THE AUSTRALIAN, TUESDAY, MAY 13, 2014 27V1 - AUSE01Z01MA

ARE the lowest mortgage rates in half a century stoking greater risk-taking in Australia’s housing market? Over the past two decades, the value of residential mortgage loans has expanded at an average compound rate of 8.5 per cent. Owner-occupiers account for two thirds of loan demand, a level that has remained relatively consistent since the late 1990s.

Amid a falling interest rateregime facilitated by the RBA since 2011, homeowners appear to have erred on the side of conservatism. The average “mortgage repayment buffer” has risen by 20 per cent to 21 months and the proportion of fixed-rate loans outstanding has almost tripled to 16.8 per cent. Unlike in the US, where mortgage interest on the primary residence is eligible for tax deductions, the Australian regulatory landscape appears to have motivated homeowners to get ahead on their bank loans.

Strength and stability of thelocal housing market is a critical driver behind the coming listing of Genworth Mortgage Insurance Australia. It began operations in 1965 when a government initiative made lender’s mortgage insurance more affordable for borrowers with limited deposits. The operation was privatised in 1997 via a sale to US conglomerate GE. A divestment process saw the operation become part of Genworth Financial in 2004, which is now in turn conducting its spin-off.

GMA has a market share of45 per cent. Steady portfolio expansion and favourable pricing is forecast to deliver its third consecutive year of underlying profit growth during 2014. Recent financial performance has benefited from two years of declining delinquency rates and mortgage rates at 50-year lows. There is a risk that present earnings represent a cyclical peak and, with 84 per cent of investment portfolio in fixed-rate securities, rising interest rates could affect performance.

But with property price appreciation delivering the company an effective loan-to-valuation ratio on its portfolio below 60 per cent, market risks appear insulated to a degree.

Tim Morris is an analyst at wise-owl.com.

Genworth building a case for growth

FLOATWATCH

GENWORTH MORTGAGE INSURANCE AUSTRALIA ASX CODE: GMASHARES ON OFFER: 195 million-260 millionLISTING PRICE: $2.20-$2.90MARKETCAPITALISATION: $1430m-$1885mLISTING DATE: May 22

TIM MORRIS

DESPITE the sub-par pace of recovery in the US economy since it was tipped into the “great recession” by the global financial crisis, the accumulation index for US shares has gained 210 per cent in a little over five years.

The US equity market is “thestand-out feature of the global sharemarket rebound since the trough of March 2009”, as Matt Sherwood of Perpetual Investments commented recently.

Sharemarkets in other industrialised countries (including Australia, where the accumulation index is up by 118 per cent) have taken their direction from US shares, even though their individual economic cycles have differed in timing and amplitude — and despite their profits growth being well below that of the US.

Today’s chart shows just howstrongly corporate earnings per share have rebounded in the US compared with Australia and compared with the world excluding the US and Australia.

US profits are now much higher than their pre-crisis peak.

It’s no surprise that the USsharemarket has outperformed. This powerful increase in US profits is not the result of strong growth in company revenues.

Instead, US businesses havecut costs aggressively; and the surge in productivity in the US economy has mostly benefited profits rather than wages.

The five-year bull market inshares also reflects a significant widening in market valuations.

In the US, that’s thanks to low interest rates, the massive expansion of liquidity from ultra-accommodative monetary policy by the Federal Reserve and the return of investor confidence.

Also, US companies, on average, have increased their share buybacks and they’ve stepped up dividend payouts, with some leading technology stocks paying dividends for the first time.

Combining buybacks and dividends, the average cash return to investors in US shares has been running at about 5 per cent of market capitalisation.

Even then, US companies remain cashed up.

I must say I’m surprised thatsharemarkets in other industrialised countries play follow the US leader as closely as they do.

Of course, the US

sharemarket is the largest and most actively tradedof all markets; many investors around the world keep up to date on what’s happening in the US; and news and views on businesses and economic policies quickly affect sentiment in other markets.

Our sharemarket is likely tocontinue taking its direction from US shares.

The identifiable worries forUS shares are not dominated by fears of a sudden decline in corporate earnings.

That should be precluded bythe improvement in the overall economy and, thanks to shale oil and shale gas, by cheaper energy.

And US companies, in aggregate, remain well-placed to raise dividends further and to remain active in buying back shares.

The US sharemarket wouldseem to be more vulnerable on the valuation side.

Specifically, price-earningsmultiples — which are seen by many investors as having stretched to neutrally priced or mildly overpriced levels — could deflate were yields on long-dated bonds (recently, a skinny 2.6 per cent) to move sharply higher.

Currently, the dominant expectation among US investors is that the Fed will delay increasing the cash rate until late next year because it wants to encourage growth in jobs and to end the ultra-accommodative monetary policy first by phasing out its purchases of bonds; and because the Fed doesn’t see inflation as an early problem.

However, market sentimenton when the US cash rate will be increased — from the near-zero level set in late 2008 — could change markedly, and at short notice.

The US sharemarket and ours, which largely follows in its footsteps, have a lot of good news factored in, and expectations for interest rates are sanguine.

There are risks of sharemarket bumps, even though the general outlook for shares is positive.

Don Stammer is an adviser to the Third Link Growth Fund, Altius Asset Management, Philo Capital and Centric Wealth. The views expressed are his alone.

don.stammer@gmail.com

Beware speed bumps on road to recovery

DON STAMMER

US earnings per share have risen strongly

Australia

US

Source: UBS, Perpetual

1500

1300

1100

900

700

500

Indexes, 2006 = 1000

2006 2007 2008 2009 2010 2011 2012 2013 2014

World (excludingUS and Australia)

Contemplating China’s new investment class

THE Chinese economy remainsseriously misunderstood, saysHong Kong-based, US-educatedfund manager Ronnie Wu, with asharemarket where major stocksare on price-to-earnings ratios ofless than 10 times.

“We believe Greater Chinaoffers a very good risk-rewardratio at this particular moment,’’Mr Wu says, pointing to a chartthat shows the top 300 stocks inChina are on a forward P/E of10.5 times on a price-to-bookratio of 1.5.

Stocks he likes are mostlypartly privatised state-ownedenterprises such as banks and oilcompanies, he says, listed eitheras “A” shares in Shanghai or “H’’shares in Hong Kong. They arenot interchangeable.

“Within the Chinese market,we think A shares are very inter-esting as there’s a lot of reformgoing on and a lot of state-ownedenterprises have been reorgan-ised. Even the oil companies aretrading at high single-digit multi-ples and paying out 4-5 per centdividends.

“When people realise that,though many of these SOEsdon’t currently add a value, theyare still very crucial and they holdon to many of the key resourcesin China.’’

Not that he expects Austra-lian investors to go whaling into amarket as complex as China’s,particularly when there are thetwin scares of country risk andcredit risk that pop up with ghosttrain regularity in front of poten-tial investors.

“That’s why when they arebeaten down it’s the best time tolook at them,’’ he says, ever theglass-half-full observer.

The Gottex organisation thathe works for has “just under$US10 billion’’ under manage-ment, of which Penjing AssetManagement, the Asian equityoperation he runs, is worth about$US800 million ($854.52m).

And of that $US800m, hesays, 30 per cent is invested in

Greater China, including HongKong. He’s looking for retail in-vestors in Australia, given thathis  fund has a 50-50 split be-tween institutions and retail in-vestors and local institutionshere are “very fee-sensitive’’.

Why’s he so positive on aneconomy that’s so opaque to somany external observers? “Therestructuring the government istrying to put in place is very posi-tive longer term,’’ he says, addingthat, for instance, the crackdownon corruption has seen somebehaviours change for the better.

“This government is almost soaggressive that it’s rocking theroots a little bit, shaking theboulder,’’ he says, which is whyobservers have been negative.

“Many of the people whowere in control and who werebeneficiaries of the system havebeen challenged, and a negativehas been the capital outflow from

China through places like Macauand Hong Kong to, for instance,the US, because the governmentis trying to clean things up. Ithink this is transitional, but it’sneeded if China is to continue togrow.”

He said while corrupt practic-es appeared to be in retreat, thestandard of education of thosegoverning China had risen sig-nificantly, “although educationhas always been at the core of anyChinese community’’.

“Those who made it to the topin China now, they know whatthey are doing. They must do,especially if you look at thegrowth of the last 25 years.

“Never in human history hasthere been such a vast lift inthe  living standards of such alarge population over such ashort period as there has been inChina, so they must be doingsomething right.

“We in Hong Kong have beenbrought up in the British system— and have traditionally chal-lenged China all the time, but Ithink you cannot argue with theresult. People are living a betterlife. And if you look at Chinesehistory, when people get a betterlife, they get fed, they are notthe aggressive people that wantto invade the world.”

He said the major SOEs inChina were where “almost cer-tainly” the next phase of growthin the Chinese economy waslikely to come.

“We need private consump-tion to pick up, to build up todrive the next phase of growth.’’

So what does he make of thecommon view excessive lendinghas left the financial system over-stretched and likely to burst?

“I think it’s a complicatedquestion, but if you think thatChinese property is overvalued

then there is a much higherchance of the bubble, if it is one,bursting. But my personal view isthat Chinese property is notovervalued because if you look atthe loan-to-valuation ratios (onproperty transactions), there’snot a lot of leverage.’’

He said that, unlike in West-ern countries where LVRs couldrun above 90 per cent, in Chinathey seldom exceeded 50 percent. So where’s the problem?

He said a lot of the complexi-ties of investing in China wereconsequences due to what was acaptive market, with only threeasset classes of interest: stocks,property and bonds.

“I personally think that thehigher valuation in property issimply a result of a lack of alter-native investment opportunit-ies,’’ he notes, adding the Chinesehave always been comfortableowning bricks and mortar.

JAMES CROUCHER

Ronnie Wu says those who made it to the top in China now ‘know what they are doing’

SOEs are ‘almost certainly’ the next phase of growth

ANDREW MAIN

Short trip OK, but don’t stay away: SMSF non-resident tax

MUCH has been written abouthow a self-managed superannu-ation fund can maintain its resi-dency status when its membersgo overseas, but many SMSFtrustees and professionals areaware of what could be somevery scary tax implications.

For a self-managed superan-nuation fund to maintain itscomplying status and receiveconcessional tax treatment, it

must be a resident-regulatedsuperannuation fund at all timesthroughout the financial year.

Three tests need to be met:• The SMSF must be establishedin Australia or have any of its as-sets situated in Australia. Thistest is easy to meet if the initialcontribution made to the SMSFis received in the SMSF’s bankaccount in Australia. This test isalso met if at least one of the as-sets of the SMSF is situated inAustralia.• The central management andcontrol of the SMSF must ordi-narily be in Australia. This testwill be satisfied if the person whomakes the high-level decisionsfor the SMSF is in Australia. Ifthis person is overseas, as long asthe period of absence is tempor-ary, it will satisfy this test. If this

person goes overseas for an in-definite period, then the SMSFwill fail the test.• The SMSF must not have anyactive members, or have at least50 per cent of the benefits in theSMSF belonging to active resi-dent members.

An active member is a mem-ber who contributes to theirSMSF or who has another person(for example, employer) makingcontributions for them on theirbehalf. So if SMSF members gooverseas, it is best they do notmake any contributions.

Once an SMSF fails the resi-dency test it becomes a non-complying superannuation fund.If an SMSF changes its statusfrom a complying SMSF to anon-complying SMSF, it goesthrough a messy high tax pro-

cess. There’s a flat rate of 45 percent on all of its assets accumu-lated through the years of itsexistence, minus any member’scontributions received by theSMSF where no deduction hasbeen claimed; plus earnings oninvestments received in the fin-ancial year that the SMSF be-comes a non-complying SMSF.

And each year that the SMSFremains a non-resident (non-complying) SMSF the incomewill be taxed at flat 45 per cent.

Another thing that people arenot aware of is what happenswhen the SMSF members returnto Australia and their SMSFchanges it status from nonresi-dent back to resident.

When an SMSF’s statuschanges from non-resident toresident, the above formula takes

effect again and all the SMSF’sassets minus any members’ con-tributions received in the non-resident SMSF are included inthe assessable income of theSMSF in the year it became a res-ident SMSF and taxed at 45 percent (if the SMSF returns to Aus-tralia during the financial year)or 15 per cent (if the SMSF re-turns to Australia for the full fi-nancial year). Then each year theSMSF is a resident (complying)SMSF it will receive the conces-sional tax treatment (15 per cent).

Monica Rule is the author of The Self Managed Super Handbook — Superannuation Law for Self Managed Superannuation Fund in Plain English.

www.monicarule.com.au

MONICA RULE

www.theaustralian.com.au WEALTH 27

US companies have, on average,increased their share buybacks and they’ve stepped up dividend payouts

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