The Experts

James Dunn
Expert
+ About James Dunn

About James Dunn

James Dunn is a freelance finance journalist and media consultant. James was founding editor of Shares magazine, and formerly, the personal investment editor at The Australian.

His first book, Share Investing for Dummies, was published by John Wiley & Co. in September 2002: a second edition was published in March 2007, and a third edition was published in April 2011. There have also been two editions of the mini-version, Getting Started in Shares for Dummies.

James is also a regular finance commentator on Australian radio and television: he gives a daily finance report on Radio 3AW in Melbourne and is a weekly commentator on Sky Business.

3 gambling stocks to bet on

Friday, November 02, 2018

The only certainty this Spring Carnival is that the tote will win. Last year, according to Racing Victoria, betting turnover reached a record $2.35 billion over the entire Spring Carnival, up 5.4%. Melbourne Cup Day saw an Australian record for turnover on an individual meeting with $334.5 million bet domestically; domestic turnover on the Melbourne Cup itself topped $200 million for only the third time with $204.5 million invested.

The annual Spring Carnival betting surge is testament to Australians’ love of the punt, but these days, there is growing concern over the social impact of gambling. It is just one of the industries in which the concept of “social licence to operate” is being closely scrutinised, in everything from lotteries to wagering, to casinos.

Gambling companies address this in two ways. The first is to emphasise the tax and industry support, and philanthropic fundraising that gambling companies throw off; and increasingly, the support for research into and redress of gambling addiction. 

The second is to stress the role of “entertainment” in their business model. That is much more palatable than focusing on the fact that for a small minority of people, gambling can be an addiction that ruins lives and families. More than ever before, investors now assess the gambling stocks with at least the knowledge that there are serious ethical concerns over deriving return from other people losing money.

However, the fact that these are perfectly legal businesses and that gambling is a person’s choice – combined with the fact that the gambling businesses do not lose in the long run, makes the investment a certainty, other corporate action notwithstanding. 

Here’s a rundown of the form guide for the gambling stocks:

1. Tabcorp Holdings (TAH, $4.51)

Market capitalisation: $9.1 billion

Forecast yield FY19: 4.9%, fully franked

Analysts’ consensus target price: $5.20

One-year total return: 8.2%

Three-year total return: 2.1% a year

Five-year total return: 11.7% a year

The December 2017 merger between Australian gambling giants Tabcorp Holdings and Tatts Group created a company with three main business divisions – Lotteries & Keno, Wagering & Media, and Gaming Services. Almost half (48%) of the merged company’s revenue comes from Wagering and Media (Sky Racing), 46% comes from Lotteries/Keno, and 6% from gaming services. 

The merger saw Tabcorp’s revenue for FY18 climb 72% to $3.8 billion, earnings before interest, tax, depreciation and amortisation (EBITDA) rise by 46% to $736.4 million, and net profit lifted by 38% to $246.2 million. 

Tabcorp is a guaranteed winner on every wager: in fact, it keeps about 17 cents of every dollar wagered. About one-third of this is paid to the relevant state government, about one-third to the racing industry, and the company keeps the rest. After covering costs and taxes, more than 2 cents of every dollar bet is clear profit to Tabcorp.

Despite clipping the ticket on every bet, Tabcorp is not always a profitable operation: like every company, it has company-specific issues from time to time. For example, from a $170 million profit in FY16, Tabcorp slumped to a $20.8 million bottom-line loss in FY17, hammered by a series of hefty bills from legal actions – including $62 million from an Australian Transaction Reports and Analysis Centre (AUSTRAC) prosecution for breaches of the anti-money-laundering and terrorism funding act – as well as write-downs from a UK joint venture it exited and costs associated with the Tatts takeover.

The company continues to bed down the Tatts business, and work to extract the synergies, which means that investors looking at the stock now have a clearer picture – and a more attractive buying proposition – than has been visible for a couple of years. They can now benefit from the strong yield – the 4.9% fully franked yield projected for FY19 equates to a grossed-up yield of 6.9%, and on Thomson Reuters’ collation of analysts’ expectations, FY20 is expected to deliver 5.4% nominal yield (grossed-up, 7.7%). On top of that, analysts see healthy scope for the share price to rise, indicating a buoyant outlook for total return. 

2. The Star Entertainment Group (SGR, $4.59)

Market capitalisation: $4.2 billion

Forecast yield FY19: 4.8%, fully franked

Analysts’ consensus target price: $6.13

One-year total return: –13.1%

Three-year total return: –0.09% a year

Five-year total return: 14.9% a year

Star Entertainment is the arch-rival of Crown Resorts: it operates the original Sydney casino, The Star – also on Darling Harbour – as well as the Jupiters hotels and casinos on Queensland’s Gold Coast, and The Treasury hotel and casino in Brisbane. It also manages the Gold Coast convention and exhibition centre. Star Entertainment Group will open its $500 million Ritz-Carlton hotel in Sydney in 2022.

Star Entertainment also heavily emphasises the tourism and entertainment part of its business – and it is true that, as with Crown, plenty of people will stay at, and eat at, its resorts without gambling – but the fact is that gambling is the main source of revenue. 

In FY18, revenue was up 5.5% to $2.47 billion, while normalised net profit (based on the average win rate) surged 20%, to $258.1 million. The result was actually a bit soft in the Queensland operations, where gross revenue rose 10.5% to $820 million, but EBITDA slipped back by 8.4%, to $178 million. The highlight of the result was a 56.7% increase in VIP turnover at The Star in Sydney: casinos need to have their biggest players at the tables, and playing – hence the rebates and travel assistance they offer their VIPs. 

Investors can profit from these VIPs – and all other players – playing, and losing. On a total-return basis, with a healthy yield and analysts tipping a price rise, buying Star Entertainment shares at the current price looks a lot more certain an investment proposition than playing at its tables and machines. 

3. Jumbo Interactive (JIN, $7.64)

Market capitalisation: $456 million

Forecast yield FY19: 3%, fully franked

Analysts’ consensus target price: $6.31

One-year total return: 151.9%

Three-year total return: 96.6% a year

Five-year total return: 27.7% a year

Online lottery seller Jumbo Interactive has emerged in recent years as a major player in Australian lotteries, operating the website www.ozlotteries.com, where retail customers can buy lottery tickets in the major draws operated by Tabcorp, including Oz Lotto and Powerball. Tabcorp has what it calls a “strategically important holding” in Jumbo Interactive, currently a 12.49% in the company.

Jumbo Interactive reported a healthy result for FY18, with revenue up 23%, to $39.8 million, total transaction volume (TTV) rising by 26%, to $183.1 million, and net profit (from continuing operations) up 55%, to $11.8 million. The fully franked dividend more than doubled, from 8.5 cents a share to 18.5 cents, and shareholders also received two special dividends in FY18 – a fully franked payment of 15 cents in August 2017 and 8 cents a share in July (for shareholders on the register at June 15, 2018).  

The deal with Tabcorp is interestingly symbiotic, because Jumbo Interactive’s site competes with Tabcorp’s own retail site, thelott.com, but acts as a channel to sell more tickets. Tabcorp is the sole supplier of lotteries to Jumbo, with the supply agreement having just under four years to run. That supply agreement is the biggest risk for Jumbo Interactive: if Tabcorp were to not renew the deal – or renew it on less favourable terms to Jumbo Interactive – the latter’s profitability could be significantly impacted. The profit opportunity for Jumbo Interactive is to increase the online sales of lottery tickets: it says that currently, only 18% of Australian lotto tickets are sold on the internet, compared to the UK penetration, at 22%, and Finland, where it is at 48%. Jumbo believes it can grow Australian internet penetration to 22% by 2020. 

Jumbo Interactive has recently opened up another line of business, positioning itself as the online distribution partner to some of Australia’s largest charity lotteries. About $1 billion of charity lottery tickets are sold in Australia each year, but because the charities use basic marketing techniques to sell tickets, they don’t achieve the sales and margins they could: Jumbo Interactive offers the ability to do this. Jumbo’s sales of charity lotteries grew by 60% in FY18, to $6.1 million: it has a lot of potential to grow its business in this market. 

Boosting the sales of Tabcorp lottery tickets online and through mobile – which now accounts for 75% of Jumbo’s customer interactions – is the main game for Jumbo. At this stage, it’s a relationship that benefits both parties. The only problem for potential investors is that Jumbo has run very strongly: its shares sold for $1 at the start of 2016, but almost reached $8 earlier this month. Analysts think it is priced far too fully at present.

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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

 

2 more stocks to ride the infrastructure boom

Friday, October 26, 2018

Australia has swung into an infrastructure boom, with spending accelerating on roads, railways, runways, tunnels, dams and electricity generation and distribution facilities. 

Yesterday, we revealed 3 infrastructure stocks to consider. Here are two more. If you like this article, click here to take a free 21-day to our Switzer Report.

Decmil Group (DCG)

Market capitalisation: $162 million

Consensus estimated FY19 yield: no dividend expected

Analysts’ consensus target price: $1.21 (Thomson Reuters), $1.12 (FN Arena)

Engineering and construction company Decmil has struggled in recent years, with a very disappointing result in FY17, but that could be to the benefit of investors looking at the company now. DCG is well-placed to tap into the increased infrastructure spending in Victoria and the expected boost to mining construction expenditure.

In FY18, Decmil’s Victorian business unit won more than $100 million worth of new transport infrastructure construction work. The company has also expanded its business in New Zealand, where last year it won more than NZ$185 million in work in the corrections end education sectors of government spending.

Decmil is also well-positioned to pick up resources work in its speciality of non-process infrastructure (NPI) construction projects. At the FY18 result, the company said it expected FY19 revenue to exceed $500 million, based on order book and tender pipeline. That is against the $342 million in revenue for FY18. Since the result, Decmil has won a $150 million coal-seam-gas work contract in Queensland and an $86 million road contract in Victoria.

Decmil is not expected to pay a dividend this year, but dividends are expected to resume in FY20 and analysts see a healthy outlook for medium-term capital growth in the stock.

Acrow Formwork and Construction Services Limited (ACF)

Market capitalisation: $88 million

Consensus estimated FY19 yield: 4.1%, unfranked

Analysts’ consensus target price: 50 cents (Thomson Reuters), 52 cents (FN Arena)

Spun off by Boral to private equity owners in 2010, and returned to the stock market through a backdoor listing in April this year, Acrow provides hire equipment to the Australian civil infrastructure and construction sectors. Once mainly a scaffolding provider, the company has moved more into providing formwork (the moulds into which concrete or plastic materials are poured) and falsework (the temporary framework structures used to support a building during construction), which are much higher-margin products. And given that its products are mainly used in building motorways, bridges and tunnels, ACF is nicely positioned to benefit from the increased infrastructure spending on the eastern seaboard.

Coming to the stock market in April at 20 cents, Acrow has been a big success, moving to 54 cents. The company announced record revenue of $65.3 million for FY18, and a net profit of $10.5 million. In August, the company announced the acquisition of Natform, which it describes as the country’s leading designer and hirer of screen-based formwork systems for commercial and residential high-rise buildings and civil infrastructure.

Acrow says its outlook for FY19 is strong, with a growing order book and new business wins in the east coast infrastructure market. At a FY18 balance date the company had nil debt, with a net cash position of $4.9 million. Although only a micro-cap company at present, Acrow knows its niche business very well, and has a high return on equity – above 20%. It is an unfranked dividend payer, with a relatively low (about 30%) payout ratio, being more concerned at present with reinvestment for growth. Analysts believe that the strong share price performance since listing has taken it past fair value, but Acrow could surprise on the upside over the medium term as the company becomes better known.

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3 stocks to ride the infrastructure boom

Friday, October 26, 2018

Australia has swung into an infrastructure boom, with spending accelerating on big-ticket public infrastructure – roads, railways, runways, tunnels, dams and electricity generation and distribution facilities. The infrastructure boom is taking over from mining construction, and as broker CommSec points out, the centre of construction activity is no longer Western Australia, Northern Territory and northern Queensland, but rather the growing population centres of south-east Australia.

Australia is spending more on infrastructure now than at any time in the past 30 years – almost $100 billion in the last financial year alone, according to the Reserve Bank of Australia (RBA). And the next few years are likely to be even bigger. Nationwide, the Australian Infrastructure Budget Monitor shows that almost $130 billion dollars is being invested in infrastructure on the eastern seaboard alone.

In Victoria, more than $100 billion worth of new roads, rail lines, hospitals, skyscrapers, prisons, wind farms and other infrastructure is being built or planned, Queensland has about $20 billion worth of work being done in Brisbane alone, and Western Australia has a $60 billion pipeline of infrastructure projects, according to CBRE, with $13 billion earmarked for projects in the Perth metropolitan area.

It’s a good time to be involved in supplying the infrastructure boom. Here are 3 players...

1. Boral (BLD)

Market capitalisation: $8 billion

Consensus estimated FY19 yield: 4.1%, 50% franked

Analysts’ consensus target price: $7.90 (Thomson Reuters), $7.55 (FN Arena)

Building products heavyweight Boral has been riding high recently on the back of the FY18 result released last month, which saw a 47% lift in net profit after tax (before amortization and significant items) and a very rosy outlook for the company’s Australian business, with the company predicting an “extraordinary next decade” in infrastructure, with what chief executive Mike Kane describe as an “amazing” amount of work on roads, highways, bridges, tunnels and airports. The stock market appears to believe that work in commercial, infrastructure and major projects activity should well and truly offset any impact from the residential property slowdown.

The major concern for analysts remains the company’s 2017 acquisition of US building supplies group Headwaters, which specialises in fly ash, a by-product of coal power stations that is used in concrete and other road making and building materials. Some analysts see Headwaters as a worryingly big bet at a crucial time in the US housing cycle, but Boral went a long way toward assuaging those doubts in the FY18 result by achieving US$39 million worth of synergies in year one, bettering its target of US$35 million.

Boral will be a major beneficiary of the Australian infrastructure boom, which could well be swelled by election promises: there is a New South Wales state election in March, and Federal elections must happen before November 2019. Analysts see plenty of scope for Boral’s share price to rise. 

2. Adelaide Brighton (ABC)

Market capitalisation: $4 billion

Consensus estimated FY19 yield: 4.7%, fully franked

Analysts’ consensus target price: $6.02 (Thomson Reuters), $6.04 (FN Arena)

Australia’s biggest cement maker, Adelaide Brighton, is also very well-placed to ride the tailwind of booming infrastructure spending by governments on projects including roads, tunnels, bridges and freeways. Adelaide Brighton has been able to lift its prices in recent years – as indeed has Boral – and thus boost its margins, and it should be able to continue that trend as infrastructure spending surges.

Adelaide Brighton has said that the infrastructure boom on the eastern states is taking over from a slowing housing sector as the prime driver of the company’s profits, and that momentum is building in its business. The residential housing sector makes up 31% of Adelaide Brighton’s revenues, while engineering and infrastructure makes up 34%: commercial building represents 24%, while the mining industry is at 11%.

However, the company’s recent half-year result (ABC uses the calendar year as its financial year) was treated by the market as a touch disappointing: first-half profit met expectations, but despite the company’s bullishness on market conditions, the guidance for full-year net profit was weaker than expected, at $200 million–$210 million – a contradiction that saw brokers lowering profit estimates and price targets, thus hurting the share price. The market was also concerned by the fact that both the chief executive officer and chief financial officer are leaving the company. Adelaide Brighton is a decent yield-payer, but is not seen as being as attractive on price grounds as Boral.

3.  Global Construction Services (GCS)

Market capitalisation: $144 million

Consensus estimated FY19 yield: 7.4%, fully franked

Analysts’ consensus target price 88 cents (Thomson Reuters)

 The Western Australian-based Global Construction Services is about to change its name to SRG Global, having merged with fellow Perth company SRG to create an engineering, construction and maintenance business. GCS is a supplier of integrated on-site products and services to the engineering, construction and maintenance industries. It is involved through the entire lifecycle of a project and provides the onsite workforce and site accommodation, scaffolding and access, plant and equipment, formwork and concrete, and specialised site services.

GCS has successfully expanded into the east coast market, particularly Victoria, where it has several major customers, including Multiplex, BGC Contracting and Lendlease. Last month the company secured $24.6 million worth of concrete structure works with Watpac Construction on two major building projects in Victoria – the construction of Deakin University’s new Law Building and the four-storey Melbourne Data Centre. GCS has timed this transition particularly well. Since entering Australia’s east coast construction market in mid-2017, the company has won more than $63 million worth of work and has more than $600 million worth of work in the contract tender pipeline. CGS has a particularly strong business in cladding rectification work, which has recently received a lot of attention

GCS is coming off a buoyant FY18, in which it lifted revenue by 33% to $247.5 million, boosted net profit by 25% to $13.6 million, and more than doubled its fully franked dividend, to 4.5 cents. The order book is healthy and the balance sheet is also strong, with a net cash position. On consensus, Thomson Reuters has analysts expecting 6.9 cents in earnings per share (EPS) in the current financial year, and a fully franked dividend of 4.8 cents. That prices GCS at 9.4 times expected earnings, which analysts see as cheap – hence the 26% discount to the consensus target price.

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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

8 company announcements to watch this week

Tuesday, August 28, 2018

Today 28 August

1. Boral (BLD)

Building products company Boral is benefiting from the momentum in US house-building as well as Australian infrastructure. There are also benefits flowing from its 2016 purchase of US building products group Headwaters – although there have been recent concerns about the fly ash (a by-product of coal combustion in power stations, and used as a concrete additive) side of Headwaters’ business. At the half-year, excluding significant items, Boral lifted net profit by 44% to $213.9 million, and the company was confident that the global economic growth picture augured well for it, forecasting continued growth across all business units during the 2018 financial year.

In April, Boral disappointed the market by reporting that earnings were below expectations for the March quarter. However, analysts are confident of a strong full-year result. The collation of analysts’ estimates by FN Arena looks for earnings per share (EPS) of 40.7 cents for FY18, up almost 40% on the 29.2 cents earned in FY17, with a 50% franked dividend of 26.4 cents, compared to 24 cents in FY17. Thomson Reuters’ collation expects EPS of 39.2 cents, with a dividend of 25.8 cents. The analysts believe Boral, at $6.46, is well under-valued: FN Arena has a consensus target price on the stock of $7.50, while Thomson Reuters has it at $7.60.

2. Blackmores (BKL)

China is the big story for health products heavyweight Blackmores – the company finds itself having to boost its marketing spending in China against arch-rival Suisse, which benefits from the marketing infrastructure of its Hong Kong parent, Biostime. In the March-quarter report, there were issues of supply chain disruption and customer renegotiations in China, and analysts were concerned about the effect of marketing spending, discounts and rebates on Blackmores’ margins. There will be a big focus on this in the full-year report.

Blackmores’ most recent update, for the March 2018 quarter, showed a profit jump of 19% for the first nine months of FY18, to $52 million. On the back of that, FN Arena’s collation comes up with an analysts’ consensus estimate of FY18 EPS at 410.7 cents, up almost 20% on the 342.6 cents in FY17, with a fully franked dividend of 318.3 cents, versus 270 cents in FY17. Thomson Reuters is looking for EPS of 409 cents and a dividend of 318 cents.

At $150.15, analysts see BKL as over-valued: FN Arena has an analysts’ consensus price target of $130.00, while Thomson Reuters has this figure at $138.65.

Wednesday 29 August

3. Bellamy’s Australia (BAL)

The market will be keenly interested in Bellamy’s forward guidance and an update on its application to the China Food & Drug Administration (CFDA) to sell its reformulated product in China. There is some nervousness that Bellamy’s may find this delayed, caught up in tensions between the governments of Australia and China. It’s possible that the Huawei ban recently announced by the Australian government could be a complication. The company has deferred a major upgrade of its Camperdown plant, pending the outcome of its CFDA licence application.

In January, infant formula maker Bellamy’s Australia lifted its full-year profit guidance on the back of better-than-expected sales in China during the first half. Bellamy's lifted its revenue growth target from between 15%–20%, to between 30%–35%. The company said its earnings (EBITDA) margin would lift from between 17%–20% to a higher range of 20%–23%. In February, it reaffirmed that guidance.

From that, analysts have extrapolated to a consensus estimate, on FN Arena’s collation, that has Bellamy’s earning 37.9 cents a share in FY18, versus a loss of 0.8 cents in FY17, and paying a dividend of 1.5 cents, versus no dividend in FY17; while Thomson Reuters is looking for EPS of 39 cents for FY18, and a dividend of 1.5 cents.

Analysts see Bellamy’s as offering plenty of value at present. The current share price is $9.86, but FN Arena shows an analysts’ consensus price target of $16.35, and Thomson Reuters’ price target collation is even more optimistic, showing a consensus target of $17.90.

4. Independence Group (IGO)

Nickel and copper miner Independence Group reported last month that it had achieved a record quarter in June in terms of revenue and underlying EBITDA, which were up 33% and 78% respectively, but the market was more interested in the fact that both copper and nickel production missed FY18 guidance and cash costs came in above expected levels.

Reduced grades from the reserve at the flagship Nova was also a worry, with production expectations for nickel and copper coming down for FY19 and FY20, and thus earnings expectations. But analysts predict a big profit jump for the miner in FY18. The market will also expect news on a site for Independence’s plans for a large-scale processing plant to produce nickel sulphate for battery manufacturers. Recent trials of a process to convert nickel concentrate to nickel sulphate were so successful, Independence has applied for a patent.

But analysts predict a big profit jump for the miner in FY18, with the analysts’ consensus estimate for EPS rising on FN Arena to 7.2 cents, well over double the 2.9 cents earned in FY17, and a fully franked dividend of 3.8 cents, nearly twice the 2-cent payout in FY17. Thomson Reuters reckons analysts’ consensus for EPS at 8.9 cents, with a dividend of 3.5 cents.

Analysts see Independence showing a lot of value. The share price is $4.16, but FN Arena has an analysts’ consensus price target at $4.76, while Thomson Reuters sees the consensus target at $4.85.

Thursday 30 August

 5. Perpetual (PPT)

Like many of its financial services peers, Perpetual is battling poor market sentiment – although it managed to avoid any Royal Commission baggage. In the June quarter, funds under management (FUM) suffered net outflows of $300 million, marking the fifth consecutive quarter of net outflows. Over FY18 the business lost $2.5 billion in FUM, to $30.8 billion. The major problem is that the company’s main Australian equity funds are under-performing, and it has lost institutional clients on the back of this. The company is in leadership limbo until its new chief executive officer (CEO), Rob Adams, starts work in September.

FN Arena says the analysts’ consensus earnings-per-share (EPS) estimate for FY18, at 299.3 cents, will be slightly less than the 300 cents earned in FY17, although it expects the fully franked dividend to be lifted from 265 cents in FY17 to 269.6 cents. Thomson Reuters puts FY18 analysts’ consensus for EPS at 302.2 cents, with a dividend of 270 cents.

At a current share price of $44.03, Perpetual is trading very close to FN Arena’s assessment of analysts’ consensus target price, of $44.12: Thomson Reuter says its consensus target figure is $45.50.

6. Ramsay Health Care (RHC)

Private hospital operator Ramsay has been doing it tough lately. The nation's largest private hospitals operator has been forced to look offshore for growth, as it has been prevented by the corporate regulator from buying more Australian hospitals. Some of the risks of this were seen in June, when Ramsay slashed its earnings guidance, on the back of onerous lease provisions and asset write-downs in its UK hospitals business, following a significant downturn in National Health Service (NHS) volumes. Ramsay’s French subsidiary is trying to buy Swedish hospitals group Capio to expand its operations in Europe further. The company is now tipping full-year core EPS growth of 7%, compared to prior guidance of 8%–10%.

In the full-year result, investors will focus on the company’s guidance for FY19 and whether trading conditions have improved. On FN Arena’s collation, analysts’ consensus estimate for Ramsay’s EPS is 269.9 cents, up from 261.4 cents, with a fully franked dividend lifted by 9%, to 146.1 cents. Thomson Reuters puts FY18 analysts’ consensus for EPS at 280 cents, with a dividend of 143.8 cents.

There appears to be a small value window: at $56.95, Ramsay Health Care is trading below what FN Arena sees as analysts’ consensus price target, of $59.56: Thomson Reuters sees the consensus price target more optimistically, at $62.28.

7. Sandfire Resources (SFR)

Copper miner Sandfire Resources expects to bring its new high-grade Monty copper-gold project into production by March next year: the small-scale underground mine will operate as a satellite project for the company’s flagship DeGrussa project, just 10 kilometres away. The company has struck a $72 million deal with its joint venture partner in Monty, Talisman Resources, to take out its 30% stake and assume full control of the asset.

Sandfire has already told the market that FY18 copper production met its guidance, coming in at 64,918 tonnes – down 3.2% – with gold production of 39,273 ounces, up 1.7%. Cash cost of production was 93 US cents a pound of copper, although the June quarter ran at 80 US cents.

FY19 guidance is for 63,000–67,000 tonnes of copper and 37,000–40,000 ounces of gold at a cost of US$1.00–US1.05 a pound of copper: that’s a higher production cost than brokers were expecting. But Sandfire ended FY18 with a cash stash of $243 million, well above forecasts, and giving a solid platform for exploration and acquisition spending. (Macquarie analysts expect Sandfire’s cash on hand to hit $1 billion within two-and-a-half years.)

FN Arena’s analysts’ consensus estimate for Sandfire’s EPS is 83.8 cents, up from 49.2 cents in FY17, with a fully franked dividend of 28.5 cents, up 58% on the 18 cents paid last year. Thomson Reuters puts FY18 analysts’ consensus for EPS at 83 cents, also with a dividend of 28.5 cents.

At $7.17, SFR is trading well below FN Arena’s consensus price target of $7.92: Thomson Reuters has $7.80.

Friday 31 August

8. Harvey Norman Holdings (HVN)

Harvey Norman was always going to be up against it to repeat FY17’s record net profit of $448.9 million after riding the tailwinds of the housing and property booms.

In the first-half, Harvey Norman’s profit slipped by 14%, as the company reported losses on its non-core dairy investment, weaker earnings from franchisees and increased investments in e-commerce and IT systems, so it could be “fighting fit” against Amazon and JB Hi-Fi. The result went down poorly on the market, with the shares falling by 15%.

Given a cooling housing market and the increased competition it faces, Harvey Norman is now one of the top-10 most short-sold stocks on the Australian Securities Exchange (ASX). And for this week’s result, analysts see a fall. FN Arena has consensus EPS expectation at 32.7 cents, down from 40.4 cents in FY17, and with a fully franked dividend of 23.3 cents, short of last year’s 26 cents. Thomson Reuters sees EPS coming in at 33.1 cents, with a dividend of 24 cents.

At $3.69, Harvey Norman shares are down 30% from their 2018 peak, and analysts don’t see that changing soon. Thomson Reuters gives an analysts’ consensus price target of $3.65, while FN Arena’s consensus target is slightly higher, at $3.807.

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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

A global high-growth fund worth examining

Friday, August 17, 2018

Diversification and home bias have been hot topics for Australian investors in recent years. Tony Featherstone’s article today explains the importance of investors investing outside of our very concentrated local market, and some global exchange traded funds to consider.

The good news is that Australian investors are realising the need to bring global exposure into their portfolios. According to SMSF administrator SuperConcepts’ latest Investment Patterns Survey for March 2018, SMSFs have lifted their allocation to international shares over the past year from 12.9% to 14.2%, mostly through using exchange-traded funds (ETFs) and managed funds. The allocation is a long way short of that to Australian shares, at 35.9%, and property, at 19.5%, but it is on the rise.

Product manufacturers have responded to the increasing demand by bringing to market ETFs and listed investment companies (LICs) that create discrete, highly targeted funds that offer investors very particular exposures, that efficiently fill gaps in overall investor portfolios (see Tony Featherstone’s article). That is very much the motivation of the new exchange-traded managed fund, WCM Quality Global Growth Fund, which will list on the ASX under the stock code WCMQ. The fund will be managed by US-based global investment management firm, WCM Investment Management. Switzer Asset Management Limited is the Responsible Entity (RE) for the fund.

The WCMQ proposition

The fund will provide investors with international exposure and participation in high-growth global industries, in the one vehicle. Investors in WCMQ will gain access to a high-conviction, actively-managed portfolio of typically 20–40 high-quality global growth companies, diversified across individual stocks and sectors, and countries (except Australia). The stocks may come from developed markets – including the US, the UK, Europe and Japan – or from “emerging” markets, such as China, India and Brazil: if a stock meets the rigorous growth criteria of WCM, its domicile will not matter. The sectors targeted will include information technology, consumer staples, consumer discretionary, healthcare, financials and industrials: the opportunity set is very broad, but the stocks have to qualify under the bottom-up stock analysis that WCM conducts, and the criteria it sets.

In practice, that means that the stocks chosen must have a market capitalisation of at least US$3.5 billion ($4.7 billion) – to put that in context, there are only 82 Australian-listed stocks larger than that. WCM says its listed universe covers more than 2,100 companies. Once the manager puts these stocks through a range of quantitative filters, which include whether it has high/rising returns on invested capital that exceed the cost of capital; low or no debt; high or rising margins; and historical growth, WCM expects to have about 450 companies to choose from.

The fund will aim to exceed the return of its benchmark, the MSCI (Morgan Stanley Capital International) All Country World Index ex-Australia (with gross dividends reinvested reported in Australian dollars, and unhedged), before tax and fees, over rolling three-year time periods, but with less volatility than the benchmark. The fund can have a cash weighting of as much as 7%, meaning that it will not ever be anything less than 93% invested in the global stock market.

The fund will be managed for 1.25% a year, with an administration fee of 0.1% a year, for total cost of 1.35% (inclusive of GST) a year. A performance fee of 10% of any outperformance above the benchmark is also payable. Normal ASX brokerage charges apply when buying or selling units.

The verdict

The fund should particularly suit investors who have an Australian-dominated portfolio and want to diversify it. Adding an allocation to high-quality global growth can help to diversify such a portfolio, at a stroke. The fund can also be seen as helping to solve, in an individual portfolio, the problem of Australia’s highly concentrated stock market – because WCMQ gives the portfolio exposure to companies in industries and sectors that are limited, or unavailable, in Australia.

Against that, the fund is not hedged, meaning that you are taking currency risk by investing in WCMQ – changes in the Australian dollar’s exchange rate can worsen any losses you make, or wipe out any gains. However, the opposite can also be true: currency movements can also increase your gains, and protect against investment losses in the portfolio. For many investors, the diversification benefits will outweigh this risk. In fact, some Australian investors actually want the exposure to overseas currencies: instead of seeing it as currency risk, they see it as another layer of diversification in their portfolios.

The WCM Quality Global Growth Fund offer will close next Wednesday 22 August. The application price is $5 a unit, with the minimum application amount of 2,000 units, meaning a minimum initial investment of $10,000.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

4 contrarian buys to consider

Tuesday, August 14, 2018

Being a “contrarian” investor, is difficult, but it can be a highly rewarding strategy. Contrarian investing is buying what everybody is selling, or selling what everybody is buying. A contrarian investor acts contrary to the popular view in the market.

In other words, a contrarian investor goes against the herd mentality.

Contrarian investing is not the same as value investing, which is identifying stocks that can be bought for less than they are actually worth. The value investor does this by working out what the investor believes the stock is worth: if this is higher than the stock price, the value investor will buy the stock and hold it for as long as it takes the market price to catch up to the investor’s opinion of the fair valuation.

A value stock might be a stock whose share price has simply not risen for a prolonged period; a stock that is a candidate for a contrarian investor has fallen – and often, fallen hard.

Value investors and contrarians may be interested in the same stock, but the value investor is more interested in the gap between the market price and their valuation – whereas the contrarian is more interested (when buying) in the extent and momentum of the fall.

In reality, the contrarian strategy is usually the province of the professional investor.

Contrarians, like value investors, can get trapped in stocks that are expected to recover – but never do. One obvious example is Myer, which has fallen from its issue price of $4.10 in November 2009 all the way to 45 cents. All along the way, people have been buying Myer because “it couldn’t go any lower, surely?” It turned that it could – and indeed, it still could.

Troubled franchisor Retail Food Group (RFG) – the owner of the Brumby’s Bakery, Donut King, and Michel’s Patisserie brands, among others – is a similar situation, sliding from $7-plus levels in 2016 to 44.5 cents at present, a 94% fall on the back of a litany of bad news. Alternative asset manager Blue Sky Alternative Investments (BLA) has plunged from  $14.54 to $1.74 – an 88% fall – as an activist investor forced the company into an overhaul of its asset, deal and cashflow valuations and forecasts, and its chief executive to quit. As these stocks were sold down savagely, any trading day gave investors the chance to buy, but also the chance to “catch the falling knife,” as the Wall Street adage puts it.

There is also the case of the “value trap,” where fundamental value measures, such as price/earnings (P/E) ratio and dividend yield look attractive, but the price keeps falling. Telstra has been a “yield trap” for investors over recent years: since August 2017, in buying the stock for its expected 5%-plus dividend yield – an expectation since exploded by the company’s dividend cuts – investors have bought themselves a 36% capital loss.

An event like the Hayne Royal Commission also excites both contrarian and value investors, as share prices of the banks and the major financial companies plunge, boosting projected dividend yields (assuming the expected dividends materialise).

Here are four potential contrarian situations on the stock market at present.

Telstra (TLS)

Market capitalisation: $32.5 billion
FY 19 estimated yield: 6.2%, fully franked
Analysts’ consensus price target: $3.18 (Thomson Reuters), $3.15 (FN Arena)

Telstra has had virtually uniformly negative commentary in the press and from brokers over the last couple of years, and the share price fall has mirrored this. One of the major issues has been the sale of Telstra’s copper network and hybrid fibre-coaxial cable network “crown jewels” to the NBN Co, in return for $11 billion in payments, and the heavy competition in the mobile business – in particular, the upcoming fourth mobile network from TPG Telecom, which is likely to increase the competition and price pressure on the major providers. The new “Telstra 2022” strategy, with includes major cost cuts and establishing a special business to hold the company’s infrastructure assets, effectively splitting the company into two businesses, has failed (so far) to provide a springboard for the share price to recover.

But the new ultra-fast 5G mobile network is on its way, and Telstra boss Andy Penn believes that will give the telco heavyweight a base from which to rebuild. The point here is that Telstra is in a much stronger competitive position than its major competitors, in particular Optus and Vodafone, which will bleed cash when this technology is deployed. Revenue, earnings and dividend targets for Telstra are very uncertain, but its competitive strength could easily turn into market share wins, and a share price recovery – which indeed was the case in 2011, when Telstra pioneered 4G. A new organisational structure announced today could also help.

An investor buying Telstra at these levels benefits from much of the risk having come out of the share price, and can reasonably expect a move higher. A warning, however, that the estimated FY19 dividend yield given above is based on a consensus analysts’ expectation of 17 cents a share being paid in the current financial year – this is by no means certain, and there are estimates in the marketplace as low as 14 cents (which would equate to a projected fully franked yield significantly lower, at 5.1%).

 AMP (AMP)

Market capitalisation: $9.5 billion
FY 19 estimated yield: 8.8%, 90% franked
Analysts’ consensus price target: $4.20 (Thomson Reuters), $4.195 (FN Arena)

After a 40% price hammering since March – courtesy of appalling revelations about the company emerging from the Royal Commission, board and executive turnover, two class action lawsuits, a huge protest vote on the executive remuneration, and a series of profit downgrades from the company – many investors would be convinced that there has to be value in AMP. There is always the risk of a value trap, but analysts mostly agree that the worst is over for AMP in terms of price declines, as its residual brand strength starts to emerge from the undeniable reputational damage. Net outflows are still a concern for the company, and it is far from out of the regulatory woods – its vertically integrated model may be disbanded – but at these price levels, analysts mostly think there is far more upside than downside.

Nufarm (NUF)

Market capitalisation: $2.4 billion
FY 19 estimated yield: 2.2%, unfranked
Analysts’ consensus price target: $9.80 (Thomson Reuters), $9.01 (FN Arena)

Agrichemicals heavyweight Nufarm has dropped almost one-quarter in price since May, including an 11% savaging last week after a weather-related profit warning that gave a particularly gloomy assessment of the effect of the drought on its crop protection market. The market reaction to the update took Nufarm shares to a two-year price low. The company warned that drought conditions would slash up to 16% from its underlying earnings in FY18, when management had originally told the market to expect growth of 5%–10%.

Drought aside, there is actually quite a bit to like about Nufarm, in particular its agri-technology side, where its patented Omega-3-oil-rich canola seeds are emerging as a new source of the oil, which hitherto has only come from fish, for both the human and animal feed markets. Nufarm sees the main market for its Omega-3 oil is as a fish feed, particularly in salmon and trout farms, but it also has great potential in the burgeoning “nutraceutical” (food products that deliver health benefits in addition to their basic nutritional value) market. The company’s expansion in North America and Europe also gives it some diversification away from Australian drought. Nufarm looks to be a compelling contrarian opportunity – the major caveat is that it is not much of a yield proposition.

Kogan.com (KGN)

Market capitalisation: $492 million
FY 19 estimated yield: 3.4%, fully franked (FN Arena)
Analysts’ consensus price target: $10.13 (Thomson Reuters), $9.55 (FN Arena)

Online retailer Kogan.com (KGN) has felt the anger that the share market dispenses to a market darling that disappoints, having being slashed in value by half since March, after first giving the market a planned sale of 6 million shares by company founder and CEO Ruslan Kogan and his business partner David Shafer, and then last week a disappointing update to profit guidance for FY 2019. Kogan.com actually flagged a 90% jump in full-year earnings to $23.7 million – the kind of rise for which many CEOs would give their beach houses to announce – but the market expected more. The (relatively) disappointing upgrade overshadowed the company’s move into the whitegoods market and the launch of its mobile service in New Zealand. The company is the standout online retailer in the Australasian market, and the price fall gives investors a good chance to enter the Kogan story at a discount – behaviour that a natural retailer like Ruslan Kogan understands well.

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Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

 

Combining active and passive strategies with ETFs

Thursday, January 19, 2017

By James Dunn

Part of the explanation for the huge growth in exchange-traded funds (ETFs) in recent years is the fact that they offer investors cost-effective, simple, instant and liquid exposure to different markets, different asset classes and different strategies by buying one product, which is itself, a listed stock.

ETFs are very flexible investment tools, which allow investors to either instantly improve their portfolio’s diversification, or employ a range of investment strategies that were once too complicated or expensive for them to consider.

Investors can use ETFs to get market exposure very quickly and easily to implement their views and meet their investing objectives.

But ETFs can also work well with traditional investment tools, such as managed funds, and direct shares.

ETFs at the heart of “core/satellite” strategy

An increasingly common approach, which works in any asset class, is to use ETFs as the “core” of a portfolio – the foundation of your investment strategy – and then add some more specialised “satellite” investments around this core. In this approach, the core investments account for the main part of the overall portfolio: a typical allocation to the core investments would be about 70%.

The core is often held in a low-risk vehicle that offers low-cost, broadly diversified exposure to an asset class, market or index. ETFs are very well-suited to this role, which is to deliver a return in-line with the performance of the asset class, market or index you want to pick up. This is often referred to as the “beta” return – in a highly liquid form.

Around this core, the investor can add the satellite investments with the aim to earn returns above what the market generates. This is often referred to as “alpha”.

For example, an investor might hold a broad Australian equity ETF in the core portion of their portfolio, and add active managed funds to the satellite portion of the portfolio to seek to enhance performance. Using ETFs will help to keep the overall portfolio costs low, allowing the investor to choose unconstrained, high-conviction or absolute-return managers that represent the best chance for alpha. It’s important to ensure that the satellite funds generate a return that differs as much as possible from the market return.

This “blending” of a passive, low-cost indexed core and higher-cost active management can deliver market outperformance for less than a fully active portfolio would cost.

Using active strategies raises the risk, for chance of extra return

The satellite investments to an Australian equity core ETF can also be direct shares. This is a popular strategy given the prevailing low-interest environment, where franked dividends are a crucial source of income for yield-oriented investors. This is especially the case for self-managed superannuation funds (SMSFs) that are able to use the partial or full rebate of the unused franking credits (depending on whether the fund is in ‘accumulation’ or ‘pension’ phase, where the applicable tax rate is 15% and nil respectively.)

When using active managers as satellite holdings, make sure you do not get panicked out of the investment by short-term underperformance – which is the bane of active management. Make sure you hold the managers long enough – at least through a full economic cycle – to give each enough time to potentially generate positive active returns through their skills and insight.

Active managers give you the possibility of outperforming the index – which of course the traditional ETF cannot do – but the flipside is much higher return variability, and much higher management costs.

Even though ETFs are usually passive investment vehicles, they can be used actively, to make tactical tilts to certain markets and asset classes, based on the investor’s view of changing short-term market conditions, or to tap into a strong global investment “thematic” exposure in a precise manner.

A good example of this is the iShares S&P Global Healthcare ETF, which taps into the increased spending on healthcare as populations in many countries – developed and developing – age. Adding this exposure – which is difficult to achieve on the Australian Securities Exchange (ASX) – can provide a targeted investment while also improving the portfolio’s international diversification.

Factor-based ETFs combine active and passive investment

Within the equity asset class, the latest generation of ETFs provide exposure to fundamental factor-based or ‘style-based’ strategies, to allow more systematic investment allocation. These newer ETFs target particular “factors,” which are fundamental underlying drivers of equity return.

For example, “value” stocks – which have low prices relative to fundamental measurements (such as price/equity ratio, dividend yield or net asset value) – have historically out-performed the broad share market over the long term. Value stocks are those that are out of favour with the market, being priced low, relative to the company’s earnings or assets.

A value stock is usually considered to have a relatively low price/earnings (P/E) ratio and a low price-to-NTA (net tangible assets) value, but a high dividend yield (because its price has fallen). Value investors buy these stocks because they believe that the market will eventually recognise its true value and the stock will be re-evaluated (bid up in price). Cheap stocks – relative to these fundamental measurements – have tended to outperform in the past.

Other common factors include size (market capitalisation), company “quality” (as indicated by a range of fundamental criteria indicating financial health), “momentum” (trending stocks) and low-volatility i.e. the stocks that historically have fluctuated in price less than the overall index. Identifying these factors and creating rules-based indexes based on them can allow investors to seek improved returns, reduced risk or enhanced diversification, within the Australian or global shares asset class. For example, the iShares Edge MSCI World Multifactor ETF combines value, smaller size, quality and momentum stocks to seek outperformance compared to a traditional index of global shares.

These “smart beta” strategies combine elements of both passive and active investment, giving the investor the opportunity to make more targeted allocations to potential sources of risk and return at a lower cost.

Disclaimer: This is a sponsored article by BlackRock Investment Management. This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

3 ways smart beta can enhance your portfolio

Wednesday, November 30, 2016

By James Dunn

The first exchange-traded funds (ETFs) offered investors ‘beta’ – the return of a market index representing a particular asset class. Therefore, ETFs allowed investors to improve diversification in their portfolios – filling gaps with cost-effective, simple, instant and liquid exposure to different markets and asset classes.

The initial use of ETFs in retail portfolios was as simple buy-and-hold passive exposure to a chosen asset class. Investors found them particularly suitable to “core-satellite” strategies, where the ETFs formed the portfolio core, established to garner the beta of a particular asset class, while satellite strategic decisions were put in place to pick up alpha, or return above the beta. 

What is smart beta?

As ETF issuers have developed products to target specific investor needs, ETFs offering particular strategies (for example, high-dividend-yield stocks) or investment styles, have become popular. Prevailing market volatility and low yields have driven many investors to search for an investment approach that better aligns with their needs. 

Strategic ETFs are designed to deliver “smart beta,” which is an approach based around capturing investment “factors,” or market inefficiencies, in a rules-based, transparent manner. 

Factors have been identified for many decades as fundamental underlying drivers of return. These factors could be macro-economic, such as the pace of economic growth and inflation, which can explain returns across asset classes like stocks and bonds: alternatively, these factors could be “style” factors (for example, “value” or “quality”) which help to explain returns within asset classes.

In effect, smart beta ETFs are built around a different index to the traditional market-capitalisation-based indices, with the index designed to harvest a different return. That allows heightened diversification, as well as the opportunity to earn enhanced, risk-adjusted returns. 

Smart beta is a strategy that involves following an index designed to capitalise on inefficiencies in the market. Smart beta ETFs sit between active and index investment approaches, incorporating elements of both. 

The three major smart beta strategies used in equity ETFs are: 

1. Low volatility - Protect yourself from market shocks 

Low-volatility ETFs take the broad stock index and choose from the stocks that show the lowest historical volatility – that is, they fluctuate in price less than the overall index. 

Lower-volatility stocks tend to be more mature companies that are less dependent on continued economic growth – such stocks also tend to have higher-than-average yields. They tend to fall by less in market downturns, but they also tend not to rise as much in market rallies. 

The theory behind low-volatility ETFs is that they give the investor roughly the same equity exposure as a broader equity ETF, but in a form that helps a nervous investor sleep better at night. The lower volatility means that over the long run, the investor is less likely to be panicked out of their investment in the stock market. 

Low-volatility ETFs have become very popular in the US market, where a number of risks have been identified. 

The first is that the strategy is in danger of becoming a classic “crowded trade.” That’s when the individual stocks are bid to higher valuations than they would otherwise justify, and the very success of the low-volatility ETFs in attracting money actually increases the likelihood of lower risk-adjusted returns going forward.

The second is the fact that the low-volatility ETFs have tended to cluster in similar stocks: as a group they are heavily weighted in financial, consumer staples, health care, utilities and telecom stocks. Despite low volatility ETFs capping exposure to these sectors, US analysts have noted that these sectors often behave like bonds, doing best in periods of falling interest rates. With the US Federal Reserve expected to lift interest rates in 2017, it may be an inopportune time to buy low-volatility ETFs.

2. High-dividend yield: Target higher income

As the term suggests, high-dividend-yield ETFs target higher levels of equity income while being diversified across sectors. To avoid ‘dividend traps’ (companies where the yield appears artificially high because the share price has fallen) the high-dividend-yield is biased to companies that have a strong track record of paying a rising dividend stream, through consistent earnings growth. 

The strategy ensures that any high yield is not due to a large one-off dividend and that the companies have the capacity to increase their dividends, through a sustainable payout ratio. 

In the Australian context, these stocks also deliver a high level of tax-effective franking credits and are therefore seen as particularly attractive investments for retirement portfolios and self-managed super funds (SMSFs). 

In the US, there’s a wide variety of criteria used by high-dividend ETFs. For example, some focus on companies that consistently raise their dividends, not simply stocks with high yields, some apply other financial strength measures such as return on equity (ROE), while others equally weight the portfolio to the highest yielders in each sector of the S&P 500 Index. 

In the Australian context, high-dividend yield ETFs run the risk of high concentration risk. They will be biased to the big four banks (Westpac, ANZ, National Australia Bank, Commonwealth Bank of Australia) and Telstra, and the real estate investment trusts (REITs) that pay large distributions. The portfolio is likely to be overly influenced by the performance of the Australian finance sector. US high-dividend-yield ETFs do not have this problem, a legacy of the financial crisis, which forced many banks to cut dividends or, at best, maintain them.

High-dividend-yield ETFs also run the risk of bidding up the target stocks. 

3. Outperformance: using style factors to beat the market

Over long periods of time in the stock market, ‘style’ factors have demonstrated the ability to earn higher long-term returns than the broad market indices, while bearing level of risk to a broad market investment. Because they’re driven by different market characteristics, these factors can be most rewarded in different market environments, and points in the economic cycle. 

For example, company ‘quality’ is usually assessed on fundamental financial criteria such as balance sheet strength, low debt levels, record of consistent earnings and dividend growth, high return on equity (ROE), profitability, management efficiency, consistently rising cash flow generation, high dividend payout ratios and sustainable competitive advantage.

The term “quality” generally denotes companies that historically have weathered economic and market downturns better than other stocks. Quality stocks, traditionally, have their strongest relative performance late in the economic cycle, when earnings are deteriorating, or in actual recessions. Quality can also be considered a defensive attribute - it has tended to only under-perform, on a relative basis, during stronger economic times.

‘Value’ stocks are considered cheap because they are out favour with the market and are consequently priced low, relative to the company’s earnings or assets. A value stock is usually considered to have a relatively low price/earnings (P/E) ratio and a low price-to-NTA (net tangible assets) value, but a high dividend yield (because its price has fallen). Value investors look for such value anomalies and buy the stock because they believe that the market will eventually recognise its true value and the stock will be re-evaluated (bid up in price). ‘Value’ stocks tend to outperform early in the economic cycle.

‘Size’ refers to market capitalisation, or the value of the company’s equity on the stock market at any time. Small caps – or small market capitalisation companies – generally tend to outperform their larger counterparts, for a range of reasons. They often have high growth rates, there is often an ‘information gap’ because they are poorly covered by analysts: this can lead to a valuation gap, and as these gaps are filled, the small-cap stocks can appreciate in value quite quickly. 

Small, high-growth companies are often more nimble than their larger counterparts, and tend to outperform them, especially in the early stages of economic recovery, and in rising interest-rate environments. 

(There is no universal definition for “small capitalisation,” which differs from market to market: in Australia, for example, “small caps” usually refers to stocks in the S&P/ASX Small Ordinaries index, which have a market value of about $2 billion or lower.)

Lastly, ‘momentum’ stocks – where the stock price is changing quickly – can come into their own when the economy is growing strongly, toward the peak of the economic cycle. There is an empirically observed tendency for stocks rising in price to keep rising, and for stocks with falling prices to keep falling. Momentum investing seeks to ride this trend.

All of these factors can be used in a smart beta strategy. Smart beta ETFs are not a magic bullet – they do not offer a safer route to returns, nor can they be expected to always outperform traditional market-cap-weighted equity ETFs. But the benefits can include improved diversification, and the ability to capture a wider spread of risk premiums than broader ETFs. Smart beta ETFs can harvest risk premiums previously only available through expensive active strategies, in a cheaper way.

Disclaimer: This is a sponsored article by BlackRock Investment Management

 

Treat your SMSF cash as an investment (and diversify it)

Tuesday, November 29, 2016

By James Dunn

Cash is a very important component of Australia’s growing army of self-managed superannuation funds (SMSFs).

According to Australian Taxation Office (ATO) data, SMSFs holdings of cash and term deposits rose to a record high of $158.9 billion in the June quarter, up from $157.3 billion in the March quarter. Cash investments now represent 26% of total SMSF assets.

SMSFs invest in cash as an asset class, as part of the defensive portion of their asset allocation, and also use cash investments as a parking place for monies on their way into or out of the fund.

Different cash products in the marketplace cater to these two ways in which SMSFs use cash. But whether it is cash that the SMSF needs to handle as part of its investment activity, or cash that is invested, the cash holdings should be treated as an investment in their own right. This means thinking about how to earn the best return on your SMSF’s cash.

Savvy SMSFs operate a savings account in addition to their cash management account, ensuring that all of their cash assets are working as hard as possible. The cash management account should hold cash for paying the costs of running the SMSF, with the remainder eg. monthly superannuation guarantee (SG) contributions held in the savings account.

Savings accounts – particularly online accounts – are a very competitive market, and as an SMSF holder you should always be prepared to check the market for a better rate. There are a range of savings accounts available and with differences of over 1.40%, it’s important to understand your options.

In addition to the standard online savings accounts, there are also accounts that pay you additional interest when you increase your balance by a minimum amount each month, as well as a new breed of accounts from RaboDirect called ‘Notice Savers’. The RaboDirect Notice Savers require customers to notify the bank about withdrawals in advance (the notice period) in return for a higher rate of interest. The longer the notice period, the higher the rate of interest. Using a mixture of these savings accounts, as well as term deposits, will enable you to maximise your cash returns, while also giving you the flexibility to invest in any opportunities that may come along.

When managing your term deposits, it's also important to take into account any loyalty bonuses that your bank may provide. As an example, RaboDirect offers a 0.10% bonus for rolling over a term deposit.

Understanding how to maximise your cash returns makes a lot of sense, especially if you’re thinking of making additional contributions to superannuation. In our next article, I’ll shed some light on some of the changes that the government has made to super, and how you can take advantage of the current rules.

Disclaimer: This is sponsored content by RaboDirect.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 

How to access hard-to-reach asset classes

Thursday, September 22, 2016

By James Dunn

Exchange-traded funds (ETFs) have become, arguably, the fastest-growing investment product in the world. There is now US$3.3 trillion ($4.4 trillion) held globally in ETFs and exchange-traded products (ETPs), up 11.5% on a year ago (July, 2015). Around the world, investors pumped US$55.2 billion ($73.6 billion) into ETFs in July, the highest monthly flow since December 2014.

Why investors like ETFs

The prime attributes that have driven this growth are the simplicity of the ETFs in offering investors exposure, through one listed stock, to a wide range of asset classes and investments.

These range from share and bond market indices, to commodities and currencies, to various investment styles, strategies and themes. This makes ETFs very efficient in diversifying a portfolio in a cost-effective way, given the typically lower management and transaction costs of ETFs compared to actively-managed funds.

All kinds of investors can use ETFs for a variety of roles, but achieving precise exposure to certain asset classes and investment niches is a feature most retail investors would certainly find handy.

Tailor your exposure

Investors can now diversify a portfolio much more effectively than before using other asset classes, and benefit from the fact that asset prices are not perfectly correlated. In other words, not all asset prices move in concert, and price movements in one asset in a portfolio can counteract price movements in another asset. A properly diversified portfolio can achieve higher levels of return, while reducing overall portfolio risk.

Even within asset classes, different sectors can give varying exposures, decreasing correlations. ETFs allow retail investors to tailor their exposure.

Within an investor’s core Australian equities allocation, for example, investors can segment their investment by factors such as market capitalisation, level of yield represented by the stocks’ dividend payout ratios, or ‘style’ considerations (whether the stocks represent “value” or “growth” opportunities). Again, this segmentation taps into differing correlation records.

Simple exposure to hard-to-reach investments

ETFs can be particularly helpful in achieving exposure to asset classes which retail investors would otherwise find hard to access. For example, fixed-income has historically been a difficult asset class for Australian retail investors to enter, as most kinds of bonds were sold in prohibitive minimum investment parcel sizes. Effectively, this locked retail investors out of the market, unless they wanted to use unlisted bond funds. But fixed-income ETFs offering exposure to investment-grade securities in the Australian commonwealth government and state government bonds space, and the global corporate bond market, have opened up these asset classes for investments of any amount.

For example, the iShares Core Global Corporate Bond (A$ Hedged) ETF (ASX code: IHCB) offers investors exposure to a portfolio of thousands of global corporate bonds, through simply buying one stock on the Australian Securities Exchange (ASX).

Small caps don’t always march to the market’s tune!

The capitalisation issue is relevant to the Australian share market, which has become one of the most concentrated in the world. The top 20 stocks account for about 62% of the total value of the benchmark S&P/ASX 200 Index. The top seven stocks represent almost half of the index. Therefore, these stocks account for most of the movement of the index.

When large-cap stocks are lagging, the index lags with them – but small-caps may be performing well, independent of this movement. For example, in the year to June 30 2016, the benchmark S&P/ASX 200 earned a return of just 0.2%, but the S&P/ASX Small Ordinaries index surged by 14.4% over the same period1 (The S&P/ASX Small Ordinaries index represents members of the S&P/ASX 300 Indexthat are not in the S&P/ASX 100 Index). 

Australian small-cap companies are easily accessible directly to local investors, but there is an information risk in the fact that the small-cap stocks are not as widely covered by investment analysts, making it a potentially troublesome sector for individual investors.

However, investors who are aware of the concentration effect of the Australian share market, and who understand the lack of correlation of the small caps’ performance with that of the market’s benchmark index, can customise their domestic stock allocation – and further diversify their portfolios – by holding a broad ETF that gives them the performance of the sector. For example, the iShares S&P/ASX Small Ordinaries ETF (ASX code: ISO) is designed to capture the performance of those 200 Australian small-cap companies not part of the S&P/ASX 100 Index.

Emerging markets give a portfolio a distinct twist

Similarly, investors can tailor their global equities exposure in a number of ways to pick up on differences across regions, sectors and markets. Within global equities, for instance, emerging markets (those countries classed as not yet at the level of developed nations) are considered a discrete asset class, with a risk/return profile different to that of standard international equities investment.

Emerging markets equities show little correlation to the developed share markets, and thus can work to reduce the overall volatility of the portfolio. Allocations within emerging market funds vary, but China usually represents the largest exposure.

China, South Korea, Taiwan and India account for almost two-thirds of the MSCI Emerging Markets Index, and therefore, an investment in emerging markets is increasingly a bet on Asia. 

Emerging markets have usually shown a strong correlation with commodity prices, being seen as producers. Returns from emerging markets shares have been largely weak since the GFC, hurt by soft commodity prices and the slowdown in China. Emerging market assets are typically considered vulnerable to periods of strength in the US dollar. For example, following US interest rate rises, because that depresses commodity prices and relatively low returns in US$ keeps money invested in emerging markets. Usually, rising US rates causes a flood capital to flow back to the US, and emerging markets are usually one of the first assets to suffer.

However, emerging markets as an asset class are changing. The emerging markets-commodities correlation – while strong between 2005 and 2013 – has lessened. The combined energy and materials sector weights in the MSCI Emerging Markets Index have come down from close to 40% at the height of the commodity boom to just 13.8%, not much greater than the 11.7% in the MSCI World Index.

The performances of the MSCI World Index and the MSCI Emerging Markets indices can diverge widely. In 2013, for example, in US$ terms, the Emerging Markets lost 2.3%, while the World Index gained 27.4%. But it would have been helpful to hold the Emerging Markets in 2009, when it gained 79%, compared to the World Index’s rise of 30.8%.

The MSCI Emerging Markets Index is heavily weighted at the top end to IT stocks. Its five largest holdings are internet company Tencent Holdings, Korean giant Samsung Electronics, Taiwan Semiconductor, Chinese online marketplace Alibaba and Chinese telecommunications company China Mobile. This makes it a different exposure to a standard global investment, picking up on different themes. The problem can be that many emerging markets are restricted to foreign investors, and expensive to enter even if not restricted. But investors wanting to tap into this exposure can easily allocate some of their international share portfolio weighting to an ETF like the iShares MSCI* Emerging Markets ETF (ASX code: IEM), which seeks to track the performance of the MSCI Emerging Markets Index. This kind of portfolio tweak is easily implemented through ETFs, tailoring an allocation more specifically, and allowing both greater diversification and the ability to make strategic tilts.

This is a sponsored article by BlackRock Investment Management

 

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