Australia remains an attractive investment destination for investors around the world, most obviously as a result of the commodities boom. One impact has been funding has flooded our bond market resulting in the higher grade bonds in our market trading at historically high prices.
The Australian Dollar is another recipient of international investors’ attraction to Australia, a mixed blessing.
Strategic disconnects remain which could improve the fundamentals for long-term investors. The Australian Bureau of Statistics noted recently that Australian births per woman have been below replacement fertility since 1979.
Also the quality of transport infrastructure in some major Australian cities has meant the choice between high property prices or long commutes. While both have long term implications for the country and our relative attraction as an investment destination, all said and done, few would argue Australians have done it tough relative to other developed countries in recent years.
However, regardless of our relative economic health, Australians have recently exhibited declining levels of confidence. In May 2012 the National Australia Bank Business Confidence indicator turned negative for the first time since September 2011, and the Westpac Consumer Confidence reading in June remained grim even following changes in RBA monetary policy.
So is our gloom warranted and hard times on the cards? One regularly cited cause for pessimism is high levels of household debt.
Debt
If we look at Australian households, do they have issues with debt levels? According to the RBA’s March 2012 financial stability report the aggregate gearing of Australian household balance sheets, or the ratio of debt to assets, was around 20 per cent at the end of 2011. In terms of servicing that debt, the RBA notes the ratio of household interest payments to disposable income was around 11 per cent in the March quarter of 2012. The value of outstanding margin loans is down around two-thirds from its 2007 peak.
Risk management
Perception can quickly become reality in investment markets. When the outlook on an asset changes from blue sky to storm clouds prices can deteriorate rapidly. If an investor is planning to sell an asset in the near term then prudence dictates the investor should utilise effective risk management tools to protect against volatility.
One powerful risk management tool that sophisticated investors can utilise is exchange traded options. A put option is the right to sell an asset within an agreed time at an agreed price and is a very effective risk management tool.
Purchasing put options when the market is fixated on blue sky is akin to taking out flood insurance when there has not been a flood for fifty years. The other point to note is while the investor might not always need their protection, the tough conversations many advisers have been having with clients in recent years illustrates that peace of mind certainly does have value to investors.
Investor need
The Rice Warner Actuaries’ Superannuation Savings Gap report reveals the lucky country has a significant superannuation shortfall. According to the Australian Bureau of Statistics almost 26 per cent of Australian household assets were held in cash in June 2012, yet term deposit returns after inflation and tax have provided paltry real returns each year.
Cash alone does not represent a realistic solution to the longevity risk many families face and under certain circumstances it could exacerbate the problem.
Equity Income Funds
Equity Income Funds are an alternate solution for risk averse investors seeking to grow the purchasing power of their investments and who require income. These funds invest in shares of blue chip companies and so provide market exposure, yet unlike traditional equity funds, equity income funds also utilise conservative exchange traded option strategies to enhance income generation and manage risk.
Given an ongoing expectation of market volatility against this need for conservative growth, risk management and income, an equity income fund’s slightly differentiated proposition from traditional equity funds contains obvious appeal and looks to have a solid role to play in portfolios over the years to come.
Angus Crennan is an investment specialist at Zurich Investments.
