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Source: Delta Research & Advisory Pty Ltd

The above chart shows the probability of running out of funds in retirement for someone who retires with $1,000,000 in today’s dollar and draws $55,080 each year (ASFA Retirement Standard for a comfortable retirement for a couple), growing at 3% inflation. It is assumed the funds are invested in a “Balanced” strategy (like most default super funds) with an expected return of 8.5% after fees (which many would say is very bullish) and expected volatility of 13.8%pa (which is probably fair). These probabilities were calculated using monte carlo simulation.

So despite an expected return (8.5%) that is much higher than the drawdown (~5.5%), the probability of portfolio failure (i.e. running out of funds) is surprisingly high. Drawing this amount each year, linked to inflation means that after 30 years there is a greater than one in three chance of running out of funds (~35%). Around a 15% chance (~one in six) of running out of money inside 20 years which is somewhat of a concern given that is roughly a 65 year old’s life expectancy.

The main reason for this high chance of portfolio ruin is the sequencing risk a balanced strategy brings to the retiree. A portfolio which has around 70% invested in growth assets has a reasonably high probability of starting off with a sequence of poor returns (like we’ve seen over the past 5 years). When you throw in the required withdrawals to pay one’s lifestyle the chance of a portfolio recovering after a sequence of poor returns is quite low indeed.

So what to do? Don’t put all retirement income at risk. Work out what the minimum required retirement income is to ensure a minimum lifestyle and lock it in with an inflation linked annuity or bond (if possible). I say inflation linked because inflation is another risk that cannot be removed with a portfolio of traditional portfolio of equities and bonds. There is no point putting one’s minimum lifestyle at risk so lock it in. Over and above that, there may be a need to chase return so that’s where the traditional portfolio of equities and bonds can come into play…surely a retiree would be less concerned about the risky portfolio if they know their basic costs are looked after.

Whilst there much more to portfolio construction in retirement the above steps are certainly a step in the right direction from the current default superannuation fund solutions.

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Source: RBA

In less than 2 weeks the Australian Government Bond yield curve has dropped another 20bps plus and since August last year, the yield curve has dropped around 160bps on average…which means for bond fund owners double digit returns over the previous 12 months continue.

Obviously the main reason for this drop in yield is the Euro situation blowing up, yet again…and it will continue to blow up over and over for possibly years to come. The search for safe havens is much harder than it used to be and when you consider that the Australian Government Bond is one of the few AAA rated sovereign bonds available its not surprise they’re popular.

The current theme is, and I’ll quote fixed interest portfolio manager Vimal Gor of BT, “investors are looking for return of capital, not return on capital.” This is pretty difficult to argue with when you consider that German 2 Year Government bond yields are yielding 0.04%…you’d have to expect that will be a reasonably negative real return over the next 2 years but deflation is a real possibility.

Oh well, Europe is a disaster zone, its difficult to see that taking on sharemarket risk (whether here or overseas) is worth it given its downside risks are far greater than the upside potential. You can still get 5% for >1 year term deposits so tactically I’m thinking this government guaranteed (up to $250K) investment continues to be the best value around whilst the Australian banks continue to be hungry for local capital. Risk off is a well ensconced theme today and volatility should be high for many months (or years) yet.

Continue reading »]]> Paul Krugman, Nobel Prize-winning Princeton Economics Professor, has placed an upcoming presentation on the European Crisis on his website…please click here.

It is such a simple story as to how badly Europe is going, why it erred, and why to continues to err. Some of the fascinating points in his slideshow include…

• British GDP has performed worse since the start of 2008 than during the Great depression of the early 1930s.
• The level of Spanish government debt and fiscal position was much better than Germany’s throughout last decade leading up to 2008
• what we’ve known for a while but noone seems to care…that Austerity fails with regards to GDP growth and that the problem is a balance of payments problem…not a fiscal problem (Greece being the badly behaved exception)
• Deflation as a solution, which appears to be Germany’s solution (thanks to their paranoia due to their history of hyperinflation), is many many years of pain.

All of this and more in a very simple slideshow that I ‘m sure I will use parts of in upcoming economic presentations.

Continue reading »]]> As expected the Federal Budget focused on a surplus and to the government’s credit is looking to distribute some of their mining profits to the not so wealthy. Whilst the opposition is suggesting that some of the cash payments will be going straight to retailers instead of their intended purpose, that’s not necessarily a bad thing given the current weak state of retail…although overseas online retail would not be a good result.

Anyway, following is a summary of some of the investment-related impacts the budget may deliver.

• The forecast budget surplus opens the way for the Reserve Bank to continue reducing interest rates. With 1 year and 2 year Australian Government Bond Yields at 2.92% and 2.68% respectively, the bond market is expecting the cash rate to be much lower.
• Higher superannuation contributions tax and other superannuation reductions will increase revenue for government but will reduce investible dollars for the superannuation industry. Impact on markets should be relatively negligible.
• The government’s decision to remove the previously promised reduction in the corporate tax rate from 30% to 29% is also expected to have negligible impact on markets.
• Aside from interest rates, the biggest specific investment-related impacts from the budget are in the areas of property and certain gearing related investment…
  • From 1 July 2012, the withholding tax rate on managed investment trusts will double to 15% and will impact non-resident’s investments in property and infrastructure trusts. This may have negative consequences for those trusts reliant upon foreign investors.
  • Non resident investors will no longer have the 50 per cent capital gains tax (CGT) discount for on capital gains accrued after 8 May 2012. This impacts non-resident individuals with Australian property and will possibly impact off-the-plan investment property which does rely on a degree of foreign investment.
  • The plan to offer tax offsets against environmentally friendly buildings is no longer.
  • Finally, the government intends to scrap deductions for assets where the taxpayer is not effectively at risk. This may impact investors who gear into capital protected products or structured products) if the interest is no longer tax-deductible.

Continue reading »]]> I thought this list would have contained at least a couple of Australian banks given their high credit ratings, profitability, and belonging to one of the stronger developed economies of the world. Anyway, the top 10 strongest banks can be found by clicking on the following link…

Bloomberg’s List of World’s Strongest Banks.

or

World’s Strongest Banks (by Nation)

…interesting.

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Source: RBA

As the above chart shows, the yield curve has dropped 70 to 90bps for all terms since March 19. With a 3 year bond yield just above 2.80%, which is close to where it was during the worst of the GFC, its pretty obvious markets aren’t too confident in the strength of our economy or the quality of tomorrow night’s budget which is highly unlikely to provide a great deal of economic stimulus.

Today we saw Australian equity markets experience their biggest one day fall in 2012 on the back of European election results that have suggested upcoming uncertainty in solving European woes plus more weak US employment data late last week. With continued weakness everywhere, fiscal austerity is not working and there needs to be a change of approach.

The investing environment continues to be very very tough. Interest rates in Australia are very low and equity market volatility has made an appearance to remind us it is still there. Even Australians appear to have lost confidence in the residential property market as it has dropped around 10% over the past 12-18 months. With banks still hungry for capital it appears their deposits still offer the best relative value but even they’re not looking as good as they used to.

Continue reading »]]> I don’t have a great deal to say other than I thought I’d take this opportunity to point out, again, that with Australia’s multi-speed economy there is absolutely no logic in having a budget surplus. The budget surplus has become a political football that is not based on logic but is based on some ridiculous perspective that a budget surplus iis what the public wants.

The reality is that there are numerous specific parts of the Australian that are not travelling so well. The high Australian dollar has resulted in weak tourism (Gold Cost, Sunshine Coast, Cairns etc are struggling), weak manufacturing, and weak performing retailers to say the least. The European situation has resulted in a financial services sector experiencing higher funding costs which in order to keep shareholders happy has resulted in thousands of job losses. On the other hand, the mining boom continues….its growth is slowing but its still strong and there are many people moving their careers to the resources sector.

This multi-speed, not so strong, economy requires multi-speed, strong targeted policy to ensure this current weakness doesn’t get worse…and that is only possible with fiscal policy. Monetary policy via the Reserve Bank’s interest rate adjustments is a blunt tool that cannot be specifically targeted to those who need it, particularly when banks decide not to pass on rate cuts.

The Keynes approach, which in this continuing global financial crisis is proving to be more spot on every day, is to save in the good times and spend in the tough times and right now there are many in Australia  who need a little bit of spending on them. Our government has very little debt and don’t let anyone fool you into thinking otherwise….besides, we even have our own currency that can depreciate to boost international investment should things go pear-shaped.

Anyway, assuming we all see the Australian government announce a budget that results in a budget surplus, don’t assume that is good budget but a dumb budget (and the opposition’s focus on a budget surplus should not be forgotten). There is no excuse for not helping those who need help.

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Source: RBA

I know its just a week and a half since I last provided an Australian Government Bond Yield curve update but over this time the curve has dropped another 20-25bps to mostly be below the bottom from 19th December. This is largely on the back of weak inflation data…deflation if you look at the seasonally adjusted data…and other weak data from Europe and China.

All in all looks like this is the type of market signal that strongly reflects a very weak outlook for the Australian economywhich should guarantee a minimum of 25bps cut by the RBA tomorrow.

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Source: RBA, Comminsure, Challenger Life, RimSec

The above chart is pretty strong evidence as to why investors are placing their money into term deposits and annuities…very very attractive margins over government bonds. As you can see, at the 5 year term the interest rates for term deposits and annuities are almost double!

When you consider that between 1962 and 2011 the Australian sharemarket only outperformed Australian bonds by 2.8%pa, and that premium is almost built into Term Deposit and Annuity rates but without anywhere near the risk of the sharemarket…in fact term deposits are government guaranteed up to a value of $250,000 and APRA monitor the life companies to ensure they have sufficient capital to meet future obligations.

To the retail investor, the sharemarket is a very tough sell at the moment and particular whilst rates are where they are. The retail investor has capitulated on the sharemarket and it looks like it’ll be quite a while, i.e. years and years, before they’ll be back.

Continue reading »]]> Following is a press release from SQM Research that was released last night. It pretty much says it all…residential vacancies relatively stable month on month and up a tiny bit year on year. Perth appears to be a rental concern with very few vacancies whilst Melbourne has the highest vacancy rate in Australia.

Figures released by SQM Research reveal that the level of residential vacancies remained relatively unchanged during the month of March 2012, increasing on a national level by only 243 vacancies. The national vacancy rate remained at 1.7%, revealing a 0.2% increase year-on-year.

It appears that Australia’s rental market is remaining excessively tight for the time being with no capital cities recording considerable increases month-on-month or recording a vacancy rate of 3% or higher.

With the housing market itself remaining sluggish, it is likely that more and more individuals are choosing the rental market over deciding to purchase property at this time. This continued negative sentiment when it comes to real estate is assumedly putting increased pressure on the nation’s vacancies.

Managing Director of SQM Research, Louis Christopher says, “Perth is now an area of major concern with vacancies now sitting at an incredibly low 0.5%. This is consistent with evidence from other researchers reporting rapidly rising rents.

“Hobart on the other hand is beginning to show signs of the opposite extreme, with vacancies doubling since this time last year and many localities recording vacancy rates above 4%. We are also seeing rising stock levels in this area, which in contrast to other capital cities which seem to suffer from one or the other, reveals that Hobart is being hit with an oversupply issue from both sides.”

SQM’s calculations of vacancies are based on online rental listings that have been advertised for three weeks or more compared to the total number of established rental properties. SQM considers this a superior methodology compared to using a potentially incomplete sample of agency surveys or merely relying on raw online listings advertised.

Key Points

• Nationally, vacancies remained the same during the month of March, recording a vacancy rate of 1.7% and a total of 47, 323 vacancies.
• Melbourne has recorded the highest vacancy rate of the capital cities- revealing a vacancy rate of 2.9% and a total of 10,738 vacancies.
• Perth has recorded the tightest vacancy rate of the capital cities at 0.5% – a total of 936 vacancies.
• Hobart has recorded the highest yearly growth in vacancies, increasing by 1.2% since March 2011 and coming to a total of 678 vacancies.
•  Darwin has recorded the most extensive yearly falls, decreasing by 1.3% since March 2011 and coming to a total of 142 vacancies.
• Adelaide, Canberra and Hobart all recorded monthly increases of 0.1%. Aside from this, there were no other increases for capital cities month on month.

Source: SQM Research