With a 3% share of net flows for the quarter, this is the first time that All Star Funds, which launched in July 2007, has participated in the Plan For Life survey.  The increase in net flows from the previous quarter was 56%, placing All Star Funds in 9^th place overall, which is, according to Mulligan, “a great start”.

Mulligan believes that this reflects two key attributes:

1. The high quality of investment managers in the All Star stable, which have delivered strong performance to investors, and
2. The commitment and support of financial planners, who need to be confident in recommending investment products to their clients that the products will deliver on their value proposition.

All Star Funds was conceived to provide consistent high alpha asset management capabilities to investors which would otherwise not be available to them in the retail market.

“When we select a manager, we look for consistent out-performance, irrespective of market cycle,” said Mulligan, “for example, Greg (Matthews, portfolio manager of the All Star IAM Australian Share Fund) and his team have a long-standing track record as a top performing Australian share manager; he and some of his team have worked together for over 15 years.”

The All Star IAM Australian Share Fund has delivered in excess of 4% net above benchmark on an annualised basis since inception (performance data to end April 2011), and is ranked number one or two across most time periods in the latest Morningstar survey (Australian shares sector specialist funds, April 2011 Morningstar survey).

The Fund’s stable-mate, the All Star KFM Income Fund, has also fared well through the liquidity crisis during the GFC and recent natural disasters, according to Mulligan, “delivering a high yield and a strong dividend stream with complete liquidity”.

This Fund is managed by Kaplan Funds Management, an absolute return manager focussed on income producing strategies, which was established in 1998.

In Mulligan’s view, All Star’s success has been driven in part by its focus on supporting financial planners and also by recognising the need for Fund Managers to offer products which deliver on their promise, and so create a trusted relationship with investors and their advisers. To this end, Mulligan believes that advisers need products which deliver solid and consistent results, and deliver on their stated objectives.
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“The support planners have given, and continue to give to the All Star Funds validates our manager selection process,” said Mulligan, “as long as they’re giving us that support, I know our Funds are delivering for them and for their clients.”
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The All Star Nomura China Fund presents a risk-controlled opportunity for investment in China. It is managed by Nomura Asset Management, a conservative manager with proven expertise in this market.
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The All Star Maple-Brown Abbott Listed Property Fund provides access to a high quality listed property capability and is the first time this capability has been offered to the Australian Retail market. The strategy has been managed by Maple-Brown Abbott for over 25 years with a consistent track record of performance delivery.
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Click to download a pdf copy of Plan For Life – Marketer view

Click to download a pdf copy of Plan for Life – Adminstrator view

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We upgraded two funds, the Latrobe Australian Mortgage Fund-Pooled Mortgage Option to four stars and the Australian Unity Mortgage Income Trust to three stars. We removed from ‘On Hold’ and assigned a three-star rating to the Challenger Howard Mortgage fund.

We only rate one fund as two stars, the OnePath OA IP-OnePath Mortgage Tr No. 2 fund, which OnePath Funds Management has decided to compulsorily return capital to investors over the next three to five years.
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S&P Fund Services analyst Peter Ward said: “We have not seen a uniform approach among mortgage fund managers or consistent timing in resolving liquidity issues. We consider this to be a reflection of the different underlying investor base, underlying investments, and different managers’ mortgage fund sector outlook.”
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“Three funds, managed by Australian Unity, Challenger, and OnePath have changed their redemption mechanisms. Each solution has provided improved certainty, but outcomes differ. The changes have contributed to our decisions to upgrade the Australian Unity fund to three stars from two stars and to resolve the long-standing ‘On Hold’ ratings on the Challenger and OnePath funds,” added Mr. Ward.
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Key areas of focus during this review included fund managers’ product strategies, investment team continuity, liquidity and redemption provisions, lending competition and margins, portfolio credit quality/arrears and defaults, and fees.

Click for a full list of funds rated in the S & P Australian Fixed Interest – Mortgages Peer Groups

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In September 2010, Australian Unity Investments (AUI) acquired the previous responsible entity and renamed the fund. Since then, it has clearly articulated its investment strategy and has focused on reducing fund gearing, improving portfolio diversification, reintroducing periodic (albeit limited) liquidity, and undertaking a discounted public offer. In late 2010, AUI provided the first limited liquidity offer to investors in over two years, and will offer additional liquidity in 2011.

“We continue to have a high opinion of AUI’s collective direct property team. For this fund, the property team is led by the experienced Peter Lambden and diversified property portfolio manager Nikki Panagopoulos, who will work closely with trust portfolio manager Vincent Stranges. We see Mr. Lambden and Ms. Panagopoulos and their team as critical to the fund’s future success due to its very active asset management strategy, which aims to reposition the property portfolio mix to address three key risks—tenant, sector, and geographic concentration,” said S&P Fund Services analyst Kelly Napier.

Our positive view of the team is tempered by the portfolio concentration risks, the fee structure, and uncertainty surrounding the fund’s future capital structure. The latter hinges on the success of the present discounted offer and there is also uncertainty surrounding the composition of the fund’s eventual property portfolio after a combination of asset sales and acquisitions.

Ms. Napier added: “On balance, we have conviction in AUI’s quality property management and strategy capability, but note there is strategy execution risk. We also think the fund represents a reasonable risk/return proposition for investors seeking a direct property investment portfolio and capital structure representing a moderate risk profile. Pleasingly, the fund has headroom against debt covenants to provide capital flexibility to execute the strategy to deliver unit-holder value and is not solely reliant on inflows. As a direct property fund, any investment should be approached as a long-term and illiquid one. While the manager intends to offer periodic liquidity, investors should not rely on it.”

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The fund affected by this announcement is:

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• The financial wealth of Australians rose in the December quarter – largely due to 4.5 per cent rise in equity markets. Net financial assets of households rose by 3.4 per cent after rising by 8.1 per cent in the
  September quarter.
• Per capita financial wealth rose by almost $1,400 to $46,330 in the last quarter – marking the highest reading in almost three years. Financial wealth is down 12.7 per cent below the record set in late 2007 Australian companies are maintaining very liquid balance sheets. Corporate Australia held a record $277.6 billion in cash and deposits as at December. As a proportion of total financial assets, companies held 30.5 per cent of financial assets in cash – the highest in 11 years.
• Assets held by superannuation funds (pension funds) rose by $40 billion (3.7 per cent) in the December quarter to $1120.9 billion. Super funds held 15.1 per cent of assets in cash and deposits, similar to 15.2 per cent held in September and well above the long-term average of 8 per cent.
• Foreigners purchased $20.3 billion of Australian equities in the December quarter – the highest result in 15 months – since September 2009. In the December quarter the Aussie dollar hit highs of US101.5 cents in early November, before easing over the following month, thus providing a buying opportunity for foreign investors.

What does it all mean?

• The latest data on household wealth certainly provides Aussie households with a bit of cheer and could not come at a better time, especially given the current level of conservatism. The global financial crisis caused the biggest ever drop in wealth for Australian households, however wealth levels have continued to repair over 2010 and are now holding at the best levels in almost three years.
• Despite the sustained improvement in wealth levels household continue to save. With almost 25 per cent of total assets being held in cash and deposits – well above the long-term average of 22.7 per cent. The current level of consumer conservatism is unlikely to turnaround anytime soon, however the improvement in household balance sheets certainly bodes well for future spending.

• It’s not only household wealth levels that have improved but also company balance sheets are certainly looking much healthier. Corporate Australia held a record $277.6 billion in cash and deposits as at December and the proportion of total financial assets, companies held in cash is now at the highest level in 11 years.
• The strength in share markets has certainly been the key driver of the turnaround in wealth and more importantly the pickup wealth is expected to continue. CommSec expects a sustained recovery in wealth over coming quarters. The rebuilding in the second half of the year will help to support activity and spending levels, while at the same time corporate Australia is likely to ramp up investment plans.

• Australian superannuation funds are holding almost double the ‘normal’ proportion of money in defensive assets like cash and bank deposits. That is not to say that super funds have not been investing in equity markets rather the equity investments have been less than the cash inflows record by fund managers. No doubt as the global economy strengths and the recovery look more concrete pension funds will feel more comfortable with allocating a larger proportion of inflows to growth assets.
• Foreign investors have become more prominent investors in our companies. At the end of the December quarter, foreigners owned almost 42 per cent of Australian listed companies, holding just shy of the 12 year highs reached in the March quarter 2009. And in the December quarter alone, foreigners made over $32 billion in net purchases of Australian equities. The movements in the Australian dollar is an important factor in driving foreign investment and if the Aussie dollar does start to ease over rest of the year – as our currency strategists expect – further inflows of funds are likely to take place. Added to which equity markets are likely to get a boost from M&A activity largely driven by cashed up companies and foreign investors.

What do the figures show?

• The net financial wealth of Australian households (assets less liabilities) rose sharply by 3.4 per cent in the December quarter after rising by 8.1 per cent in the September quarter.
• Financial assets of households (such as shares, bank deposits) rose by $58.8 billion or 2.4 per cent in the December quarter to $2,557 billion. Of the total, 24.9 per cent was held in cash and deposits, above the long-term average of 22.7 per cent. Financial liabilities of households grew by $24.3 billion or 1.6 per cent to a record $1,515 billion.
• Overall, net household financial wealth (assets less liabilities) rose by $34.5 billion to $1041.6 billion at the end of December quarter. Financial wealth is up 4.0 per cent on a year ago but is still down 12.7 per cent from the record high set in the September quarter 2007.
• Net household wealth per capita rose from $44,936 to $46,330. Per capita wealth is up only 7.0 per cent over the past five years and up 32.2 per cent over the past decade.
• The household debt to liquid assets ratio fell by 0.4 percentage points to 160.1 per cent in the December quarter. The ratio shows that households do not have sufficient readily liquefiable assets to cover outstanding debt, highlighting a degree of vulnerability in the current economic environment.

• Foreigners purchased $20.3 billion of Australian equities in the December quarter – the highest result in 15 months – since September 2009. In the December quarter the Aussie dollar hit highs of US101.5 cents in early November, before easing over the following month, thus providing a buying opportunity for foreign investors.
• Foreign investors held $586.2 billion of Australian listed shares as at the end of December, up $31.9 billion (5.8 per cent) over the quarter. Foreigners held 41.9 per cent of Australian shares, unchanged over the quarter and not far short of the 12-year high of 43.3 per cent in March 2009 (when the Aussie was at US68.7 cents).

• Assets held by superannuation funds (pension funds) rose by $40 billion (3.7 per cent) in the December quarter to $1120.9 billion. Super funds held 15.1 per cent of assets in cash and deposits, similar to 15.2 per cent held in September and well above the long-term average of 8 per cent.
• Non-equity assets held by Australian companies (non-financial) stood at $652.6 billion at the end of December, a record $100 billion higher than loans. The $552.2 billion held in loans was the lowest in 3-1/2 years. Companies held 30.5 per cent of assets in currency and deposits – the highest share in 11 years.
• The value of listed equities rose by $94.5 billion (5.9 per cent) to $1400.6 billion as at the end of December. The value of currency and deposits rose by $35 billion (2 per cent) to $1599.5 billion
• As at the December quarter, 19.7 per cent of assets were held in listed equities (19.8 per cent long-term average); 20.2 per cent held in bonds (17 per cent average); 22.5 per cent held in cash and deposits (20.5 per cent average). Smaller than normal shares of assets were held by unlisted equities (20.3 per cent, compared with 24.1 per cent average) as well as bills of exchange, accounts receivable, derivatives and one-name paper.

What is the importance of the economic data?

• The Australian Bureau of Statistics releases the Financial Accounts publication each quarter. The data covers assets, liabilities and financial flows for the key sectors of the economy. Figures on financial wealth help reveal the true state of household finances.

What are the implications for interest rates and investors?

• The financial accounts data is essentially backward looking and the Reserve Bank would be well aware that the improvement in wealth over the December quarter would be more muted over the March quarter. Importantly the modest weakness in activity levels, conservative attitudes of consumers and the natural disasters are likely to keep the Reserve Bank on the interest rate sidelines in the near term.
• The Reserve Bank has continuously highlighted the strength of corporate and household balance sheets and the latest result will give the Reserve Bank further confidence that the longer term fundamentals for the economy look sound.
• Super funds and households are still holding much higher than normal levels in cash. CommSec expects that money to be put to work in equities, leading to further gains in share markets in coming quarters. CommSec expects the ASX200 to reach 5200 by December 2011.

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• At 2.46pm on Friday March 11, an earthquake measuring 9.0 on the Richter scale occurred off the north east coast of Japan near Sendai, triggering a 10 metre tsunami that was felt across the Pacific Ocean. The earthquake has been ranked as the fifth largest in modern history and the biggest in Japan.

Main Developments

New agencies provide the most accurate and timely compilations of facts of major events. The situation following the great earthquake is clearly still evolving and the economic impact will be felt for years to come. The following report comes from Reuters:

• “Death toll expected to exceed 10,000 from the quake and tsunami, public broadcaster NHK says. About 2,000 bodies found on two shores of Miyagi prefecture, Kyodo reports.
• Japan battles to prevent nuclear catastrophe as there is a hydrogen explosion at the No. 3 reactor of the quakehit Fukushima Daiichi nuclear power plant, which is 240 km (150 miles) north of Tokyo.
• Chief Cabinet Secretary Yukio Edano says the core container at the reactor is intact after the fresh explosion which is unlikely to have led to a large escape of radioactivity.
• Edano says six people were injured after the explosion at the nuclear plant.
• Prime Minister Naoto Kan says the situation at the nuclear power plant remains worrisome and authorities are doing their utmost to prevent damage from spreading.
• Earlier, Tokyo Electric Power Company (TEPCO) said radiation levels at the Fukushima Daiichi nuclear power plant, which is 240 km (150 miles) north of Tokyo, had risen above the safety limit but this posed no “immediate threat” to human health. An explosion blew the roof off at reactor No. 1.
• International Atomic Energy Agency (IAEA) says the lowest state of emergency had been declared at a separate nuclear power plant north of the town of Sendai. But Japan’s nuclear safety agency says there has been a rise in radiation at the Onagawa facility due to leakage from the Fukushima plant and there was no problem with the cooling process there.

• Authorities have set up a 20-km (12-mile) exclusion zone around the Fukushima Daiichi plant and a 10 km (6 miles) zone around another nuclear facility close by.
• Strong aftershocks persisting in the stricken area.
• About 300,000 people evacuated nationwide and almost 2 million households without power in the freezing north.
• The Bank of Japan offers to pump a record US$85 billion into the banking system to soothe market jitters.
• TEPCO says rolling blackout to affect 3 million customers, including large factories, buildings and households.
• Nuclear safety agency rates the incident a 4 on the 1 to 7 International Nuclear and Radiological Event Scale, less serious than Three Mile Island,which was a 5, and Chernobyl at 7.
• Quake triggered tsunami up to 10 metres (30 feet). Waves swept away homes, crops, vehicles and submerged farmland.
• Total insured loss could be up to $15 billion, equity analysts covering the industry say. Disaster-modelling company AIR Worldwide estimates the insured losses from the Japan earthquake at between $14.5 billion and $34.6 billion.”

Financial & economic effects

• The Bank of Japan will expand asset purchases from 35 trillion yen to 40 trillion yen in order to boost liquidity in the economy. The BoJ is
  worried about the impact of the earthquake on household and corporate sentiment.
• The Japanese yen has strengthened against the US dollar since the earthquake on expectation that foreign currency will need to be sold in exchange for Japanese yen to fund the massive rebuilding work. The Australian dollar fell from US100.25c to US99.65c initially after the earthquake. But it rose to US101.60c in US trade on Friday night before easing to US100.75c today.
• The Japanese sharemarket (Nikkei) fell 6.2 per cent on the expectation of weaker short-term prospects for manufacturing companies and the overall Japanese economy. In contrast, shares of construction companies have been well supported.
• Shares of food exporters in the Asian region have been supported on the expectation of higher demand (Sendai is a major food producing region of Japan).
• The Australian All Ordinaries index fell as much as 85 points before retracing to be down 24.6 points (0.5 per cent) to 4710.1 at the close. Uranium stocks fell from favor as investors feared reduced demand in reaction to the explosions at nuclear facilities in demand. In contrast, shares of thermal coal and natural gas producers rose on expectation of demand for alternative fuels following damage to Japanese nuclear facilities.
• Our commodity strategist said: “We expect that a prolonged shutdown of the Fukashima Daiichi power station will increase import demand for fuel oil, coal and LNG, putting upward pressure on coal and gas prices. The quantum of increased coal, LNG and fuel oil demand is hard to estimate and depends on the extent of nuclear outage. But the Fukashima Daiichi nuclear power plant’s capacity translates through to up to 14Mt of thermal coal equivalent – or ~1.5%-2% of world trade per year.”
• Similar to the natural disasters experienced in New Zealand and Australia, the Japanese economy will soften in the short term as production is constrained and consumer and business sentiment are negatively impacted. But activity will be boosted in the medium-term as rebuilding/repair/refurbishment work begins. The Japanese economy contracted by 0.3 per cent in the December quarter and a technical recession (two consecutive quarters of falling output) cannot be ruled out.
• In response to the Kobe earthquake (January 17 1995; magnitude 7.3; damage estimated at US$100 billion) industrial output fell 2.6 per cent in January before rebounding in the following three months.
• The Japanese economy had only been expected to add 0.14 percentage points to the 4.4 per cent global economic growth this year, so the ‘big picture’ impact will be modest.
• Despite high government debt levels (gross debt to GDP stands at 225.9 per cent), Japan should have few problems in securing foreign funding for rebuilding operations. Japan has consistently maintained a current account surplus, estimated at 3.1 per cent of GDP in 2010.

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Currency markets are one of the largest and most liquid in the world. Economic variables like interest rates, economic growth, inflation and productivity are some of the drivers of currency movements making predicting currency difficult.  Extreme fluctuations in currency can have a meaningful impact on client returns and can also impact the ability of fund managers that employ currency hedging to pay distributions in the future. This has been the case in more recent times for Australian investors.

In Australia, 2008 was a dismal year for investors. We saw a huge devaluation of the Aussie dollar against the US dollar from a high of 0.9794 on the 15th July to a low of 0.6013 on the 27th of October. This amounted to a 38% decline in just over 3 months. The chart below demonstrates just how large the fall was and how volatile currency markets can be.

The Australian dollar didn’t just drop against the US dollar (USD).  In the same period it fell 45% against the Yen and 22% against the Euro.  The reasons behind the drop were a combination of rapidly declining interest rates, the unwinding of the AUD YEN carry trade, the decline in both demand and prices for commodities and a ‘flight to safety’ to the USD.

How important is Currency?

Normally, small currency fluctuations over time are easily managed and would not typically have a material impact on investors’ funds and portfolios.  But large movements, such as the ones experienced in 2008, will have an impact.

This paper will discuss the two main effects of significant currency fluctuations:

• The cash flow effect, and
• The performance effect

The Cash Flow Effect

Many of the funds that are routinely used in portfolio construction use currency hedging to remove risk associated with the movement of the Australian dollar.  Funds that will typically be 100% hedged include international fixed interest funds, international property funds, some international equity funds and global listed infrastructure.

If a managed fund hedges out the effect of a fluctuating currency, then the usual mechanism for this is to use currency forward contracts. If forward contracts are in place in a portfolio then this is what happens:

The key part of the table above is the highlighted cell.  If the Australian dollar devalues, then the forward contract makes a loss which must be settled in cash.  In the normal course of events this is not a problem.  The manager simply settles out of cash in the portfolio or sells assets.  This settlement in cash becomes a problem when:

• The devaluation of the Australian dollar is very large over a short period so that a large amount of cash is needed; and
• Some or all of the assets in the portfolio are illiquid.

The other key part to understanding this problem is to appreciate the quantity of the cash needed.  Fund managers have sometimes needed to find enormous amounts of cash.  To illustrate, it’s best to work through an example.

Numerical Example – AUD against USD 3 month forward contract.

In a forward contract the following may occur:

• The Australian fund manager agrees to sell Australian dollars and buy USD today (T0) at the ‘spot’ rate (today’s transaction rate).
• The fund manager simultaneously agrees to reverse this, that is sell USD and buy AUD, in 3 months time (T90) at the forward rate.

The forward rate is calculated using the AUD/USD spot rate and the two risk-free interest rates for each currency. This is a 90 day example, where at T0 we sell AUD and buy USD, and at T90 we sell USD and buy AUD.

Note: We have selected values that were applicable in July 2008 for this example.

So the Australian fund manager has agreed to buy USD and sell AUD at 0.9379 in 3 months time.

At the forward date the transaction unwinds itself.  The profit/loss of the transaction is shown in the table.  For simplicity, we have used a USD amount of $1,000,000 at the end of the forward contract.

The calculation is simple. At the end of the forward contract the fund manager is selling USD 1m at the forward rate to get AUD (1,000,000/0.9379) = AUD $1,066,118.

If the fund manager doesn’t have USD1m to sell at the end of the contract because there have been no sales from a portfolio, then they also have to buy USD at spot.  If we use 0.6500 as the spot price, this would cost $1,000,000/0.6500 = AUD $1,538,461. That is, it costs $A 472,343 net to settle the contract. When the AUD goes from 0.9500 to 0.6500 in a three month period, then the currency forwards lose AUD $472,343 for every $1m hedged. This was the situation in 2008.

The table below shows the cash flows associated with unwinding the forward contract above (0.9379) at different T90 spot rates.

To repeat, in this example, which mimics the market in the 3rd quarter of 2008, a fund manager with a portfolio of fully hedged USD assets would have had to find almost half a million dollars in cash to settle every million dollars hedged through a currency forward.  A fund manager with a $1 billion portfolio would have had to pay out close to $500 million in cash to settle the contract.

Of course not all fund managers had fully hedged portfolios or 3 month forward contracts.  Many had longer dated forwards or some of their portfolios unhedged.

Effect on Portfolio

There are several potential effects on a portfolio, depending on how it is structured:

• When there is a cash loss from currency forwards, there is also a matching upward valuation in the assets.  The value of the fund does not change.  The difficulty is that the portfolio value is paper profit and the payment of cash is a real payment.
• Assets may have to be sold to settle the forward contract.  In a ‘hybrid’ portfolio that has both liquid and illiquid assets, this might alter the proportions of each.  The fund might become overweight in illiquid assets.  Most funds have limits around the proportions of each.
• The cash that needs to be paid may use up the existing liquidity in the fund, including the normal cash buffer that is used for redemptions and any accumulated income.
• The forward loss may be accounted for as a trading loss.  Income flowing into the fund will be set against the loss and not paid out as distributions.
• The fund, if it is able, may have to borrow to fund the cash settlement.  Income coming into the fund would then go to paying off the loan.

Where there has been the extraordinary circumstances of both market illiquidity in property and fixed interest, coupled with the enormous fall in the Australian dollar, it is not surprising that there have been some funds that have had to alter the redemption schedule or distribution practice due, at least in part, to the effects of the negative cash flow on the currency forward contract.

The Performance Effect

You have seen from the example above the possible scale of the effect of extreme currency movements.  Of course not all funds are fully hedged. International equity funds or those funds that are perceived more liquid behaved differently to the cases we have discussed above:

• International equity funds are liquid.  If cash is needed the manager simply has to sell assets.
• International equity funds can range from fully hedged to fully unhedged. Typically, most would not hedge more than 50%. There are both passive currency managers and active currency managers. The focus for international equity funds is not just the cash flow effect in very volatile markets – it is the currency effect throughout all market cycles.  An appendix has been attached to the back of the paper highlighting the different approaches adopted by ‘International Equity’ managers on the Lonsec approved list.

In summary, it is important to be aware of the effects of currency movements along with asset sector movements. Even skilled equity fund managers find predicting the direction and size of exchange rate moves difficult, therefore using currency as a source of alpha can be fraught with danger. In many cases the currency effects swamp the underlying market effects and, as we have seen, can also lead to changes in redemption and distribution policies for some Funds.

The post White Paper: How important is Currency? appeared first on AdviserVoice.

• Australian companies are maintaining very liquid balance sheets. Corporate Australia held a record $271.4 billion in cash and deposits as at September. As a proportion of total financial assets, companies held 30.7 per cent of financial assets in cash – the highest in 11 years
• Super fund holdings of cash assets rose to a record high $162.9 billion in the September quarter. The proportion of super funds (pension funds) assets held in cash remained unchanged at 15.4 per cent in the June quarter, well above the decade average of 9.2 per cent.
• The financial wealth of Australians rose sharply in the September quarter – largely due to 7.2 per cent rise in equity markets. Net financial assets of households rose by 8.0 per cent after sliding by 8.7 per cent in the June quarter.
• Per capita financial wealth rose by over $3,000 to just under $44,000 in the last quarter. Financial wealth is down 17.8 per cent below the record set in late 2007.
• In seasonally adjusted terms imports rose by 4 per cent in November supported by a 8 per cent lift in capital goods imports.

What does it all mean?

• Australian households have plenty to cheer about with wealth levels repairing in the September quarter. Financial wealth is holding just shy of the two year highs reached in the March quarter and given the recent rally in equity markets it is likely to surpass those levels when the December quarter wealth figures are released. As the recovery gains traction the improvement in wealth levels should support confidence, and in turn translate to an increase in spending and overall economic activity.
• Interestingly company balance sheets are certainly looking much healthier with Corporate Australia held a record $271.4 billion in cash and deposits as at September and the proportion of total financial assets, companies held in cash is now at the highest level in 11 years.
• The unpopularity of high gearing levels has seen domestic companies pay down debt significantly, and the uncertainty surrounding the global recovery and lacklustre activity has seen business hold back from committing to investment plans.
• It’s not only companies that are cashed up, Australian superannuation funds are holding almost double the ‘normal’ proportion of money in defensive assets like cash and bank deposits. That is not to say that super funds have not been investing in equity markets rather the equity investments have been less than the cash inflows record by fund managers. No doubt as the global economy strengths and the recovery look more concrete pension funds will feel more comfortable with allocating a larger proportion of inflows to growth assets.
• Super funds are spoilt for choice at present, given the attractive yields being offered on term deposits, however the longer that fund managers maintains an abnormally high proportion of money in defensive assets, the greater the risk that returns will underperform its competitors. A combination of factors such as new fund inflows, asset allocation decisions, and valuation changes should underpin further growth of the sharemarket over 2011. We expect the All Ordinaries & ASX 200 indexes to lift to around 5,400 by December 2010.
• Over the three months to September, foreign investors were certainly maintaining their love affair with Australia, purchasing an additional $23.8 billion of Aussie shares in the past quarter. Over 40 per cent of listed shares are held offshore, highlighting the importance of foreign investors in driving our sharemarket.

What do the figures show?

• The net financial wealth of Australian households (assets less liabilities) rose sharply by 8.0 per cent in the September quarter after sliding by 8.7 per cent in the June quarter.
• Financial assets of households (such as shares, bank deposits) rose by $88.3 billion or 3.7 per cent in the September quarter to $2,472 billion. Financial liabilities of households grew by $15.4 billion or 1.0 per cent to a record $1,491 billion.
• Overall, net household financial wealth (assets less liabilities) rose by $72.8 billion to $980.8 billion at the end of September quarter. Financial wealth is up 1.7 per cent on a year ago but is still down 17.8 per cent from the record high set in the September quarter 2007.
• Net household wealth per capita rose from $40,580 to $43,638. Per capita wealth is up only 4.7 per cent over the past five years and up 29.3 per cent over the past decade.
• The household debt to liquid assets ratio fell by 4.8 percentage points to 159.6 per cent in the September quarter. The ratio shows that households do not have sufficient readily liquefiable assets to cover outstanding debt, highlighting a degree of vulnerability in the current economic environment.
• The share of foreign (non-resident) holdings of Australian listed shares fell from 42.9 per cent in the June quarter to 41.2 per cent in the September quarter – easing further away from the 12 year highs of 43.3 per cent reached in March 2009. Overall foreigners bought a net $23.8 billion of Australian equities in the September quarter, compared with selling $41.3 billion in the June quarter.
• Pension fund holdings of cash & deposits rose by $6.1 billion to $162.9 billion in the September quarter – a record high. The proportion of super funds (pension funds) assets held in cash largely remained unchanged at 15.4 per cent in the September quarter, remaining well above the decade average of 9.5 per cent.
• Corporate Australia held a record $271.4 billion in cash and deposits as at the end of September. As a proportion of total financial assets, companies held 30.7 per cent of financial assets in cash – the highest in 11 years (since September quarter 1999.
• Net financial assets held at private companies (non-equity assets less loans) stood at a record $77.4 billion at September. Australian companies are maintaining very liquid balance sheets.

Merchandise imports

• Imports rose by 4 per cent in seasonally adjusted terms in November according to the Australian Bureau of Statistics. Consumption goods imports rose by 1 per cent, intermediate goods rose by 4 per cent while capital goods rose by 8 per cent.

What is the importance of the economic data?

• The Australian Bureau of Statistics releases the Financial Accounts publication each quarter. The data covers assets, liabilities and financial flows for the key sectors of the economy. Figures on financial wealth help reveal the true state of household finances.
• The ABS figures on imports refer to physical goods such as cars and computers. The figures are not adjusted for seasonal effects. The data is useful in highlighting the strength of consumer and business spending and gives some guidance as to the likely trade position in the month. But analysis can be clouded by currency changes.

What are the implications for interest rates and investors?

• Equity markets are likely to remain well supported over coming months. The latest round of data has confirmed that super funds still remain heavily underweight equities. Super funds are holding almost double their traditional amount in cash and as fund managers become more confident about the economic recovery more money will be put to work in the share market.
• In the longer run, the strength of domestic companies, and in particular the resilience of the Australian economy will no doubt be a strong drawcard for foreign investors
• CommSec expects the All Ordinaries & ASX 200 indexes to lift to around 5,400 by December 2011.

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According to Mr McNeill, Aviva Investors has seen strong signs that the listed property sector is recovering from its ‘self inflicted wounds’, largely driven by a return to the fundamentals that stood it in good stead prior to 2005: conservative gearing, good management, and ownership of high quality properties.

“The role of listed property as a defensive asset class offering reliable returns and high liquidity even during the tough times is one that was forgotten when many listed property trusts (also known as REITs – Real Estate Investment Trusts)  took their eye off the ball in the chase for frankly unrealistic and certainly unsustainable returns,” said Mr McNeill. “Such strategies included the use of excessive gearing, unsuccessful forays into overseas property markets and corporate structures that failed to focus on shareholder value.

However, according to Mr McNeill, many REITs have learned their lesson, cleaned up their portfolios and strategies, and refocused on the basics. And investors should be the beneficiaries.

“There’s an increasing number of REITs now able to offer investors what they should always have had from their listed property investment – that is, exposure to high quality, diversified real estate portfolios that deliver an attractive, sustainable and growing income stream,” he said. “These options may not be glamorous but they are solid, effective and reliable.

“Investor interest in the sector has definitely increased. We’re meeting and briefing an increasing number of advisers and they are very pleased to hear our current views on how the listed property sector has improved, as it enables them to offer their clients a relatively low risk investment with the income returns they want,” he said. “Even advisers who’ve been burnt in the past are now revisiting the sector and looking for a managed fund that has a simple structure, full liquidity and offers exposure to a diversified portfolio of good quality REITs.”

According to Mr McNeill, three REITs that illustrate Aviva Investors’ current view on listed property are:

• Bunnings Warehouse Property Trust. “This has been a good performer over the last five years, with growing income distributions, quality management and conservative gearing,” he said. “It is an example of how a simple, old fashioned property trust can meet the risk and return objectives of REIT investors.”
• GPT Group. “GPT is probably the best example of the sector’s back to basics approach, having fixed its balance sheet, simplified its strategy and returned to its position as an owner of some of Australia’s best commercial property assets,” said Mr McNeill.
• Westfield Retail Trust. “This spin off of 50% of Westfield’s Australian and New Zealand shopping centre portfolio has been designed as a simple old-fashioned REIT, focused on owning quality property and paying out the majority of its net income as a distribution to investors,” said Mr McNeill.”

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Mark Burgess, incoming Chief Investment Officer at Threadneedle, looks ahead to 2011: “Our central case for 2011 is one of reasonable global growth led by emerging markets. Against this backdrop world equity markets look good value, particularly against government bonds. In addition, many companies have strong, healthy balance sheets and are sitting on large cash piles, having held back on investment during the recession. We expect corporates globally to start to use this cash to increase capex, raise dividends, buy-back stock or undertake merger and acquisition activity. We believe that emerging markets will continue to grow and outperform the rest of the world, helping to fuel demand for consumer goods and commodities.

“At the same time we must be mindful of the risks to this scenario. The credit crisis elicited a range of untested policy responses and we are yet to see the full consequences of these policies. The banking sector globally needs to continue to raise capital, which will restrain credit expansion and hence economic growth. In emerging markets there is the potential for growth to turn into a bubble and inflation to become a risk. Globally, markets remain fragile and any major shocks could cause volatility.

“This volatility should create opportunities for nimble, experienced investors with a proven ability to look through short-term noise and indentify long-term winners.”

INVESTMENT THEMES FOR 2011

Policy responses to remain a key driver of markets

Growing economic divergences highlight critical global imbalances that require intervention. The Eurozone is in crisis, China is tightening policy and the actions of developed markets threaten to spark currency wars. These issues all demand that policymakers adopt appropriate measures in a timely manner, yet policy response remains the single most difficult risk to assess. We believe that the ride will be bumpy but that policymakers will eventually arrive at the right place, allowing supportive fundamentals and ample liquidity to support asset prices.

• The European Central Bank must act urgently, as it has been reactive and fallen behind the curve in protecting the Eurozone. The ECB should recognise that policy must support the weaker economies and not simply be tuned to the mantra of “one size fits all”. This will necessitate a policy that is far too easy for stronger members, but the viability of the monetary union is at stake. We believe the ECB is likely to adopt some combination of lower rates, below-market rate loans to troubled economies, liquidity provisions and outright bond purchases.
• As QE becomes a more prevalent policy tool it is certain to evoke fears of competitive currency devaluation. There will likely be growing calls for capital controls in many developing economies reluctant to see an unwanted surge of liquidity into their economies. Such steps should not undermine the global growth story, but will likely stoke higher volatility across markets.
• China’s deflationary boom is turning inflationary, representing a paradigm shift in the economy at the heart of global imbalances. The ability of Chinese policymakers to tighten policy without rattling investors will require more skill than in past cycles.
• Ongoing de-leveraging continues to unleash powerful deflationary forces, which should allow developed economies to sustain modest growth whilst pursuing reflationary policies.

QE consequences

Quantitative easing has unleashed a wave of liquidity that must find a home. At the same time, it has stirred strong opposition in some quarters.

• QE2 is explicitly targeting asset prices and liquidity is likely to find its way into the areas offering the best value and potential returns. Currently this means higher risk assets such as equities. This is one of the reasons why we remain overweight in equities versus bonds.
• Specifically, emerging market equities and bonds are likely to be well supported. We may be in the early stages of a bubble in these assets.
• Subsequent waves of QE will become increasingly difficult to defend on the world stage. This could tip the current phase of currency devaluation into full-blown protectionism. Stocks with significant overseas earnings could suffer in this scenario (this is not our central case).

“Emerging market exposure is a consensus trade, but it can continue to reap rewards throughout 2011. It doesn’t make sense to stand in the way of this tide of liquidity.” Sarah Arkle, Chief Investment Officer (Vice Chairman from Jan 2011)

Stock picks: Sun Hung Kai, Barrick Gold

Untested policies

The credit crisis elicited a range of innovative and untested policy responses. This is likely to lead to ongoing volatility, rotation and unforeseen consequences.

• An important skill in 2011 will be the ability to look through short-term volatility to see the longer-term pricing anomalies.
• Ongoing uncertainty means that it will be more important than ever to be aware of risks in portfolios and ensure that all risks are understood and intended.
• Active management and stock picking are likely to add significant value in 2011.

“We are in completely uncharted waters here. Investors expecting a reversion to mean may be disappointed.” Jim Cielinski, Head of Fixed Income

The haves and the have-nots

Two-speed economies are developing at a global (emerging vs developed world), European (core vs periphery) and US level (skilled vs unskilled workforce). These distortions create socio-political tensions but also provide opportunities in a number of sectors.

• US unemployment remains high but in certain sectors, wage bargaining power is evident. When analysing companies, we will be emphasising their ability to retain talented staff without instigating wage inflation.
• With interest rates at all-time lows and QE2 targeting higher asset prices, employed, asset-rich consumers with mortgages should feel wealthier in 2011. This will support high-end consumer discretionary stocks.
• European banks with exposure to the periphery have been de-rated significantly. This creates the scope for a sharp rally if solvency fears are addressed decisively by the ECB. We remain underweight but continue to monitor the sector closely.

“You can’t take someone that was laying bricks on a building site in 2007 and put them into Google’s product development team. Specialist skills are in short supply and will be rewarded in 2011.” Cormac Weldon, Head of US Equities

Stock picks: Tiffany, Polo Ralph Lauren

The search for yield

We believe that inflation is not a risk in the developed world and that interest rates will be kept at historic lows in these markets. As such, government bond yields are unlikely to rise significantly and investors will seek income in higher-yielding areas.

• Emerging market and corporate bond valuations remain attractive relative to their improving fundamentals. We continue to favour these bonds over government issues in fixed income.
• Income stocks are likely to be in favour in equities. Moreover, companies that are reinstating or raising their dividends are likely to be re-rated.

“Why would I lend money to the UK government at 3.5% when I can get 5.1% with the prospect of dividend and capital growth from AstraZeneca?” Leigh Harrison, Head of Equities

Stock picks: AstraZeneca, Vodafone, BT

The emerging market consumer

Emerging markets will continue to produce superior growth in 2011 and growing wealth among consumers in these markets will support demand in a number of areas.

• We continue to invest in luxury goods stocks in Europe, where robust earnings growth has seen multiples decline despite rising share prices.
• More recently, we have expanded this theme into European premium auto stocks, eg BMW, where the valuation is attractive relative to its Asian joint venture partners.
• Banks in under-penetrated markets such as Indonesia and India are likely to attract capital as investors follow through the consumer theme.

“Luxury goods stocks were the first beneficiaries of growing emerging market wealth. The developing consumer credit cycle will create bigger ticket opportunities as this theme matures.” William Davies, Head of European Equities

Stock picks: BMW, Bank Rakyat

The return of capex

Companies have been very cautious in their investment plans in this cycle, preferring to maintain high levels of cash. Corporate balance sheets are strengthening and capital expenditure to depreciation ratios are at all time lows. We believe this trend will change in 2011.

• Improving economic confidence and high commodity prices are likely to drive increased capex in the extractive industries. Industrial stocks will be among the key beneficiaries.
• The replacement of ageing IT infrastructure at a wide range of companies will support earnings in the software and hardware sub-sectors.

“Mining equipment companies have been buffeted by changes in economic sentiment in 2010. They are attractively valued and there is scope for significant upgrades to earnings.” Simon Brazier, Co-Head of UK Equities

Stock picks: IMI, Komatsu

Mergers and acquisitions

Cash balances are high, valuations are attractive and companies will crystallise value in the market by undertaking earnings-enhancing corporate activity such as m&a. Meanwhile, private equity companies are under pressure to invest. Emerging market corporates are also likely to take advantage of currency strength to acquire footholds in companies in the developed world. This, together with share buy-backs, will drive a significant phase of m&a.

• Companies with unique assets, superior growth or access to proprietary technology will be among the main takeover targets.
• Management quality and valuation may not always be key drivers: small and mid-caps are likely to attract interest despite full relative valuations.
• Companies deploying cash in shareholder-friendly ways are likely to outperform as investors become more focused on the efficient use of capital.

“2011 could be the year when a household western name gets taken over by an emerging market rival.” Jeremy Podger, Head of Global Equities

Stock picks: Mid-cap resources, industrial companies

Commodity prices will remain underpinned

The outlook for commodity prices is positive, given the recovery in the world economy and the dominance of resource-hungry emerging markets in the global growth profile.

• Commodity-rich nations will continue to witness capital inflows, further strengthening FX positions and credit worthiness. This should support equity valuations and further spread tightening in fixed income.
• Companies using more expensive raw materials in their production processes will witness margin pressures.
• Rising commodity prices could be a source of inflationary pressure.

“Our growth forecasts imply additional demand of around 1.5m to 2m barrels of oil per day in 2011. If it becomes apparent that OPEC does not have sufficient spare capacity to meet this demand, the oil price could move sharply higher.” David Donora, Head of Commodities

• Mark Burgess becomes Chief Investment Officer from Jan 2011, when current CIO Sarah Arkle moves into her role as Vice Chairman.

The post Threadneedle’s outlook and investment themes for 2011 appeared first on AdviserVoice.

Access to three new investment strategies

Russell has introduced three new sector strategies to its diversified portfolios – the Russsell Alpha Fund, the Russell Australian Shares Enhanced Income Fund and the Dexus Wholesale Property Fund (Dexus WPF).

The Russell Alpha Fund is designed to provide an absolute return above an Australian cash benchmark.

“By drawing on our global expertise in manager research across multiple asset classes and hedging market risk, the Alpha Fund isolates and delivers an absolute return stream from our highest conviction managers,” said Russell Portfolio Manager, Andrew Sneddon.

Russell’s recently launched Australian Shares Enhanced Income Fund has also been introduced to provide investors with an income-oriented strategy through exposure to securities with higher dividend yields.

The Dexus Wholesale Property Fund (Dexus WPF) is a portfolio of prime Australian unlisted property assets, diversified both regionally (assets in most major cities) and across sectors (office, retail and industrial).

“We believe this is an opportune time to partially rotate from our strongly performing REIT strategies and see this is an opportune time to establish a new position in Australian unlisted property,” Sneddon added.

A more tailored approach

The SAA changes mean that Russell’s diversified products will now be more tailored to the end-client with respect to liquidity and tax status. The Alpha Fund has been added across the suite of diversified products (pooled superannuation trust or PST, Tax Exempt and Fund) to enhance portfolio diversification, while the Russell Australian Shares Enhanced Income Fund has been introduced to the tax-exempt units only to generate income for non-tax paying investors.

In contrast, the Dexus WPF has been added only to the taxed PST units to provide further diversification for investors with an appetite for unlisted assets.

‘Right strategy, right time’ approach to alternatives

Over the last year Russell has materially increased its strategic asset allocation to alternatives in its flagship Balanced Opportunities Unit from near zero to around 10%. This has been rewarded with both its alternative fixed income strategy, the Global Strategic Yield, as well as the Russell Global Listed Infrastructure Fund -$A Hedged, which has returned more than 20% in the year to October 2010.

“High conviction active strategies such as the Russell Alpha Fund represent our ‘right strategy, right time’ approach to alternatives in the Russell Diversified portfolios,” Mr Sneddon concluded.

The following table provides a breakdown of Russell’s Diversified products.

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