Spring 2007

The power of reinvestment and margin loans

Automatically reinvesting your dividends and distributions into your margin loan is an easy way to increase the margin on your loan and the equity in your investments.

Interest rates up again… and so they should

The RBA's announcement on the second Tuesday of the month can impact upon anyone who has borrowed to invest. BT's Chief Economist. Chris Caton, BT's Chief Economist, tells us why an RBA move to increase rates now can actually save us over the long-run.

To gear, or not to gear…

After a long period of growth in the Australian share market, what would a geared investment into Australia's BHP three years ago look like now?

Markets and Performance - October 2007

Global share markets were generally stronger in October, despite the International Monetary Fund (IMF) cutting its forecast for global growth next year. October also saw the Aussie dollar hit a 23 year high as investors made a beeline for currencies with higher returns.

The power of reinvestment and margin loans

Many investments, both shares and managed funds, give you the option to have the dividends (from shares) or the distributions (from managed funds) automatically reinvested.

Choosing the reinvestment option for your margin loan investment is an easy way to increase your available funds to make sure you have enough for that next investment opportunity. Here’s how it works, and how you can benefit.

How does dividend or distribution reinvestment benefit you?

Choosing to have the income generated from your investment automatically reinvested can give your earnings a boost because you are adding to, or compounding, the amount originally invested. Each time you earn a share dividend or a managed fund distribution, the amount earned can be used to purchase more shares or units in that investment at the market price on the day the dividend or distribution is made.

Your original investment plus the additional reinvestment then have the potential to earn more income. You then reinvest these earnings on this greater principal and so on, in effect ‘snowballing’ your investment and potentially greatly increasing your capital growth and income in the future.

→   Find out more about compounding

Reinvest and repay 

If you have a margin loan the benefits of reinvesting investment income can be fantastic. Firstly, it can put you in a better position to avoid or manage a margin call. If the value of your portfolio grows, you increase the buffer between the value of your current investment and the amount it would have to fall before a margin call is triggered.

Secondly, the amount available for you to borrow will increase as you are providing additional security to the loan. This will put you in a stronger position to take advantage of any investment opportunities that may arise.

Setting up share dividend reinvestment for your loan.

Although not all companies offer a dividend reinvestment plan, many do. To confirm if your shareholding offers this option please contact the company share registry and request a dividend reinvestment form. Once complete (ensuring that the new shares are lodged onto your BT margin loan) return the form to the registry.

Setting up managed fund distribution reinvestment for your loan.

Depending on how your loan has been set up, there are a couple of ways you can make sure your next distributions are reinvested into your loan:

If you hold ‘Register on’ investments:

As these holdings are in our nominee name, simply provide written instructions to us to change the method of payment. Please note the instructions need to be signed by the owner of the investments.

→   Download the Managed Fund Transaction form (PDF 80KB).

If you hold ‘Register off’ investments:

You’ll need to contact the fund manager for each holding. The fund manager will be able to assist you in setting up the reinvestment plan for your managed funds, ensuring that the new units are lodged onto your BT margin loan.

Want to find out more?

If you’d like further information please call BT’s Margin Lending Team on 1800 816 222 (Monday to Friday, 8.00 am to 6.30pm – Sydney time) or email BT Margin Lending.

Interest rates up again… and so they should

Another month has gone by, and it’s still pretty much la meme chose (or perhaps les meme choses). There is still a question about the resilience of the US economy, world share markets still appear to have recovered a little too quickly, and credit markets are still a little jammed up. And, of course, there’s an election due.

There are some new wrinkles to the story. The Australian dollar has been very strong indeed, oil prices have hit yet another record high, and it now seems to be London to a brick that interest rates will rise again in Australia (if you’re reading this on or after 7 November, you will know how good a forecast this is).

Let’s start with interest rates. First, the RBA has never before raised rates in an election year, and now it is apparently going to do it during an election campaign. The Reserve Bank’s job is to keep headline CPI between 2 and 3%, and currently it’s at 1.9%. So why on earth is it even thinking about raising rates?

What the RBA is planning to do is the right thing. First, the oft-repeated claim that rates never go up in an election year is mainly because, more by good luck than good management, election years have usually coincided with periods in which rates have actually been falling.

This was true in 1993, 1996, 1998 and 2001. The only time it hasn’t been true in modern history was in 2004, when one could make the case that the RBA hiked early (in 2003) so that it wouldn’t have to in 2004.

The truth about ‘banana inflation’

Second, the RBA’s focus is on future inflation, rather than the current rate, and when it looks at growth in the non-farm economy in the past year of more than 5%, and at a 33-year low in the unemployment rate (currently 4.2%), it is justified in drawing the conclusion that inflation pressures are building up. 5% growth is simply unsustainable; we are running out of room in many industries and markets. The RBA calculates a measure of “underlying” inflation – the technical details need not concern us here, but it aims to strip the headline rate of “one-offs”—which it believes gives a better indication of where inflation is going. That measure currently stands at 3% and, almost inevitably, will be above 3% for at least the next two quarters.

While the fact that the headline measure is currently below the bottom of the target range does give the RBA a presentational problem, the low reading is a complete fluke, owing a lot to a change in child-care subsidy arrangements and to (drum roll please) bananas, which rose rapidly in price in the June quarter 2006, but have fallen in the past year. Now as soon as one starts taking stuff out of the headline measure, some others smell fish, so let’s not take anything out. Let’s instead change the period over which we measure inflation to get around the banana issue. If we begin before banana prices rose, from the March quarter 2006, and measure headline CPI inflation over the next 18 months, to the recent September quarter, we get 2.9 % inflation (annual rate). If, on the other hand, we start after banana prices fell, in the March quarter 2007, we get 3.8%. No more needs to be said; inflation is already uncomfortably high.

Throwing interest rate stones in glass houses 

I have written before about the economic and market effects of the election result. Suffice it to say that elections have no systematic (or even discernible) effect on markets. As to the economy, I don’t know a single private-sector economist who has two forecasts for the future economy depending on which side wins, and there are good reasons for this.  In particular, the argument as to which party will oversee higher interest rates is at best inconclusive and at worst silly. The Coalition points to a 17% variable mortgage rate under Labor in 1989, while Labor can point to a 22% short-term bill rate, and a 13% variable mortgage rate, under the Coalition in 1982. Both parties apparently live in a glass house.

The world has changed hugely in the past 18-25 years. First, inflation is lower (it hit 12% in 1982 and 8% in 1989), so interest rates are now so much lower, and we are not going back to high inflation. Second, the extremes in interest rates in 1989 occurred in the immediate aftermath of the deregulation of the banking sector, when banks lent like there was no tomorrow (think Bond, Skase etc), and businesses and consumers kept on borrowing until rates were close to the stratosphere. Finally, of course, the setting of rates is now out of the hands of the politicians, so any tendency to go for broke now and worry about the consequences later simply won’t happen. If we really want to keep rates low, perhaps we should just elect the RBA!

Getting some bang for your Aussie buck

So what about the exchange rate, and oil? First, some modesty is required. I never expected the $A to reach 92 cents, something that you should take into account when I tell you that it is unlikely to reach parity ($A1=$US1). Investors with money offshore are justified in worrying about the currency appreciating further and thus cutting into their returns but, and this is a view that I have expressed before, the rest of the world is on sale right now for Australians, so it seems to make sense to invest offshore. Incidentally, the $A is at a 23-year high. If you’re impressed by that, think about this: the Canadian dollar is within a cent of a 130-year high!

The oil price has spiked again, mainly because of increased mid-East tensions, this time involving Turkey and Kurdish rebels in northern Iraq. Once the market becomes jittery, a storm or two, or rumours of production cutbacks, become disproportionately important. It is amazing that the oil price keeps making new highs, but so far there has been no change to world growth forecasts as a result. With OPEC likely to increase production, and with the possibility of economic weakness in the United States, the price should come back down without too much damage.

Chris Caton

Chief Economist

To gear, or not to gear…

There’s no doubt that investors, particularly in the share market, in Australia have had a good run over the last three years. And, in many instances, investors who have borrowed funds to increase the amount that they had to invest would have been able to multiply the returns on their investments.

Borrowing money may increase the size of your investment, and your potential returns. Of course, a geared portfolio can also increase your potential losses should the investment fall in value.

The hypothetical example below shows how gearing can help investors build wealth more quickly.

Meet Robert…

In September 2004 our hypothetical investor, Robert, decided to invest a lump sum in Australian resources giant, BHP. Robert had two choices – to invest in BHP shares using only a lump sum he’s saved of $20,000, or to gear his investment by taking out a BT margin loan of $30,000, giving him $50,000 in total to invest.

As the table shows, 3 years after Robert invested in BHP, the return on his geared investment was significantly greater through the use of gearing. Robert may also be able to claim a tax deduction against the interest incurred on his margin loan.

Can BT help you build your wealth?

We recommend you contact your financial adviser to discuss whether gearing can help you reach your investment goals more quickly. For more information about BT Margin Lending, call our Margin Lending Team on 1800 816 222 (Monday to Friday, 8.00 am to 6.30pm – Sydney time) or email BT Margin Lending.

Markets and Performance - October 2007

Global markets up in October

Global share markets were generally stronger in October, despite the International Monetary Fund (IMF) cutting its forecast for global growth next year on the back of the threats posed by the recent sell-off in global credit markets. The IMF lowered its estimate for global expansion next year to 4.8% from 5.2% in July. Contributing to the fall in their latest forecast was a weaker outlook for the US economy, where the growth estimate was reduced from 2.8% to 1.9%. However, US weakness is likely to be offset by robust growth in emerging economies like China, India and Russia, which between them have accounted for half the global expansion over the past year.

In the US, the Dow Jones Industrials Index fell 2.4%, while bourses elsewhere made just modest gains. Funny enough, the biggest single day fall in the US over the month came on the 20-year anniversary of ‘Black Monday’, the day when Wall Street crashed and sparked a major sell-off worldwide. Markets always get a bit edgy around this time, even when there’s no obvious reason to be concerned. But whilst the Dow Jones’s 367 point loss on 19 October 2007 may have, at first glance, looked comparable to the 508 point slump on 19 October 1987, it would actually have had to drop 3,200 points this time around to deliver the same percentage fall.

Bond markets were again the big beneficiaries of renewed market uncertainty, though expectations of further interest rate cuts in the US also helped push yields lower. Bond yields have an inverse relationship with bond prices, meaning that yields fall when prices rise and vice versa.

The Fed moves again…

The US Federal Reserve (Fed) reduced interest rates by a further 0.25% following its latest meeting, taking the official Fed Funds rate to 4.50%. The move comes after the Bank’s decision last month to cut rates by 0.50% in a bid to prevent the US economy from falling into recession. Continued weaker housing data and lingering concerns about the true impact of the global credit crisis were perhaps the key drivers behind the Fed’s decision.

The Reserve Bank of Australia (RBA) also moved on interest rates, but in the other direction. The Bank decided to increase rates a further 0.25% at its early November meeting, taking the official cash rate to 6.75%. The catalyst for the move was the higher than expected underlying inflation data released on 24 October, which took inflation to the top end of the Bank’s 2-3% target band. The decision probably didn’t come as any real surprise, though, with 26 of 27 market economists having accurately predicted the increase immediately following the inflation numbers.

Elsewhere, the Bank of Japan (0.50%), the European Central Bank (4.00%) and the Bank of England (5.75%) all left interest rates on hold in October.

Oil prices hit US$90 a barrel

Oil prices continued to rally throughout October, reaching a record high of US$96 ($A103) a barrel on the back of ongoing supply concerns, further US sanctions against Iran, and rising tensions between Turkey and the autonomous Kurdish region in northern Iraq. Iraq has the third-largest oil reserves in the world, behind Saudi Arabia and Canada, and continues to be a constant source of anxiety for countries that rely on oil out of the Middle East.

With oil prices at such high levels, it’s perhaps not surprisingly that a number of leading Peak Oil advocates have started up again. Peak Oil is the theory that world oil production has reached, or is at least very close to reaching, its zenith, after which production will enter an unstoppable decline that will push prices drastically higher. Critics of this theory argue that it’s impossible to know exactly when oil production has peaked due to uncertainties around the actual level of global reserves.

Australian dollar hits 23-year highs

The Australian dollar (A$) cracked the US$0.90 cent mark in October, taking it to its highest level in 23 years. The A$ continues to be well supported by strong commodity prices and general US dollar (US$) weakness. The US$ has fallen against all the 16 most actively traded currencies except the Mexican peso this year as slower growth and the Fed’s recent interest rate cuts impact demand for US dollar-denominated assets.

However, the big question now is whether or not the A$ can reach parity with the US$. With higher commodity prices and US$ weakness looking set to continue over the medium-term, and with further interest rate cuts in the US still a possibility, there is a chance that the A$ could eventually match the greenback dollar for dollar over the next six months or so.

^{Source: Datastream}

Australian share market stronger

The Australian share market made further gains in October, and hit yet another record high in the process. The S&P/ASX 300 Accumulation Index closed the month up 2.94%, thanks mainly to continued strong local economic data, positive company earnings expectations and a positive outlook for commodity prices.

^{Source: Datastream}

The strong performance of the Australian share market fed through into strong returns for many of BT’s Australian share funds, which continue to perform well over the long-term. The BT Australian Share Fund returned 26.49% in the year to 31 October 2007, the BT Imputation Fund was up 29.27%, the BT Ethical Share Fund returned 28.55%, and the BT Smaller Companies Fund was up 35.33%.

Australian listed property was also stronger over the year, with the BT Property Securities Fund returning 19.04%. The BT Active Balanced Fund, which invests across a number of different asset classes, including Australian shares, bonds and listed property, also performed well, returning 10.31%.

Looking ahead

Uncertainty seems to have crept back into global financial markets amid fears of a weakening US economy and doubts over whether the full extent of the fallout from the global credit market crisis is really known. This will likely keep central banks worldwide on their toes in the short-term, particularly the Fed, who have already shown that they’re not afraid to act if it means averting a recession.

Despite the RBA’s decision to lift interest rates again, the underlying strength of the Australian economy looks set to continue. The Australian market is less exposed to the global credit crisis and also remains well supported by higher commodity prices and solid economic fundamentals. However, investors need to be mindful that any downturn in the US economy will have a knock-on effect locally, making it important that investors remain focussed on their long-term investment horizon. At BT, we continue to invest in companies that have durable earnings, strong cash flows and supportive valuations. 

• To find out the latest perfomance figures for BT’s entire range of managed funds, visit the performance pages on our website.