the newly arrived immigrants may shed some light on the cause of the widespread discontentment and the breakdown of a precarious equilibrium and unity.

And so we present you with this special report from  Charles Weule. Charles is a former investment analyst at Platinum, who now lives and works in Germany. Equipped with a unique linguistic gift, Charles has travelled to and lived in many parts of the world. Having learned Japanese fluently, he went on to become totally proficient in Mandarin.  As with these two Asian languages, his use of German leaves him indistinguishable from a native.

Charles has been teaching languages in Berlin. In 2015 he joined the ranks of thousands of Germans to help – to work with – the one million refugees that have found their way to this new ‘Promised Land’. The seemingly trivial encounters relayed in Charles’ account paint quite a different picture to what one might hear from both Chancellor Merkel and her counterpart in the Alternative for Deutschland (AfD) party.

The picture is not one comprised only of lifeless children washed up on the shores of Greek islands and war-ravaged families marching through the perilous roads of the Balkans. Nor is it as simple as altruism versus xenophobia, good against evil, right versus wrong. Truth and reality is often drowned out by the voices from the two extremities of the spectrum.  

The multiple rounds of financial bail-outs extended to other EU nations did not much diminish the heroic status of Angela Merkel in the eyes of the German people. But when she decided to welcome the countless immigrants fleeing war-torn Syria and Iraq (and whoever else that saw it desirous to join them on the journey) with open arms, many turned against her and sided with neighbouring governments with less magnanimous policies.

The lack of consultation with Germany’s own citizenry as well as other European countries, the lack of consideration given to both short- and long-term consequences, and the sheer unpreparedness for what was to follow – which was so atypical of Germans – annoyed, frustrated and enraged many.

When large numbers of foreigners with different religions, different values and different expectations are suddenly imposed on communities, at least some of their concerns and displeasure seem natural enough. The issue of immigration is much more than economics and politics. It impacts on the collective sense of security, identity and sovereignty of a population, and is emotive at an individual level.

While we may observe from afar the geopolitical crises playing out in Europe and analyse the economic impact of the ECB’s negative interest rates, Charles’ report brings a broader and closer view on the situation in the region and gives us a rare insight into the thinking of ordinary German citizens. He also provides us with a historical perspective. Viewed in the context of the country’s past woes and vicissitudes, the generosity of the German people shines through as all the more extraordinary and their fear and exasperation all the more understandable. It helps to understand how governments’ mismanagement of sensitive issues like mass immigration could lead to popular revolts and irrational outcomes like Brexit, and this may in turn help us prepare for what may be lying ahead.

 To download the full report - which is a fascinating read - click on the download link below.


Megatrends impacting investment markets

Key points


- Key megatrends relevant for investors are: slower growth in household debt; the backlash against economic rationalism &rise of populism; geopolitical tensions; aging and slowing populations; low commodity prices; technological innovation &automation; the Asian ascendancy &China's growing middle class; rising environmental awareness; and the energy revolution.  


- Most of these are constraining growth and hence investor returns. However, technological innovation remains positive for profits and some of these point to inflation bottoming.  



Recent  developments – including the rise of populism, developments in the South China  Sea and around commodity prices along with relentless technological innovation  – have relevance for longer term trends likely to affect investors. So this  note updates our analysis on longer term themes that will likely impact  investment markets over the medium term, say the next 5-10 years. Being aware  of such megatrends is critical given the short term noise that surrounds  markets.




The super cycle slowdown in household debt

Household  debt to income ratios surged from the late 1980s fuelled by low starting point  debt levels, financial de-regulation and the shift from high to low interest  rates. But it's likely run its course as the GFC and constrained economic  growth have left consumers wary of adding to already high debt levels and banks'  lending standards are now tougher. This has seen growth in debt slow & households run higher savings rates.


Source:  OECD, RBA, AMP Capital

Implications – slower growth in household debt likely means slower growth in  consumer spending, lower interest rates and central banks having to ease more  to achieve a desired stimulus. Slower credit growth is also a drag for banks.

The backlash against economic rationalism

Its arguable that support for  economic rationalist policies (deregulation, privatisation and globalisation)  peaked over a decade ago. The corporate scandals that followed the tech wreck  and the financial scandals that came with the GFC have seen an increase in regulation, the Doha trade round has been stalled for years and now the combination of slow post GFC growth and rising inequality (see the next chart) in  the absence of the ability to take on more debt to maintain consumption growth are leading to growing populist angst. This is evident in the success of Donald  Trump, the Brexit vote and the recent Australian Federal election.  Of course this is just the way the secular  political pendulum swings - from favouring free markets in the 1920s to  regulation and big government into the 1970s, back to free markets in the 1980s  and 1990s and now back the other way with each swing ultimately sowing the  seeds for the next. But the risk is that the shift away from economic rationalist policies in favour of more populist policies will lead to slower productivity  growth and ultimately rising inflation as the supply side of economies are  damaged & easy fiscal policy is adopted.


Data  is after taxes and welfare transfers. Source: OECD, AMP Capital

Implications – populist polices could slow productivity and set the scene for the next  upswing in inflation.

Geopolitical tensions

The end of the cold war and the  stabilising influence of the US as the dominant global power in its aftermath  helped drive globalisation and the peace dividend post-1990. Now the relative  decline of the US, the rise of China, Russia's attempt to revisit its Soviet  past and efforts by other countries to fill the gap left by the US in various  parts of the world are creating geopolitical tensions – what some have called a  multi-polar world. This is evident in increasing tension in the Middle East between (Sunni) Saudi Arabia and (Shia) Iran; Russia's intervention in Ukraine;  and tensions in the South China Sea (which have recently been increased by a UN sponsored international court ruling in favour of The Philippines regarding  island disputes) and between China and Japan.

Implications –geopolitical tensions have the potential to disrupt investment markets at  times.
Aging and slowing populations

The  demographics of aging and slowing populations have long been talked about but  their impact is now upon us. We are living longer and healthier lives (eg,  average life expectancy in Australia is already around 83 years and is  projected to rise to 89 years by 2050) but falling fertility rates are leading  to lower population growth. The impact is more significant in some countries,  which are seeing their populations fall (eg, Japan, Italy and even China) than  others (eg, Australia, where immigration and higher fertility is providing an  offset) and others still where population growth remains rapid (eg, India,  Africa and the Middle East). 

Implications – at the macro  level this means: slowing labour force growth which weighs on potential  economic growth; increasing pressure on government budgets from health and  pension spending and a declining proportion of workers relative to retirees; a  "war for certain types of talent"; and pressure to work longer. At  the industry level it will support growth in industries like healthcare and leisure. At the investment level it will likely see an ongoing focus on strategies  generating income (yield) while at the same time providing for "more stable"  growth to cover longevity.
The commodity super cycle may be close to bottom

Since  around 2008 (for energy) and 2011 (for metals) the commodity super cycle has  been in decline as the supply of commodities rose in response to last decade's commodity  price boom combined with somewhat slower growth in China. However, after 50 to  80% peak to trough price declines and with supply starting to adjust for some  commodities (eg oil) it's quite likely that we have seen the worst (in the absence  of a 1930s style recession). This doesn't mean the next super cycle commodity upswing  is near – rather a long period of base building is likely as we saw in the  1980s and 90s.


Source: Global Financial Data, Bloomberg, AMP  Capital

Implications –  Low commodity prices will act as a constraint on inflation and interest rates but  the likelihood that we have seen the worst may also mean that the deflationary  threat will start to recede. In other words it adds to the case for a bottom in  global inflation. A range bound environment less clearly favours commodity user  countries over producers.  

Technological innovation & automation

The impact of technological  innovation is continuing to escalate as everything gets connected to the  internet. The work environment is being revolutionised enabling companies to increasingly  locate parts of their operation to wherever costs are lowest and increasingly  to automate and cut costs via automation, nanotechnology, 3D printing, etc. The  intensified focus on labour saving is likely good for productivity and profit margins  but ambiguous for consumer spending as it may constrain wages and worsen inequality and could ultimately hamper growth in emerging countries. There is  also the ongoing debate that with so many "free" apps and productivity  enhancements, growth in activity (GDP and hence productivity) is being underestimated/inflation  overestimated and consumers are doing a lot better than weak wages growth  implies. So fears around inequality and stagnant real incomes may be exaggerated. Time will tell.

Implications –  technological innovation remains a reason for inflation to stay low and profit  margins to remain high. But also a potential positive for growth.

Asian ascendancy & China's growing middle class

Low levels of urbanisation, income  and industrialisation continue to mean that the emerging world offers far more  growth potential than the developed world. While big parts of the emerging  world have dropped the ball (South America and Russia particularly), the reform  and growth story remains mostly alive in Asia – from China to India. Both China  and India are seeing a surging middle class, with China's growing from just 5  million people 15 years ago to now 225 million. This means rising demand for  services like healthcare, leisure & tourism.

Implications – favour non-Japan Asian shares (allowing of course for risk). Tourism and  services should benefit particularly from the rising middle class in China and  India.

The environment and social values

Concern about the environment is continuing  to grow and higher social standards are being demanded of governments and corporates. This reflects a range of developments including increasing evidence  of the impact of human activity on the environment, younger generations  demanding higher standards and social media that can destroy reputations in a  flash.

Implications – this will favour companies that adhere to high environmental, social and  governance standards.

The energy revolution

Renewables share of power production  will only grow as alternatives like solar continue to collapse in cost and  solar energy storage becomes mainstream. Likewise advances in battery  technology are seeing a massive expansion in the use of electric cars which  will feed on itself.

Implications – this has huge negative implications for oil and coal and along with the  impact of shale oil production will keep a ceiling on energy prices.


At  a general level there are several implications for investors

    • Firstly – several of these trends will help keep inflation  low, eg, slower growth in household debt, low commodity prices automation &  the energy revolution. By the same token if commodity prices have seen the  worst and government policy shifts towards stimulus we may have seen the worst  of deflationary and disinflationary pressures.
    • Secondly – several are also consistent with constrained  economic growth, notably aging and slowing populations, slower growth in debt,  the backlash against free markets and geopolitical tensions. This is not  universal though as increasing automation is positive for profits.
    • This is all still consistent with ongoing relatively low interest  rates (albeit we are likely around the bottom) and relatively constrained  medium term investment returns.
  • Several sectors stand out as winners including health care  and leisure but producers of energy from fossil fuels are potential losers.
Dr Shane Oliver 
Head of Investment Strategy and Chief Economist 
AMP Capital

The truth about Blockchain - the system behind Bitcoin

Blockchain really only does one thing well

Stephen Wilson, UNSW Australia

No new technology since the dawn of the internet has captured the imagination like blockchain.

Designed to run unregulated electronic currency, the blockchain is promoted by many as having far broader potential in government, identity, voting, corporate administration and healthcare, to name just some of the proposed use cases. But these grand designs misunderstand what blockchain actually does.

Blockchain is certainly important and valuable, as an inspiration for brand new internet protocols and infrastructure. But it’s a lot like the Wright Brothers' Flyer, the first powered aeroplane. It’s wondrous but impractical.

Not quite eight years ago, in November 2008, a mysterious and still unknown developer going by the pseudonym Satoshi Nakamoto launched bitcoin –- the first practical electronic cash that didn’t rely on a digital reserve bank. A decentralised crypto-currency scheme requires global consensus on when someone spends a virtual coin, so she cannot spend it again. Blockchain’s trick is to broadcast every single bitcoin transaction to the whole community, which then in effect votes on the order in which transactions appear. Any attempt to “double spend” (move the same bitcoin twice), or to introduce a counterfeit coin that hasn’t been seen on the network before, is detected and rejected.

With no umpire, the continuous arbitration of blockchain entries requires a massive peer-to-peer network in order to resist distortion or manipulation.

Anyone at all is free to join the blockchain network, as a holder and spender of currency, and/or as a node contributing to the consensus process. The incentive to participate comes in the form of a random reward paid whenever the ledger is settled, which is roughly every 10 minutes. The odds of a node winning the reward go up with the amount of computing power it adds to the network, and so running a node is dubbed bitcoin “mining”.

The only authoritative record of anyone’s bitcoin balance is held on the blockchain. Account holders operate a wallet application, which shows their balance and lets them spend it, moving bitcoin to other accounts. Counter-intuitively, these “wallets” hold no money; all they do is control account holders’ private keys, and provide a user interface to what’s in the blockchain.

In fact bitcoin is entirely ethereal, with not even virtual coins. The Blockchain only records the movement of bitcoin in and out of account holders’ wallets, and calculates virtual balances as the difference between what’s been spent and what’s been paid.

The only way to spend your balance is to use your private key, to digitally sign an instruction to the network, specifying the amount to move, and the address (that is, the public key) of where to move it to. If a private key is lost or destroyed, then the balance associated with that key is frozen forever and can never be spent. Ever.

There has been a string of notorious mishaps where computers or disk drives holding bitcoin wallets have been lost, together with millions of dollars of value they controlled. And predictably, numerous pieces of malicious software have been developed specifically to steal bitcoin private keys and balances.

The enthusiasm for crypto-currency innovation has proven infectious; the feeling is that if blockchain “squared the circle” in payments, then it must have untold powers in other domains.

In particular, many commentators have promoted blockchain for identity management.

The conspicuous thing about proposals to put “identity on the blockchain” is that they overwhelmingly come from blockchain advocates and not identity management experts. What’s missing in the great majority of blockchain-for-identity proposals – and indeed in most of the non-payments use cases – is a careful statement of the problem and proper analysis of why distributed consensus is important.

Blockchain has captured the imagination of people around the world. O'Reilly Conferences/Flickr, CC BY-NC

What the blockchain can’t do

Sadly, when you look closely, the blockchain just doesn’t do what most people seem to think it does. There is nothing “on” the blockchain. All it holds is a record of bitcoin movements and associated metadata. The metaphor of recording anything “on” it belies the need for additional technologies and processes over and above blockchain, to decide how to represent physical items in code and to oversee the assignment of those codes. These necessitate extra key management, registration of ownership, and governance.

Blockchain does nothing about these realities, neither does any other distributed ledger technology that has followed in bitcoin’s wake. Blockchain was expressly designed to manage crypto-currency without any key management or registration. No one is trusted in the naked bitcoin world. No administrator and no third party is needed to vouch for any wallet holder or network node. The lack of friction is great for the unbanked (as well as illicit users) and it also helps build the peer-to-peer network, which must be maintained at a huge scale in order to guard against those untrusted participants conspiring against the system.

And it’s best to remember that the incentive to run blockchain nodes comes from the mining reward. Take bitcoin away from non-payment use cases and it’s unclear who will pay for the infrastructure, and how. The original blockchain is not separable from bitcoin. Now, there is certainly plenty of fresh research and development being done on alternative consensus mechanisms and participation models. But nothing yet is up and running like the established public blockchain, and nothing else has yet been proven with blockchain’s security properties.

Blockchain does just one thing: it establishes the order of entries in a distributed ledger, so as to prevent double spend without an umpire. The truth of the contents of the ledger is an entirely different matter. Blockchain doesn’t magically make the entries themselves trustworthy, let alone the people that created them.

Despite the hype, blockchain is not a “trust protocol”; it’s actually the opposite. Just think about it: it’s not as though paying by bitcoin stops you from being ripped off. For anything of value other than bitcoin to be transacted via the blockchain requires additional layers of agents, third parties and auditors – things that just don’t square with the trust-free architecture.

Lofty claims are made for blockchain’s ability to decentralise all sorts of things. But in truth, blockchain only decentralises the adjudication of the order of entries in a ledger. It is not a general or native “Internet of Value” as claimed by authors like Don and Alex Tapscott. It was expressly designed for electronic cash; it has no native connection to real world assets.

Few businesses have escaped the call to evaluate blockchain technologies. If you’ve been persuaded to have a look, then as a first step, re-examine your security and record keeping needs. Take the time to understand what blockchain does, and all the things it leaves to be done by other systems. If your business is decentralised and your assets are purely digital, then blockchain has a lot to offer, but otherwise, it’s just another database.

The Conversation

Stephen Wilson, PhD Candidate, UNSW Australia

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

Roger Montgomery's Best of the Best Magazine - August 2016

Roger Montgomery, Investment Manager and regular presenter on ABC, 2GB and Sky Business News produces a regular magazine.

We have been allowed to bring you access to this magazine's August 2016 edition.

In this edition, the team at Montgomery's cover the following:

Investment research- How Amazon is changing the way we shop

- How to pick the best growth stocks

- Why you should stick with quality

- Property can only produce modest returns from here

- Why the strong $AUD is an opportunity

- America's ageing population.




Get ready for the $AUD to fall

Richard Holden, UNSW Australia

Vital Signs is a weekly economic wrap from UNSW economics professor and Harvard PhD Richard Holden (@profholden). Vital Signs aims to contextualise weekly economic events and cut through the noise of the data impacting global economies.

This week: Australian inflation remains low, the Fed signals a rate rise, and the G20 misses its growth goal, by a lot.

A large chunk of data was released this week, with more to come next week. And while nothing was either shocking or terrible, there is mounting evidence the world’s economic growth problem is even more entrenched.

Australian inflation was keenly anticipated because of the surprising and concerning low figure last quarter. All groups CPI came with an increase of 0.4% for the quarter, compared to a fall of 0.2% in the prior quarter.

But that puts annual growth over the last 12 months at just 1.0%, well below the Reserve Bank’s target band of 2-3% year. The number was encouraging in part because of the bounce back, but distressing because it puts annual inflation even further away from the RBA target. That increases the already significant likelihood of an interest rate cut, or two, in coming months.

As expected, the US Federal Reserve remained cautious, not raising rates, but commenting that “near-term risks to the economic outlook have diminished”. They will probably look to start a tightening cycle of interest rate rises in 25bp increments, perhaps at the next meeting. When the economy was looking stronger late last year, there was discussion of 300bp of increases over a 18-24 month period.

With Australia cutting and the US raising rates the Australian dollar looks likely to fall. The real question is just how much.

Also in the US, less good news was that durable goods orders fell by 4.0% for the month, compared to market expectations of a 1.4% decline. Possibly softening the blow was that a large chunk of the decline was caused by a decrease in aircraft orders, which are notoriously lumpy. For instance, Boeing received 12 aircraft orders in June, down from 125 in May.

Finally, the Bureau of Labor Statistics reported a rise in the Producer Price Index of 0.5% for the June quarter on a seasonally-adjusted basis.

Meanwhile, you might remember Joe Hockey’s admirable goal from the G20 meeting a couple of years ago of a US$2 trillion boost. The IMF instead released figures suggesting that will be missed by US$6 trillion.

To put that in perspective, Australia’s entire GDP was $1.56 trillion. So the G20 basically missed the target by four Australias. Ouch.

Japanese prime minister Shinzo Abe announced plans for a 28 trillion yen (about US$265 billion) stimulus package. This was met with approval by markets, but shows the size of the economic challenges most advanced nations are facing as more and more evidence of secular stagnation mounts.

Over the weekend, US economic growth for the June quarter will be a key measure to watch out for, and will weigh heavily on future Fed rate decisions.

But it seems more likely than not that the Fed will raise rates cautiously, starting with a 25 basis points hike at their next meeting. Meanwhile, expect pressure for an RBA rate cut in Australia and a decline in the Australian dollar if that happens.

The Conversation

Richard Holden, Professor of Economics, UNSW Australia

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

9 reasons why the Investment Outlook is not that bad


The past few weeks have been messy with Brexit, the Australian election, another terrorist attack in France and an attempted coup in Turkey. In fact, the last 12 months have been - starting with the latest Greek tantrum and China share market plunge a year ago. It’s almost as if someone has listened to Taylor Swift’s song “Shake It Off” and decided to try and shake up investment markets. This has all seen a rough ride in investment markets with most share markets falling into bear market territory at some point over the last year and bond yields plunging to record lows. This note reviews the worry list from the last 12 months, the impact on returns and looks at the outlook going forward.

There’s been a long worry list

The past year has seen a long worry list with:

  • Another Greek tantrum in June-July last year;
  • A 49% plunge in Chinese shares with worries about debt, growth & capital outflows as the Renminbi was devalued;
  • An ongoing collapse in commodity prices;
  • Intensifying concerns about deflation;
  • Recession in Brazil and Russia and concerns about a new emerging market debt crisis;
  • Worries about energy producers defaulting on their loans;
  • Ongoing angst about the end of the mining boom and the risk of a property crash in Australia;
  • A slump in manufacturing globally led by the US & China;
  • Concerns that the Fed raising rates and causing a further surge in the $US would accentuate problems for China, the emerging world and commodity prices;
  • Another soft start to the year for US growth;
  • Falling profits in the US, Australia and most regions;
  • Numerous IS related terrorist attacks;
  • A “surprise” vote by the UK to Leave the European Union setting of a new round of fears that there will be a domino effect of countries seeking to leave the Eurozone;
  • A messy election result in Australia with likely an even more difficult Senate which will make it even harder for the Government to control spending and implement reforms;
  • An escalation of tensions in the South China Sea; and
  • An attempted coup in Turkey.

The success of Donald Trump in the US, the Brexit vote & the close election in Australia highlight a growing angst at rising inequality and a loss of support for the economic rationalist policies of globalisation, deregulation and privatisation. While understandable, the resultant populist policy push risks slower long term economic growth and lower investment returns.

Constrained and uneven returns

The turmoil over the last 12 months has shown up in very messy share markets (with most falling into bear market territory with 20% plus falls from last year’s highs to their lows early this year before a rebound) and a sharp decline in bond yields to record lows. However, unlisted assets like commercial property, infrastructure and listed yield-based plays like real estate investment trusts have done very well. Reflecting the constrained environment, balanced growth superannuation funds saw average returns of around 1-2%.

Source: Thomson Reuters, AMP Capital

Nine reasons why it’s not all that bad

But while super funds had soft returns over the last year they were not disastrous and moreover they averaged 8-9% over the last three years – which is not bad given how low inflation is. What’s more, while the worry list may seem high that has been the story of the last few years now. For example, 2014-15 saw worries about the end of the US Fed’s quantitative easing program, Ukraine, the IS terror threat, Ebola, deflation, a soft start to 2015 for US growth (we hear that one a lot!), worries about China, soft Eurozone growth and on-going noise about a property crash/ recession in Australia. So nothing new really! More fundamentally there are nine reasons for optimism.

First, global growth is okay – there has been no sign of the much feared global recession. Global business conditions surveys point to ongoing global growth of around 3%.

The shift to overvaluation more than a decade ago went hand in hand with a surge in the ratio of household debt to income, which took Australia’s debt to income ratio from the low end of OECD countries to now being around the top.

Source: Bloomberg, AMP Capital

In Australia, growth has in fact been particularly good at around 3%. The economy has rebalanced away from a reliance on mining and it has benefitted from the third and final phase of the mining boom which has seen surging resource export volumes.

Second, central banks have signalled easier monetary policy for longer post-Brexit which is likely to ensure that liquidity conditions remain favourable for growth assets.

Third, while the shift to the left by median voters in Anglo countries resulting in more populist policies is likely to harm long term growth potential, it could actually boost growth in the short term (including under Trump in the US) as it sees a relaxation of fiscal austerity.

Fourth, we may have seen the worst of the commodity bear market. After huge 50% plus falls some commodity markets are moving towards greater balance (notably oil and some metals).

Fifth, deflation risks look to be receding. Oil prices which played a huge role in driving deflation fears look to be trying to bottom and a shift towards more inflationary policies by governments and some central banks are likely to start shifting the risks towards inflation on a 2-5 year view.

Sixth, the profit slump may be close to over. US profits are showing signs of bottoming helped by a stabilisation in the $US and the oil price. Australian profits are likely to rise modestly in the year ahead as the commodity price driven plunge in resource profits runs its course.

Seventh, the latest falls in interest rates and bond yields have further improved the relative attractiveness of shares and may unleash yet another extension of the search for yield.

Eighth, investors have been more relaxed about the latest decline in the Chinese Renminbi - reflecting slowing capital outflows from China, reassurance from Chinese officials and a growing relaxation about fluctuations in the value of the RMB.

Finally, all the talk has been bearish lately – Brexit, Chinese debt, US slowing, messy Australian election – which provides an ideal springboard for better investment returns!

What about the return outlook?

The August–October period can often be rough for shares. But looking through short term uncertainties and given the considerations in the previous section, – it’s hard to see the outlook for investment markets differing radically from what we have seen over the last few years albeit stronger than over the last 12 months for shares. Growth is not flash but okay, inflation is low and monetary conditions overall are set to remain easy. For the main asset classes, this has the following implications:

  • Cash and term deposit returns to remain poor at around 2%. Investors remain under pressure to decide what they really want: if its capital stability then stick with cash; if its a decent stable income flow then consider the alternatives.

Source: RBA, AMP Capital

  • Ultra-low sovereign bond yields of around 2% or less, with a third of the global bond index in negative yield territory, indicate that the return potential from bonds is low.
  • Corporate debt should provide okay returns. A drift higher in bond yields is a mild drag but with continued modest global growth the risk of default should remain low.
  • Unlisted commercial property and infrastructure are likely to benefit from the ongoing “search for yield”.
  • Residential property returns are likely to be mixed with some cities continuing to see price falls and a further slowing in Sydney and Melbourne property prices. Very low rental yields are not good, particularly in oversupplied apartments.
  • The rising trend in shares is likely to continue as: shares are okay value, monetary conditions remain very easy and continuing moderate economic growth should help profits. Within shares, we favour European, Japanese and Chinese/Asian shares over US shares.
  • Finally, the downtrend in the $A is likely to resume enhancing the case for global shares (unhedged).

Things to keep an eye on

The key things to keep an eye on over the year ahead are:

  • Global business condition PMIs – these currently point to constrained but okay growth.
  • Signs of European countries seeking to leave the Eurozone and investors demanding higher borrowing rates to lend to countries like Italy, seen to be at risk of leaving. Italian banks are also a risk worth keeping an eye on.
  • When/if the Fed starts to raise rates again later this year and the impact on the US dollar.
  • Chinese economic growth readings.
  • Whether Australian non-mining activity keeps improving.

Concluding comments

The September quarter is historically a rough one for shares and the prospect of a Trump victory in the US and worries about Italian banks may cause some nervousness. But looking beyond near-term uncertainties, the mix of reasonable share valuations, continued albeit constrained global growth, easy monetary conditions and a lack of investor euphoria suggest returns are likely to improve from those seen over the last year.


Shane Oliver

Chief Economist AMP

Scam Watch

How to spot some of the most common frauds

Scams are all around us. In fact, they're so common that more than 105,000 scams were reported to the Australian Competition and Consumer Commission ACCC last year, resulting in losses of more than $84 million. And that's just the tip of the iceberg: many more scams went unreported, often because the victim was too embarrassed to tell authorities about the crime.

So, to help you identify and avoid the increasing number of scams, we've compiled a guide to 12 common scams that we've recently come across. 

1. The urgent transfer

What it looks like: You receive an email from a friend, family member or senior staff member telling you they need urgent access to funds. The story adds up (they're probably overseas and short on time). Besides, it comes from their email address and looks authentic. 

What's really happening: Their email account has been compromised andyou're transferring your money straight into the scammer's bank account.


2. The tampered ATM

What it looks like: You use a busy ATM to withdraw money. You notice nothing unusual and receive your money, just as you always do.

What's really happening: You've just passed your card through a skimming device, which has captured all of the data on its magnetic strip. Meanwhile a pinhole camera catches you entering your PIN. The scammers can use this information to create a dummy card that lets them draw on your account.


3. The mail that never came

What it looks like: That credit card you applied for never seemed to arrive.

What's really happening: Scammers accessed your letterbox and intercepted the card before you had a chance to receive it. They've changed the PIN and are now using it for themselves. In the process, they're racking up a significant debt in your name.


4. The parcel pickup

What it looks like: A postal services company sends you an email telling you that you have a parcel that can't be delivered. If you can't collect it within 30 days it will be destroyed. But first, you need to print off a label to redeem your package.

What's really happening: Rather than printing a label, you're actually downloading dangerous ransomware. Once it's installed, scammers can use it to lock files and even destroy them. The only way you can take back control is to pay them. Making sure your computer is regularly backed up can also help counter-effect the impact of ransomware.


5. The tax refund

What it looks like: You receive an email from a government agency advising you of a tax refund. To receive it, all you need to do is follow the link to your bank and enter your account details.

What's really happening: The link takes you to a fake site set up by the scammers. Instead of giving your account details – and internet banking password – to your bank, you're actually delivering this vital information straight into the scammer's hands.


6. The 'free' wifi

What it looks like: You're at the airport or hotel and need to connect your laptop or mobile to the internet. When you search for a connection, you're in luck. There's a free hotspot right nearby.

What's really happening: You've actually just connected to a fake network. This allows a scammer to intercept all network traffic and steal your personal information. And the pain doesn't stop there. From now on, every time you turn on your device, you could be transmitting the same 'free' wifi to other unsuspecting users. You should only connect to wifi that you know is legitimate and, if in doubt, pay to access a secure network. You should also make sure your anti-virus software is up to date and your firewall is turned on.


7. The overseas placement

What it looks like: A recruiter posts an advertisement for a job in another country. When you apply you need to pay the recruiter for your visas, travel or other expenses before you start.

What's really happening: You've just handed money, and possibly your personal information, directly to a scammer who now disappears, never to be seen again.


8. The unrealistic job offer

What it looks like: You respond to an advertisement that promises you'll earn good money from the comfort of your home as an 'accounts processor'. All you need to do is set up a bank account and forward any money that comes into it, onto another account. You even get a cut of each transaction for your troubles. 

What's really happening: You're being used by fraudsters as a “money mule”: an everyday person with no criminal history through whose bank account they'll move the proceeds of crime. If you're in any doubt about the seriousness of what you're being asked to do, just remember that intentionally laundering money carries a prison sentence of up to 25 years.


9. The speeding fine

What it looks like:  A government body/law enforcement agency, emails you to tell you that your vehicle has been caught speeding. You need to download the photo they've taken to confirm you were driving.

What's really happening: The link you click on downloads ransomware to your computer. You'll have to pay the scammers to get back the files they encrypt.


10. The love interest

What it looks like: You sign up to a dating site and meet someone like you've never met before. Luckily for you, they fall fast too. Before long they want to move it beyond the internet, the only problem is they're overseas. So they need you to wire money to them so that they can come and visit you.

What's really happening: The love of your life never really existed. You've been scammed.


11. The computer problem

What it looks like: You receive a call from your internet service provider. They've detected a virus on your computer and it's sending error messages. The good news is that they can fix it, so long as you give them remote access.

What's really happening:  You've handed control of your computer to a scammer. They'll probably try to steal your personal data or hold your computer to ransom until you pay.


12. The store voucher

What it looks like:  A well-known brand uses its social media account to post that it's giving away gift vouchers or free flights or another very attractive perk. To claim your prize, all you need to do is like the post.

What's really happening: You've fallen victim to a 'like farming' scam. The page isn't authentic but has been sent up by a scammer who's trying to get as many likes as possible. They'll on-sell these likes - and your profile - to other fraudsters, who will start pushing spam posts in an effort to get hold of your credit card data.


And that's just the beginning...

As the world becomes alert to the prevalence of scams, scammers are responding by becoming more creative. So, as these 12 scams start to become less effective, it's likely that newer and more sophisticated ones will take their place. That's why it pays to stay vigilant and to report any suspicious activity to both Scamwatch and the police.

Brexit Commentary - Platinum Asset Management

The decision by the British people to withdraw from the European Union (EU) took markets by surprise.  Yet, it did not occur in a vacuum.

 Britain's vote to leave the EU needs to be seen in the context of a confluence of global social and economic trends.

  • Large scale migration within Europe (from East to West) as well as to Europe, from Africa and the Middle East.  Lured by both the pull of better economic prospects and driven by the horror of war, these movements of people raise a formidable challenge the social and political fabric of Europe.
  • The long-running trend of international economic integration – Globalisation – has removed trade barriers and opened labour markets to competition, allowing both labour but especially capital to migrate across national borders.  International business and political leaders promoted ever-greater internationalisation over the increasingly vocal fears and frustrations of the Western middle class who faced job insecurity and financial regression.
  • A European Union whose weak form of political representation (at the European level) and barely integrated financial structure was ill-equipped to cope with the fallout of the Global Financial Crisis (GFC) in the absence of the traditional currency devaluation pressure-release valve.

The frustration and sense of powerlessness of the middle-class has become increasingly tangible since the GFC of 2008 and is manifesting itself in a shift away from traditional political parties of the center. The vote to ‘Leave’, is simply one expression of voter dissatisfaction with this state of play and, in the European context, downright anger at the refusal of the unelected bureaucrats in the European Commission to acknowledge their plight.

Turning to the ‘Remain-Leave’ campaign itself, the debate was focused on ideological and rhetorical arguments which were fanned by a cacophony of emotional pleas in the media, rather than points of fact raised by the Treasury and Parliamentary Commission in the lead-up to the vote.

So what now for Britain?

The prospect of a re-run of the referendum is unlikely, couched more in hope than reality.

The immediate effect will be a jolt to consumer and business confidence in Britain, depressing investment and spending, and resulting in significant economic weakness and probable recession.

The Bank of England is highly likely to cut interest rates from 0.50% to zero in coming weeks.

Further weakness in the British pound is to be expected.  In the six months preceding the vote, the pound has traded in a range between 1.40–1.45 per US dollar.  It’s trading around 1.35 per US dollar today, a mere 5% depreciation from the mid-point of this range.  Britain is now a small, open, economy that is heavily reliant on foreigners to finance its large current account deficit.  We expect the pound to act as its primary shock absorber and depreciate significantly to absorb this economic shock, but first expect a back-up of decisions by consumers and businesses.

Turning to the Continent

We expect a re-appraisal of the relationship between the European Commission and the sovereign states of the Union and hence, implicitly, the electorate.  This will result in some conciliatory measures to reassure voters who share the deep frustration and sense of powerlessness of their British counterparts.  Less high-handedness by the Commission and a more consultative approach are likely.  There will also be questions raised around the Head of the Commission who epitomises the powerful elite, unanswerable to the electorate.

Further accommodation by the European Central Bank (ECB) is also likely.  It is imperative that it be seen to be doing something, at least to demonstrate that they are in control.  This will represent a worrisome raising of the stakes.  With sustained economic growth proving elusive despite negative interest rates and quantitative easing in full flight, the market is becoming increasingly unnerved by the seeming impotence of Central Banks globally.  The ECB is thus forced to walk a dangerous line between having to do something and revealing its impotence.

Fiscal stimulus is now probable and we expect the 3% fiscal deficit ceilings to be ignored.

Looking further afield, we expect that the shockwaves will be felt in Emerging Markets, Asia and the United States.  However, it is reasonable to expect the impact to significantly dissipate as we move from the UK and Europe.

The US dollar will likely absorb some of the shock for the world economy by appreciating while the prospects of higher interest rates in the US will be put on hold for some time.

Why should I own shares in this environment?

The ‘Leave’ vote is but one instance of a broader push back against ever increasing globalisation and demands for redistribution of the economic pie by a middle class that feels increasingly more marginalised and frustrated.

Where it can be expressed through the ballot box, governments will respond with measures to placate this angst.  Ultimately, governments don’t create wealth, they re-distribute it.  This is already underway.  Monetary policy is being used to push interest rates to zero or even into negative territory, effectively taxing savers.  Fiscal expansion will need to be financed by taxes, excessive borrowing or simply by printing money.

While cash or bonds might seem like a safe alternative, they entail risks that need to be carefully weighed.  As a saver holding cash or bonds, your interests are diametrically opposed to those of governments who are large borrowers and are in a position to dictate both your return on capital and return of capital.  Essentially you need to believe that the government will act in your interest and not those of the electorate.

The global economy continues to grow and civilised society continues its inexorable progress, questions around the distribution of wealth notwithstanding.  Shares represent an ownership interest in real assets and in corporations that can marshal human and financial resources to participate in various economic activities.  Businesses are living organisms that possess the flexibility to adapt to new threats and opportunities, unlike bonds or cash.  Good businesses will have numerous opportunities to grow and thrive, and reward their shareholders, regardless of the economic environment.

When fear and uncertainty prevail, share prices can fall sharply.  While it may be tempting to simply respond to the financial pain that these price falls cause, it is worth remembering that it is precisely these price falls that open the best wealth creating opportunities. 


Platinum Asset Management

Brexit Bulletin - from Westpac Economics

Here is an executive summary of the special edition "Brexit Bulletin" from Westpac Economics.  The full bulletin can be downloaded from this article by clicking on the "Download Now" icon.

Last Thursday, the UK voted in favour of exiting the European Union.

• 52% of the population voted in favour of the decision, on a turnout of around 72%.
• The decision was against market expectations, bringing about a savage market response.
• Subsequent to the result being announced, Prime Minister David Cameron resigned, effective by October. The opposition is also in disarray, with ten or so members of the shadow cabinet having quit or been fired.
• Until a new Prime Minister takes office, the next step in the Brexit process seemingly will not take place.
• That next step is most likely to be Article 50 of the Lisbon Treaty being invoked, ushering in a two-year consultative period between the UK and European Union.
• Note the UK will also have to enter into separate negotiations with a further 60 non-EU nations, whose trade terms are dictated by European Union agreements.
• Of particular concern for markets is the potential for the ‘Brexit’ decision to trigger similar reviews of EU membership across other member countries and the unity of the UK itself, with Scotland and Northern Ireland voting in favour of the UK remaining in the EU.
• The above highlights that we are at the beginning of a long process full of uncertainty and tension.
• With the end-point of this process unknown, we are unable to estimate the full impact of Thursday’s decision. IMF estimates however highlight it will be substantial: a shock to the level of GDP of between 1.4ppts and 5.6ppts (in the UK) by 2019. Note, UK growth to March 2016 was 2.1%yr.
• Of course, all of this is not happening in a vacuum. The implications for the rest of the world have, and will continue to be, significant.
• Market pricing for the FOMC (United States) has reversed, with a near 20% probability of a cut now priced in by November. A rate hike is not fully priced in until June 2018.
• Policy intervention by the Bank of Japan also seems likely, with USD/JPY nearing the ¥100 mark.
• Elsewhere in emerging Asia, policy makers will be paying close attention, not only for potential implications for their real economies, but also in case funding dislocations become apparent. Europe has long been a key provider of direct and portfolio funding for the region.
• For Australia, the RBA stands ready to act to provide liquidity (if needed), while the Australia dollar has fallen with the shift in risk sentiment.