HorizonsWin

ter 2

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The success story of Jim Carmichael

A magazine for St.George Private Clients

Rugby’s

matchman of the

Other stories:Evolving market dynamics: Global spotlight

How to keep a healthy self managed superannuation fund

2 | Horizons

Contents

08 International – Economic power shift

10 Investment – Tempered buoyancy

14 Economy – Caton’s corner

18 Property – Signs of hope for residential property

20 Q&A – George Toubia and Vimal Gor

04 Cover story The success story of

Jim Carmichael

16 Evolving market dynamics

Global spotlight

22 SMSF How to keep a healthy self

managed superannuation fund

Web: stgeorge.com.au/private

Horizons — A magazine for St.George Private Clients

Horizons | 3

Contents

WelcomeI trust this issue of Horizons magazine finds you well. In this first issue for 2013 we’re sharing some good news from the latest St.George Private Clients Investor Sentiment Indicator. It reveals a shift in mood among HNW investors who are becoming more optimistic after a turbulent year.

Historically, the outlook in the HNW Investor Sentiment Indicator Survey has been quite accurate. If you followed predictions in this survey of wealthy Australians over the past eight years, you’d have been better off than those who invested in the ASX 200 index. For the coming year, many HNW investors expect a small deterioration in business growth but they see their own financial position as steady.

On the overall fitness of the Australian economy, BT Financial Group Chief Economist, Chris Caton, expresses that the share market got ‘back on track’ in April.

Residential property, on the other hand, is well positioned for moderate growth with demand increasing as a result of limited supply. Investors are upbeat about lower interest rates and higher yields (rents are rising across the country). Even though house prices are trending lower at the moment, we anticipate modest increases of between five and 10 percent per annum.

Another sector attracting attention is emerging offshore economies. We’re focusing on India – one of Australia’s fastest growing economic partnerships – and expect to see business and investment opportunities expand over the coming decades as this increasingly powerful relationship continues to mature.

So please contact your St.George Private Clients Banker.

Happy reading,

Dylan Harrad-Chantler

Head of St.George Private Clients, NSW

If you have any feedback on Horizons, please let your Private Banker know, or email us at privateclients@stgeorge.com.au

4 | Horizons

Profile

Rugby’smatchman

of the

Horizons | 5

Profile

Sporting administrators today are on a roller coaster of highs and lows. By Richard Jones.

In just the last few months, professional sport in Australia has come in for renewed public scrutiny. From the conduct of Australia’s Olympic swimmers, and alleged tanking in the AFL, to drug allegations, bad behaviours and personal failings in a range of sports, sport has settled on the front pages rather than the back pages across the country. Ironically this is at a time when elite sport has never been more professional, competitive and well-funded.

One outstanding success story that bucks the trend is the achievements of Rugby Union in Queensland and its man at the top, Jim Carmichael.

Since being appointed CEO of Queensland Rugby at the end of 2009, Jim Carmichael has breathed new life into the state’s governing body and resurrected the heart of the code in Queensland. He has turned an underperforming code and sporting team into the national benchmark of its industry, culminating in the St.George Queensland Reds winning the 2011 Super Rugby title.

Jim Carmichael believes his vision for a “whole of Rugby economy” and achieving growth and scale is vital to future-proofing the code in his administration’s next three-year plan, the Future Generation strategy. And the numbers are there to back him up. In the three years to 2012, attendances have increased 161 percent, membership is up by 424 percent, and participation has risen 108 percent.

Excellence at every levelCarmichael believes contemporary sport is no longer just about what happens on the field; it is about excellence and influence at every level of the business and the sport.

“When I look at successful sporting franchises and models today, they command my attention. Top teams, I imagine, would have the same philosophies as we do and I don’t believe anything that we say from a leadership perspective is unique. The commonality is that they are all continually striving to be excellent.”

Carmichael says that, while one of the organisation’s major assets is the St.George Queensland Reds and sporting franchises are first judged by their on-field success, the governing body is responsible for growing, nurturing and developing the sport as a whole.

“The challenges arise when we try to build and then balance a model in which all the assets must work concurrently to ultimately deliver our mission to secure our code. By that I mean delivering a strong and sustainable economy that allows the necessary investments into programming, education and infrastructure support to the game’s grass roots.”

Carmichael brings to Queensland Rugby a wealth of experience in sport and business administration. Before his appointment as Queensland Rugby CEO, he spent three years as a senior executive at the Australian Football League (AFL), serving as the executive in charge of New Business and Enterprise.

“In this role, I was responsible for developing major strategic initiatives for the AFL to produce sustainable growth, profit and brand value for its state league bodies and clubs.”

All up, he has almost 30 years experience as a senior executive, board member, and executive management consultant, working across a range of businesses, including local and international firms, private and publicly listed start-ups, and established organisations. He has worked in multimedia, lifestyle, entertainment and major sports industries.

So how does an experienced senior executive measure a sporting organisation’s success?

“We measure our success in a number of ways - participation, membership, attendance and also by the quality of partnerships that we bring into our game and that support the code, from the elite through to the grass roots.

“In terms of benchmarking, we have an incredibly competitive market here in Queensland and we need to be pre-emptive in our decisions. We always keep our long-term strategy for the code in mind, which is to ensure the long-term security and sustainability of the game.

“In 2012, we were the benchmark in our industry and in Queensland in terms of membership and average crowd attendance, while we were ranked ninth overall in membership across all codes which is a significant feat when you consider the membership of clubs such as Collingwood and Essendon.”

6 | Horizons

Profile

Governance reviewA recent governance review has taken Queensland Rugby, and the code itself, to a more modern structure, says Carmichael.

“Some of the more obvious challenges as a state governing body are the governance and performance of the code at a national and even international level. At the state level, we are not always in control of the strategic outcomes for the game, and occasionally our needs may be at odds with the strategic outcomes for the code at a wider level. For me, as a CEO of this sport, those instances are major challenges.”

He is proud that Queensland Rugby has achieved more than 100 percent growth in participation since 2009, with more than 200,000 players participating in Rugby in Queensland in 2013.

Skilled and professional administrators are necessary in sporting organisations, he says. They should not allow themselves to be swept up by the emotion of sport or captured by special interest groups.

Understanding what motivates your stakeholders and how their motivations relate to your business helps to “keep everyone on the same page”, he says.

“Sport is one of the most complex businesses. If you want to do it well, you must fully understand your

sport, as well as all of its relationships and accompanying objectives. These include your corporate partners, stadiums, technologies and consumers. I believe that if you do not take that view, you will undervalue your business and what it can offer,” he says.

“The diversity of the stakeholder base is a challenge. Everyone loves their sport, however they are not always necessarily armed with the skills, knowledge or inclination to deliver what the governing body wants.

“The biggest challenge is not to become unduly influenced by persons or proposed policies that deliver the wrong outcomes for the sport.”

There are challenges in-house as well, in balancing the commercial demands of the business and the performance of the elite team, says Carmichael. The organisation’s solution is to focus on its long-term objective.

Nonetheless, it can be difficult to separate emotion from business in sport, even for a seasoned administrator. Carmichael names the Super Rugby Grand Final in 2011 as “undoubtedly the best moment in sport” as he watched the players run out before a packed stadium of more than 52,000 adoring fans.

“It is important to understand this was a group of young men who, two years before, were without

Profile

Horizons | 7

reputation, had limited intellectual property, and low self-esteem as a group. For me it was not about the success of that evening, winning the Super Rugby title, it was simply seeing the faces in the crowd and just what it meant to those young men to be able to be important to so many people in Queensland.

“That was undoubtedly one of the proudest things I have ever been attached to professionally.”

Measure of successWhen it comes to a career as a professional manager and sports administrator, Carmichael believes it is about seeing where you have been and the work you have done.

“Not just in terms of the success of your organisation by way of a balance sheet; it is also about seeing your people grow and seeing your people develop. It’s also seeing people you admire, admire you for the work you have done.

“For example, in less than two years, we transformed the fortunes and the outlook of Queensland Rugby. We created a vision for a “whole of Rugby economy” by focusing on building the health of the code for the future generation and many years beyond that.”

Carmichael stresses that, for him, everything begins with examining what the long-term outcome needs to be.

“This philosophy applies not only to my business but to my personal growth and ambitions also. Everything I undertake professionally is about stretching and growing every part of the organisation, from the board, to CEO, right the way down to our youngest staff member – that is how I learn. With learning comes growth, and first and foremost the most important objective of our sport is growth.”

Asked for his tips for aspiring sports administrators, Carmichael recommends learning to be patient.

“Do not see leadership as a career aspiration; see it as a personal aspiration. Be prepared to learn up and learn down. Everyone has something worthwhile to say if you have them in your company and you have determined they have a part to play.

“I think you have to lead by example and act with honesty and integrity, not just with the organisation’s ambitions, but also the staff, because it’s the staff who are at the heart of the organisation,” Carmichael says.

Queensland RugbyQueensland Rugby is the governing body for the code of rugby union in Queensland.

In its 130th anniversary year, the union has 27 affiliated members and represents the interests of more than 200,000 players at over 200 clubs and 450 schools that incorporate around 20,000 officials, administrators and volunteers across the state.

Queensland Rugby is also responsible for the representative rugby pathways that culminate in the professional Super Rugby team, the St.George Queensland Reds Super Rugby Champions in 2011 and back-to-back Australian Conference winners in 2011/12. The Reds continue to capture the hearts and minds of the rugby community in Queensland (and elsewhere) after re-energising the game with their flowing brand of Rugby and their ongoing community engagement.

St.George has been the proud partner of the St.George Queensland Reds since 2010. St.George began as the sleeve sponsor and stepped up to be the major sponsor in 2011, the year the St.George Queensland Reds won the Super 15 Championship. In 2012 St.George Bank signed on as major sponsor for another three years.

St.George are extremely proud to be able to support not only the Reds but the Queensland rugby community on a wider scale via a dedicated Rugby Referral Program, driving direct financial benefit back to clubs. The association has been a true partnership and one that has worked well across so many levels for the Bank and also the QRU.

Richard Jones is a freelance writer.

8 | Horizons

Contents

Economic power shift

Horizons | 9

International

As the Asian century unfolds, India is grabbing the attention of investors. By Tracey Evans

Prime Minister Julia Gillard’s visit in 2012 to India has underlined the potential value of the country to the Australian economy as emerging market economies, particularly those in Asia, begin to pull their economic weight.

More than a third of the world’s economic output is now located within 10,000 kilometres of Australia and it’s expected to continue to rise, according to Federal Treasury Secretary Dr Martin Parkinson in a recent speech.

“Clearly, much of this shift is attributable to the growth of China and India – combined, these economies accounted for less than one-tenth of the global economy twenty years ago. Today they account for over one-fifth.”

Long-term projections, as far ahead as 2050, place India as one of the biggest economic powers in the world. It wasn’t always the case. Despite having the world’s second largest population after China, India was struggling before the introduction of tough economic reforms during the 1990s. They helped India to withstand the global financial crisis and set the country on a path to prosperity, according to many commentators, notwithstanding a slight weakening of late.

For Australia, it means that business and investment opportunities in India are likely to expand over the coming decades as the two countries build an increasingly powerful relationship, says international economics and diplomacy expert Professor Peter Drysdale, a member of the Advisory Committee that guided the work of the taskforce for the Federal Government’s White Paper on Australia in the Asian century.

Drysdale, the Head of the East Asian Bureau of Economic Research and East Asia Forum at the Australian National University’s Crawford School of Public Policy, notes that China’s population is expected to peak relatively soon and the labour force has already begun to shrink. “So relatively what’s commonly called the ‘demographic dividend’ [a rising economic growth rate due to an increasing number of working age people] is running out of steam. Whereas in India, the demographic structure is still quite young and the demographic dividend will continue for quite some time.” (see graph)

In the next five years alone, the expectation is that there will be about 12 million young entrants to the Indian workforce, says Drysdale.

“On top of that, there are 3 million Indians under the poverty line that can be drawn into more productive activities. So the opportunities to capture the benefits of the expansion of the workforce opportunities are strong,” he says.

“India now has a high investment rate from domestic savings, with about 40 percent of GDP going into investment and 36 percent of that drawn from domestic savings. With that level of investment, given the relationship between investment and output, India has a potential rate of growth of at least 10 percent a year. That means that growth rate can absorb population growth and deliver strong growth.”

Australia’s trade relationship with India has grown rapidly; in fact it’s one of our fastest-growing economic partnerships.

“India accounts for about four percent of our total trade. We export around $19-$20 billion worth of goods and services to India, mostly coal, gold and education,” says Drysdale. “We should also welcome and encourage greater investment from India, to help open up the commercial links between the two countries.

“The expectation is that, if India continues to open up, Australia’s opportunities there will parallel the growth in trade with East Asia,” Drysdale says.

2010 2015 2020 2025 2030 2035 2040 2045 205050

55

60

65

70

75%

China

India

Australia

Source: UN population projects and Australian Treasury, 2011

10 | Horizons

Investment

Tempered buoyancyWealthy Australians are becoming more optimistic, according to the St.George Private Clients Investor Sentiment Indicator.

The latest survey of high net worth (HNW) investors shows a jump in positive sentiment, with the index now at its highest level in the six quarters of its history. The overall score in the St.George Private Clients Investor Sentiment Indicator in the first quarter of 2013 was 13.4, compared with 5.4 for the previous quarter.

While last year’s volatile results may point to a need for cautious optimism, says Jane Watts, BT Financial Group’s General Manager, Private Wealth, there’s no doubt there’s been a shift in mood as this year gets underway.

The Investment Sentiment Indicator, produced by St.George Private Clients in partnership with CoreData Research Australia, provides an insight into investment markets by examining both past results and investor intentions.

“In fact, the research shows that, if you had followed the predictions of wealthy Australians over the past eight years of the survey, you would have been better off than those who kept invested in the ASX 200 index”, says Watts.

“There’s a pretty strong correlation with the ASX 200 so the Indicator is often a good sign of where the market may be going. It’s a very interesting indicator to watch.”

The survey comprises five key drivers: market prediction, household financial security, investment satisfaction, new investment product purchase intention, and intention to invest new money into existing investments.

For the most recent survey, more than 220 HNW investors were interviewed in the February 13-27 period from CoreData’s panel of about 17,000 Australians holding investment portfolios of $1 million or more (not including their superannuation or principal place of residence). Those with an annual household income of $250,000 or more are also classified as HNW investors.

Horizons | 11

The indicator also compares HNW investor sentiment with that of ‘mass affluents’ – investors holding smaller portfolios of $50,000 to $750,000. The research shows that sentiment among mass affluents typically lags HNW investors by about 12 weeks. While sentiment for this group remained in negative territory, it improved to -4.2, its highest level since 2010, compared with -7.0 in the previous quarter (Q4 2012); -9.9 in the third quarter and -23.5 in the second quarter (the lowest level recorded in the indicator’s eight-year history).

Investor intentionsDespite the renewed optimism, HNW investors indicated they were less likely to make further investments, compared with the last survey. The Investor Intention Indicator registered a drop from -6.4 in the period before Christmas to -12.0 in the first months of 2013.

As with the Investor Sentiment Indicator, there is a considerable difference in intent among the mass affluents, who are still much less likely to invest (-19.6) than HNW investors.

12 | Horizons

Investment

The difference may be partly explained by the HNW investors having more active investment strategies based on broader sources of advice, and generally being more willing to rebalance their portfolios in a timely fashion.

In terms of asset class, the 2013 first quarter data reveals that HNW investors continue to consider equities as the most preferred class when rebalancing their portfolios.

The HNW equities sentiment index has jumped to 32.0 points, its highest level in six quarters. The mass affluent investor equities sentiment has also increased to 11.0. This is the first time it has been positive since Q2 2011.

In contrast, two in five say they are less likely to invest in property trusts, the bond market or cash.

More than 68 percent of HNW investors believe the Australian share market will outperform residential property in the next quarter. This has grown from 41.2 percent in Q4 2012.

Similarly, the proportion of mass affluent investors that believe shares will outperform property has increased this quarter, although not to the same extent as HNW investors.

The shift in sentiment suggests the equities rally is expected to continue.

Looking at the broader picture, many HNW investors anticipate an improvement in business conditions in the next quarter. Meanwhile there’s been a considerable increase in the number of HNW investors who believe the financial position of their households will be somewhat better over the next 12 months.

The proportion of HNW investors who expected the Australian economy to grow at a faster rate over the next quarter increased from 22 to 35.8 percent. Accordingly, those who thought it would slow down fell to 40.1 percent from 52.8 percent in the previous quarter.

If you would like to receive the latest St.George Private Clients Investor Sentiment Indicator report, contact your Private Banker.

Horizons | 13

Investment

14 | Horizons

Economy

Caton’s corner01 May 2013

Chris Caton Markets, EconomicsBT Financial Group

The share market got “back on track” in April, with the ASX rising by 4.5% in the month, to be up by 11.7% so far this year. The end-April level was the highest end-month close since June 2008. The US share market, as measured by the S&P500 index rose by 1.8% in the month, to be up by 12% year-to-date.

Previously I have written about the Cyprus situation and suggested that it could turn out to be a one-month wonder. So far, that assessment has held up. But other international risks emerged during the month.

China reported disappointing GDP growth in the first quarter of the year. That economy grew by “only” 7.7% in the past year, and at an annualised rate of 6.6% in Q1. The most interesting point about the latter figure is that it is not usually published; analysts usually have to back out an estimate of the current quarterly growth rate from the published annual data. 7.7% growth is hardly shabby, but it compares with a consensus forecast of 8.2% for 2013, a figure that now seems unlikely to be attained. The official view, on the other hand, has been that the economy would achieve about 7.5% growth, so this month’s news should perhaps not have been too surprising.

It’s not just China that reported slower growth. A number of indicators in the United States (March employment and retail sales for example) suggest some slowing there. Plus we know that sequestration (mandatory cuts in government spending) is already having an effect, which will intensify in the coming months. Government spending was a drag on the economy even before sequestration. In the past six months, it has declined at its fastest pace since the end of the Korean War in the mid-1950s, while since the economic recovery began in mid-2009, public-sector austerity has sliced about 1 percentage point per year from overall economic growth. The US reported growth at an annual rate of 2.5% in Q1; this is likely to slow to 2% or less in Q2.

What’s significant about this is that we’ve been here before. Indeed, in each of the past three years, the US economy has experienced something of a springtime swoon in growth. Like Pavlov’s dogs, economists and analysts are primed to expect it to happen again.

And where the economy goes, the share market tends to follow. For many years, there has been in mantra in the market: “sell in May and go away”. This refers to the statistical regularity that, on average over a long period of time, share markets around the world have tended to do worse in the six months beginning in May than they do in the other six months of the year. Note the words “on average”; there is nothing inevitable about this.

Take one long-run average and overlay apparent cyclical weakness and what happens? The US share market has had a “local peak” in each of the past three Aprils, and has then fallen by an average of more than 10% in the next two months, as the following table shows. Furthermore, it has taken an average of almost seven months before the market has regained its April peak, although this period has been (artificially?) lengthened by the 2011 experience, when the market began to recover but then fell hard again in the second half of the year because of concerns about Europe.

Horizons | 15

Economy

Springtime Swoons in the US share market

Date of Peak

Date of Trough

% Fall Return to April Peak

2010 23 April 2 July 16% 11 October

2011 29 April 15 June 7.2% 24 Feb (2012)

2012 2 April 1 June 9.4% 6 September

Average 18 April 16 June 10.9% 14 November

This doesn’t have to happen again this year, and my belief is that it won’t, but the fact that it has happened in each of the past three years means that the level of uncertainty about the near-term direction of the market will remain high for some time. In particular, the flow of US economic data will remain under close scrutiny for any signs of slowing. Any subsequent weakness in the US market is likely to be translated to the Australian market, which is no longer fundamentally cheap. Message: expect significantly slower gains in the months ahead. I maintain my forecast for the ASX200 index of 5300 at the end of the calendar year, although the risk now appears to be to the upside.

Incidentally, there has also been some good international news. Both the UK and South Korea have reported better-than-expected growth lately (although in the case of the UK, the rejoicing was that Q1 growth was actually positive!), while Japan has embarked on a program of quantitative easing that, measured relative to the size of its economy, dwarfs efforts in the rest of the world.

The outlook for monetary policy has changed in Australia. In my view, the Reserve Bank is now likely to cut the cash rate again in either May or June. In the past month, we learned that the employment gain in February was indeed overstated (this should have surprised no-one). The March data show just a 0.9% increase in employment in the past year. More importantly, the unemployment rate now stands at 5.6%, up from 5.4% in February and 5% in April 2012. In addition, the March quarter CPI release showed that inflation continues to be remarkably low.

The well-known deterioration in the nation’s fiscal position also means that monetary policy will have to do more than its share of “heavy lifting” in maintaining growth in the Australian economy. We now know that the Budget has lurched into significant deficit for the current financial year as revenue growth has collapsed,

and that it is likely to remain in deficit, in a structural sense, for several years yet. I have argued previously that the commitment to return quickly to surplus was not good economics, but a medium-term plan to get back in the black is necessary. No matter which side wins the upcoming election, there will be a lot of repair work to be done. Hard as it is for Australians to accept this, not all of this can be done by cutting spending; tax increases should also be on the table.

If you would like to see more of my reports, please ask your Private Banker.

Chris CatonChief Economist The views expressed in this article are the author's alone. They should not be otherwise attributed.

Disclaimer and DisclosureThis publication has been prepared and issued by BT Financial Group Limited ACN 002916458. While the information contained in this document has been prepared with all reasonable care no responsibility or liability is accepted for any errors or omissions or misstatement however caused. All forecasts and estimates are based on certain assumptions which may change. If those assumptions change, our forecasts and estimates may also change.

16 | Horizons

Investment

George Toubia Chief Investment Director for BT Private Wealth

Since the start of 2013, signs of improving economic growth have emerged in global markets. Despite these positive signs, we expect the global growth trajectory to remain gradual for far longer than many market participants expect. Therefore the search for differentiated risk-adjusted returns and growth opportunities persists and becomes more acute after the recent global credit and equity market rallies. Here, we explore conditions in credit and equities markets.

Snapshot of market conditionsThe US equity markets have experienced a decent rally since the start of the year. This was driven by a range of factors: the fiscal compromise, awareness that an automatic $85bn in spending cuts represents a very small percentage of the US’s GDP, improving economic data, energy efficiency, productivity and, importantly, better than expected corporate earnings.

It’s a different story in Europe, however, where economies broadly remain weak. Although the European equity and credit markets have enjoyed good returns since the start of the year, this has largely been in response to less onerous banking liquidity requirements. There is still a need for significant

structural reform to European economies to underpin future growth. Hence, we are concerned that European markets are ahead of themselves and that conditions are structurally favourable for distressed investment opportunities in Europe.

Asia is a quiet achiever. Focus on quality of economic growth, reduced political uncertainty and attention to necessary reform are creating a renewed focus for investors in the region.

Back home, large Australian businesses are at an important crossroads. Markets are waiting for large listed companies to demonstrate they can either put in place plans to grow their top line, or restructure their business to adapt and lower costs to enable them to maintain their earnings.

In credit markets, we have seen compressed yields in global and domestic credit yields and spreads.

Focus on sound fundamentals and reasonable valuations when investing in global equitiesThere are growth opportunities in global equity markets. But one needs to look for sound fundamentals to drive forward earnings and support reasonable valuations. For those investors focusing on dividends, it is sustainable dividends – and not the ones masking poor earnings – that warrant differentiation.

In Australia, the major banks have delivered value this year and it’s likely they will continue to do so in the near term as they benefit from cheaper wholesale funding supporting their net interest margins. In contrast, other sectors will need to work very hard to deliver top line revenue growth; although many major businesses are lowering their cost base and cutting capital expenditure. In this environment, opportunities lie in interest rate sensitive and diversified financials, corporates with sustainable return on equity and dividends, and those ahead of others in their restructuring initiatives.

Evolving market dynamics: global spotlight

Horizons | 17

Investment

Globally, multinational corporations with dominant market positions and cost advantage, whose earnings are resilient, is an area that may pique investors’ interest. Investors might also explore companies that are operating in sectors where long-term growth is expected, or that are exposed to specific Asian markets.

In the US, record stimulus coupled with low mortgage rates, energy efficiency, gradual healing of negative home equity, productivity and manufacturing renaissance are driving the US economy through its adjustment phase. This is creating opportunities in various asset classes. With global labour cost rebalancing at play, US competitiveness is now becoming attractive compared to the traditional areas of Asia and Eastern Europe, which are undergoing upward adjustment in their cost structures.

Indeed, when it comes to the transition economies of Asia, Latin America and Eastern Europe, prospects in Asian markets are relatively more attractive than in other developing regions. This is due to the potential for Asian businesses to grow earnings, the region’s demonstrated ability to manage inflation, improving credit discipline and current reform initiatives (relative to the other two regions). It’s worth further exploring some of these factors.

There are favourable conditions in Asian markets for investors, including reasonable valuations, manageable inflation, decent earnings growth, mild investor positioning and lower policy uncertainty than in the past. Asia now represents 60 percent of world growth and the conditions for continuing growth remain

promising. Coupled with this are low corporate and household debt levels.

China’s focus of prioritising quality over quantity and demonstrable persistence to contain property prices (by tempering consumer demand through various measures) is exactly the right approch that will create longevity to medium-term opportunity, although this may not be welcomed by markets over the short term. We are focused on quality and longevity.

Asian nations are also turning their attention to large infrastructure and transport projects, especially in South East Asia and particularly in the Philippines. Other countries such as India are starting to encourage increased investment, hence allowing greater participation in markets from large global companies. These positive factors, as well as continuing tax, social security and interest rate reforms, make select Asian equities attractive for investors, especially in the face of uncertainties in other markets around the world.

Credit landscape: never has discipline been more importantGlobal and domestic yields and credit spreads compression has significantly lowered prospective returns on credit. High dollar bond prices offer little-to-no margin for safety. We couldn’t stress enough the importance of resisting the temptation of generically and universally moving down the capital structure (lower seniority) and longer across the term structure (longer duration) for the sake of yield capture. Only selective cases of credit strength may warrant that.

18 | Horizons

Property

Signs of hope for residential propertyThe residential property market, in some parts of the country, is one bright spot in a patchy and uncertain outlook for the Australian economy.

With mining investment set to peak, there is hope for other areas of the economy to fill the gap. Unfortunately, some of these sectors have been slow to pick up, and the transition is unlikely to be smooth sailing. After solid growth of 3.7 percent in 2012, we expect the Australian economy to grow at a below trend pace, just below 3 percent in 2013.

The impending peak in mining investment, however, has been a factor in the RBA’s decision to cut interest rates which are now well below their long-run averages. Being sensitive to interest rates, housing is one area of the Australian economy that is well positioned for moderate growth.

Over the past decade, a lack of new supply has placed a floor under house prices. Residential building has been running at below average levels for some time, notwithstanding certain parts of the country. At the same time, population growth has picked up once again, after slowing throughout 2010 and 2011.

Successive interest rate cuts since November 2011 have begun to have an effect on the market. House prices across the country have stabilised and most capital cities are starting see modest annual growth. In the year to April 2013, Australia-wide house prices rose 2.7 percent according to RP Data-Rismark. Dwelling prices in Darwin (5.9 percent), Perth (3.5 percent), Canberra (2.7 percent), Sydney (3.7 percent) and Brisbane (2.0 percent) grew in the year to April 2013. Even in Melbourne and Adelaide, where housing markets have underperformed, dwelling prices are also on the increase, with annual rises of 1.6 percent and 1.0 percent respectively. Only dwelling prices in Hobart are in decline, falling 1.4 percent in the year to April 2013.

Slow but steady improvementThe pre-conditions are in place for further growth in house prices, and an improvement in residential construction, although performance is likely to be uneven across the country. For investors, rental yields have improved in many capital cities. According to the

Real Estate Institute of Australia, weekly rent for a two-bedroom “other dwelling” (unit) rose significantly in Darwin (14.3%) and Perth (10.5%) in the year to the December quarter 2012. Two-bedroom units in Sydney and Brisbane also saw rents gain in the year, rising 4.4% and 2.9% respectively. The improved yield is encouraging to many investors, who are now also appreciating the low-interest rate environment. Rental markets are considered tight in Melbourne (vacancy rates under 3 percent) and very tight in Sydney, Perth and Brisbane (vacancy rates under two percent). Low vacancy rates indicate there is still strong demand for rentals, and there is scope for rents to rise further. The recent stabilisation in house prices should also give greater confidence for investors to purchase. A slight pickup in investor housing credit is suggesting that investors have been encouraged by more favourable conditions.

For owner-occupiers, affordability has increased. Demand from owner-occupiers has been slow to respond to recent rate cuts. Additionally, there has been a drop in first home buyers as a proportion of owner occupiers due to changes to the benefits for first home buyers. This impact has been more pronounced in New South Wales and Queensland. Despite these changes, we expect that would-be home buyers will eventually return. The improved affordability should outweigh the loss of incentives in these States.

Generally, first home buyer activity is important for driving a recovery in housing, because it adds to housing demand and provides a market for those wanting to upsize. However, a pickup in first home buyer activity may not necessarily be a precondition for house price growth in this cycle. If uptake by first home buyers remains low, then rental markets will likely remain strong and further boost investor demand.

We should see some modest house price increases of between 5 percent and 10 percent over 2013. This is a much softer pace of growth than in earlier years. It is unlikely we’ll see the nearly 20 percent growth that was witnessed in the early 2000s any time soon. But we expect a recovery nonetheless.

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House prices in Perth and Sydney are likely to continue to outperform the Australian capital city average, since these cities have seen below average activity in residential construction in recent years. Melbourne may continue to underperform until the recent boost in supply flows through the market, but relatively strong population growth and low interest rate settings should see modest gains in the Victorian capital as well.

Brisbane and Adelaide have not performed as well as other Australian capital cities, but we expect some improvement in those cities in the longer term. For housing in Canberra, it faces a mixed outlook given the impact of fiscal tightening from the Federal Government. However, strong population growth and high rental yields should put a floor under house prices.

In Tasmania, conditions are likely to continue to lag for some time as the high Australian currency and rising unemployment impact on housing markets in that state.

Downside risks remainThere are some uncertainties that could dampen a recovery in house prices. While the unemployment rate is currently low, there is a risk that it could edge higher. In many parts of Australia, business conditions are subdued and companies have indicated they are somewhat concerned about the outlook, which may weigh on hiring, in turn impacting on people’s desire to either enter the housing market or upgrade. Concerns about job security are likely already keeping potential home buyers sidelined.

Reluctance by Australian households to increase their levels of gearing, following a trend in recent years to pay down debt and increase savings, may also restrain prices. Household debt as a proportion of disposable income remains high, although it has declined from its peak in 2007.

The major area of concern for the outlook for housing and the domestic economy is the high Australian dollar, which is weighing on certain sectors such as manufacturing, tourism and education. Recently, it has fallen, however we expect the Australian dollar to

remain high and stay close to parity. The sustained strength of the currency is a likely factor behind subdued business confidence in recent times.

There also remain concerns for the global economy. The debt problems in Europe are complex and have the potential to destabilise financial markets. Although leaders have taken important steps to resolve some of the issues, the region is in recession and unlikely to see much growth next year.

Despite the risks, there are reasons to be optimistic Talk of the mining boom coming to an end has been overdone. We are heading into a new production phase that promises to increase Australia’s export capacity. China is expected to post strong growth this year, providing a solid base for continued demand, and, although the peak in commodity prices is probably behind us, the situation is not as negative as some commentators would suggest. In the US, notwithstanding some fiscal challenges, the outlook for the largest economy in the world is also generally more positive, given its housing sector is finally on the mend.

The range of data to date also suggests that a recovery in Australian housing has still further to run. Housing finance is growing at a modest pace. Auction clearance rates have picked up. An encouraging sign is the improvement in home buyer sentiment, according to the most recent Westpac-Melbourne Institute “good time to buy a dwelling” index which is near its highest since 2009.

If the outlook turns out worse than anticipated, there is scope for the Reserve Bank to stimulate the Australian economy by cutting rates further. This would help mitigate any fallout from a deterioration in economic conditions. The more interest-rate-sensitive areas, including housing, would therefore be set to benefit.

Janu Chan Economist, St.George Banking Group

20 | Horizons

Q&A

Vimal GorHead of Income and Fixed InterestBT Investment Management

What’s the outlook for fixed interest investments? BT Private Wealth’s Chief Investment Director George Toubia talks to BT Investment Management Head of Income and Fixed Interest Vimal Gor.

George Toubia: Given the contraction in both credit spreads and significant rally in government yields, where do you see the opportunities and risks in fixed income investing as at now?

Vimal Gor: On a long-term valuation basis, bonds markets are arguably overvalued. But we are still going through a deleveraging and a slow-growth environment in the global economy and we know that these deleveraging cycles take a while.

Given this backdrop we think it is unlikely that bond yields will rise in the medium term and there is significant risk that bond yields will actually fall further providing capital gains from that part of your portfolio.

Irrespective of whether you think bonds are over or undervalued, the key is to have bonds as part of a balanced portfolio because they offer diversification against equities. If you don’t have bonds and just have term deposits, you don’t get any negative correlation benefits.

GT: The government bond market of Australia is significantly held by overseas institutional investors. Isn’t that affecting the price action in that sector and its liquidity?

VG: The latest numbers show that around 80 percent of Australian bonds are held by overseas investors. If you look at the RBA [Reserve Bank of Australia] breakdown,

Australian pension funds only own about five percent of the Australian bond market.

When you see large holdings from overseas, they tend to buy the bonds and lock them away to get the yield out of them and they tend not to come back to the market so that does impact on liquidity. But, if we compare that to what’s happening in Europe, the US and UK, where markets are experiencing large amounts of quantitative easing, liquidity is also drying up.

GT: There’s probably a positive angle in that sovereign or global institution players, holding Australian government bonds for the longer term, gives certainty that this will remain a relatively stable market as opposed to one that may experience forced liquidation?

VG: That’s the point. If there’s large overseas buying it’s because it’s a high-quality asset. We have a very good credit rating, very low net debt to GDP ratios – and there are myriad strong reasons why you should be buying Australian bonds, and that is what has driven the overseas holdings up to such a high level. We think it’s a good thing. Australian bond yields are one of our favourite assets in the world and we still favour being long here.

GT: Obviously we’re surprised that market participants are not allowing for the possibility for lower yields in Australia, especially with the structural change our economy has to go through. What are your thoughts on that?

VG: Yes, that’s a key point for bond yields – a lot of people didn’t believe they’d go this low; we hit new all-time lows in 2012 and we forecast they will fall back towards these lows.

Part of the reason people are so concerned about the level of yields right now is they can’t get their head around the RBA taking real interest rates negative, so they believe the floor on interest rates will be somewhere around 2 to 2.5 percent.

We don’t believe that’s the case. We think the RBA will be more than happy to take rates negative if the economic growth warrants it. The crucial period is in 2013/14 when the mining capital expenditure will slow without a boost from the rest of the economy to offset it. We were saying back in early 2011, when rates were at 4.75 percent, that we thought they’d bottom out between 1 and 1.5 percent sometime in 2014 and we still think that forecast is credible.

The search for yield

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GT: As for other opportunities within your mandate – such as the semi-government bond market, swap spreads and currency opportunities – what areas represent reasonable value outside government bonds for you?

VG: We have a strong view that swap spreads globally should continue to tighten as they have done throughout the world. Obviously Australian swap spreads have come in recently, but the narrowing is much more pronounced in the overseas markets and that’s because governments are explicitly trying to bring down that credit premium. If you look at the UK’s Funding for Lending scheme, the government is actually lending to small business via banks, therefore there should be zero swap spread in the market. While we understand why Australia structurally should trade with a higher swap spread than globally, we still believe there’s more room for swap spreads to fall and we are playing that trade.

In terms of currencies, we believe the US dollar is undervalued in the medium term and that the Australian dollar is very overvalued.

GT: Would you reconsider Australian government bond risk if the Australian dollar falls, given the large number of offshore holders of Australian government debt?

VG: We’re not worried about wholesale selling of Australian bonds, but it is something that we look at and try and model. It’s fair to say that the large-scale reallocations into the Australian dollar have already happened. While overseas buyers normally buy bonds unhedged, and therefore a weaker currency will negatively impact on their holdings, we think they’re reasonably happy with their exposures right now.

GT: You analyse forward-looking indicators and commodity inputs in terms of the effect on risk appetite and the general level of spreads. Are there any strong signals right now from your process?

VG: What’s jumping is that many asset classes – specifically US equities – are being driven by liquidity, as the search for yield goes on. You can see that clearly through credit spreads, which are declining. So it’s very clear to us that central banks globally are driving asset

prices up to levels that may not be sustainable over the medium to long term. The clearest example of that is the US equity market where the recent rally has all been driven by multiple expansion rather than earnings growth.

GT: As a veteran fixed income and interest rate portfolio manager, what observations do you have in terms of how the world responds to a very low interest rate environment and flat yield curve?

VG: That’s an interesting point about the yield curve because Australia has by far the flattest yield curve of any developed market. Numerous empirical and academic studies show that the steeper the yield curve, the stronger economic growth; the flatter the yield curve, the more likely growth will slow. That’s a potential worry for us, and one of the reasons we expect growth to tail off over the next couple of years.

When comparing Australian investors relative to the UK and US, in Australia we’ve been very lucky to have high yield and it would be fair to say that’s going to stop. Interest rates are going to continue to come down and we need to get used to generating a lower level of return on our assets.

If you look at the level of holdings in fixed income in Australia relative to overseas, we are materially lower. There are a couple of reasons for that, including our demographics. But it’s not hard to see Australia moving to the same equity bond weightings they have in the rest of the world. And that will mean material will shift into fixed income, and the acceptance of lower returns that goes with that.

GT: Even if decisions are made to reallocate to a world standard in terms of equity bond balances, doesn’t the size of these domestic markets make it technically difficult?

VG: Yes. In an environment where bond yields will probably stay at current levels or go slightly down over the next few years and the US equity markets will probably trade in this range, you need active management of both your equities and bonds. That’s why you need to look at managed funds and have your manager actively move your asset allocation around for you.

22 | Horizons

SMSF

Matthew van DijkSenior Private Client Adviser, St.George Private Clients

The rules for self managed superannuation funds allow for many different opportunities. They also allow for plenty of pitfalls for the ill-advised. As an adviser it’s my job to have some of the ‘black thoughts’ for my clients, so I’d like to share three common issues we’ve been seeing lately.

1. Looking at a single piece of the puzzle, instead of the whole pictureSuperannuation, irrespective of whether it’s self managed or not, is often dealt with separately to other financial concerns. In reality, it is one-third of three major interlocking financial strategies. The second is appropriately managing risk transference (typically via an insurance policy or adequate cash reserves) and the third is about planning for the early death or disability of the member.

Dealing with any one of these three areas should trigger a conversation around the impact on the other two. For example, when trustees develop and incorporate their Insurance Strategy (in line with the SIS amendments introduced on 7 August 2012) consideration needs to be given to whether or not holding insurance inside of superannuation is the best way to proceed, given the complex tax issues and accessibility issues around the benefit.

As superannuation is a separate asset generally not dealt with by a Will, consideration should also be given to the estate wishes of the member to avoid potentially lengthy and expensive challenges to an estate or fund, as well as avoiding any unnecessary tax liabilities.

2. Funds with large, illiquid assetsFor some people an SMSF provides a superb way to gain access to assets not available in a public offer fund, such as commercial and residential real property.

Should the bulk of the fund be invested in a single property, this can become an issue in a number of circumstances. For example, if the fund is paying a pension and the net rental income cannot meet the minimum payment required (perhaps due to unexpected loss of tenants or a business collapse), assuming there are no other assets or contributions available, a range of tax penalties can apply to both the fund and the pension recipient.

Additionally, in the event of the death of the member, a death benefit must be paid to their dependants or their estate. One of the worst case scenarios in this instance is that the property must be sold to pay the deceased member’s benefit, potentially resulting in a sale price below expectations and definitely resulting in costs associated with disposal of a property.

It is worth noting this is a complex area and requires individual attention, given the myriad of different situations and variations to specific trust deeds.

3. New SMSF penalty regimeNew penalties for contravening the SMSF rules are due to come into force from 1 July 2013. The penalties provide the the ATO with more flexibility in dealing with noncompliance.

The options currently available to the ATO are considered to be at the ‘heavy handed’ end of the scale: making the fund non-complying for tax purposes, applying to a court for civil penalties to be imposed or criminal penalties for more serious breaches of the law, accepting enforceable undertakings and the disqualification of a trustee of an SMSF.

The new penalty regime can result in the ATO imposing rectification and education directions as well as administrative penalties. The administrative penalties can be as much as $10,200 and cannot be met from the assets of the fund, meaning recalcitrant trustees or corporations must pay the money from their own reserves.

The administrative penalty system appears to be much easier to apply and enforce. Trustees of SMSFs must accept that ignorance is no excuse and really push to ensure the fund they administer is following the letter of the law at all times. I know I could think of other ways to spend the $1,700 fine for failing to keep member reports for 10 years or 10 years’ worth of trustee minutes!

In closingWith the right advice, you may be able to successfully unlock a vast range of investment and strategy options for your self managed superannuation fund. The strategies mentioned here provide general information, so you’ll need to check whether they work for your fund. It’s also worth remembering recent changes to the regulations, requiring that SMSFs give consideration to holding life insurance cover for members. With the help of a St.George Private Client Adviser, drawing on a range of expert resources, you can ensure you comply with the often complex SMSF rules and avoid holding a stressful, mismanaged superannuation fund.

As a Trustee and member, you’re in the best position to engage your trusted advisers to work with you in developing the right solution for you and your family.

Staying super healthy

Horizons | 23

Disclaimer

This publication has been compiled by St.George Private Clients. St.George Private Clients provides specialised services to customers of St.George Bank. St.George Bank – A division of Westpac Banking Corporation ABN 33 007 457 141 AFSL 233714. This publication is current as at time of preparation – May 2013.The information and any advice in this publication is general in nature and does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. It is important that your personal circumstances are taken into account before making any financial decision and, as such, you should seek detailed and specific advice from a suitably qualified adviser before acting on any information or advice in this publication. The information contained herein does not constitute an offer to acquire a financial product. Your individual situation may differ and you should seek independent professional tax advice in relation to your circumstances. Material contained in this publication is an overview or summary only and it should not be considered a comprehensive statement on any matter nor relied upon as such. Any taxation position described in this publication is general and incidental to the financial advice. You should consult a registered tax agent for specific tax advice on your circumstances. While the information contained in this publication is based on information obtained from sources believed to be reliable, it has not been independently verified. To the maximum extent permitted by law: (a) no guarantee, representation or warranty is given that any information or advice in this publication is complete, accurate, up-to-date or fit for any purpose; and (b) neither St.George nor any member of the Westpac group of companies are in any way liable to you (including for negligence) in respect of any reliance upon such information or advice. Any outlooks given in this publication may be based on incorrect assumptions or may not take into account known or unknown risks and uncertainties. Past performance is not a reliable indicator of future performance.

St.George Bank – A Division of Westpac Banking Corporation ABN 33 007 457 141 AFSL 233714.ST20321 03/13