INSIGHT ISSUE 2, 2012
finding quality amongst scarcity Investing in overseas property
POSITIVE trends Investor sentiment moving towards optimism
Strategies to supercharge your SMSF
JanE WATTS General Manager, Private Wealth BT Financial Group email@example.com
Welcome to the second edition of Insight for 2012. It has been an exciting year for Westpac Private Bank, with the past six months bringing success and recognition for our people. Firstly, I’d like to thank you for helping us become the most awarded institution at the 2012 Australian Private Banking Awards. We received five awards, including being named Outstanding Institution ($10m – $30m), recognising our ability to best meet the needs of successful Australians with portfolios between $10 million and $30 million. In October we received further industry recognition when our Private Office Services team won a Customer Service Institute of Australia (CISA) Service Excellence Award in Melbourne and Willis Phong (Private Banker NSW) was named “Outstanding Young Private Banker” at the Private Banker International Global Wealth Awards held in Singapore. We take great pride in these achievements and we are celebrating our point of difference by reinvigorating our brand. You’ll see our new look in this edition of Insight and reflected in all our communications with you going forward. What won’t change is our commitment to bringing you the latest information to ensure you have the financial strategies in place to adapt and thrive. With this in mind, in this edition, we give you an overview of our most recent quarterly Westpac Private Bank Investor Sentiment Indicator. The data reveals that high net worth (HNW) investor sentiment moved back to positive territory in Quarter 3, with the overall sentiment score increasing to 9.4 from -10.9 in Quarter 2 of 2012.
We are also celebrating Westpac’s role in building our nation for nearly 200 years by supporting and helping our clients. One example of Westpac’s commitment to proudly supporting Australians is our long association with the Hannan family profiled on page 4. The Hannan family own the Independent Print Media Group (IPMG) – Australia’s largest privately-owned printing company. I am immensely proud of our continued relationship with the Hannan family, a family that has been in business for 125 years, banking with Westpac the entire time. IPMG director, Michael Hannan, places a high value on client relationships and client service, and says a big part of IPMG’s success comes down to “quality of staff and the quality of the product”. We couldn’t agree more. Property features in two of our articles, with Frank Allen, a Director in Westpac’s Property Finance Group, providing his view on the Australian property market. Interestingly, some investors are benefiting from purchasing overseas property for lifestyle or investment purposes and we hear from several people that have done just this. We hope you enjoy this latest edition of Insight. Please remember that we are always keen to receive your feedback and suggestions on topics for future issues. Finally, I’d like to take this opportunity to wish you and your loved ones a very happy, relaxing and safe festive season and a prosperous New Year. Jane Watts General Manager, Private Wealth BT Financial Group
Features Profile 2 Skills, experience and support give The Kanga Group an edge Global outlook
Why India is a hot topic for investors Planning 4 Succession planning is behind the Hannan familyâ€™s business longevity Indicators 6 Wealthy Australians are optimistic about the economy International assets
The ups and downs of investing in property overseas Art in this issue
Private Bank updates Economy 12 The outlook for 2013 Investment 14 Finding quality amongst scarcity Property 16 The housing market is more affordable Q&A 18 The search for yield SMSF strategies Supercharging your funds
Leaps & bounds
Managing a young and rapidly growing enterprise can be a wild ride but it helps to have a pedigree in entrepreneurship and business strategy. by Tracey Evans
With many retailers and manufacturers falling victim to hard times, promotional merchandise and product development agency The Kanga Group (TKG) has prospered in a crowded market. From a standing start five years ago, TKG has grown into an international business that in the last 12 months has designed more than 200 bespoke products and manufactured around four million items shipped to 21 countries. The business has experienced annual growth of 50 per cent for the past three years that shows no signs of abating, says co-owner and CEO Brett Law. Bringing the right mix of skills and experience to the business has also helped to sustain and increase growth. TKG was founded by Brett and Annalise Law in 2007 and entrepreneurship is in their blood. Brett brought to the business more than a decade of corporate business development and strategy skills, while Annalise had gained valuable experience through her parents’ successful promotional products company supplying the medical sector. TKG has chosen to specialise in providing individual solutions for companies. “We start with understanding who our client is trying to reach, the message they want to convey and what they want people to think, do and feel after that engagement. We then design a product to enable that engagement to occur,” says Brett. A swag of awards during its short life underline TKG’s achievement and it’s been identified as one of the world’s top five fastest-growing distributors by the Advertising Specialty Institute. 2
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With a client list that includes multinationals such as American Express and GlaxoSmithKline as well as Telstra, Commonwealth Bank and Vittoria Coffee, TKG offices in Sydney, London, Manila and Hong Kong provide an edge both in local expertise and in productivity, by using the time zone differences to their advantage. “For instance, our sales folk in London can be taking a brief from a client on their iPad and that will pop up on the desk of one of our data entry people in the Philippines, who can enter it into the management system, which sends it to the inbox of one of our people in Hong Kong so they can start talking to the factories in China. And that’s all before the person in London gets back to the office,” says Brett.
The right advice Recognising that rapid business growth can be as much a curse as a blessing, TKG is focusing on efficient business systems that underpin its activity and growth and in finding the right business support. “That was one of the reasons we were so excited to become part of Westpac Private Bank. Having experts to step us through things like the complexities of trade finance and dealing with time zones and currencies has been invaluable,” says Brett.
BRETT LAW THE KANGA GROUP
“We’ve fundamentally changed our banking structure to better manage free cash flow and reduce our exchange rate exposure. Westpac have seen our growth and the associated structural change in our business and helped to implement a trade finance facility to better manage our cash flow from our international operations. “I’m also a member of the Entrepreneurs Organization – a global organisation that provides a useful support and learning framework, and we tap into business mentors and the like. “Entrepreneurs aren’t always the best people managers and business managers, so there’s a need to bring in specialists to allow the entrepreneurs to focus on what they’re good at, which is the next idea and the growth.
“For me, it’s very much those three elements: having the best people sitting in the right seats on the bus; getting external validation and assistance from experts like Westpac Private Bank; then calling on mentors who’ve seen the movie play out before,” Brett says.
Economic power shift As the Asian century unfolds, India is grabbing the attention of investors. By Tracey Evans
Prime Minister Julia Gillard’s recent visit to India has underlined the potential value of the country to the Australian economy as emerging market economies, particularly those in Asia, begin to pull their economic weight. More than a third of the world’s economic output is now located within 10,000 kilometres of Australia and it’s expected to continue to rise, according to Federal Treasury Secretary Dr Martin Parkinson in a recent speech. “Clearly, much of this shift is attributable to the growth of China and India – combined, these economies accounted for less than one-tenth of the global economy twenty years ago. Today they account for over one-fifth.” Long-term projections, as far ahead as 2050, place India as one of the biggest economic powers in the world. It wasn’t always the case. Despite having the world’s second largest population after China, India was struggling before the introduction of tough economic reforms during the 1990s. They helped India to withstand the global financial crisis and set the country on a path to prosperity, according to many commentators, notwithstanding a slight weakening of late. For Australia, it means that business and investment opportunities in India are likely to expand over the coming decades as the two countries build an increasingly powerful relationship, says international economics and diplomacy expert Professor Peter Drysdale, a member of the Advisory Committee that guided the work of the taskforce for the Federal Government’s White Paper on Australia in the Asian century. Drysdale, the Head of the East Asian Bureau of Economic Research and East Asia Forum at the Australian National University’s Crawford School of Public Policy, notes that China’s population is expected to peak relatively soon and the labour force has already begun to shrink. “So relatively what’s commonly called the ‘demographic dividend’ [a rising economic growth rate due to an increasing number of working age people] is running out of steam. Whereas in India, the demographic structure is still quite young and the demographic dividend will continue for quite some time.” (see graph)
In the next five years alone, the expectation is that there will be about 12 million young entrants to the Indian workforce, says Drysdale. “On top of that, there are 3 million Indians under the poverty line that can be drawn into more productive activities. So the opportunities to capture the benefits of the expansion of the workforce opportunities are strong,” he says. “India now has a high investment rate from domestic savings, with about 40 per cent of GDP going into investment and 36 per cent of that drawn from domestic savings. With that level of investment, given the relationship between investment and output, India has a potential rate of growth of at least 10 per cent a year. That means that growth rate can absorb population growth and deliver strong growth.” Australia’s trade relationship with India has grown rapidly; in fact it’s one of our fastest-growing economic partnerships. “India accounts for about 4 per cent of our total trade. We export around $19-$20 billion worth of goods and services to India, mostly coal, gold and education,” says Drysdale. “We should also welcome and encourage greater investment from India, to help open up the commercial links between the two countries.
“The expectation is that, if India continues to open up, Australia’s opportunities there will parallel the growth in trade with East Asia,” Drysdale says.
Working age population as a proportion of population % 75
60 55 50 2010
Source: UN population projects and Australian Treasury, 2011
The Hannan family’s long history of success in business comes down to hard work and planning. By Barbara Drury
There is an old saying that in family businesses the first generation makes money, the second generation holds onto it and the third generation loses it. But whoever said that has not met the Hannans. The Hannans have been in business and around Sydney’s eastern suburbs for 125 years. What sets them apart from other business dynasties is that each generation has built on the achievements of the generation before them. The company is currently led by Michael Hannan as Executive Chairman, who is fourth generation, and the fifth generation is already cutting its teeth in the business. The Hannan family’s Independent Print Media Group (IPMG) is Australia’s largest privately-owned printing company. The latest BRW Rich List estimates the family wealth at $640 million, making them Australia’s 20th richest family. The business has three pillars: the printing operations, an extensive property portfolio and a digital marketing services business, IPMG Digital. Together they turn over $500 million a year and employ around 1800 people.
A modest beginning The Hannan family started business in Randwick, in Sydney’s eastern suburbs, with a butcher shop in 1887. Before long 4
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Francis and Elizabeth Hannan and their three sons were running a chain of shops across the eastern suburbs. The youngest of Francis’ sons, Norman, presided over the next big expansion of the business, branching out into community newspapers in 1934. Over 70 years the family built a stable of local newspapers and magazines under the Federal Publishing banner that they eventually sold to Rupert Murdoch’s News Ltd in 2007 for $500 million. This sale allowed investment in the capital-intensive print business and investment in major building development work in the Sydney suburb of Alexandria. Michael Hannan believes the reason the family has succeeded where others have failed comes down to a strong work ethic and a basic philosophy that the development of the business should be the primary driver. “If you take care of the business, the business will take care of the family,” he says. There is also an expectation that rewards are not an entitlement of birth but must be earned, especially as the business and the family continue to expand. There are seven
direct descendants in Michael Hannan’s generation, four in his father’s and 17 in his children’s generation.
“If you take care of the business, the business will take care of the family.”
Michael’s uncle John Hannan is foundation chairman and, at age 84, still comes into the office every day. Michael’s brother David is the Chief Executive of the property division and sister Kim O’Connor was the newspaper division’s chief reporter. Their cousins Lindsay and Stephen Hannan work on the printing side.
the business, at the expense of dividends to the family, and bank borrowings,” he says.
The fifth generation range in age from 21 to 32. Adrian has a senior role in Hannan Print, James works in the digital business and has just accepted a posting to the New York office, Richard and Emily work in property and twins Ben and Angus work part-time in the company’s gym and retail operations while they attend university. While there is an expectation that a Hannan family member will always be chairman, the chief executive is appointed purely on merit. This role is currently held by Stephen Anstice. In fact, the family has a written constitution setting out this philosophy. It says in part: “Family members should expect to be assessed against other internal and external candidates for any such positions and promoted to such positions based on merit rather than any perceived right of entitlement.” Every effort is made to bring the younger generation into the business once they complete their education and they are encouraged to gain work experience outside the business. Then they are offered a role they are capable of performing and given appropriate training. “We don’t want to set a family member up to fail,” says Michael. “The benefit of being a tightly-held private company is that we can take long-term decisions that are impossible in public companies where often only short-term results are rewarded. Our investment in the new printing plant at Warwick Farm would not be undertaken by a publicly listed company focused on short-term results and under the scrutiny of the public shareholders and analysts,” he says. Being private also allows them to keep below the radar and maintain confidentiality. Throughout the company’s long history it has taken advantage of economic downturns to make acquisitions, often on very favourable terms. However, being wholly family-owned does sometimes limit what they can do. “It is difficult to expand without access to public shareholder funding. All our expansion comes from profits reinvested in
A tale of two dynasties Like the Hannans, Westpac has deep roots in New South Wales. The bank can trace its corporate roots back to 1817 but the relationship between the two dynasties began in the late 1880s when Irish immigrant Francis Hannan opened his first butcher shop. Westpac holds original records of transactions between Francis Hannan and the Australian Joint Stock Bank, one of many smaller institutions absorbed by Westpac over the years.
One element in the family’s success is the value it places on maintaining good long-term relationships based on mutual respect with their customers, service providers and even their bank (see box). The Hannans have always had a good eye for property and a history of purchasing not just their business premises but investment property with the support and encouragement of their bank. John Hannan recalls the bank manager coming to his father Norman in the early days and saying, “Norman, you’ve got £30,000 cash just sitting in the bank. Don’t leave it idle; put it to work.” The bank would lend another £70,000 and urge him to go out and find something for £100,000. Today the family owns industrial property in Sydney, Melbourne and Brisbane, a major residential housing development on the NSW central coast and the farm Rosslyn in the southern highlands. “We are proud of our 125-year relationship with Westpac. We also have long-term relationships with a number of customers going back decades. We’ve always valued customer relationships and customer service and I think we may have put that before profits sometimes. Westpac Chief Executive Gail Kelly is equally proud of the long-standing relationship. “Our connection with IPMG is truly a great example of Westpac and the customer working in a partnership together to achieve shared goals. It’s no coincidence that we both share a deep passion for creating enduring customer relationships. “We feel very privileged to be bankers to the Hannan Family and congratulate them on their 125 years of successful business operations,” she says. Michael Hannan says success in business comes down to the quality of staff and the quality of the product.
“We have a reputation for being trustworthy and for performance and delivery that puts us in good stead,” he says. Barbara Drury is a freelance writer.
The Joint Stock Bank became the Australian Bank of Commerce in 1910 before amalgamating with the Bank of New South Wales in 1931. In 1982, the Bank of New South Wales changed its name to Westpac Banking Corporation and its relationship with the Hannan family continues to survive and prosper. Today, three generations of Hannans count on Westpac for business and private banking. Westpac Private Bank – Insight Magazine – Summer 2012
Positive trends. Wealthy Australians are feeling a little more optimistic, according to the Westpac Private Bank Investor Sentiment Indicator.
Results from the latest survey of high net worth (HNW) investors were distinctly more buoyant in the third quarter of 2012. The overall score in the Westpac Private Bank Investor Sentiment Indicator jumped to 9.4, compared with -10.9 in the previous quarter. The Indicator, produced by Westpac Private Bank in partnership with CoreData Research Australia, provides an insight into investment markets by examining both past results and investor intentions. “In fact, the research shows that, if you had followed the predictions of wealthy Australians over the past eight years of the survey, you would have been better off than those who kept invested in the ASX 200 index”, says General Manager, Private Wealth BT Financial Group Jane Watts.
“There’s a pretty strong correlation with the ASX 200 so the Indicator is often a good sign of where the market may be going,” she says. “It’s a very interesting indicator to watch.” For the most recent survey, 220 HNW investors were interviewed in August this year from CoreData’s panel of around 17,000 Australians holding investment portfolios of $1 million or more outside of both their superannuation and their principal place of residence. Those with an annual household income of $250,000 or more are also classified as HNW investors. The Indicator also compares HNW investor sentiment with those holding smaller portfolios, between $50,000
HNWI versus Mass Affluent Sentiment:Q3 2012 30
HNW Investor Sentiment Mass Affluent Investor Sentiment
10 3.6 0 -10
-30 Q4 11
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and $750,000, a group referred to as ‘mass affluents’. The research shows that sentiment among mass affluents typically lags HNW investors by about 12 weeks. While sentiment for this group has also improved considerably, it remains in negative territory at -9.9, up from -23.5 in the second quarter – the lowest sentiment level recorded in the history of the Indicator. “There may be more promising signs this quarter from both groups of investors but results throughout the year have been volatile, which point to a need for cautious optimism”, says Watts. Underpinning the improved results has been a big turnaround this quarter in investors’ outlook for the Australian economy. The number who believe the economy will grow at a faster rate in the final quarter, and that business conditions will be better, has more than doubled. Slightly more investors than last quarter also expect the financial position of their households to improve in the coming 12 months, although, almost a third believe the position won’t change. “It certainly means that HNW investors are far more confident that the business and economic outlook is going to be more robust; less anaemic,” says Watts.
Looking offshore Continued rounds of economic stimulus in the United States and Europe, as well as the chance to snap up distressed assets mean that Australian investors are now more interested in prospects offshore. “HNW investors are global citizens who naturally look beyond our borders for investment opportunities,” says Watts. CoreData research shows that 39.5 per cent of Australian HNW investors include overseas assets in their portfolios. “Interestingly, of those investing overseas, 71.4 per cent are looking to the US”, says CoreData Founder and Principal Andrew Inwood.
“It’s clear they believe the US will recover more quickly than Western Europe or the UK,” Inwood says. If you would like to receive the latest Westpac Private Bank Investment Sentiment Indicator report, contact your private banker.
Investment activity Despite the improved outlook, only about a quarter (26.2%) of HNW investors were planning to make new investments while almost a third (32.6%) were intending to invest further in an existing investment, in a slight increase on the previous survey. Almost three quarters (73.8%) thought they would ‘stay the course’ with their current investments. HNW investors are generally more likely to be happy with their current investments than those in the mass affluent group. It’s thought this may be partly explained by HNW investors’ willingness to rebalance their portfolios more regularly using active investment strategies. However, both groups are closely aligned on their negative view of the outlook for both direct and indirect property investment with only a slight increase in confidence for the quarter. Nonetheless, HNW investor satisfaction is highest with current residential property investments (65.3%), a slight increase on the previous quarter (60.7%). Satisfaction with the performance of Australian equities also rose (from 30.6% to 46.9%) and surprisingly, given the falling cash rate, there was a slight increase in satisfaction for term deposits although the appeal of cash is clearly diminishing with a big drop of those in favour of new or extended cash investments (from 30.7% to 19.7%). “While cash has still been king for many, over the past few months clients have also been looking for yield enhancement solutions beyond term deposits,” says Watts.
According to the Westpac Private Bank Investment Sentiment Indicator report these include: —— Corporate debt: typically from sound issuers with sufficient premium to term deposit rates, good debt serviceability, shorter terms and some resilience to the current economic backdrop. —— Real estate opportunities: highly selective yield-based opportunities within specific segments of the real estate sector, with defensive characteristics and quality tenants. —— Equity yield solutions: solutions that take advantage of volatile equity markets to generate risk-considered income. In a complete reversal from the previous quarter, there are now more HNW investors believing the Australian share market will outperform residential property in quarter three (44% versus 25.4%).
The Investor Equities Sentiment Indicator increased sharply during the quarter, climbing from -23.8 points to 8.8 in the third quarter. Of those planning a change in their portfolios, most (35.5%) are looking towards Australian shares, a significant increase on the previous quarter (15.7%).
Westpac Private Bank – Insight Magazine – Summer 2012
Buying international property can offer many benefits to investors but it’s not for everyone. By Deborah Tarrant
Fancy owning a Manhattan apartment on 34th and Fifth, just a stone’s throw from the Empire State building? How about three premium properties in Las Vegas, with a combined value of A$380,000 that are returning rental yields of around 15 per cent? On the other hand, getting a foothold in the property market of a growing south-east Asian economy may make sense to some. For example, there may be a certain appeal in buying a place in bustling Kuala Lumpur that provides immediate accommodation for business when required and, when not, can be let out to other business travellers. These are just a few of the appealing opportunities that Australian property investors have picked up offshore in recent times. Spurred on by the strong dollar and lower relative property values, they are spreading their wings as they diversify their portfolios, and buying up in locations that many, previously, had only dreamed about. Brisbane property investor Jim McKnoulty and his wife, Lea, have a habit of chancing on properties with more than investment potential while on holiday. About five years ago, the couple acquired a villa in prime powder-snow ski location Niseko, Japan. Now they ‘ski free’ for a few weeks every year, while the villa’s high-season premium rental returns cover its summertime vacancies. In partnership with five others, the McKnoultys subsequently bought a small retreat in Bali. And, in the tiny Italian township of Mercatello Sul Metauro, they have syndicated ownership arrangements (unit trusts) with friends in three properties 8
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where, for a $40,000 lifetime investment, every 13 months the owners can spend a month exploring the delights of Italy’s Marche region. Needless to say, the couple regularly takes off to enjoy their exotic domains offshore.
Coming up trumps Sydney-based Michael Suto takes a more traditional, long-term approach to the three Las Vegas residences he bought at almost rock-bottom prices in the wake of the global financial crisis. For Suto, who paid cash by direct transfer for all three, the properties are pure investments managed by a local real estate agent. While their values bottomed out a further 16 per cent after he bought them, he’s not concerned. The rental yields, which also dropped “but not so much”, considerably outstrip the returns from his Australian commercial property investments, he says. This foray into international property also delivers good times for Suto, who avoids the risks of foreign currency exchange by leaving his rental funds in the US. “When they build up to $15,000 or $20,000 I just go over and travel,” explains Suto, who’s also co-owner of a restaurant in California’s Orange County. In addition, he owns land in Croatia, his father’s birthplace, which has doubled in value over a seven-year period. Westpac Private Banker Brett St Pierre says interest in buying international property has definitely grown in recent times with many clients keenly focusing on the US “because they go there for business”. However, business is just one motivation for the choice of location, adds St Pierre’s colleague Susan Taylor, also a
Westpac Private Banker. Lifestyle is another major factor in where clients choose to buy, she says. “Many are looking at investments with a view to using the property as a base in Europe or North America in their retirement. Others have romantic notions about owning a cottage in Provence or the Champagne region of France,” says Taylor. Where and why clients buy property offshore is up to them, say the bankers. “We can advise on the funding of loans. We can also provide a range of potential strategies to mitigate risks from adverse foreign currency movements during the investment term. Our job is to help people through the thinking and execution process,” says St Pierre. Settlement on a property may take several months, during which time currency fluctuation could shave significant percentages off original values. Hedging against fluctuations may prove beneficial in mitigating this risk. Private bankers call on Westpac’s foreign exchange experts to discuss currency options with clients. For example, says Nicolas Steiger, Westpac Private Bank’s Director of Financial Markets, a client borrowing to purchase a property overseas is, under some circumstances, able to convert the Australian dollar loan into the currency of the country the property is in. Another potentially risky time for investors is when repatriating funds following the sale of a property, notes Taylor. A client can also consider a hedging strategy at this time.
The other side of the coin While the allure is obvious, so are the challenges, with every country having its own rules and regulations for offshore property investors, real estate and property management, and different banking and taxation systems. Due to language barriers, many Australians look first to English-speaking countries, such as the UK or the US, but this does not always guarantee a seamless process. A standout example is the experience of St Pierre’s client, a very experienced Brisbane property investor with extensive interests in Australia, who acquired his “dream property” in February this year. The one-bedroom apartment in New York City looked like a snap at US$1.2 million, but its acquisition has proved an ongoing nightmare. “In terms of the strong Aussie dollar and getting a foothold in Manhattan, it was the best opportunity in probably 50 years,” enthuses the investor, who had researched the US property market extensively on the internet prior to buying and, ultimately, chose to borrow in the US. However, no aspect of the property transaction – from the financing to the property purchase, leasing and management, legal and conveyancing – bore any resemblance to how things happen in Australia, he laments.
“It’s a fabulous property in a fabulous location in a fabulous city that anywhere else could be leased many times over in the first 24 hours,” the investor suggests. But it took five months to find a tenant. After inquiries, the proud new Manhattan property owner discovered real estate agents charged prospective tenants a US$9,000 finder’s fee, a US$10,000 bond and the first month’s rent of US$5,000. “So a tenant needed US$24,000 just to move in. Estate agents there also seem reluctant to use their trust accounts, instead asking the owner to hold the tenants’ bond cheques.” The purchase has provided many lessons, he says. Reliable partners on the ground in the purchasing location can make all the difference to the ease of an offshore transaction, ongoing maintenance and other issues, concur seasoned international property investors and their advisors. For his Las Vegas properties, Michael Suto had the benefit of a family friend on the ground to help. Westpac arranged finance for Jim and Lea McKnoulty to purchase their Japanese property using a foreign currency overdraft, which was later restructured into a cross currency swap. The couple has provided Australian properties as security. The upside, Jim McKnoulty suggests, is that they only had to deal with Westpac. “There has to be someone there that you trust,” emphasises McKnoulty who speaks passionately about his offshore acquisitions.
“You have to remember that, when you’re thousands of miles away, you can’t always just hop on a plane,” McKnoulty says. Deborah Tarrant is a freelance writer.
10 essentials for international property buyers 1. Always consider the financial aspects of the purchase, even if there are strong emotional reasons for wanting to buy. 2. Research and take advice on the property market in your chosen location before putting down a deposit. 3. Be sure to get professional advice on the potential tax consequences of owning property offshore.* 4. Hire a good property lawyer in the country of purchase. 5. Remember the same commonsense rules apply everywhere, so building inspections and other checks on property are vital. 6. Pay cash if you can. 7. Recognise that the culture is different – things may take longer than you expect. 8. Seek advice on strategies to mitigate currency risks. 9. Find reliable and savvy partners for property management. 10. Consider the political and economic stability of the country or region where you intend to buy. * Westpac Private Bank has strategic alliances with tax services firms that can assist with this. Westpac Private Bank – Insight Magazine – Summer 2012
Phillip George The Paradise Suite #3 (Persia) 2010 c-type photograph 100 x 100 cm © Phillip George, 2012. Courtesy the artist and BREENSPACE, Sydney
Phillip George The Paradise Suite #4 (Tamil) 2010 c-type photograph 100 x 100 cm © Phillip George, 2012. Courtesy the artist and BREENSPACE, Sydney
Phillip George Inshalla 2008 fibre glass and carbon fibre with digital decal 213 x 52 x 7 cm each © Phillip George, 2012. Courtesy the artist and BREENSPACE, Sydney
Art in this Issue – Phillip George Phillip George’s artistic practice operates across zones of cultural difference, exploring and probing the complexities that exist between East and West and our conceptions of Us and Them. His work draws connections between Australian beach culture and the fractured, turbulent zones of cultural conflict. Ostensibly ethereal close-ups of roses in full bloom or surfboards with intricate and colourful patterns, they harbour a confluence of motifs that delve into the struggle between national identity and ideological traditions. Multilayered imagery and multilayered mythologies – his objects, in their many guises, question symbols of culture, nationhood, identity, beauty, power and eternity. George meticulously renders digital images that employ layers as both method and metaphor. The Paradise Suite: Persia, Tamil, East, Firenze, Al-Nahayan, from Edge of Empire, 2010 is a series of five photographs of roses incorporating Eastern and Western religious motifs. Superimposed within the petals of George’s roses are images and patterns of religious and cultural significance. George’s interest in the
rose as a site of cultural enquiry perhaps lies in its symbolic significance across a multitude of cultures. Roses are a sign of beauty, a sign of martyrdom, a sign of eternity. The series of patterned surfboards, Inshalla, 2008, from the Borderlands series further this inversion of cultural representation. The surfboard seems a particularly loaded arena in the aftermath of the 2008 Cronulla riots in Sydney. George is a keen surfer at Sydney’s Maroubra Beach and these works literally bring the issue home. His boards celebrate the metaphysical art of the ‘other’, of Arabic, Ottoman and Persian worlds and the transcendental nature of surfing. They are ‘asking us to reconsider not only where we stand in the world, but also who ‘we’ might be’. To the seasoned surfer, Inshalla or God Willing may also serve as an appropriate appeal for perfect weather.
Phillip George is based in Sydney and represented by Breenspace, Sydney.
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Chris Caton Chief Economist BT Financial Group
One can never talk about Australia without first considering the global environment. 2012 began with three major international concerns and it looks like finishing the same way. These concerns are: the possibility of a return to recession in the United States, a slowdown in China and European debt. The chance of recession has actually increased in the US, because of the so-called “fiscal cliff”. This is the name, coined apparently by Dr Bernanke, given to the possibly massive fiscal tightening – equivalent to about 5 per cent of GDP – slated to take place in the US early next year if lawmakers do nothing. The cliff comes about because of possible mandated spending cuts to bring the Federal deficit down, as well as because of the expiration of the Bush tax cuts, a payroll tax cut and extended unemployment benefits. If nothing is done, this tightening would unquestionably push the US back into recession, with nasty consequences for the rest of the world. One has to think, however, that sanity will prevail, although it may not be fully resolved until sometime in the New Year. This means a continuing period of (completely unnecessary) uncertainty. No matter what, fiscal policy will almost certainly be tightened next year, thus keeping the recovery subdued. But the question is: will the tightening be close to 1.5 per cent of GDP (if sanity prevails) or close to 5 per cent (if partisanship rears its ugly head). China continues to be an enigma. In October, the consensus forecast for GDP growth for this calendar year was 7.7 per cent. It was 8.4 per cent as recently as April. Growth is then expected to pick up to 8.1 per cent (down from 8.6 per cent
12 Westpac Private Bank – Insight Magazine – Summer 2012
The Outlook for the Australian Economy
in March) next year. History suggests that these forecasts may yet be trimmed further. But steel production seems to have stopped falling and, as a consequence, spot iron ore prices have improved significantly since early September. It is now accepted that commodity prices have passed their peak, and that mining investment in Australia may not be as strong as thought earlier, but it will still be strong. Growth in China will eventually pick up again, but it is unlikely to return to the 10 per cent rates we saw in the 2000s, and the pattern of growth will be different. More of it will come from private consumer spending and less from construction and infrastructure. What this means is that China’s demand for our commodities will increase far less rapidly than in the past, which implies that commodity prices are not likely to resume their upward trajectory any time soon. Australia will have to get used to doing without a boost to real incomes every year just from rising commodity prices. The European debt issue looks far better than it did in mid-year. The best indicator of this is long-term bond rates in the two important economies, Spain and Italy. They are both down by more than 150 basis points since the ECB announced its determination to do “whatever it takes” in late July. This hasn’t solved the problem; it has stabilised the situation so that the countries involved can get on with the process of fiscal repair. This almost certainly means no catastrophe, but a long period of slow growth in Europe (but what is new about that?). Australia has little direct exposure to Europe so, barring a financial meltdown, we will be little affected by developments there.
The Australian Economic Landscape
Employment growth has been slow
Australian economic growth is still “OK but not great”. GDP increased by 0.6 per cent in the June quarter, to show yearto growth of 3.7 per cent, down from 4.4 per cent in the year to the March quarter. The labour market continues to track sideways; estimated employment has shown no net increase in four months to September and rose by just 0.5 per cent in the previous year. The unemployment rate is still just 5.4 per cent, but this is the highest since early 2010.
Much of the growth this year has come from mining investment. This has not yet ceased growing, but we know this will happen, and probably sometime in 2013. When that occurs, overall growth will slow sharply unless something else comes along to replace mining investment.
This slowdown is likely to be cushioned to some extent. While the Australian dollar has remained stubbornly high despite the softening in commodity prices, a peak in mining investment will almost certainly cause it to decline, possibly to as low as 90 cents. This will bring some relief to manufacturing, tourism and retail. In addition, the Reserve Bank has been cutting rates recently, partly because of the likely eventual softening in the resource sector, and it is likely to do so again. Overall, GDP growth may slow from about 3.5 per cent this year to about 3 per cent in 2013. This is trend growth at best, but still far better than in the rest of the developed world. The unemployment rate is likely to drift upwards from its current level of 5.4 per cent. The dire media stories of 6 per cent or higher, and of unemployment affecting white-collar workers (shock, horror) could come true, but they should not be anyone’s base case forecast. Inflation has been remarkably low. In the year to the June quarter, the RBA’s measure of underlying inflation increased by just 2 per cent. This figure will rise, in part because of the impact of the carbon tax. Let me say, however, that the likely macroeconomic effects of this tax have been massively overstated; as in the case of the GST, it has been “overcompensated” (for most consumers) and will quickly become part of the economic landscape.
Unemployment rate Source: Australian Bureau of Statistics
Australian inflation % 7 BT forecast 6 5 GST effect 4 3 2 1 0
Underlying inflation Source: Australian Bureau of Statistics
One consequence of the weakness of commodity prices has been increased speculation that the much-hyped surplus in the Federal budget in the current fiscal year won’t be achieved. In fact, a significant deficit is now likely. What should policymakers do? Absolutely nothing. The Budget bottom line is extraordinarily sensitive to commodity prices and offsetting the loss in revenue from lower prices by means of tightening elsewhere would only magnify any damage to the economy.
Westpac Private Bank – Insight Magazine – Summer 2012 13
No room for complacency
George Toubia Westpac Private Bank Chief Investment Director
Australia has just entered one of the most difficult periods of recent history, but good results can be achieved.
An increasing number of growth decelerating factors are confronting the Australian economy including the high Australian dollar, declining terms of trade, significant fiscal tightening and a maturing profit cycle in the mining sector. Growth in emerging economies is also likely to slow while other developed markets will remain firmly in a low to no growth environment. Monetary policy levers will be ineffective at reversing the global growth slowdown, debt de-leveraging and deficit management. But a liquidity injection orchestrated by the central banks of developed countries is likely to reduce excessive downside risks in the marketplace. In Australia, it is imperative that declining productivity and the strength of the currency are addressed. For example, Switzerland is targeting its currency by enforcing a ceiling on the exchange rate to protect what’s left of its competitiveness. The US Federal Reserve does it indirectly by flooding its system with cash and Brazil does it by regularly altering tax on inward investments. The need for debt management is also just as important in Australia as elsewhere; the only difference is that it is about personal balance sheets in Australia (as opposed to public balance sheets in the US and Europe). We are extremely relieved that the Reserve Bank is finally recognising the softness of the mining sector and the weakness in other domestic sectors. It’s an opportunity to be ahead of the curve by jump starting confidence and activity. And yet, state governments are showing a lack of corporate mindset as they continue with royalty policies that have limited regard to the increasingly challenged profitability of the mining giants’ operations in Australia. It’s time to enrich, not weaken, those long-term corporate relationships.
14 Westpac Private Bank – Insight Magazine – Summer 2012
Meanwhile, the possibility of interest rates lower than where current market expectations deem them to bottom (2.50 per cent to 2.75 per cent for official rates and 3 per cent for long-end government yields) should not be ignored. A budget surplus is simply unachievable and the deficit will gradually rise. The yield curve is very flat and that is a credible signal for far more moderate growth in the next two years than current expectations. In this environment, the search for quality becomes even more critical. Quality comes in various forms: for credit investors, it is unquestionable debt serviceability and a shorter term outlook; for equity investors, it is earnings resilience (as opposed to growth); for real estate investors, it is value retention and tenant quality.
Embracing foreign investment Investing offshore is increasingly a necessity rather than a choice. Given the Australian market’s weighting towards financials and mining, investors focusing on domestic equities are facing fewer opportunities to access global franchise equity return streams – and specifically those that offer global earnings resilience and limited base metal commodity exposure. To that end, investing in global equities has its merits. It is true that less than 25 per cent of global equities are showing leadership but there is an opportunity for those with seasoned stock picking skills.
In Europe, not only are sovereign funding costs subsiding, those of European banks are too. The primary market for banks has just re-opened (with about 21 billion euros of senior unsecured paper) and – following the inability to access US dollar funding over the last two years – French banks have just been able to do so. As a clear signal of the market’s willingness to lend when reform is embraced and progress is made, Ireland has successfully issued medium-term debt recently. In addition, the European Central Bank reforms have had the desired effect of crushing the risk premium in Italian and Spanish sovereign debt, as seen in lower short-dated yields. Meanwhile, the move by the US Federal Reserve to prioritise employment over inflation is questionable. We are not convinced that these actions will deliver the desired goals. If employment is the objective, then corporate management’s confidence is the Achilles’ heel. That will not be restored through keeping rates low – both US mortgage rates and borrowing costs are already low.
Gold continues to shine Twelve months ago, investors considered the world was awash with liquidity. Today it has more liquidity than it had a year ago and in a year’s time it will have more than today. The open-ended and unlimited liquidity injection by the US Federal Reserve, the European Central Bank, Bank of Japan and Bank of England will pump at least another 1.5 trillion US dollars into the financial system over the next 12 months. As central bank balances have expanded, the gold price has climbed. The combination of low US/EU short-term interest rates for at least another three years and a perceived fear of resurging inflation from system liquidity (which in our opinion is unfounded) also serve to support the case for gold.
Volatility advantages The unlimited nature of central bank liquidity injection is now having a strong impact on investor mentality by removing tail risk pricing from the market. Across currency, credit and equity markets, short-dated price volatility is seeing significant compression. This is now resulting in lower implied volatility and a steep term structure of the volatility curve between spot and 18 months. Similarly, the equity volatility term structure (the equivalent of an interest rate yield curve but in volatility terms) is steep between spot and beyond 12 months. Implied Volatility
Source: Bloomberg, Various Banks
While it can be argued that this is too steep, it highlights that – for the short term – market participants believe that the central bank liquidity put can be an effective band aid. For those investors that are interested in positioning themselves in asset classes with limited downside risk, low implied volatility (up to 12 months) affords a cheaper option than at any time during the last few years, making risk-reward payoffs more attractive.
From a basic supply and demand standpoint: —— Strikes in South Africa at large producers (AngloGold and Goldfields) are causing production stoppages. —— Indian demand for gold eased this year due to the high gold price in Indian rupee terms (as the rupee sharply depreciated) and the lower farming income due to monsoons. —— Chinese demand is positive but lower than previous years as Chinese inflation has eased to 2 per cent from 5 per cent last year. Importantly, central bank gold buying continues at a healthy pace particularly by Turkey, Russia, Philippines and Mexico. The loss of faith in paper currency, in the face of abundant currency supply, makes the case even stronger for gold’s wealth preservation power. In that context, we expect gold to retain its shine until the monetary conditions reverse.
Relative value As public credit opportunities get full in valuation, yield-based ideas in other markets will invariably present good relative value. In equity markets, these opportunities can be exploited if downside risk is tightly managed. Suitable methods include enhanced buy write strategies and strategies with conditional capital protection.
We expect Australia’s equity market underperformance compared with global markets to persist owing to another domestic cycle, this time away from mining and defensive yield stocks (such as utilities and telecom) towards interest rate-sensitive sectors (such as banks and diversified financials) and event-driven equity investing.
Westpac Private Bank – Insight Magazine – Summer 2012 15
No rude shocks here
FRANK ALLEN Director Westpac Property Markets
Prices may be subdued but Australia remains in a good position to withstand further pressures.
Despite two years of softening in the Australian real estate market, talk persists of property being highly overvalued and in line for a crash. However, four years after the global financial crisis hit, the Australian property market has lost its heat, thanks to affordability issues and a shift in attitude of Australians towards debt. Property prices across Australia fell 3.8 per cent during 2011, according to RP Data, but improved a little at 0.8 per cent higher in the first nine months of this year. City home values rose 2 per cent in the September 2012 quarter, suggesting the market may have stabilised. While property markets in Australia are expected to remain subdued, they are not likely to plummet as has happened in the United States, the United Kingdom (outside of London), Ireland and Spain in recent years. Australia’s stable economy, low unemployment rate and stable banking system are well-positioned to underpin the real estate market. Unemployment is low at just over 5 per cent, inflation is also low at about 2 per cent, and annual GDP growth was a healthy 3.7 per cent to the end of June 2012. Focusing on the property market, supply is improving – construction of new dwellings rose in August and September. Figures from the Australian Bureau of Statistics show building approvals increased by 7.8 per cent in September, in seasonally adjusted terms, and the value of residential building approved rose by 12.5 per cent, while non residential building fell by 12.3 per cent.
How we compare To understand why we believe Australia is not likely to experience plunging prices, it is worth looking at two of the hardest-hit countries: Ireland and Spain. Australia’s house prices grew 198 per cent in the 13 years from 1997 to 2010, and 150 per cent in the ten years to December 2006. It was, without doubt, spectacular growth. But not anywhere near the 270 per cent increase seen in Ireland over the ten years to 2006 as the boom took hold and fed a construction frenzy. As of April last year, the Irish market was estimated to be oversupplied by about 110,365 dwellings, with another 17,972 uncompleted properties. House prices in Ireland plunged 53 per cent from their peak in 2006, to the first quarter in 2012. And a lack of jobs continues to dog the nation. At 14.9 per cent, Ireland’s unemployment rate is the fifth worst in the European Union.
Commercial property yield stability continues, premium to 10 year bond and 3 year swap remains high. 12%
Average since 2000 10 year bond 5.23% 3 year swap 5.4%
2 Dec99 10yr bond
Dec05 Prime retail
Dec07 Prime office
3 year swap
Raw data: CB Richard Ellis Pty Ltd. Sources: RBA. Analysis: Westpac Property.
16 Westpac Private Bank – Insight Magazine – Summer 2012
Similarly, Spanish house prices soared by 270 per cent in the ten years to 2006. Spanish unemployment is now running at 25.1 per cent – the highest rate in the EU – and property prices are down 31 per cent since the GFC hit.
a-half years to the end of December 2011. It is now worth about $15 billion. Over the same period, investment in nonresidential real estate rose 49 per cent from $30.6 billion to $45.6 billion.
Oversupply was a major issue in Spain where, as of 2010, there were 1.5 million unfinished, unsold or unwanted residential units scattered across the country. More than 800,000 homes were built in Spain in 2006 – exceeding the number constructed in France, Germany and Italy combined.
Across Australia rental yields on residential property range from 3.6 per cent for houses in Melbourne to 5.8 per cent for houses in Darwin, according to RP Data-Rismark.
Affordability improving The Australian housing market is certainly not cheap but affordability has improved over the last two years thanks to the softening prices and monetary policy easing. The Real Estate Institute of Australia’s affordability measure considers the proportion of average household income directed at servicing an average mortgage. In the June quarter of 2012, 31.9 per cent of average household income was needed to service a mortgage, down from 34.6 per cent in the June quarter of 2010, and far below the 39.8 per cent experienced in mid-2008. Although there are concerns in Australia over whether our ‘luck’ has run out, with China slowing and mining investment in Australia potentially having reached its peak, the Australian economy is expected to remain steady. China’s slowdown has been orchestrated to stop its economy from overheating. It appears to be “a normal cyclical slowing, not a sudden slump of the kind that occurred in late 2008” and China’s GDP growth continues to be 7 to 8 per cent, Australia’s Reserve Bank Governor Glenn Stevens noted recently in a speech, while lamenting that the nation is “grimly determined to see our glass as half empty”. Stevens addressed a number of factors that seemed to be creating a more negative view of the Australian economy than he thought necessary. One was: does Australia have a housing price bubble that is due to pop? Stevens said that, scaled to measures of income, Australian dwelling prices have actually declined and are now about where they were in 2002, making housing more affordable. Australian households are in a good position to withstand falls in household income, should an economic downturn arrive. The proportion of households that are ahead on their mortgage repayments is high – with up to half of mortgage holders having built in a buffer, and arrears for Australian mortgages remain low. Self Managed Super Funds are also playing an increasing role in the property market – Australian Taxation Office figures reveal that investment in residential real estate by SMSFs grew nearly 40 per cent in three-and-
There is no doubt there are some sectors of the economy that are hurting, due to either the high Australian dollar or a more cautious attitude towards investment. Three of these are among the biggest employers in the country: manufacturing, retail trade and construction. Westpac Economics expects the job losses in these industries to result in a stagnant employment market over the second half of this year. This will affect the housing market, but, while unemployment may rise towards 6 per cent, overall it remains low and Westpac Economics believes interest rates will fall further in 2013 to help stimulate the economy. Of course, there is the possibility of a more negative impact from an unforeseen problem in Europe, affecting China and as a result growth in Australia. However, the current cash rate of 3.5 per cent and our relatively low Government debt provide tools to try to stabilise a slowing economy. The RBA has already shown its hand with four cuts amounting to 125 basis points. Glenn Stevens has openly discussed how the RBA is viewing external factors and what can be done, which provides some comfort that it will act if need be. While a return to strong price growth appears a long way off, I don’t believe the crash that many overseas and some local experts have been predicting will occur. Certainly the market is weaker than I had expected two years ago, but, barring an economic recession, Australian prices do not look like following some of their European or US counterparts. On the other hand, they are not likely to take off, either. Any growth is, at best, likely to reflect growth in household incomes.
Australia’s stable economy, low unemployment rate and stable banking system are well-positioned to underpin the real estate market.
Westpac Private Bank – Insight Magazine – Summer 2012 17
The search for yield
Vimal Gor Head of Income and Fixed Interest BT Investment Management
What’s the outlook for fixed interest investments? Westpac Private Bank’s Chief Investment Director George Toubia talks to BT Investment Management Head of Income and Fixed Interest Vimal Gor.
George Toubia: Given the contraction in both credit spreads and significant rally in government yields, where do you see the opportunities and risks in fixed income investing as at now?
Vimal Gor: On a long-term valuation basis, Australian bonds are overvalued. But, when we’re going through a deleveraging and a slow-growth environment in the global economy, we know that these deleveraging cycles take a while. We think it is unlikely that bond yields will rise in the medium term and there is significant risk that bond yields will fall further to provide capital gains from that part of your portfolio.
compare that to what’s happening in Europe, the US and UK, where markets are experiencing large amounts of quantitative easing, liquidity is also drying up.
GT: There’s probably a positive angle in that sovereign or global institution players holding Australian government bonds for the longer term gives certainty that this will remain a relatively stable market as opposed to one that may experience forced liquidation.
Irrespective of whether you think bonds are over or undervalued, the key is to have bonds as part of a balanced portfolio because they offer diversification against equities. If you don’t have bonds and just have term deposits, you don’t get any negative correlation benefits.
VG: That’s the point. If there’s large overseas buying it’s because it’s a quality asset. We have a very good credit rating, very low net debt to GDP ratios – there are myriad strong reasons why you should be buying Australian bonds, and that is what has driven the overseas holdings up to such a high level. We think it’s a good thing. Australian bond yields are one of our favourite assets in the world and we still favour being long here.
GT: The government bond market of Australia is significantly held by overseas institutional investors. Isn’t that affecting the price action in that sector and its liquidity?
VG: The latest numbers show that around 80 per cent of Australian bonds are held by overseas investors. If you look at the RBA [Reserve Bank of Australia] breakdown, Australians only own about 5 per cent of the Australian bond market. When you see large holdings from overseas, they tend to buy the bonds and lock them away to get the yield out of them and they tend not to come back to the market. But, if we 18 Westpac Private Bank – Insight Magazine – Summer 2012
GT: Obviously we’re surprised that market participants are not allowing for the possibility for lower yields in Australia, especially with the structural change our economy has to go through. What are your thoughts on that?
VG: Yes, that’s a key point for bond yields – a lot of people didn’t believe they’d go this low; we’ve hit new all-time lows this year and we forecast they will fall further. Part of the reason people are so concerned about the level of yields right now is they can’t get their head around the RBA taking real interest rates negative, so they believe the floor on interest rates will be somewhere around 2 to 2.5 per cent.
We don’t believe that’s the case. The RBA will be more than happy to take rates negative if the economy pans out as we’re seeing it. We see a problem in 2013/14 when the mining capital expenditure will slow without a boost from the rest of the economy to offset it. We were saying back in early 2011, when rates were at 4.75 per cent, that we thought they’d bottom out between 1 and 1.5 per cent sometime in 2014 and we stand by that forecast.
GT: As for other opportunities within your mandate – such as the semi-government bond market, swap spreads and currency opportunities – what areas represent reasonable value outside government bonds for you?
VG: We have a strong view that swap spreads globally should continue to tighten as they have done throughout the world. Obviously Australian swap spreads have come in recently, but the narrowing is much more pronounced in the overseas markets and that’s because governments are explicitly trying to bring down that credit premium. If you look at the UK’s Funding for Lending scheme, the government is actually lending to small business via banks, therefore there should be zero swap spread in the market. While we understand why Australia structurally should trade with a higher swap spread than globally, we still believe there’s more room for swap spreads to fall and we are playing that trade. In terms of currencies, we believe the US dollar is undervalued in the medium term and that the Australian dollar is very overvalued.
GT: Would you reconsider Australian government bond risk if the Australian dollar falls, given the large number of offshore holders of Australian government debt?
VG: We’re not worried about wholesale selling of Australian bonds, but it is something that we look at and try and model. It’s fair to say that the large scale reallocations into the Australian dollar have already happened. While overseas buyers normally buy bonds unhedged, and therefore a weaker currency will negatively impact their holdings, we think they’re reasonably happy with their exposures right now.
GT: You analyse forward-looking indicators and commodity inputs in terms of the effect on risk appetite and the general level of spreads. Are there any strong signals right now from your process?
VG: What’s jumping is that many asset classes – specifically US equities – are being driven by liquidity, as the search for yield goes on. You can see that clearly through credit spreads, which are deteriorating. So it’s very clear to us that central banks globally are driving asset prices up to levels that may not be sustainable over the medium to long term. The clearest example of that is the US equity
market. The period we’ve had recently is very similar to what we saw earlier in the year when the market movement upwards was all based on multiple expansion.
GT: As a veteran fixed income and interest rate portfolio manager, what observations do you have in terms of how the world responds to a very low interest rate environment and flat yield curve?
VG: That’s an interesting point about the yield curve because Australia has by far the flattest yield curve of any developed market. Numerous empirical and academic studies show that the steeper the yield curve, the more likely the growth; the flatter the yield curve, the more likely growth will slow. That’s a potential worry for us, and one of the reasons we expect growth to tail off over the next couple of years. When comparing Australian investors relative to the UK and US, in Australia we’ve been very lucky to have high yield and it would be fair to say that’s going to stop. Interest rates are going to continue to come down and we need to get used to generating a lower level of return on our assets. If you look at the level of holdings in fixed income in Australia relative to overseas, we are materially lower. There are a couple of reasons for that including our demographics. But it’s not hard to see Australia moving to the same equity bond weightings they have in the rest of the world. And that will mean material will shift into fixed income, and the acceptance of lower returns that goes with that.
GT: Even if decisions are made to reallocate to a world standard in terms of equity bond balances, doesn’t the size of these domestic markets make it technically difficult?
VG: Yes. In an environment where bond yields will probably stay at current levels or go slightly down over the next few years and the US equity markets will probably trade in this range, you need active management of both your equities and bonds. That’s why you need to look at managed funds and have your manager actively move your asset allocation around for you.
We were saying back in early 2011, when rates were at 4.75 per cent, that we thought they’d bottom out between 1 and 1.5 per cent sometime in 2014 and we stand by that forecast.
Westpac Private Bank – Insight Magazine – Summer 2012 19
Mark Elding Executive Financial Planner Westpac Private Bank
2 strategies to optimise your SMSF
The rules for self managed superannuation funds allow for many different strategies. Here are two to get you started.
1. Reserving benefits for the future
2. Using lump sums to fund income
Some SMSF trust deeds specify the use of ‘reserve accounts’ which can help manage peaks and troughs in income, as well as maximise tax deductions and benefits. A ‘contributions reserve’ is one of many different types of reserve accounts. It holds contributions to the fund before they are allocated to a specific member’s account. This allows members to potentially make two contributions in June, claim a tax deduction for both, and then allocate the second contribution to the member in the next financial year. This strategy can provide a ‘double tax deduction’ but there’s a catch: the contribution must be allocated to the member’s account within 28 days of the end of the month in which the fund received it.
If you’re retired and aged between 55 and 59, it’s possible to take lump sums from your SMSF at any time and it can be tax effective for some. This rule applies whether or not you’re taking a pension.
20 Westpac Private Bank – Insight Magazine – Summer 2012
Mark Elding was the winner of the Outstanding New Wealth/Investment Adviser category in the 2012 Australian Private Banking Awards.
O utsta n d
The anti-detriment payment increases the death benefit to beneficiaries and increases tax deductions for the SMSF which may offset any current capital gains from having to selldown assets, other assessable income and future capital gains and tax on contributions.
With the right advice, you may be able to successfully unlock a vast range of investment and strategy options for your self managed superannuation fund. The strategies mentioned here provide general information, so you’ll need to check whether they work for your fund. It’s also worth remembering recent changes to the regulations, requiring that SMSFs give consideration to holding life insurance cover for members. Your Westpac Private Bank Planner, drawing on a range of expert resources, can help to ensure you comply with the often complex SMSF rules.
Another type of reserve account is the ‘anti-detriment’ reserve – a pool of funds used to pay out additional death benefits to an eligible spouse and/or dependants when members of the fund die. These payments are increases in lump sums paid on death to eligible dependants and effectively represent a refund of the tax on contributions paid by the deceased member.
As an individual, the first $175,000 of taxable component drawn as a lump sum is tax-free and anything above that is taxed at 15 per cent (plus Medicare). So if your minimum income requirement is, say, $110,000 per annum as a couple (ie $55,000 each) for the three years to age 60 you could meet your minimum income obligations without paying any taxes. This strategy depends on your circumstances and the amount of taxable and non-taxable components in your individual fund. This is because you have to withdraw tax-free and taxable components together in their relative proportions and you cannot just take the taxable component by itself.
For example, if an SMSF member wishes to contribute, say, $50,000 (two contributions of $25,000 each) to their fund in June, the full amount may be claimed as a tax deduction but, given the annual concessional contribution cap of $25,000, the member would have created an excess contribution of $25,000. If the fund puts the second $25,000 contribution into the SMSF’s contribution reserve it can be allocated to the member in the following financial year and tested against next year’s cap.
If you are in pension phase and aged 55 to 59, using lump sum payments to meet your minimum pension requirements, rather than income payments, may be useful because lump sums are taxed differently.
e a lt h /I nv
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