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.