Market Watch

At its meeting today, the Board decided to leave the cash rate unchanged at 0.75 per cent.

While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US–China trade and technology disputes continue to affect international trade flows and investment as businesses scale back spending plans because of the uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken steps to support the economy while continuing to address risks in the financial system.

Interest rates are very low around the world and a number of central banks have eased monetary policy in response to the persistent downside risks and subdued inflation. Expectations of further monetary easing have generally been scaled back over the past month and financial market sentiment has improved a little. Even so, long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at the lower end of its range over recent times.

The outlook for the Australian economy is little changed from three months ago. After a soft patch in the second half of last year, a gentle turning point appears to have been reached. The central scenario is for the Australian economy to grow by around 2¼ per cent this year and then for growth gradually to pick up to around 3 per cent in 2021. The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a brighter outlook for the resources sector should all support growth. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending. Other sources of uncertainty include the effects of the drought and the evolution of the housing construction cycle.

Employment has continued to grow strongly and has been matched by strong growth in labour supply, with labour force participation at a record high. The unemployment rate has remained steady at around 5¼ per cent over recent months. It is expected to remain around this level for some time, before gradually declining to a little below 5 per cent in 2021. Wages growth remains subdued and is expected to remain at around its current rate for some time yet. A further gradual lift in wages growth would be a welcome development and is needed for inflation to be sustainably within the 2–3 per cent target range. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.

The recent inflation data were broadly as expected, with headline inflation at 1.7 per cent over the year to the September quarter. The central scenario remains for inflation to pick up, but to do so only gradually. In both headline and underlying terms, inflation is expected to be close to 2 per cent in 2020 and 2021.

There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne. In contrast, new dwelling activity is still declining and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.

The easing of monetary policy since June is supporting employment and income growth in Australia and a return of inflation to the medium-term target range. Given global developments and the evidence of the spare capacity in the Australian economy, it is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

Source: Reserve Bank of Australia, November 5th, 2019

Enquiries

Media and Communications
Secretary’s Department
Reserve Bank of Australia
SYDNEY

Phone: +61 2 9551 9720
Fax: +61 2 9551 8033

Email: rbainfo@rba.gov.au

Right now, the developed world is on the cusp of a fourth industrial revolution, and it is set to have a more transformative impact on everyday life than the three revolutions before it.

The fourth industrial revolution is about embedding the cyber world into everyday lives and workplaces. The roll-out of 5G is core to this revolution, enabling technologies which can power and transform energy management, transport networks, healthcare and entertainment.

A fundamental change in how we live, work and transact will have a knock-on impact to how industrial real estate is used and valued. This disruption presents both opportunities and challenges for investors – industrial real estate will see some big wins as 5G is rolled out, but not every asset will have the potential for gains.

Author: James Maydew, BSc (Hons), MRICS, Head of Global Listed Real Estate, Sydney, Australia

Source: AMP Capital 20 Sept 2019

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Retirees now face a bold truth: investing in traditional safe haven assets do not provide the returns they once did. So, where to from here?

The first thing is to accept that today’s returns are lower on retiree favourites, like cash and bonds.

Second, there are tools available to provide forecasts for what the market will return over a 10-year period. These forecasts have been relatively reliable through history and are useful for investors who, understandably, are looking at short-term volatility and thinking there is no hope in predicting long-term patterns.

What the future could look like

In our view, investors should expect lower returns on bonds over the next 10 years than the past 10 years, simply because the starting point of today’s yields is extremely low.

Low bond yields have the potential to cause other riskier assets such as equities to trade at higher valuations and therefore also offer lower expected returns. Because of market conditions, annuities may also pay less.

The combined effect in our view is that the expected return on a simple 50/50 stocks and bonds portfolio is likely to be less than 5% p.a. over the next 10 years¹. The only compensation accompanying these lower returns is that this environment is likely to produce lower levels of inflation. 

Source: Bloomberg, 30 August 2019

This is the lowest forecast return for this type of portfolio in history, matched only by those made in the run-up to the global financial crisis. In that instance, high equity valuations were driving down expected returns. This time, it’s low bond yields.

This is a very importance difference; if you were aware in 2007 that equities were the source of deterioration in your expected return, you could de-risk your portfolio into cash and bonds and still expect a reasonable result. However, in 2019, there is nowhere to hide.

To avoid the risk of holding a poorly performing asset, like cash and bonds, one option is to look beyond these conservative asset classes and take on higher levels of risk with more volatile assets. At a time when investors can least afford shocks to the downside, this is a conundrum with no simple answer.

Retirement savings, then and now

For retirees whose focus is to preserve and prolong their stockpile, all this begs the question: how large a reduction in retirement income should one expect?

To illustrate how much lower today’s average retirement income is expected to be, we can simulate a $500,000 investment in a simple portfolio of 50% Australian government bonds and 50% Australian shares with our current expected return of 4.9% and 2.5% inflation. Before looking at the chart, consider how far this is from the 11.9% historical return and 5.3% inflation rates of the halcyon days. This is where it hits home.

Source: AMP Capital

The bottom line is: retirement savings won’t last nearly as long as they have in the past. Based on the average market return from 1969 to today, a retiree could have expected to receive a comfortable retirement income² for 18.5 years. For retirees in 2019, that drops down to just 13.5 years.

There is no doubt that the investment environment moving forward is going to be significantly more challenging than it has in the recent past, with today’s retiree facing the prospect of some of the lowest returns in living memory.

What retirees can do?

Still, far from waving the white flag, in our view there are some things investors can do to improve their prospects.

With traditional strategies returning less in today’s environment, retirees will now more than ever reap the benefit of a good adviser. Three investment strategies which could help manage the situation are:

1. Retirees can seek higher returns from active management. By finding managers who can outperform the market, retirees can give their returns a boost that may go some way to offsetting the impact of lower market returns.

2. Retirees can also employ a dynamic asset allocation approach in their diversified portfolio. Dynamic asset allocation seeks to navigate the market cycle and gain exposure to asset classes that are delivering the most attractive returns. By dynamically managing their exposure to different asset classes through the cycle, retirees may be able to secure more attractive returns and better manage risk compared to a traditional ‘buy and hold’ strategy. 

3. Retirees could consider increasing their exposure to alternative sources of return that aren’t linked to bond and equity markets and aren’t likely to suffer as badly from the low-return environment.

Additionally, retirees will benefit from an effectively constructed portfolio that minimises waste, such as transaction costs, and maximises structural advantages, such as access to franking credits. 

Unfortunately, there is no magic tonic for the situation and retirees should be wary of anyone claiming to have one. However, by partnering with a good adviser, managing their expectations and positioning their portfolio for a lower return future, they will be in the best possible position to thrive.

Author: Darren Beesley, BCom FIAA, Head of Retirement and Senior Portfolio Manager, Sydney, Australia

Source: AMP Capital 9 Oct 2019

¹ Based on an expected 10 year return on Australian government bonds equal to current 10-year bond yield of 0.9% and expected return on equities of 8.9% based on a historical regression of 10 year returns against starting Cyclically Adjusted Price/Earnings Ratio of 20.3

² As defined by ASFA’s retirement income standards

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Economic conditions, including falling cash rates at home and abroad, are prompting investors to shake up their asset allocation. This is having an impact on allocations to direct real estate worldwide.

The state of play

At its October board meeting, the Reserve Bank lowered the official cash rate by 25 basis points to 0.75 per cent.

The RBA is not alone in its fight to kick-start the national economy. Developed nations worldwide are grappling with sluggish growth and below-target inflation figures, and there’s no end in sight for the mid-term.¹

“Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation”

said RBA governor Philip Lowe in his statement supporting the cash rate decision.

One well-understood impact of this lower-for-longer environment is compression of returns from traditional safe haven assets like bonds and cash. As a result, institutional and retail investors alike are on the hunt for new opportunities, and we see that manifesting in a jump in investors’ interest in direct commercial real estate.

Key market observations

In the last 12 months, commercial real estate (CRE) has delivered an average return of 4.9 per cent, placing it amongst the highest income return of all asset classes.²

Further, investors worldwide have lifted their exposure to CRE, from an average of 8 per cent in 2012 to 11 per cent today.³  At AMP Capital, we anticipate this figure will continue to rise, reaching approximately 15 per cent by 2025.

However, it’s important to note that while falling cash rates will likely prolong the real estate capital growth cycle, which is currently in its ninth year of positive capital growth, we expect yields to compress in the office and logistics space over the next 12 months, as the cost of capital falls.⁴

Similar patterns and projections were identified in a report from Cornell University in the United States and capital advisory firm Hodes Weill.⁵

Its 2018 Allocations Monitor, which includes research collected from 208 institutional investors in 29 countries, said that, on average, institutions are expected to increase target allocations to real estate by 20 basis points over the next 12 months.

Further, the research found that after two years of “moderating” portfolio investment returns, performance increased in 2017. Real estate portfolios generated an average annual investment return of 9.2 per cent in 2017, up from 8.7 per cent in 2016, according to the report.

“This is consistent with industry-wide real estate returns, which trended upward in 2017, spurred by a rebound in economic growth which led to stronger operating fundamentals (i.e. rent and occupancy trends) across asset classes and geographies,” the report said.

Notably, the report also measured institutions’ view of real estate as an investment opportunity from a risk-return standpoint, using a so-called ‘Conviction Index’. After four years of steady declines, this index moved from 4.9 to 5.1.

Interestingly, on the flipside, despite 92 per cent of institutions reporting that they are actively investing in real estate, institutions remain approximately 90 basis points under-invested relative to target allocations, the report found.

One to watch

At AMP Capital, we anticipate the cash rate will continue to fall, potentially as low as 0.25 per cent by early 2020. As a result, we expect the hunt for yields and growth to intensify, as investors search for steady and prolonged sources of income. In this context, real estate will be one to watch as time wears on.

Author: Luke Dixon, Head of Real Estate Research – Real Estate, Sydney, Australia

Source: AMP Capital 10 Oct 2019

¹ Source: https://www.rba.gov.au/media-releases/2019/mr-19-27.html
² Source: IPD/MSCI Total Return Digest, Q2, 2019
³ Source: Cornell/Hodes Weill & PwC
⁴ Source: AMP Capital Real Estate Research as at September 2019
⁵ Source: https://www.hodesweill.com/research 

Important notes: AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMPCFM) is the responsible entity of the Responsible Investment Leaders Balanced Fund (Fund also known as the AMP Capital Ethical Leaders Balanced Fund) (ARSN 095 787 723) (Fund) and the issuer of the units in the Fund. To invest in the Fund, investors will need to obtain the current Product Disclosure Statement (PDS) from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232 497) (AMP Capital). The PDS contains important information about investing in the Fund and it is important that investors read the PDS before making a decision about whether to acquire, or continue to hold or dispose of units in the Fund. Neither AMP Capital, AMPCFM nor any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this article. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this article, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to their objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Bridging troubled waters: the pros of investing in infrastructure

Global markets are yet to enter any serious downturns. Still, fragile growth outlooks, high levels of market volatility, record-low interest rates and myriad geopolitical and macroeconomic risks – not least of which is a trade war between the world’s two largest economies – will leave many wondering how they will meet their investment goals in the short to medium term.

The current investment environment is no doubt an uneasy one for many investors. Rather than wait for economic winds to change, investors could instead look to investment classes with outlooks that are less dependent on external and cyclical factors as some others. In this regard, infrastructure investment offers some compelling features in an uncertain climate.

What are some of the benefits of investing in infrastructure?

1.  Consistent returns with lower volatility¹  through market cycles

Infrastructure assets are commonly “essential services” assets. This means people have to use them on a day-in and day-out basis. As a result, both utilisation and returns can often be less dependent on the prevailing economic climate than other investments. It is very hard for someone to get through a day without having to use some form (or forms) of essential infrastructure such as electricity, water, gas, schools, hospitals, roads, rail and airports.

In addition, infrastructure assets often benefit from significant barriers to entry in the markets in which they operate. They can have contractual protection from competition by government, while high costs and long lead times for construction provide natural monopolies, and give advance warning and further insurance against new competitive threats to existing revenue streams.

For this reason, returns are often more reliable than those associated with comparable assets outside the sector. Figure 1, below, compares the performance and volatility of infrastructure in various forms, with a range of other asset classes being Australian equities, global equities, global bonds, and global real estate investment trusts (Global REITs). It demonstrates that that over the last 10 years, on an annualised basis, and relative to other asset classes with comparable performance, returns on infrastructure have been delivered with much lower levels of volatility.

Figure 1: Return and volatility of selected asset classes, 10 years to 30 June 2019.³

 
Past performance is not a reliable indicator of future performance.

2. Reliable long-term income yields

Infrastructure asset revenues are often underpinned by regulation or long-term contracts, which provide a high level of visibility of, and certainty around, future cashflows from the asset.

The most obvious example of this in practice occurs with Public Private Partnerships or ‘PPPs’ which are often used by governments to deliver infrastructure projects such as roads, hospitals, schools and public transport systems.

Concessions for assets such as these are often granted over lengthy contractual periods (which can be 30 years or more) and typically offer ‘availability’ revenues, which are paid on the basis that the asset is made available and maintained in a fit state for the intended use, irrespective of the extent to which it is actually used.

For example, in the case of a school of this type, so long as the asset is maintained in a fit state and made available for use, the asset owner gets paid a fixed amount irrespective of the number of students that are enrolled in the school.

Isolation from usage risk in this manner provides a unique level of visibility and security of future revenues from the asset, particularly given that the counterparty responsible for making the availability payments is often a highly creditworthy government body. In addition, infrastructure asset revenues are often linked to inflation, which can help investors protect against the erosion of the value of their investment by inflation over time.

3. Diversification and reduced overall portfolio risk

Overall portfolio diversification is improved when assets have a low level of correlation² – that is, where assets don’t behave the same way at the same time. The infrastructure asset class, and unlisted infrastructure in particular, has historically demonstrated low levels of correlation with other asset classes, meaning its inclusion in a broader portfolio can be an effective means of reducing overall portfolio risk.

This is illustrated in Figure 2, below, which compares the correlation of various forms of infrastructure investment with a range of other asset classes being Australian equities, global equities, global bonds, and global real estate investment trusts (REITs).

As can be seen, most listed indices are highly correlated with one another, suggesting that even portfolios that were spread across a number of listed asset classes would be poorly diversified. Bonds are negatively correlated with other asset classes, and represent an effective option for diversification, albeit one which traditionally has offered lower long-term returns (see Figure 1.)

Infrastructure, and particularly unlisted infrastructure, displays low correlation with many other asset classes, making it another option for investors wishing to diversify their portfolio, and an attractive one given the historically strong returns illustrated in Figure 1.

Figure 2: Quarterly return correlations for selected asset classes, 10 years to 30 June 2019.³

Past performance is not a reliable indicator of future performance.

Conclusion

Many investors have cottoned on to the benefits of infrastructure, and we expect this to heighten. There is a significant need for new infrastructure in both developed and developing economies. With governments across the globe burdened with high levels of debt, fewer infrastructure projects are likely to be publicly funded. The need for private capital to replace ageing infrastructure or fund new projects will consequently persist over the long term, which we believe will support a broad and growing range of infrastructure investment opportunities.

Author: John Julian, Investment Director – Infrastructure Equity, Sydney, Australia

Source: AMP Capital 10 Oct 2019

¹ Volatility is a means of measuring investment risk. It is a probability measure of the standard deviation of expected returns, and hence can provide a useful comparative measure of the relative risk of different investments over a particular time period.

² Correlation is another comparative statistical measure. It shows how asset valuations move relative to each other. For example, if assets have a correlation of 1, their values move exactly together. Hence, the addition of assets with a correlation of 1 to a portfolio would provide no diversification benefit. If the correlation was -1, the valuations would move exactly opposite to each other, providing great diversification benefits by lowering the volatility of the portfolio. Interestingly, Figure 1 shows that the volatility of a portfolio of 50% listed and 50% unlisted infrastructure is much lower (~5.5%) than would be expected by simply averaging the volatility of each (~7%). This is because of the low correlation of unlisted infrastructure to listed infrastructure as can be seen in Figure 2 (0.13).

³ Notes to charts:
The charts compare the returns, volatility and correlation of a range of asset classes represented by the indices specified below. Different asset classes will offer different investment features, including differing levels of liquidity.

Unlisted Infrastructure represented by the MSCI Australian Unlisted Infrastructure Index. Listed Infrastructure represented by the Dow Jones Brookfield Global Infrastructure Net Accumulation Index. Global Treasury Bonds represented by Bloomberg Barclays Global Treasury GDP Index. Global Equities represented by the MSCI World Net Accumulation Index. Global REITS represented by the FTSE EPRA NAREIT Developed Rental Net. Australian Equities represented by the S&P/ASX 200 (franking credit adjusted). 50/50 Unlisted/Listed Infrastructure Portfolio represented by a 50% weighting to the MSCI Australian Unlisted Infrastructure Index, and a 50% weighting to the Dow Jones Brookfield Global Infrastructure Net Accumulation Index. All data in AUD. All data is for the period 31 March 2009 to 30 June 2019, except for the FTSE EPRA NAREIT Developed Rental Net index where data is for the period 31 May 2009 to 30 June 2019 (as the data series only began in May 2009).  

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.75 per cent.

While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US–China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken further steps to support the economy, while continuing to address risks in the financial system.

Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation. Long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at its lowest level of recent times.

The Australian economy expanded by 1.4 per cent over the year to the June quarter, which was a weaker-than-expected outcome. A gentle turning point, however, appears to have been reached with economic growth a little higher over the first half of this year than over the second half of 2018. The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets and a brighter outlook for the resources sector should all support growth. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending.

Employment has continued to grow strongly and labour force participation is at a record high. The unemployment rate has, however, remained steady at around 5¼ per cent over recent months. Forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate. Wages growth remains subdued and there is little upward pressure at present, with increased labour demand being met by more supply. Caps on wages growth are also affecting public-sector pay outcomes across the country. A further gradual lift in wages growth would be a welcome development. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.

Inflation pressures remain subdued and this is likely to be the case for some time yet. In both headline and underlying terms, inflation is expected to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne. In contrast, new dwelling activity has weakened and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.

The Board took the decision to lower interest rates further today to support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target. The economy still has spare capacity and lower interest rates will help make inroads into that. The Board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes.

It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

Source: Reserve Bank of Australia, October 1st, 2019

Enquiries

Media and Communications
Secretary’s Department
Reserve Bank of Australia
SYDNEY

Phone: +61 2 9551 9720
Fax: +61 2 9551 8033

Email: rbainfo@rba.gov.au