Archive for category: News & Insights

Behavioural finance tells us that herd behaviour is hard wired into our brains. As investors we don’t want to miss out on opportunities, especially when we see others taking advantage of them. Herd behaviour and a fear of missing out is what drives asset bubbles, which means as investors we need to be on guard to ensure our emotions take a back seat when we make buy and sell decisions.

Investors are familiar with the FAANG stocks (for the uninitiated FAANG stands for Facebook, Apple, Amazon, Netflix and Google). Some of them are among the highest valued stocks in the world (Apple became the first company in the world to reach a market cap of $1 trillion but has since fallen below this level due to falling iPhone sales). In Australia we have our own acronymised technology cohort called the WAAAX stocks, which include WiseTech, Altium, Appen, Afterpay and Xero.

While hardly on par with the US tech giants in terms of size, these businesses have managed to capture people’s attention and imagination in a similar way. But like the FAANGs, the WAAAXs are certainly not a homogenous group. While each has seen eyewatering growth in recent years, they are essentially very different businesses with different growth drivers and risks.

WAAAXing fortunes

It’s sometimes easy to forget how parochial the Australian share market can be. The WAAAX phenomenon is undoubtedly a good thing, especially given that the ASX remains dominated by banks and miners. Australia’s tech sector may still be small, but its growth is helping to provide some much-needed diversification. While only 2.4% of the ASX 200’s total market cap, there are now 15 names in the tech sector with a combined market cap of over $75 billion.

WAAAX share price returns (12 months to end March 2019)

Source: FE, Lonsec

When you look at the stellar growth of these shares, it’s easy to see why they’re considered the Australian FAANGs. But how useful is it to group shares together in this way? Certainly in the US, the FAANGs don’t always behave as a group. While the return of risk appetite contributed to their strong performance in the March quarter, most were unable to make up for earlier losses due to the ongoing impact of idiosyncratic issues plaguing each stock.

Facebook continues to be scrutinised for their lax privacy policies, Amazon is facing a challenging earnings outlook, Apple’s revenue and product launches have fallen short of expectations, Netflix faces increasing pressure from new competitors, and Alphabet (Google) received another fine from the European Union for violating antitrust laws.

In Australia, the diversity of the WAAAX stocks poses a similar challenge for investors. To give a sense of how different these businesses are, let’s have a quick look at two of them: Appen and Afterpay. These are among the most popular shares over the past two years, but they have fundamentally different core businesses. For Appen, revenue is driven by the growth in AI and machine learning solutions, with Appen providing quality datasets that help make these products smarter. In contrast, Afterpay’s extraordinary growth has been due to the company’s ability to take advantage of a potential step change in consumer behaviour, with a younger generation of consumers favouring digital payments and more flexible spending.

Source: Lonsec

While these stocks are different, there is no denying the extraordinary growth of the WAAAX group, which is indicative of some of the disruptive trends taking place in the digital world. This is reflected in the sales and EBITDA growth of Afterpay and Appen, which becomes starker when compared to other popular sector peers Seek and Carsales. Clearly there are good reasons to be optimistic, but the question is how best to take advantage of these opportunities in your broader portfolio.

Source: FE, Lonsec

Using WAAAX shares in your portfolio – key things to note

When incorporating the WAAAX shares in your portfolio, the most important thing to remember is that they are not homogenous, which means you shouldn’t group them together. While these shares may grow together in a risk on environment, each face their own set of risks and opportunities which could see results diverge significantly.

The second thing to note is that these are capital hungry businesses with a mandate to grow, which means you should not expect a steady stream of hefty dividends. Because they are long duration assets, they will also be more sensitive to movements in interest rates.

Thirdly, while each of these stocks appears to enjoy significant upside, there are always risks around valuation and potential bubble-like behaviour. Valuing things like network effects can be difficult, while forecasting consumer trends and the role of AI require a host of assumptions to hold true. When it comes to technology, there is usually a significant degree of uncertainty involved, not to mention the regulatory risks faced by successful disruptors.

Our view of the WAAAX stocks is that you want to take advantage of the growth opportunities they represent, but don’t fall into the trap of bucketing them together. Understand the drivers of each business and let the winners run, but be sure to carefully monitor the market and regulatory risks of each business.

Last week, we partnered with Money Management to recognise the best performing funds at the annual Money Management and Lonsec Fund Manager of the Year Awards Dinner. A full list of winners can be found below.

Congratulations to all of our award winners and nominees!

Category	Winner
Australian Large Cap Equities	AB Managed Volatility Equities Fund
Australian Small Cap Equities	Perennial Value Microcap Opportunities Trust
Global Equities	Generation Wholesale Global Share Fund
Global Emerging Market Equities	Fidelity China Fund
Long/Short Equities	Solaris Australian Equity Long Short Fund
Responsible Investments	Australian Ethical Australian Shares Fund (Wholesale)
Australian Property Securities	Pendal Property Securities Fund
Global Property Securities	Quay Global Real Estate Fund
Infrastructure Securities	Magellan Infrastructure Fund
Direct Property	Australian Unity Retail Property Fund
Australian Fixed Income	Janus Henderson Australian Fixed Interest Fund
Global Fixed Income	Colchester Global Government Bond Fund Class I
Alternative Strategies	Partners Group Global Value Fund (AUD) – Wholesale
Multi-Asset	BMO Pyrford Global Absolute Return
ETF Provider	Van Eck
SMA Provider	AB Concentrated Global Growth Equities Portfolio
Listed Products (LICs & LITs)	Australian Foundation Investment Company Limited
Retirement and Income Focussed	Legg Mason Martin Currie Real Income Fund
Emerging Manager	Lennox Australian Small Companies Fund
Fund Manager of the Year	AllianceBernstein

Last night Treasurer Frydenberg handed down his first budget a month before the regular budget season. With the possibility of a May election, this budget is as much a political statement as an economic one, with tax measures to please key voter groups, a further boost to infrastructure spending, and the much-vaunted return to surplus. But the implementation of these measures depends on the re-election of the current government, while the surplus itself remains at the mercy of the economic outlook.

The long-awaited surplus

As expected, the underlying cash balance is forecast to return to a surplus of $7.1 billion in 2019-20, or 0.4% of GDP. Revenue growth is being driven by an improving economy, and a surplus may even be achieved slightly sooner than expected given the rise in commodity prices (especially iron ore) and associated company tax receipts.

Budget aggregates

Source: Budget 2019-20

The Budget also forecasts that the surplus will be maintained through the four-year period. However, these forecast surpluses remain small at less than 1.0% of GDP and are based on a range of assumptions. If the global and domestic economies slow, or if the government is not as frugal as it expects to be, the slim surpluses could easily be eroded.

Commonwealth revenue and expenses (% GDP)

Source: Treasury

Income tax cuts

Another key selling point of this Budget is the income tax cuts, both to low- and middle-income earners and high-income earners. The Low and Middle Income Tax Offset (LMITO) will be more than doubled from $445 to $1,080 for this financial year. From 2022-23, the Government will increase the top threshold of the 19% tax bracket from $41,000 to $45,000 and increase the Low Income Tax Offset (LITO) from $645 to $700.

These measures have promised more than what the opposition proposed and are designed to peel low- and middle-income voters away from Labor. These measures are likely to be passed in parliament with oppposition support given many of the measures align with Labor policies, but it will be interesting to see Labor’s response to match these.

The long-term tax changes will take effect from July 2024 and will see a reduction in the marginal rate from 32.5% to 30% for those earning between $45,001 and $200,000. Tax changes this far out will inevitably be subject to future changes and election bargaining, and will likely not receive Labor’s support given their opposition to tax cuts for wealthier Australians.

Taxation receipts (% GDP)

Source: Treasury

Infrastructure spending boost

Infrastructure spending for the next ten years has been increased from $75 billion to $100 billion, or around 0.4% of GDP. This is a small increment from the already committed infrastructure spending and a lot of the money is scheduled for the outer years. Some of the bigger projects include the $2 billion fast rail from Geelong to Melbourne, the $3.5 billion Western Sydney Rail, the $1.6 billion M1 Extension in NSW, the $1.5 billion North-South Corridor in SA, and the $800 million Gateway Motorway upgrade in QLD.

Economic outlook is still shaky

While the budget has delivered a surplus, it remains at the mercy of the economic outlook. The Government is assuming GDP growth of 2.25% this financial year, and 2.75% for the next two years. It also assumes the unemployment rate will remain at 5.0% until 2020-21 and that wages growth will pick up to 3.25% in 2020-21. While the labour market remains strong and is likely to continue to improve further, the wages growth assumption seems optimistic.

The Budget also forecasts inflation to return to 2.5% in 2020-21. This also seems overly optimistic and will likely be revised down again given that wages growth has been incredibly modest despite a tightening labour market. Australia’s GDP growth also faces a range of external uncertainties, including a slowdown in our biggest trading partner China, a slowdown in Europe, and geopolitical risks including Brexit and China-US trade tensions. Overall the economic outlook remains subdued.

Implications for the Australian dollar, RBA and financial markets

The RBA left the cash rate unchanged at 1.5% at its April meeting, however the easing bias saw the Australian dollar trade lower. In contrast, the Budget failed to move the dollar as markets had anticipated the surplus and there were no surprises in the budget measures. While income tax cuts and infrastructure spending—as well as other spending on education and health—are supportive of the economy, there is little in the Budget to boost productivity or shift the economic fundamentals. This means the RBA will likely remain in wait-and-see mode before deciding on the next rate move.

Australia holds on to its AAA rating

Australian general government net debt has been increasing since 2010 but is forecast to peak at 19.2% of GDP in 2018-19. The expected return to surplus and improvement in our fiscal position had already seen Standard & Poors lift its outlook for Australian sovereign debt from ‘negative’ to ‘stable’ back in September 2018. With few surprises in this Budget, Australia is likely to maintain its coveted AAA rating, along with only a handful of other countries.

At below 20%, its net debt-to-GDP ratio remains in the middle of the pack compared to other AAA-rated economies, while the average for advanced economies is higher at a 70% ratio. Holding onto the AAA rating means the Australian government can continue borrowing at cheaper interest rates (compared to lower-rated peers), with the rating favourably affecting the state and local governments as well as Australia’s banks, which tend to be rated one or a few notches below the sovereign credit rating.

Net government debt in advanced economies (% GDP)

Source: IMF World Economic Outlook Database, October 2018; Bloomberg

This is an election budget containing few surprises. A return to surplus is undoubtedly welcomed, but the forecast surpluses are slim and vulnerable to the economic outlook. This Budget does not change the economic outlook for Australia, meaning the RBA will remain in wait-and-see mode with an easing bias. While the Budget contains many measures to please the electorate, it remains unclear whether they will be implemented, especially the long-term tax changes. With a federal election looming, it will also be interesting to see the response from Labor, which currently leads the government in the opinion polls.