Autumn 2008

The fund manager's view

Dirk Morris, CEO of BT Investment Management on the outlook for the rest of 2008.

The economist's view

BT Chief Economist Chris Caton on the causes of volatility and where to find the silver lining.

Use BT’s Transaction Simulator to help manage your portfolio

BT's Transaction Simulator let's you see the impact of proposed transactions and market movements on your margin loan account.

Markets and performance - March 2008

March was a volatile month for global share markets, even as the US Federal Reserve lowered interest rates and pumped $200 billion into the US financial system.

The fund manager's view

16/04/2008

Global investment markets have had a pretty shaky start to the year so far as they continue to battle rising market volatility and concerns about the outlook for the world economy. Here, Dirk Morris, CEO of BT Investment Management, takes a look back at what’s been happening over the last few months and what investors might expect over the rest of 2008.

Share markets continue to weaken

It’s been a pretty difficult start to the year for global share markets, with some having fallen as much as 35% from last year’s highs on the back of ongoing problems in global credit markets and increasing concerns over the outlook for the US economy. Just last month, several of the world’s leading financial institutions were forced to announce additional write-downs and credit losses relating to the US sub-prime mortgage market, and there is now some speculation that total losses could rise from around US$188 billion currently to as high as US$350 billion ¹.

At the same time, we’re beginning to see increasing evidence that the US economy is weakening. A combination of rising unemployment and a housing market in perpetual freefall has seen consumer confidence in the US slump to 16-year lows.

What makes this so important, of course, is that the US consumer actually accounts for around 70% of all US economic activity, meaning any slowdown in consumer spending will have a significant impact on future economic growth. So far this year, the US share market is down 9.92% ²  and this has had an obvious ‘knock-on’ effect on bourses elsewhere, including the UK, Europe and Asia.

Unfortunately, weaker global share markets had an adverse effect on the performance of BT’s flagship international share fund — the BT International Fund — which returned -12.58% in the March quarter. Given the current market environment, we’ve now positioned the fund more defensively, with a preference for larger markets that we believe offer good value, such as the UK and Japan.

We’ll also continue to invest less in markets that we consider to be relatively expensive, such as Canada. But I think it’s important to note as well that, in addition to rising market volatility, the strength of the Australian dollar this year has also hindered the returns of Australians invested overseas.

Australian economy holding up

Despite what’s been happening in global markets in recent months, the underlying strength of the Australian economy has remained relatively robust. However, domestic inflation concerns and two interest rate hikes — in February and in March — were enough to push the S&P/ASX 300 Accumulation Index 14.61% lower over the March quarter.

The weakness in the local market was reflected in the performance of our flagship BT Australian Share Fund, which returned -14.43% over the quarter. But despite the fund’s poor returns, it did perform relatively well against the broader market. This is because we’ve invested only in stocks
we believe offer good fundamental value, such as Rio Tinto, Oxiana and Qantas. We believe Rio and Oxiana will continue to benefit from China’s thirst for raw materials, while Qantas, in our opinion, is still very much undervalued by the market.

At the same time, we’ve also avoided investing in highly-leveraged companies and companies exposed to what’s been happening in the US and the rest of the world.

As we move into the next quarter, the Fund’s focus is now very much on identifying those companies that have been sold down on the back of recent market volatility but which we expect to perform well in tougher market conditions.

Listed property funds mixed

Market volatility has had a major impact on the Australian listed property sector lately, with the S&P/ASX 300 Property Accumulation Index falling 19.14% in the March quarter thanks to a combination of rising interest rates and ongoing problems in global credit markets.

We’ve already seen a number of highly-leveraged companies, such as Centro Properties and Valad Property Group, take a hit as banks become more and Global share market performance, March quarter 2008 more reluctant to lend, and this has had a significant effect on investors’ confidence.

Needless to say, the returns from our flagship BT Property Securities Fund were weaker over the quarter, down 18.35%. On the positive side, though, the fund has managed to avoid the likes of Centro and other highly-leveraged stocks vulnerable to the current credit market crisis, and we’ll continue to invest only in companies with low levels of gearing, reliable income streams and good management teams; companies like Commonwealth Property Office Fund and CFS Retail Property Trust.

I think it’s also worth noting that, in our view, we’re probably nearing the bottom in the Australian listed property market and that we still anticipate reasonable medium- to long-term gains from the sector. By contrast, global listed property markets rallied over the quarter — helped by falling interest rates in the US and UK — and this benefited our BT Global Property Fund, which returned 0.48% over the period.

Global bond funds positive

Global bond markets have performed relatively well in recent months, with the inevitable ‘Flight to Safety’ seeing investors offloading shares in favour of government debt. A series of rate cuts by the US Federal Reserve (Fed) has seen US 10-year bond yields fall sharply (prices higher) this year, and this had a positive effect on our flagship BT Global Bond Fund, which returned 4.90% in the March quarter.

With concerns over the outlook for the US economy intensifying, it’s very likely that we’ll see global bond yields continue to fall over the coming months, which should ensure further gains for the Fund in 2008.

In contrast to global bond markets, the Australian bond market has struggled of late, with yields moving higher (prices lower) as the Reserve Bank of Australia continued to raise interest rates to help battle inflation. Our flagship BT Fixed Interest Fund suffered as a result of the weaker domestic bond market, returning just 1.12% over the period, though performance was also hampered by the ongoing problems in global credit markets, which saw a negative contribution from the fund’s credit portfolio.

Diversified funds, which invest across multiple asset classes and which typically come into their own during times of market volatility, have also struggled so far this year. Our flagship diversified fund — the BT Active Balanced Fund — returned -9.43% in the March quarter, with our allocation to international and domestic shares impacting performance. Losses were limited, however, by the Fund’s investments in global bonds and alternative assets.

Where to from here?

With the economic news out of the US likely to get worse before it gets better, we’re undoubtedly going to see further market volatility in the near-term, though recent moves by the US Federal Reserve to lower interest rates should limit the chance of a long-term bear market. The Bank has already cut interest rates three times this year in a bid to maintain economic growth and it certainly appears ready to cut further if necessary.

The Australian economy should remain relatively robust compared to some of its global counterparts, though there are a couple of factors that will determine the direction of the local market in the medium-term.

The first is the impact that any slowdown in the US will have on China. Australia has benefited considerably from Chinese growth in recent years so if that growth begins to slow, it will have an obvious effect on our own market.

The second factor is whether the Australian consumer is able to withstand the ‘triple whammy’ of rising interest rates, higher household debt levels and falling share prices. We think that they can, though the risks obviously remain skewed to the upside.

Here at BT, we’ve stepped up our focus on ensuring that we have the right valued stocks and the right levels of diversification and risk within our portfolios, whether its Australian shares, listed property or fixed income, and we will continue with this strategy in the current market environment.

1_Source: Bloomberg

2_Returns to 31 March 2008. US share market measured by the S&P 500 Index.

The economist's view

17/04/2008

Volatility continues in financial markets, and it’s a gut-wrenching time for investors. As is almost always the case, this bout of uncertainty is coming from the United States, where there are continuing signs of grief in the financial sector.

The latest casualty is Bear Stearns, an 85 year old institution about to ‘disappear’. Readers may remember that two hedge funds run by Bear Stearns got into trouble last June, when the sub-prime mortgage crisis reached a tipping point. Since then, it has been a downhill slide. In January 2007, Bear Stearns traded at US$172 a share. Around 12 March it was US$60; two days later it was close to US$30 and clearly suffering massively from funds withdrawals.

Over the following weekend, another brokerage house, JPMorgan, announced an offer to buy Bear Stearns for just $2 a share. How the mighty have fallen. The Bear Stearns building, in mid-Manhattan, is estimated to be worth about six times the value of the offer for the entire company. That a company can sink so far so fast has naturally increased concerns that there may be other ‘bodies’ from the sub-prime shipwreck about to wash up on shore.

The Fed acts

The US Federal Reserve has acted decisively. In a series of moves, it has dramatically increased the provision of liquidity to financial markets, and it has cut the Federal funds rate (the equivalent of our cash rate), by two full percentage points in just the past three months, the quickest pace of easing in more than twenty years. It also facilitated the bailout/takeover of Bear Stearns, a degree of intervention not used since the Great Depression.

On the day of the rate cut, two other financial institutions that were thought to have sub-prime related issues both reported surprisingly strong earnings and the share market had a great day, both in the United States and Australia. It’s worthwhile remembering that the only time that the US market rises by more than 3% in a single day is when the market is (still) in a declining trend, so it should have been no surprise that more than half of the day’s gains were ‘given back’ the very next day. Message: the day-to-day volatility in markets is not over yet.

The Fed’s actions have been assessed by many as treating symptoms rather than causes, and there is something to this. But the fundamental cause of the loss in value of mortgage-backed securities, which is what is behind all this, is falling house prices, and there is little the Fed can do to hold them up. Concerted action by Congress and the Administration to slow the rate of foreclosures could help, but the main reason why house prices are falling is that they just got too expensive in the first place.
Remember, too, that this is happening in an economy that has entered recession for the first time in seven years. The increasing realisation of this, and the fear that the financial crisis will make the downturn worse, caused large drops in oil, sugar and copper prices. The US dollar continues to fall but, unusually, the $A has fallen at the same time, a victim of risk aversion.

What to do?

So, what’s an investor to do? Let me say first of all that I’m not licensed to give financial advice, so what follows should not be construed as such. First, I’m sure that you wish, as I do, that you (and I) had sold out of the share market at the end of October last year. But hindsight is a wonderful thing, and that’s not the decision facing investors now. Second, as I have written before, the best assumption right now is that the volatility will continue, and that we probably haven’t yet reached the share market low.

That said, the falls have been impressive. The S&P 500 index in the US is down some 15% from its late-2007 peak, while the Australian market is off 20%, with our financial sector down by 23% at time of writing. Our financial sector is, of course, not immune from the troubles besetting world credit markets — it is ironic that the willingness to lend to all and sundry a couple of years ago has now led to a situation in which no-one wants to lend to anyone! But you just have to look at the current dividend yields for Australian banks to conclude that, barring a major accident, they are cheap right now.

If the recession in the US turns out to be mild, then share markets may not have to fall very much further for economy-wide reasons. And there are good grounds for believing that the US recession could be mild, although one can’t safely conclude that it will be until we see improvement in the functioning of the financial system.

What we do know is that, just as share markets always fall during recessions, they also bounce back strongly (beginning before the recession ends!), and investors who move to the sidelines now may avoid further short-term pain, but they may also miss the medium-term gains.

Silver lining?

Meanwhile, there is a silver lining to the cloud. The ongoing market turmoil, possible knock-on effects on the Australian economy, and some signs that the interest rate rises we’ve already had are getting some traction (consumer confidence has slumped, mortgage clearance rates are down) may cause the Reserve Bank of Australian (RBA)) to decide not to raise rates again in May after the next CPI inflation news.

The RBA will be hoping desperately for some sign in the next CPI that will at least enable it to forecast that inflation will fall back to less than 3% some time in the not-too-distant future!

Managing your margin loan in a volatile market

29/04/2008

If you have a margin loan, you may be concerned about the impact of recent global market volatility on your investments, and the subsequent risk of a margin call. Here, we explore the relationship between margin calls and volatility, and how you may be able to reduce the risk of a margin call.

Margin calls - a call to action

A margin call usually results because the market has dropped and the value of your security portfolio has fallen, or the lender has reduced the lending ratio of a security you hold within your margin loan.

Both events reduce the amount you can borrow and increase your gearing levels (the ratio between the equity you hold in your investments compared to the amount of borrowed funds).

Minimising the risk of a margin call

While the possibility of a margin call is increased in times of market volatility, there are some steps you can take to minimise the risk.

Invest in quality

It may sound obvious, but investing in high-quality shares and managed funds can reduce the risk of a major loss or margin call. That's why you should consider seeing a financial adviser before choosing investments. Read more about why you should seek advice.

Limit your loan

Borrow less than your total loan limit. Limiting the amount you borrow ensures you can easily meet your regular interest payments and cope with any sudden financial emergencies. Learn more about loan limits and how much you can borrow.

Repay and reinvest

Regularly paying your loan interest helps to stop your loan balance from increasing. Not only does this reduce the risk of a margin call, it gives you the flexibility to invest more money if an attractive opportunity crops up. Re-investing distributions, or crediting them against your loan, also helps to reduce your gearing level. Read more about interest payments.

Manage and monitor

Keep track of your margin loan. Consider and plan an appropriate personal strategy that you can rely on in the event of a margin call. To track your BT Margin Loan, you can check your portfolio value, loan limit and loan balance 24 hours a day, seven days a week, through our website. Check our online services.

Careful timing

Be aware of timing. Mistiming can add to the risk of your margin loan. The timing of your dividend and distribution payments may not coincide with your interest payments.

A fall in the market between the time you place an order and settlement could mean the trade does not settle because you have insufficient funds available.

At any time, the lending ratio assigned to a security may change - it may even be reduced to zero. This can result in a margin call or the non-completion of transactions. Find out more about a margin call.

What happens in a margin call?

In a margin call situation, you’re required to take immediate action to restore your loan balance to your loan limit. Your options include:

• Repay some or all of your loan balance;
• Lodge additional acceptable securities;
• Sell or redeem some or all of the portfolio and use the proceeds to reduce your loan balance.

To help manage your margin call, you can also use BT’s Transaction Simulator to assess the possible impact of any action you plan to take to correct your margin loan position. To find the Transaction Simulator, log on to your BT Margin Loan account on BT Online (secure) - (opens in a new window) and follow the links.

For more information

If you need more information about your margin loan or about margin calls, contact BT Margin Lending Customer Relations on 1800 816 222 with your client code ready, or visit www.bt.com.au/marginlending.

Use BT’s Transaction Simulator to help manage your portfolio

29/04/2008

During periods of market volatility it’s important to understand the impact of market movements or transactions on your margin loan.

BT’s online Transaction Simulator enables you to experiment with possible market movements or transactions and view their effect on your loan account. For example, you can enter a nominated share purchase or sale and immediately see the effect on your loan balance, total market value, loan limit and funds available.

Transactions that can be simulated include:

• purchases, sales, lodgements and releases
• cash advances and repayments
• adjusting the percentage change in market price (up or down)

Importantly, the Transaction Simulator can indicate the percentage drop in simulated portfolio value that may result in a margin call, as shown in the example below.

The Transaction Simulator also displays current pending transactions and indicates a reason for failed simulated transactions, such as insufficient available funds.

Where can I find the Transaction Simulator?

To use the Transaction Simulator, simply log on to your BT Margin Loan account through BT Online (secure) - (opens in a new window) and follow the links to the Transaction Simulator.

If you need assistance using the Transaction Simulator, simply visit the Transaction Simulator User Guide or call BT Margin Lending Customer Relations on 1800 816 222, 8.00am to 6.30pm (Sydney time) Monday to Friday with your client code ready.

Important notice

1. The information generated by the Transaction Simulator is only intended to be a general guide. Simulations may be based on historical data or on assumptions which may not be applicable to the user.
2. BT does not warrant the accuracy, adequacy or completeness of the information in, or results produced by, the Transaction Simulator and it is not intended as a substitute for professional financial or legal advice.
3. Except where contrary to law, BT expressly disclaims any liability (however arising) for any direct, indirect, incidental, consequential or other damages arising out of or in connection with the use of or access or reliance on the results of the Transaction Simulator.

Markets and performance - March 2008

10/04/2008

March proved to be yet another volatile month for global share markets, even as the US Federal Reserve lowered interest rates and pumped an additional $200 billion into the US financial system to help shore up banks battered by recent credit losses.

At a glance

• Global share markets continue to weaken
• US Federal Reserve cuts interest rates for the third time this year
• Australian share market closes lower for the fifth month in a row

Global share markets remained under pressure throughout March amid continued market volatility and question marks over the outlook for the US economy. But perhaps the biggest news in financial markets over the month was the bail out of US investment bank, Bear Stearns.

Bear Stearns was one of the first high profile US financial institutions to feel the impact of what’s become known as the ‘global credit crunch’. It was the collapse of two of their hedge funds last year that put the spotlight on companies that used considerable debt to generate returns in areas such as hedge fund management and mortgage securities trading.

JPMorgan, backed by the US Federal Reserve (Fed), initially offered just $2 a share for the company, though the offer was later revised to around $10 a share. The effect the deal had on the market was significant, with financial stocks tumbling as investors began to wonder just how many other companies out there may be in line to suffer a similar fate.

Despite most global share markets ending the month lower, there were still some good gains across many of BT’s international share funds. The BT International Fund returned 0.90% (after management fees) in March, the BT European Share Fund was up 2.71% and the BT American Fund returned 0.72%. The BT Japanese Share Fund was also up 0.34% but the BT Asian Share Fund recorded negative growth, returning -3.64% for the month. It is worth noting that the continued strength of the Australian dollar also weighed on returns over the month.

Weaker global share markets were also positive for bond markets as investors once again offloaded shares in favour of the relative safety of government debt.

The Fed cuts again

The Fed lowered its benchmark interest rate a further 0.75% in March, taking the official Fed Funds rate to just 2.25% as policy officials try to prop up a weakening economy and restore faith in the US financial system.

Recent economic data out of the US shows that growth in consumer spending, which accounts for around 70% of US economic activity, has slowed and that the labour market has also weakened. At the same time, tougher credit conditions and the ongoing contraction in the US housing market are likely to continue to weigh on economic growth over the next six months or so.

The Fed has now cut interest rates six times since August last year.

Elsewhere, the European Central Bank (4.00%), the Bank of England (5.25%) and the Bank of Japan (0.50%) all left their respective rates on hold.

Oil prices spike to record highs

Oil prices spiked to over US$111 a barrel in March – their highest level since trading began back in 1983 – amid continued US dollar weakness and OPEC’s decision not to increase its output.

OPEC, or the Organisation of Petroleum Exporting Countries, is a group made up of the world’s largest oil producers, including Saudi Arabia, Iran, Kuwait and Venezuela. Member nations account for around 66% of the world's oil reserves and around 35% of the world's oil production. Oil ministers from each country meet regularly to co-ordinate their respective oil production policies in a bid to maintain price stability.

In recent months, a number of world leaders, including US President George W. Bush, have been rather vocal in their opinion that OPEC needs to do more, including upping its level of output, to keep oil prices down, though their comments have so far fallen on deaf ears.

However, despite hitting record highs in March, profit-taking and concerns that weaker US economic activity will translate into weaker demand for oil meant prices fell away late in the month, eventually closing flat at around US$101 a barrel.

Australian share market weaker

The Australian share market was again weaker in March, with the S&P/ASX 300 Accumulation Index closing the month down 3.42%. It was the fifth month in a row that the local market has posted a negative return, this time driven largely by a weak lead from the US and the Reserve Bank of Australia’s decision to raise interest rates to 7.25%.

The weakness in the local market was reflected in the performance of some of our Australian Share Funds over the month. The BT Australian Share Fund returned -3.80% in March, the BT Imputation Fund was -3.43%, the BT Ethical Share Fund returned -3.65%, and the BT Smaller Companies Fund, which invests in companies outside of the ASX top 100, was -5.09%.

Australian listed property was also weaker over the month, with our BT Property Securities Fund returning -0.34%. Likewise, our BT Active Balanced Fund, which invests across a number of different asset classes, including Australian and international shares, bonds and listed property, closed March 0.95% lower.

Looking ahead

Economic data in the US has clearly weakened and is likely to get worse before it gets better so we can expect further market volatility in the near-term. Importantly, though, the Fed’s response to the deterioration in market conditions has been substantial and this should have the effect of limiting the chance of a long-term bear market. The Fed has already cut interest rates three times this year in a bid to maintain economic growth and the Bank appears ready to cut further if necessary.

The Australian economy should remain relatively robust compared to some of its global counterparts, though there are a couple of factors that will determine the direction of the local market in the medium-term. The first is the impact that any slowdown in the US will have on China. Australia has benefited considerably from Chinese growth in recent years so if that growth begins to slow, it will have an obvious effect on our own market.

The second factor is whether the Australian consumer is able to withstand the triple whammy of rising interest rates, higher household debt levels and falling share prices. We think that they can, though the risks obviously remain skewed to the upside.

Here at BT, we’ve stepped up our focus on ensuring that we have the right valued stocks and the right levels of diversification and risk within our portfolios, whether its Australian shares, listed property or fixed income, and we will continue with this strategy in the current market environment.

Find out how all of BT’s managed funds performed during March by visiting the performance pages on our website.