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Equities

How geared equity funds offer an alternative to home buying for Australian investors

By Duy To
Portfolio Manager Sydney, Australia

Australian residential housing is a very popular investment. Why? In part because it is possible to get up to ten times leverage – you can borrow ten times the amount of your deposit, depending on your financial position.

It’s also part of the psyche. Australians grew up being told to save for a deposit for a house. They talk about property prices at barbeques, or at least did in the non-lockdown world, and the size of the property market now dwarfs other assets.

According to CoreLogic, the size of the housing sector hit $8 trillion in May this year1, while the total superannuation pool is closer to $3 trillion2.

While housing prices have risen over the past year, so too has the equity market. And arguably the outlook for stocks is at least as strong as it is for the housing market.

It’s one of the reasons why we believe investors should consider Australian geared equity funds.

An Australian geared equity fund is an actively managed fund that borrows money to invest in a portfolio of listed Australian equities, mostly drawn from the top 200 or 300 companies on the Australian Securities Exchange (ASX).

They are a good way of getting Aussie housing style leverage characteristics, particularly in a superannuation fund environment. Of course, given the risk characteristics of leverage, the geared fund magnifies both gains and losses.

Tailwinds

Equities as an asset class has tailwinds behind it over the long term.

The flow of money going into superannuation funds should support local equities. The increase on 1 July of the superannuation guarantee means that a minimum of 10% of an employees’ ordinary time earnings is now going into superannuation. This is legislated to gradually increase to 12% by the middle of 20253.

This growth provides a natural increase in demand for local equities and given 23% of a super fund will be allocated to Australian equities in general4, that provides a strong tailwind for the market.

Given there’s cash chasing Australian equities, and assuming companies don’t issue shares at a rapid pace, which is unlikely, we expect the share markets will increase over the medium to longer term.

There’s still plenty to like about Aussie housing. If you believe the residential property market will keep rising, and you can get ten times leverage, then it makes sense. Just as it is for Australian equities, there are structural tailwinds for housing too – population growth, constrained supply and people’s preference to live near the city centre.

Similarities between housing and equities

Both have tax benefits – negative gearing for housing and franking credits for equities. Both have the potential for income generation, be it rent from housing and dividends for equities.

There’s also default risk. In housing it’s around an investor’s ability to meet their interest repayments. And that’s mostly dependent on employment and interest rates. Interest rates are likely to stay low for the next five years or so based on the current macro environment.

In geared equity funds, the default risk involves debt covenant obligations and interest rates.

But there are also differences.

While the leverage available for housing is higher, the cost of borrowing can be lower for geared equity funds. Geared funds are non-recourse loans. An investor isn’t going to lose their ‘house’ if it goes bad. However, that’s not necessarily the case in the property market.

There are much lower barriers to entry in geared funds. Loan applications are relatively seamless, whereas in home loans, there are high documentation requirements. Geared loans are more of a plug-and-play investment where you select an option and off you go. It’s a lot more complicated buying a house.

Also geared funds are generally very liquid investments whereas Aussie housing can take time to get into, and out of.

Another advantage of geared equity funds is that they can invest in a range of sectors, from technology and healthcare, through to financial, retail and materials. They can be diversified across large and small companies. This diversification means that geared equity funds spread the risk.

There’s also the not insubstantial issue of minimum amounts needed to invest. Geared funds have different rules inside and outside of superannuation, but typically an investor can buy into a fund with $10,000. In housing, the deposit is typically much larger.

Overlaying all investments is the macroeconomic outlook. Our central view in 2021 has been that the S&P/ASX200 will continue its rise from its 2020 COVID-19 lows, driven by strong earnings growth, which we saw in the recent profit season, while receiving support from a highly accommodative macro backdrop.

Our central case is largely on track with the ASX200 consensus earnings rising 22% year to date. However, the S&P/ASX200 reached our year end targets quicker than we expected. Since then, the bourse has pulled back somewhat. Markets have a tendency to overshoot and then pull-back, and that has happened in the past few weeks.

There are mixed messages from central banks at the moment, and they are likely to impact markets. At the recent Jackson Hole Symposium, the US Federal Reserve Chair Jerome Powell started on a positive note, saying he believed substantial further progress had been made on some economic metrics, and that the time was right for the Fed to start tapering its economic support5.

In Australia, the Reserve Bank Governor Philip Lowe said the lockdowns along the east coast of the country would delay, but not derail, the economic recovery. And the bank stuck to its plan to taper bond purchases, though Governor Lowe said the bank would keep buying bonds into next year6.

Also in Australia, August and September are traditionally weaker months of the year. That’s because the largest company in the country, Commonwealth Bank, goes ex-dividend, causing underperformance across the banking sector7. Additionally, the big three miners, BHP, Fortescue Metals and Rio Tinto, all of which are top 15 companies, have underperformed this year as the price of iron ore has tumbled from record levels8.

Overall, the macroeconomic environment now is one where we have quantitative easing and historically low interest rates. We believe that’s going to be the case for some time and this background should be conducive to a geared equity investment in our opinion.

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Duy To, Head of Public Markets, Sector Multi-Manager
  • Equity
  • Income
  • Market Watch
  • Opinion
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Important notes

While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455)  (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

 

This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

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