By Chris Rylands
Outlook
We have a highly experienced team of liquidators and trustees who are able to bring their extensive expertise and experience to assist in times of financial distress to achieve the best outcome for all stakeholders.
Click on the links below to see examples of our most recent experience across a range of common business recovery matters.
Market Update
Cash
- The Reserve Bank of Australia (“RBA”) left interest rates on hold during June; with Governor Glenn Stevens maintaining a “wait and see” approach in relation to future interest rate cuts. This stance was unchanged during July and no change is forecast for August.
- The RBA will be closely watching recent measures taken to support the Australian economy before deciding on the need for an additional stimulus. These measures include tax breaks for small businesses announced in the Federal Budget, the impact of earlier interest rate cuts and a lower Australian dollar.
- The RBA is also closely monitoring the impact of international events on the domestic economy. Greece and China were mentioned in the July Statement of Monetary Policy, with these issues to remain contained to financial markets and not impact the broader Australian economy.
- Term Deposit rates remain at similar levels to our last update. The highest term deposit rates currently available are 2.90% across 3 months and 2.95% across 1 year and 6 months.
Fixed Income
- June was an unusual month for both domestic and global bond markets. There were losses in both sectors despite the sharp fall in equity markets. Historically bonds increase in value during falls in equity markets, as investors rotate into more defensive asset classes.
- The Australian Bond market fell by -0.93 % in June, with the yield on the 10 year bond increasing 0.28% to 3.01%. The rise in yields came despite the RBA’s ongoing bias for lower interest rates and generally weaker domestic economic data.
- Global yields also rose, leading to a -1.07% decline in the global bond index during June. Yields on peripheral European government bonds (Spain, Italy and Portugal) increased as uncertainty over Greece spread to other European countries with high debt levels.
- United States (“US”) bond yields increased in June as investors became increasingly confident that the US Federal Reserve will increase interest rates in September this year. The US 10 year bond yield rose by 0.43% to 2.35% by month’s end.
- The global bond market has recovered some of its losses during July. Yields on peripheral European bonds have deceased (increasing bond prices) as investors became more relaxed about owning the bonds post the Greek resolution. Bond yields in Australia have also trended lower during the month, whilst US yields remain steady given the likely rise in interest rates later this year.
Australian Equities
- Australian equities retreated -5.30% during June. Investors were particularly unsettled by events in China given Australia’s dependency on the country for economic growth. The selling was consistent across all sectors, with resource stocks particularly vulnerable.
- The ASX 200 has rebounded during July, however, investors remain cautious given the ongoing volatility in the Chinese share market. The focus will soon begin shifting towards the Australian reporting season which begins in earnest in the coming weeks.
- July also saw a major shift in the Australian Prudential Regulation Authority (“APRA”)’s policy on bank capital requirements. APRA has decided that the big four banks and Macquarie must hold more capital on their balance sheets to protect against potential weakness in the Australian residential property market.
- The requirement to hold higher capital levels means that this capital can no longer be used in profit making activities. This is unlikely to result in any material downgrade to profits as these companies will simply pass on these costs to their customers.
- We have already seen many of the banks increase interest rates and deposit requirements for property investors in response. These measures are likely to slow the residential property investor market and provide additional scope for the RBA to cut interest rates again without fear of overheating the property market.
- As part of our Australian equities investment strategy, we maintain an exposure to investment managers with flexible mandates. These managers increase the ability to preserve capital during a fall in the market in which they invest.
- This strategy can be implemented by selling shares when the manager believes they are overvalued or when a negative market event is anticipated. This increases the level of cash held in the Fund, which can then be used to re-enter the market at a more desirable time or level. One of our preferred funds in this sector is the Perpetual Share Plus Fund. The Fund was able to limit losses to -2.7% for the month of June, compared to a -5.30% loss in the Australian equity market.
- Despite the recent volatility, the ASX 200 index is trading at a similar level to our last update. The ASX 200 continues to trade around “fair value” on a Price Earnings Ratio of 16.2x and forward dividend yield (unfranked) of 4.5% or 5.9% when grossed up for franking.
Global Equities
- The MSCI World Index declined -2.66% during June. The major declines were in European and Asian markets given their proximity to Greece and China. The US was a relative outperformer returning -2.10% for the month.
- Despite the recent volatility in Chinese equities, we continue to believe Asian equities can deliver attractive long term returns to investors. However, it is important to access these markets in a disciplined manner to protect against the potential for higher volatility levels which are common in these markets.
- Our preferred exposure to Asia is via the Aberdeen Asian Opportunities Fund. Aberdeen has been investing in Asia for 25 years through a variety of market cycles. The Fund has a highly disciplined research process, which combines a patient, high conviction approach to investing. The Fund has a long term “buy and hold” approach which improves after tax returns and a highly competitive management fee which is also critical for maximising investor returns.
- The Fund has been progressively reducing its exposure to China as valuations in the market became increasingly expensive. With a focus on “quality” and “valuation,” Aberdeen must sell share holdings when they become overvalued. The Fund currently holds a 9.1% weighting to China, compared to an Index weighting of 29%. This means the Fund is currently “underweight” China.
- We continue to remain unhedged in our exposure to global equites. The Australian dollar will remain under pressure given the increasingly divergent path of Australian and US interest rates. In the last financial year, unhedged International equities returned 25.2%, whilst hedged International equities returned 10.9%, with the difference in these returns attributable to the fall in the Australian dollar.
Market Return
| RETURNS (%) | 1MTH | 6MTH | 1YR | 3YR | 5YR |
| AUSTRALIAN EQUITIES | |||||
| S&P/ASX 200 TR Index AUD | -5.30 | 3.10 | 5.68 | 15.06 | 9.69 |
| S&P/ASX Small Ordinaries TR Index AUD | -7.77 | 2.97 | 0.44 | 2.46 | 1.35 |
| GLOBAL EQUITIES | |||||
| MSCI World ex Australia NR Index AUD | -2.66 | 9.46 | 25.18 | 26.12 | 15.43 |
| MSCI Emerging Markets NR Index AUD | -2.95 | 9.94 | 16.53 | 14.18 | 5.66 |
| S&P 500 PR Index USD | -2.10 | 0.20 | 5.25 | 14.84 | 14.89 |
| FIXED INTEREST | |||||
| Bloomberg Ausbond Composite 0+ YR Index AUD | -0.93 | 0.63 | 5.63 | 4.82 | 6.44 |
| BarCap Global Aggregate TR Index (AUD Hedged) | -1.07 | 0.84 | 5.62 | 5.98 | 7.27 |
| EXCHANGE RATE | |||||
| AUD/USD Spot Rate | 0.37 | -6.36 | -18.58 | -9.17 | -1.87 |
Source: Bloomberg
Fixed Income Focus | Part 1
- The core principles surrounding fixed income are relatively simple. The “seller” of a fixed income security offers to pay the “buyer” for the use of the buyer’s money. The buyer is paid interest until the original investment amount is returned at the end of the investment’s term. The return of capital at the end of the term is subject to seller’s ability to meet this obligation.
- There are many types of fixed income investments, including government bonds, semi – government bonds, corporate debt, high yield credit and emerging market bonds. The term “fixed income” is a broad expression which covers instruments which pay both fixed and floating interest payments.
- An increase in the expected return from a fixed income investment is commensurate with an increased risk that some or all of your capital may not be returned to you at maturity. Some fixed income investments are “perpetual,” which means there is no set maturity date and they must be sold to another party to recoup some or all of the original capital invested. Below is a chart which shows the risk versus return across a series of traditional fixed income investments.
Risk versus Return across different fixed income investments
Source: Kapstream Capital
- The value of a bond can fluctuate on a daily basis due to a number of factors, including the future direction of future interest rates and the bond’s credit rating. Bonds that make fixed payments are the most sensitive to changes in market interest rates. Market interest rates in any country are generally the rate on the country’s 10 Year Government Bond. It does not refer to the official interest rate set by the domestic Central or Reserve Bank such as the RBA.
- For example, assume an investor purchases a bond for $100 which pays a fixed coupon of 5% or $5 per year. If market interest rate increases from 5% to 5.5%. The interest rate received on the actual bond cannot change to reflect the new market interest rate because it is fixed. Instead the price of the bond must change.
- The price of the bond would need to fall to around approximately $91 to provide the next purchaser with a yield of 5.5%, which reflects the market rate ($5 fixed interest payment / $91 purchase price = ~5.5%). The increase in the market interest rate has caused a loss on the bond of $9.
- The same principle applies when interest rates move in the opposite direction. If market interest rates fall, the price of the bond will rise to reflect the impact of the new interest rate. In summary, there is an inverse relationship between the price of a bond and the movement in the market interest rate.
Bond Price and Yield: Inverse Relationship
- The value of a floating rate investment is less sensitive to changes in market interest rates. This is because the interest rate on the investment can automatically adjust to the change in market interest rate. It would seem logical for investors to only invest in floating interest rate securities to limit the potential impact of interest rates on the value of their fixed income portfolio.
- The challenge with this strategy is that that the safest issuers of fixed income, such as major Governments, generally only issue fixed rate bonds. In our future updates we will take a closer look at the different fixed income sectors, their role in portfolios and the challenges achieving a satisfactory return in a low interest rate environment.
