September 2012 Review Comments
Written by Tony Gray   
Wednesday, 19 September 2012 10:41

Portfolio Valuation & Comment

Planning Issues

There are a number of important changes to be aware of this financial year that may be relevant to your position:

Marginal Tax Rates

The tax free threshold has been lifted to $18,200 from $6,000.  That is the good news; the bad news is that the rate from $18,201 to $37,000 has risen to 19% (from 15%).  The $37,001 - $80,000 tax rate has also increased – to 32.5% from 30%.  The Medicare Levy is in addition to these rates.  For those earnings $80,000+ there is no effective change in the total amount of tax paid.

Concessional Superannuation Contributions

For employer contributions (including salary sacrifice) or for personal (self employed) contributions where a tax deduction is claimed, the limit for everyone is $25,000 per financial year.  Indexation of this figure has been frozen (again) for this and the next financial year.

This amount includes any Superannuation Guarantee Charge (SGC) amounts and therefore any regular salary sacrifice arrangements may need adjusting early in the financial year to avoid going over the threshold and paying penalty rates of tax.

These restrictions mean earlier planning to maximise superannuation becomes more important if your goal is to build a sizeable superannuation balance.

Non-Concessional Superannuation Contributions

There has been no change in the annual limit of 6 times the Concessional Contribution amount (i.e. $150,000 per annum) that may be contributed to superannuation with no tax deduction claimed and no tax deducted from the contribution.

The ‘bring forward rule’ also remains available – where up to 3 years worth of contributions may occur for those under 65 years of age.  My expectation is that the current government will act to curtail these limits to reduce the amount of money moving into the low tax superannuation/tax-free pension environment.

Self Managed Superannuation Funds (SMSF)

For SMSF trustees, legislation passed on the 7th of August now require the following:

o Trustees must consider insurance when reviewing their fund’s Investment Strategy (this does not necessarily mean insurance is required); and
o The Investment Strategy must be reviewed regularly; and
o Any material change in a member’s circumstance (such as the commencement of a pension) requires the Investment Strategy to be reviewed; and
o All Fund assets must be held at Market value (not simply historical cost).

These are not particularly onerous requirements and where TG Financial are involved in the advice process, we will assist with updating the Investment Strategy – as a minuted meeting of the trustees.

Australian Shares

Reporting season showed a minor decline in overall earnings for Australian companies (again) – mainly attributable to lower results from resource companies.  Falling metal and coal prices since 30 June paint quite a bleak picture for earnings from the mining and mining service sector over the coming years, as over-supply of key iron ore and coal markets has happened faster than most expected.  Whilst a rally may occur, it seems more likely to us that prices will trade at lower levels for the foreseeable future.

To gain an idea of the magnitude of the falls, in June the price of iron ore was ~$137 per tonne, whereas last week it traded below $90 per tonne.  This comes straight out of profit, with some estimates that earnings for the likes of BHP and RIO will halve if prices do not recover.

BHP and RIO are better placed than most, being amongst the lowest cost producers globally – so while earnings and the share price may suffer, they will not fail.  The same cannot be said for mid and high cost producers.  Many may cover the cash cost of production, but will really only be operating to pay off debts/recover capital.

This situation flows through to mining service providers, with major projects already scaled back or deferred indefinitely.

The outlook for thermal (steaming) coal for power generation is also weaker, with supply from China’s western provinces rising dramatically over the coming decade.  The outlook for coking coal is not overly strong given the cuts in steel production and also as rail imports from Mongolia ramp up over the next few years.

In summary, we are still wary of these sectors and are not yet tempted by the lower prices.  BHP’s share prices has tended to halve in previous cycles and a price in the mid $25 region would be of interest – and at that price we expect the dividend would be acceptable.

It appears to us that there is renewed interest by investors in companies that earn money outside Australia.  If the Australian dollar begins to trend lower (not yet occurring) then expect this trend to intensify.

International Shares

Our theme of adding to international exposure is strengthening and specifically introducing more Asian share exposure.  Markets in this region tend to be more volatile and have underperformed in 2011 and 2012 to date – despite sovereign debt and budget risk hotspots being in the US, Europe and Japan.  This also means the potential for growth is enhanced.

There is a risk from the China slowdown, but there are some 800 million people in Asia outside India and China – predominantly with younger populations and vigorous economies.

A low cost means of gaining exposure to the region is the iShares Asia 50 ETF (IAA).  Whilst it has a sizeable single stock exposure to Samsung (~15% of the ETF), the portfolio is otherwise quite diversified, with holdings in China, Hong Kong, Singapore, Taiwan and South Korea.

Another low cost exposure of interest is the iShares Emerging Markets ETF (IEM).

Listed Property

Values are ‘ok’ but not compelling and we have not found new holdings to recommend at current levels.  Prices have risen due to lower interest rates (cutting interest expense) and as investors chase yield.

Fixed Interest

The risk/return from investing in Commonwealth Bonds appears poor unless you are convinced of further falls in bond yields.  With average duration, a rise of 0.5% percentage points will wipe out a year’s worth of income at current levels.

We feel longer dated term deposits still offer value as part of a rolling strategy and are much safer than bonds in terms of capital stability (but consider allocations in light of comments below on inflation).
On a bounce in longer dated bond yields we would re-commence the introduction of inflation linked bonds to portfolios – using either the exchange traded fund or one manager we have identified in this sector.

Inflation & Gold

Most of the underlying issues do not appear to have been solved in the developed world - high sovereign debt, low or negative economic growth, budget deficits and a budgetary time bomb in the form of unfunded retirement benefits. 

This will result in slower growth and higher taxation and an increased propensity for consumers to save.  This will make the budgetary adjustment process even harder and it seems almost certain that central banks will continue to create more fiat (paper) money to partly inflate away the real value of their debts.  I see no ‘real world’ manner in which this process can be reversed once this feeds into inflation.

This is why the Future Fund has launched a takeover offer for Australian Infrastructure Fund and why Connect East was bought out by the Canadian pension funds – they want inflation hedged assets and can take a longer-term view than most listed companies or trusts can get away with (any trust that is too conservative will get taken over in this current ultra low interest rate environment).

It’s very difficult to find acceptable inflation hedged infrastructure assets that are not over-geared – but there are some possibilities – which I will leave for personal portfolio reviews.

In relation to gold, the price of gold mining stocks have recovered modestly from the very sharp sell-off over the past 12 months.  We are also re-introducing gold to some portfolios by way of a physical gold backed exchange traded fund – for those who want a hedge against circumstances that could hit the prices of growth assets.

Best wishes,

A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin
Principal, TG Financial

Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.

Last Updated on Wednesday, 19 September 2012 10:54

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