The Australian investment market of 2017 is evolving rapidly: low interest rates and global monetary policy have pushed yields to record lows; in March of this year, according to figures from ASIC, property prices reached “bubbly” proportions in many locations; exchange-traded funds (ETFs) and listed investment companies (LICs) are attracting fans for their lower fees and higher liquidity; meanwhile, more and more Australians are eschewing the confines of a pooled superannuation and going it alone. And against this backdrop, a wave of baby boomers reaching retirement age is creating huge demand for income-producing assets. By Alan Greenstein, CEO, Zagga.
How will the investment industry respond to these trends? How will it meet the demand for transparency, control and income that today’s sophisticated investors demand? And what opportunities does this new marketplace create for investors?
THE RISE AND RISE OF THE “SELFIE”
Figures from the most recent Black Sky Report from AMP Capital show self-directed investors are on the rise, driven in large part by the growth of self-managed super funds (SMSFs), which now account for almost one-third of the superannuation pool in Australia. These ‘selfies’ are driving a do- it-yourself ethos in the wealth management industry, and it’s distinct from the traditional strategies of institutional investors.
SMSF investors represent the largest group of ‘DIY’ investors, with significant investable assets and defined investment goals (accumulation ahead of retirement or income during retirement).
However, there are many other independent investors, with the ASX reporting in its 2017 Investor Study that 60 per cent of Australian adults hold investments outside of super. And while these investors are self-directed, they’re not always unadvised. 60 per cent use professional advice from financial planners, accountants, stockbrokers and lawyers to make investment decisions.
1.1 million Australians use a SMSF to manage their super, collectively holding $656 billion. The behaviours and preferences of this group are shaping the investment market, influencing the products developed by the wealth industry, and the allocation of capital in Australia.
Many SMSF investors also fit within the category of ‘sophisticated investor’ (annual income of $250,000 and above, or $2.5 million in assets, or able to make a single investment of $500,000 or more), able to access products and schemes not usually available to retail investors.
A DIFFERENT APPROACH TO PORTFOLIO CONSTRUCTION
A common theme with Australian investors is their risk-averse outlook: nearly 70 per cent are seeking stable, reliable or guaranteed returns from their investments, and, compared to the rest of the world, only 29 per cent of Australian investors are prepared to increase their risk profile for the opportunity to earn more income, compared to 66 per cent of investors globally, according to the ASX’s Investor Study.
As a result, many investors have built barbell-style portfolios: low-return cash investments to stay safe, balanced by higher- return equities, further up the risk spectrum, to increase returns.
This raises the question: why are they studiously avoiding the middle ground?
PRICES ARE UP. YIELDS ARE LOW. WHAT NEXT?
In a low-interest-rate world, income investors are keener than ever to get returns above the cash rate.
But as they flock to income- producing assets, it has pushed valuations up, and perversely, pushed yields ever lower. Capital growth is good for overall returns but poses problems for investors, especially those in pension phase, seeking income.
Property prices have increased by up to 70 per cent in a five-year- period, while rents lag behind, leading to record-low yields.
This yield dilemma is true for both residential and commercial property.
Similarly, in the equities market, valuations and PE ratios are high, relative to historical trends. The income-focused investor must pay a high price for bond-proxy stocks in this situation.
THE BONDIFICATION OF SHARES
Their high allocation to cash suggests that for Australian investors, consistent income and capital preservation are top of mind, except when it comes to equities, where the search for growth and yield trump capital guarantees.
This has been called the ‘bondification’ of shares – turning to equities for the consistent income; or as The Financial Times explains it, investing in stocks “with good dividends, fewer debts, strong pricing power, free cash flow and high return on equity — factors that make them more bond-like.”
However, shares are not bonds, and they have two crucial differences: their dividends are discretionary and they rank last in the capital stack. In contrast to debt products, where borrowers must make repayments (for example, paying coupons), companies are only permitted to pay shareholders if they are in good shape. And unlike fixed income securities, equities come last in the capital structure.
In other words, if the company is liquidated, bondholders get paid ahead of equity holders.
THE CREATION OF ALTERNATIVE INVESTMENT OPPORTUNITIES
Australia is unusual in its low allocation to fixed income investments at both institutional and individual investor levels.
According to Mercer Australia, local super funds have an average of 25 per cent allocation to fixed income (including cash), compared to 40 per cent for the USA and Canada, 65 per cent for Sweden and 80 per cent in China.
These are professionally managed investment portfolios. According to Franklin Templeton, when we look at SMSFs, as an example of self-directed investors, “the allocation to fixed income is alarmingly low, at one per cent”.
There are a number of possible reasons for this bias among investors, who favour share ownership ahead of fixed income, including familiarity with equities; dividend imputation; transparency and control.
Investors have the opportunity to increase their exposure to debt products, as long as they can increase their familiarity with them, understand the need to balance risk with reward, and have a sense of control and visibility.
DEMOCRATISATION OF LENDING
It’s clear that Australian investors are comfortable with being owners and borrowers: they take out mortgages for their homes; negatively gear their investment properties; take limited-recourse loans to buy property in their SMSFs; they take equity stakes in companies.
And yet they are missing out on a key opportunity: to be a lender.
A range of factors have seen banks pull back on lending both globally and locally. Post-GFC regulation and capital requirements are key factors, but in Australia this has been magnified by efforts to dampen the housing boom.
Macroprudential policy has forced the banks to reduce their lending to property investors and foreign residents, with the result that credit is essentially being rationed, even to quality borrowers. It creates a significant gap – and opportunity – for lenders who don’t have the same restrictions.
While the opportunity to lend money has been around as long as bonds, the advent of marketplace lending has made it more accessible for individual investors.
There are a number of models in this sector but the underlying concept is that borrowers can access capital being lent by individual (or institutional) investors, rather than just banks.
It’s a democratisation and disintermediation of the traditional banking role.
A NEW APPROACH TO INCOME GENERATION
The marketplace lending model provides exposure to the debt asset class, but for an investor focused on capital preservation, the solution needs to be safe as well.
Most existing players offer unsecured loans, meaning that the risk profile of their products may not align with the needs of investors, especially those in retirement.
Zagga flips the concept of a traditional marketplace lender on its head with a secure, fully-licensed offering suited to wholesale / sophisticated – including self-directed – investors, in a safe environment. By providing only high-quality loans backed by real mortgages, the risk of capital
loss is very low, offering a better investment overall.
This way of investing provides investors the ability to add a ‘middle ground’ to their portfolios, providing regular, consistent income.
Zagga believes this new type of income-producing asset will appeal to a growing class of wholesale / sophisticated investors, who want transparency, control and returns from their investment products. BFM
Zagga is an alternative investment platform connecting wholesale/ sophisticated investors with quality, creditworthy borrowers via an online marketplace.