text:
Jeremy Grantham: To scale some of these issues, $9 trillion to decarbonize electricity completely; $6.5 trillion toward energy efficiency retrofitting buildings. The global revenue of advanced energy industry throwing all these together is currently $1.4 trillion a year, twice the airlines and larger than apparel and growing in America at 5 per cent a year three times the underlying GDP and worldwide at over twice the rate.
The uncertainties of what you ignore at your portfolio's peril. Will there be carbon taxes everywhere and if there are, what are the potential for stranded assets, particularly in the oil industry. And I'm happy to pause for breath.
Jon Hale: So, it's really, Jeremy, a race between resource depletion that's exacerbated by climate change, and I mean, the human's ability to develop through technology and renewable energy the solutions?
Grantham: That's exactly right. And by the way, if we were well-behaved individuals, if we actually lived up to our potential as a species, we would have no problems. We could do away with global poverty, we could have the population gracefully decline over 200 or 300 years back to 2 billion to 3 billion and everything would work out fine. It's because we are not well-behaved. It's the gap between what we're capable of doing and how American alleged democracy works where it is basically owned by large corporations and notably the fossil fuel industry.
Hale: You mentioned the gap. Do you have any sense of the gap between the numbers you showed about what's needed from an investment standpoint and what's actually being invested and available to be invested, is it a private market's, is it capital market's issues, or is it something that takes public investment?
Grantham: At the moment, not only is the investment flow inadequate, but actually the demand for the investment is inadequate. In other words, the plans are not being put on the table. Those that are kicking and screaming tend to be able to raise the money these days. And for a very good reason because many of them have a perfectly decent return associated with them. In my foundation, which has taken virtually all my income for the last 15 years and has 80 per cent of my capital, engages 20 per cent of its money in mission-driven investing. And so, we have a very lively interest in these issues. And we expect to make a very handsome return investing in renewables and efficiency in particular.
Hale: You mentioned carbon tax as one of the uncertainties investors ought to be paying attention to. It seems like that would address demand issues. We got a proposal recently floated by some Republican ... statesmen, I guess, I would call them since they are politicians who are no longer in office, recently and seemed like a reasonable approach and kind of a standard approach to reducing our carbon footprint. How important do you think something like that is to solving the problem?
Grantham: I think a historian 30, 40 years from now looking back would see that if it happened as a watershed event, a decent carbon tax starting at $25 and rising to $100 a ton would change the world as we know it. And if you took that money, it's a real revenue raiser, and rebated it equally to every American or every European, it's a very cost-effective way of solving this problem and bringing on--encouraging improvements and the move to solar cars and so on, sorry, electric cars.
01/05/2017 Long-term investors in Australian shares will continue to find value, but the time for risk-taking on more speculative plays has passed, says Martin Conlon, Schroders' head of Australian equities Schroders stays hot on commodities, cooler on tech and defensives Glenn Freeman 01/05/2017 http://video.morningstar.com/aus/video/170407_Conlon_Schroders_AUDIO.mp4
Transcript to be available shortly./video/transcript/2700 mailto: ?subject=Schroders stays hot on commodities, cooler on tech and defensives&body=http://www.morningstar.com.au/video/story/2700 Introducing star ratings to Morningstar Australasia equity research
27/04/2017 What investors can expect from Morningstar's roll-out of its star rating methodology across Australian and New Zealand stocks, as explained by the regional director of equity research, Adam Fleck. Introducing star ratings to Morningstar Australasia equity research Adam Fleck 27/04/2017 http://video.morningstar.com/aus/video/170421_Fleck_Star_Ratings_AUDIO.mp4
Transcript to be available shortly./video/transcript/2699 mailto: ?subject=Introducing star ratings to Morningstar Australasia equity research &body=http://www.morningstar.com.au/video/story/2699 French elections: Macron versus Le Pen
26/04/2017 Following the first round of the French Presidential elections, the 7 May vote is now between Emmanuel Macron and Marine Le Pen. What does it mean for investors? French elections: Macron versus Le Pen Emma Wall 26/04/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar Investment Management's Cyrique Bourbon to talk about the French election.
Hello, Cyrique.
Cyrique Bourbon: Good morning, Emma.
Wall: So, the French election is in two parts and we've had part one where two frontrunners have emerged which will go head-to-head next month in the second round of the elections and they are two people that perhaps you would assume were the outsiders because what we have in essence, here is the French election with neither of the two major parties.
Bourbon: Exactly. I think, that is the kind of main message. First is that the traditional parties, the left and the right, are not represented. So, this is interesting from the perspective of the view the French people have taken for the future. Obviously, Marine Le Pen was generally expected to be of the final two given the kind of populism movements and the rise we've seen from these types of movements in the last couple of years globally, but also importantly in France.
Emmanuel Macron, very interesting to see him come as first. Clearly, which is good from a political perspective. I think the French have taken the view that the traditional way of looking at politics, left/right, you probably needed to go beyond that. And Emmanuel Macron, his message was clearly to try and harness the best of both in this campaign. And the French seem willing to give him this mandate or at least he is clearly in the lead.
Wall: He is in the lead and he will be the youngest French President since Napoleon I read this morning. He doesn't have a political background unlike Marine Le Pen which has controversial politics but comes from a family of politicians. What do those two things mean for the French people?
Bourbon: I mean, I think, I would divert slightly. I mean, Emmanuel Macron, he doesn't come from a traditional, say, political family but he does have a similar background in terms of his studies. He has been well-trained. Obviously, he is very young. He has risen through the ranks very quickly. So, he is clearly very clever and has very strong views and very interesting ways of being accepted and presenting himself. So, I think it's very refreshing as well for French politics to have a younger candidate who has got strong views, who seems very dynamic and very positive generally.
Wall: Let's boil it down. This is a sort of beginner's guide to French politics. Le Pen is basically the Trump of France, is that fair, anti-EU, anti-immigration, and Macron is much more left-wing, much more pro-Europe, is that fair?
Bourbon: I think on Le Pen, that's definitely fair. She is clearly anti-Europe, anti-euro, anti-European Union and she basically wants to close the borders in light of what's been happening, especially in the last few years. Macron, I'd say, is still quite--I'd say he is economically a bit more close to the right and socially, in terms of values, probably more close to the left. So, I think, it's kind of a good blend that should work quite well for French politics in the future.
Wall: And Macron is the leader so far, but we have learned over the last couple of years not to trust the polls. We've seen that in the US and indeed, in the UK over Brexit. We've also seen a right-wing politician be very positive for markets in the US Le Pen maybe a divisive character, but if she follows the policies and has the same effect on markets that Trump has in the US, it could actually be a positive thing for stocks. What are the likely outcomes in terms of investment both for economics and indeed, stock markets of these two results?
Bourbon: Yeah, I mean--and I think we see it a little bit this morning. We've got about 4 per cent rally in French equities, broadly speaking, European equities, but banks are up about 9 per cent, 10 per cent in a couple of hours. I've personally thought the outcome of Macron/Le Pen was broadly priced in but it clearly seemed it kind of wasn't. So, it would be interesting to see what happens next.
I think the outcome from a Le Pen win in two weeks' time is most likely to be negative. If you start kind of do the math after the scores last night, you still get to about--probably about 40 per cent for Marine Le Pen. Probably the best-case scenario, I think the kind of unity of the French people against the kind of extremism that she represents will probably prevail. That's what's happened before. Of course, a lot of people say, with Trump you never know. But I think it's quite different.
I mean, the type of moves you require for Le Pen to win in two weeks' time are way, way, way, higher than you saw with Trump winning last year in the States. So, kind of, unlikely in my view. So, from a market perspective, yes, it would be negative if Le Pen were to win. For Macron, it's broadly positive, but I thought most of it was priced in, clearly wasn't quite. And just--I mean, my personal view of investments does remain very long term and we don't anticipate any short-term moves based on the outcome of political events.
And it's worth reminding people and investors that political elections and obviously political mandates are by nature short term, they are finite, so therefore, in the case of France, it's five years and that does mean that for investors with long time horizons of five years on the scale of 20 to 30 is actually not that much.
Wall: Cyrique, thank you very much.
Bourbon: Thanks for having me.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2697 mailto: ?subject=French elections: Macron versus Le Pen&body=http://www.morningstar.com.au/video/story/2697 How climate change will impact your portfolio
20/04/2017 Ignore climate change at your portfolio's peril, says Jeremy Grantham, founder of asset manager GMO. How climate change will impact your portfolio Morningstar UK 20/04/2017 http://video.morningstar.com/aus/video/
Jeremy Grantham: To scale some of these issues, $9 trillion to decarbonize electricity completely; $6.5 trillion toward energy efficiency retrofitting buildings. The global revenue of advanced energy industry throwing all these together is currently $1.4 trillion a year, twice the airlines and larger than apparel and growing in America at 5 per cent a year three times the underlying GDP and worldwide at over twice the rate.
The uncertainties of what you ignore at your portfolio's peril. Will there be carbon taxes everywhere and if there are, what are the potential for stranded assets, particularly in the oil industry. And I'm happy to pause for breath.
Jon Hale: So, it's really, Jeremy, a race between resource depletion that's exacerbated by climate change, and I mean, the human's ability to develop through technology and renewable energy the solutions?
Grantham: That's exactly right. And by the way, if we were well-behaved individuals, if we actually lived up to our potential as a species, we would have no problems. We could do away with global poverty, we could have the population gracefully decline over 200 or 300 years back to 2 billion to 3 billion and everything would work out fine. It's because we are not well-behaved. It's the gap between what we're capable of doing and how American alleged democracy works where it is basically owned by large corporations and notably the fossil fuel industry.
Hale: You mentioned the gap. Do you have any sense of the gap between the numbers you showed about what's needed from an investment standpoint and what's actually being invested and available to be invested, is it a private market's, is it capital market's issues, or is it something that takes public investment?
Grantham: At the moment, not only is the investment flow inadequate, but actually the demand for the investment is inadequate. In other words, the plans are not being put on the table. Those that are kicking and screaming tend to be able to raise the money these days. And for a very good reason because many of them have a perfectly decent return associated with them. In my foundation, which has taken virtually all my income for the last 15 years and has 80 per cent of my capital, engages 20 per cent of its money in mission-driven investing. And so, we have a very lively interest in these issues. And we expect to make a very handsome return investing in renewables and efficiency in particular.
Hale: You mentioned carbon tax as one of the uncertainties investors ought to be paying attention to. It seems like that would address demand issues. We got a proposal recently floated by some Republican ... statesmen, I guess, I would call them since they are politicians who are no longer in office, recently and seemed like a reasonable approach and kind of a standard approach to reducing our carbon footprint. How important do you think something like that is to solving the problem?
Grantham: I think a historian 30, 40 years from now looking back would see that if it happened as a watershed event, a decent carbon tax starting at $25 and rising to $100 a ton would change the world as we know it. And if you took that money, it's a real revenue raiser, and rebated it equally to every American or every European, it's a very cost-effective way of solving this problem and bringing on--encouraging improvements and the move to solar cars and so on, sorry, electric cars./video/transcript/2696 mailto: ?subject=How climate change will impact your portfolio&body=http://www.morningstar.com.au/video/story/2696 How dwindling resources will push up commodity prices
13/04/2017 Jeremy Grantham, renowned investor and founder of GMO, explains how a growing population is putting a strain on global resources. How dwindling resources will push up commodity prices Morningstar UK 13/04/2017 http://video.morningstar.com/aus/video/
Jeremy Grantham: This is my favourite exhibit on oil. For 100 years, it oscillated wildly, which is its wont, around $19 and then in OPEC of 1972 it jumped to about $36 and then more recently it jumped, I think, to about $65. I used to think $75, but about $65. The point here is it's not $19 in today's currency. We have nearly quadrupled the cars. We are beginning to show signs of all resources running out.
This was the general graceful decline in prices of resources and then we had a recovery for no known reason. Not World War I or World War II like the others, it just went up. And then it came down and bounced around. But you can see that the old trend is probably dead and gone, and I believe the price of oil will once again in several years be considerably higher.
Agriculture is another point which interacts with climate change and other problems. The productivity in the green revolution on the left was 3.5 per cent a year, just sensational. In three years, you had a 10 per cent increase. Not surprisingly, it came down. It's down to 1.2 per cent which is exactly the 10-year average growth in global population. We have no safety margin, no room for people to eat cattle which is five times as grain intensive. It is a dead heat at the moment and erosion and climate change working against us.
Another problem you will not be aware of is that you cannot grow anything, animal, or vegetable, without phosphorus or potassium, but we'll deal with phosphorus because 77 per cent of all the cheap useful phosphorus in the world is in Morocco and the Western Sahara that it controls. If you took them out for any political reason, in 55 years, assuming a 2 per cent annual growth in food, and we run out.
Why a crisis now on resources? The population explosion. When you see any chart like this in investing, you want to jump. I put in Malthus at 1 billion and my birth at under 2 billion, 1.7 billion, and now we're 7.5 billion heading almost certainly to 10 billion. And the other reason was China gobbling up the world. Fifty-three per cent of every bag of cement on the planet was used in China and 48 per cent of all the iron ore, et cetera, 47 per cent of the coal.
The possible saving grace to frame this picture is the declining population growth, the fertility rate that Malthus never even dreamt of. We have chosen because children are damn expensive and incredibly inconvenient. All the developed countries have decided to drop below a replacement level as have China, Japan, and the Far East. The only problem here is Africa, and if the UN were to be right, which it will not be, you can see in red a 2-billion increase and change, 2.5 billion, in the rest of Africa and Nigeria exploding to 750 million. When I was born, it had 26 billion.
Incidentally, Syria had 2.8 million and now has 28 million. It has many more migrants than it had population when I was born. The big problem here is pressure on resources forcing immigration from Africa and the near east, climate change making it worse and threatening the liberal tradition of Europe with the waves of immigration, which I'm sorry to say I wrote about four years ago, the liberal traditions are looking a little shaky as we sit.
The other saving grace is the enormous progress in alternatives, far greater than most people realise. You can see the stunning scale for utility, solar there from $400 to $54 just in the last handful of years and wind keeping up. They have actually been bided and accepted, signed contracts at 30 on both of them in northern Chile and Qatar.
And this is now competitive. Solar and wind without year-round storage is cheaper than coal. On the contracts signed, in Chile, you are talking a lower price than the variable cost of coal, just the cost of the material not the cost of the plant, the maintenance, and the depreciation./video/transcript/2695 mailto: ?subject=How dwindling resources will push up commodity prices&body=http://www.morningstar.com.au/video/story/2695 How retirement spending affects withdrawal rates
10/04/2017 Data shows that the withdrawal rate gets higher as spending decreases in retirement, says Michael Kitces, a US-based financial planning expert. How retirement spending affects withdrawal rates Christine Benz 10/04/2017 http://video.morningstar.com/aus/video/
Christine Benz: Hi, I'm Christine Benz for Morningstar.com. How does spending change over retirees' life cycles, and what are the implications for safe withdrawals rates? Joining me to discuss that topic is financial planning expert Michael Kitces.
Michael, thank you so much for being here.
Michael Kitces: Thanks, Christine. It's good to be here.
Benz: You and a colleague wrote a piece about retirees' spending patterns looking at how retirees spend over their own life cycles. So, I know there's a body of research in this area. Let's talk about what the data tell us and talk specifically about how when you look at the data you do tend to see spending trail off a little bit as people get older.
Kitces: Yeah. So, there has been a lot of interesting data that's starting to come forth over the past five and 10 years, some very good national data sets that look at spending behaviour patterns and even now some major financial institutions that can like literally look internally--how do all their bank customers behave. And we're learning some interesting stuff. The prevailing view has always been people want to live a stable standard of living in retirement. I mean, the whole essence of a pension is built around you're going to get the same check every year for life, hopefully, it's an inflation-adjusted check, like at least an inflation-adjusted standard of living is going to remain constant throughout retirement. And now, we're digging into the data and we're finding out it's not what people actually do.
So, your colleague actually here at Morningstar, David Blanchett, did a nice slice of this data a couple of years ago and found this effect where when we look at inflation-adjusted spending what we find is, as people get older, the spending trails off. It trails off by about 1 per cent a year through our 60s, 2 per cent a year through our 70s, and then another 1 per cent a year through our 80s. So, if you, kind of, draw that, it goes negative, more negative and then a little less negative. So, David called it like a smile, retirement spending smile.
Benz: Healthcare expenses at the end, right?
Kitces: Right. So, early on our spending slows down a little as our lifestyle slows down. In the middle, our lifestyle slows down a lot. We get kind of the slow-go years, much less traveling, discretionary expenses fall off. And then even in our 80s the spending still trails off. So, inflation-adjusted it starts slowing down by less, but even in our 80s the data is showing that the average household spending continues to decline in our 80s even with the uptick of healthcare because the other stuff, mostly kind of our discretionary buckets, slows down even more. So, yeah, I have more healthcare spending, but we only need one car now. Those kinds of trade-offs that start shifting in the household means the spending continues to slow down even in the later years.
Benz: OK. Let's take a look at the implications then for sustainable withdrawal rates, because a lot of the research there, sort of, assumes that, oh, yes, I'm going to need 4 per cent and then I'm going to inflation-adjust that dollar amount over time, and it assumes a fairly stable level of consumption when in fact the data don't necessarily support that.
Kitces: Yeah. The early safe withdrawals rate study--I mean, I've been guilty of this as someone that published to that literature as well--we were all essentially looking at replicating pension streams of income which were stable inflation-adjusting streams of income, and so we shot for the same thing in a lot of the research. Now we get all this data coming forth that says, well, actually people's behavior doesn't match that.
So, we actually re-ran some of the numbers and published a study a couple of weeks ago about what does it look like when you actually assume decreasing spending by something like maybe 1 per cent a year through retirement or 10 per cent a decade or like maybe we stay steady for the first decade but then we slowdown in the second and third. And what we found, I mean, no great surprise, your withdrawal rate gets a little higher when you assume spending decreases.
Now, the interesting effect is, it's actually not as much of a boost as maybe you would think. If you imagine spending going down by 1 per cent or 2 per cent a year for 30 years, like that cuts 30 per cent to 40 per cent off your inflation-adjusted spending by the end. So, it's a big number. But what we found is the safe withdrawal rate only goes up a little. It goes from 4 per cent to maybe something like 4.4 per cent to 4.8 per cent. So, we get maybe a 10 per cent or 20 per cent increase in safe withdrawal rate for what could actually be a 30 per cent or 40 per cent decrease in cumulative spending.
Benz: And what sort of asset allocation do you assume there?
Kitces: So, we look at over a range of asset allocations, what we generally find is balanced portfolios really do still work the best where we can rely on the interest and the dividends and the capital gains and tapping the principal when we need to. The good news of diversified portfolios is there's always something that we can tap from year to year to generate the cash flows and that still matters. Too conservative, inflation is damaging; too aggressive, market volatility is damaging. But when we get back to those balanced portfolios, generally in the 40-60 to 60-40 kind of range, we would find these effects where your initial safe withdrawal rate lifts up some, but not a huge amount, in part because even though your spending declines, it's only in the later years. So, kind of, cumulatively over a retirement, your spending does decrease quite as much. And the effect that we still have to deal with good old-fashioned sequence risk.
You might realize, hey, yeah, I'm not probably going to do as much world cruising when I'm 80, but unfortunately if you do lots when you're in your 60s and there's a bear market and you run out of money, it doesn't really matter that you're going to do less travel in your 80s because you might have no money left. And so, that need to have a little bit of conservatism in the early years to defend against sequence risk is part of--even if we assume spending goes down a bit, we don't quite get as much of an offsetting increase in the initial safe withdrawal rate, because we still have to hedge a little against that sequence risk.
Benz: OK. Fascinating research, Michael. Thank you so much for being here to discuss it with us.
Kitces: My pleasure. Thanks for having me.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com./video/transcript/2694 mailto: ?subject=How retirement spending affects withdrawal rates&body=http://www.morningstar.com.au/video/story/2694 What lies ahead for mining and materials
10/04/2017 Iron ore, coal, lithium, and uranium: some end-markets will rise and others will fall behind, says Morningstar commodities and resources analyst David Wang. What lies ahead for mining and materials Glenn Freeman 10/04/2017 http://video.morningstar.com/aus/video/170406_Wang_Commodities_AUDIO.mp4
Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm here today with David Wang, equity analyst in Morningstar's Chicago office.
David, thanks for joining us today.
David Wang: Yeah. Thank you for having me, Glenn.
Freeman: Now, David, what's Morningstar's view on commodities? Are we particularly bullish or bearish? And how correlated are some of these different end markets?
Wang: We have a fairly bearish view on iron ore and metallurgical coal and we have a bullish view on lithium and uranium. We're bearish on the steelmaking raw materials largely because we think that the investment-led economic cycle for China has ended. In fact, going forward, the economy will really face a rebalancing away from this investment and commodity-intensive growth to far more consumption-oriented type of growth. So, as China doesn't need a lot more new buildings or new machinery in the economy, we expect that the amount of steel demand to decline over the next five to 10 years. In contrast, we see a far greater upside for commodities like lithium and uranium. We think that the market underestimates the growth potential for electric vehicle adoption, and with lithium the primary beneficiary of its higher adoption rate, we think that higher-cost sources of lithium will need to come online in order to balance the market longer term and this should drive pricing upwards.
Iron ore and metallurgical coal are fairly tied together in the sense that they both go into steelmaking, which is heavily tied to the Chinese economy. On the other hand, for a commodity like lithium, the primary driver is the adoption of lithium-ion batteries, which is primarily going to be used in electric vehicles and consumer electronics, so quite a different end markets there. Uranium, in contrast, is tied to electricity production around the world. So, it's effectively consumed within all the nuclear plants that are built in, say, China, Japan, and the United States.
I'd say that most commodities are prone to boom and bust cycles depending on the overall supply and demand dynamics. Recently, what we've been seeing in lithium is a pretty rapid rise of the price of the commodity, largely driven by the increase in electric vehicle adoption. For uranium, this has been on a down market for many years as the effects of Fukushima still play out across the market. We've begun to see a slight uptick in uranium prices recently and we continue to forecast that uranium price will need to increase over the longer term to incentivise sufficient production.
Freeman: Which companies are the major players in these commodity spaces that you're covering?
Wang: The major players are, including on the Australian side, BHP and Rio Tinto. Other larger players on the global market include, Vale, Anglo American, and Teck Resources. So, we have a fairly bearish view on the outlook for the stock prices of these companies. We've got 1 to 2-Star ratings for this assortment. In contrast, we've got fairly positive outlook for uranium producer Cameco as well as lithium producer Albemarle. These two companies are on the Morningstar Best Ideas List.
Freeman: Now, David, what are some of the ways that investors can get exposure? Do they buy the producers directly? Or can they go, for instance, through secondary producers?
Wang: Our preferred way is largely through the companies themselves. Commodity prices themselves don't really garner themselves to typical investment to the extent that commodities don't generate cash flows. It's for production and sale of commodities that actually generates profits. So, our preferred way to play in uranium and lithium is through the producers of those commodities and we would really avoid exposure to the iron ore and met coal producers at this point.
Freeman: And David, you've just produced a special report into commodities. It's called "False Dawn". Can you just give us a brief overview of this?
Wang: We've seen price for miners decline over the past couple of years. They experienced a fairly rapid rebound during 2016 as the market was extrapolating the increase in Chinese steel demand during that year. We think that this rally is unsustainable. It was really driven by credit-fueled stimulus into the economy and really pulls forward future demand of steel that country would really need. So, our expectation is for steel demand to continue its long-term secular decline in China as the country rebalances away from this investment-oriented growth to this more consumption-oriented economy and we see considerable downside for iron ore prices as well as coal prices. And as leverage plays on commodity pricing, we see significant downside for the major producers of these commodities.
Freeman: And David, what are some of the distinguishing features of Morningstar's analysis of commodities?
Wang: Unlike some investment advisories or shops out there that would really look at the next year's earnings to put a price tag on a company, we tend to look at mid-cycle cash flow generation by these companies. So, we're not really trying to forecast one year out, but more so looking across the cycle, what is the normalised earnings power of the company is. So, our commodity price forecasts are based on what we think equilibrium prices for the commodity will be in the long-term based on the marginal cost of production to meet the final ton of demand.
Freeman: Thanks for your time today, David.
Wang: Thank you, Glenn.
Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching./video/transcript/2693 mailto: ?subject=What lies ahead for mining and materials&body=http://www.morningstar.com.au/video/story/2693 The evolution of multi-asset investing
07/04/2017 More difficult market conditions in a rising interest rate environment highlight the value of active management across your portfolio, says Simon Doyle, Schroders' head of fixed income and multi-asset. The evolution of multi-asset investing Glenn Freeman 07/04/2017 http://video.morningstar.com/aus/video/170331_Schroders_Doyle_AUDIO.mp4
Glenn Freeman: I'm Glenn Freeman for Morningstar, and I'm joined today by Simon Doyle, head of fixed income & multi-asset with Schroders.
Now, Simon, just firstly, on the multi-asset side of things, how popular is this approach with retail investors and have you had to adapt this to be more popular with that segment?
Simon Doyle: Well, certainly, I think, multi-asset generally has adapted quite significantly over the last probably eight to 10 years and certainly, we started really evolving our approach probably around 2007-2008 moving away from the traditional balanced fund structure towards an objective-based portfolio approach. And we did that really to try and solve some of the problems that were inherent to the traditional balanced structures and really align with the sorts of issues that our investors were facing and that was how to deliver decent positive rates of return without the volatility that you typically get with a balanced portfolio and without the drawdowns that sort of come with that. And so, that's been the main sort of evolution of our multi-asset approach.
Freeman: What are some of the main trends that we're seeing there? Is it that drive to reduce costs and fees for investors or are there other things happening as well?
Doyle: Well, I think, pressure on costs and fees are--they are industry-wide, they are sector-wide. They are not really unique to multi-asset. I think within multi-asset I'd say probably the single most evident thing that's happening is really innovation. In the last five or six years, there has been a plethora of new strategies launched into the domestic market available to domestic investors, both institutional and retail, objective-based portfolios. So, like ours, where a lot of the value is really through managing asset allocation and making sure we're in those, sort of, right parts of the market at the right time. We're seeing the development of strategies that are very much dependent on cross-market or relative value trades and that's sitting alongside risk parity-type approaches or even sort of combinations of the three. And so, I think, competition and innovation, I think, is really driving multi-asset managers to continue to deliver interesting strategies that really try and solve the core problem that investors have in different ways.
Freeman: From a retail perspective, who is your audience and has there been much popularity among SMSF trustees?
Doyle: Well, from a multi-asset perspective, I think our core constituency, if you like, in terms of the natural investors in these types of strategies is relatively broad, but probably focused on investors who are coming up towards retirement and really don't want to see sort of big drawdowns from capital; investors who are maybe post-retirement and are looking at generating decent income without significant volatility; investors who are indifferent to what they own, so they're not worried about whether it's equities, bonds, property or what have you, what they are worried about is the profile of the returns of their investment, the income that that delivers; or investors that actually otherwise have relatively narrow portfolios that don't have a lot of--are unable to get a lot of diversification. And I think it's that latter category that sort of captures a lot of the self-managed super market where they may have relatively concentrated portfolios but are looking to find a way to diversify their exposure. And multi-asset strategies like our Real Return Fund actually do have some appeal for them to be able to do that.
Freeman: And just lastly, some market commentators have been quite dismissive of active investment approaches with index managers having done quite well in recent times. How do you respond to that?
Doyle: Well, if I put my multi-asset portfolio manager head on, I actually think that sort of the active versus passive debate is a bit of a distraction. It focuses very much at the sector level in sort of equities or bonds. It suffers from I think, what I call, a recency bias and that's very much dependent on the performance of active and passive managers in the most recent couple of years and I think it ignores risk, particularly the sort of risk that's been brought to bear on markets based on the behaviours of central banks.
So, as a multi-asset portfolio manager who is looking to deliver absolute outcomes for their clients, there isn't a passive portfolio that I can own. So, I need to take active risk all the time to be able to do that and do that via asset allocation. And all portfolio constructors need to be active in a way they think about asset allocation simply because there isn't that neutral portfolio./video/transcript/2692 mailto: ?subject=The evolution of multi-asset investing&body=http://www.morningstar.com.au/video/story/2692 When is the right time to buy stocks?
29/03/2017 Davis' Associates Chris Davis says the best time to invest is when you have the money, and to ignore market "noise". When is the right time to buy stocks? Emma Wall 29/03/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello, and welcome to Morningstar. I am Emma Wall and I am joined today by Chris Davis to talk about US equities.
Hello, Chris.
Christopher Davis: Hello, Emma.
Wall: So you've done a lot of work about investor philosophy, investor sentiment and how people tend to buy atop and unfortunately sell at the bottom. How does this concept relate to the current market conditions, because we have had significant rally in US equities?
Davis: Well, what's interesting is of course as it was recently characterised this is one of the most hated rallies in US equity history. People seem to be looking for excuses not to invest. When stocks were down and were cheap, nobody wanted to invest because they hated stocks, memories of the financial crisis. Stocks have come back, they don't want to invest because of uncertainty.
My grandfather had a great expression. He said the best time to invest is when you have the money. And the way you smooth out the gyrations and the fear of the correction that's inevitable the timing is uncertain but that there will be a 20 per cent correction is certain. Simply by spreading out the decision over time. I think people that are anxious and worried about valuations of the market should simply get started because valuations on cash and bonds is way worst.
Wall: I suppose it also depends on your time horizon because if you need the money in six months' time perhaps investing in US stocks is not the best idea because of that uncertainty element. However, if you have a 10-year time horizon the bumps along the way are less of a big deal?
Davis: Absolutely, and spreading out the decision, and that's the key. And it's not just for individual investors. So many institutions would perform better if they simply made the allocation decisions more gradually. So if somebody--if my own mother wants to get into stocks what I tend to tell her is start immediately do 5 per cent today, do 5 per cent next quarter or next month depending how long you want to spread it out but 5 per cent a quarter gets you fully invested over five years and it takes all of that anxiousness about the timing away and it allows the growth underlying to be the driver of your return.
Wall: Do you feel that it should be automated in some way because 5 per cent a quarter sounds easy from where I am sitting today when the market has done so well, despite the fact that there has been such a hated rally. But as soon as that correction comes in behavioural finance teaches us that you won't want to put that 5 per cent in.
Davis: Of course, this is the area where automating you know whatever you can do in a sense to automate that decision to take away the stress of the daily decision this is the reason why 401(k) investors [personal pension investors] have done so well. They bought right through the financial crisis the sort of deliberate constant--the apathy you know not looking at the statement is an enormous advantage provided you've made the right allocation to begin with. Of course what's happened for some 401(k) investors is they just sit in cash straight through and then that undermines the strength of it.
But if you set a 401(k) plan to just put a certain amount into equities each month, each paycheck that is almost guaranteed to produce a good return over time. And I say that not based on my own knowledge, but Ben Graham wrote that back in the 1930s. He said a systematic approach to investing is almost certain to work out, no matter when somebody starts provided that it's adhered to conscientiously and courageously. And the best way to do that is to automate it.
Wall: Chris, thank you very much.
Davis: Thank you so much.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2690 mailto: ?subject=When is the right time to buy stocks?&body=http://www.morningstar.com.au/video/story/2690 How misinterpreting risk impacts financial returns
28/03/2017 Dr Gerd Gigerenzer says fund providers need to invest in education so that savers are better equipped to deal with risk--and can make better financial decisions. How misinterpreting risk impacts financial returns Emma Wall 28/03/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Prof. Gerd Gigerenzer to talk about risk.
Hello, professor.
Prof. Gerd Gigerenzer: Hello.
Wall: So, I suppose the first question we should start with is, what is risk.
Gigerenzer: Now, if you are in a world of certainty, there is no risk, but most of the time we are not in the world of certainty. And risk is usually a term meant for a situation where you can fairly know the probabilities as opposed to uncertainty. That's risk. So, for instance--and the problem is that many people don't understand risk and also try to mislead you.
The Worth Health Organization recently informed us and warned us that for every 50 gm of sausage we eat your risk of getting colon cancer increases by 18 per cent. Many of my friends stopped eating sausage because they believed. So, out of 100 people 18 will get colon cancer? No, it was a trick.
The risk increased from lifelong about 5 per cent to almost 6 per cent. That wouldn't cause much fear. But instead of saying 1 percentage point or less 1, it's 18 per cent. So, 5 per cent to 6 per cent would be 20 per cent, it's less at 18 per cent. And it's a common trick. It works for most people and we can steer their emotions and their behaviour.
Wall: And how does this misinterpretation of risk impact investors and their portfolios?
Gigerenzer: We know from studies that even professional brokers and people who are in the investment business do not really always understand what volatility means. So, one study in the US, in New York, showed that most professionals confused volatility with the average deviation. Volatility is the standard deviation, which is larger, so they underestimated volatility. It's one example.
Another one is that the general public is not financially literate with very few exceptions and I think we need to do something about that that we create a society where people can make informed decisions and we are not there and we do very little about that.
Wall: That was going to lead on to my next question is, what can we do harnessing what we know about behavioural science perhaps to make sure that we don't come a cropper when misinterpreting risk?
Gigerenzer: One thing to do is, start early, say, in school. And our children learn lots of things, few of them they will need in the rest of their lives. But how to deal with money, how to deal with health, how to deal with digital media to control this rather than being controlled, those will be important things. And if only some investment firms would invest in the education of the own general public, that would be wonderful.
Wall: Professor, thank you very much.
Gigerenzer: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2689 mailto: ?subject=How misinterpreting risk impacts financial returns&body=http://www.morningstar.com.au/video/story/2689 Are European stocks overvalued?
27/03/2017 Isabel Levy of French asset manager Metropole Gestion explains how she uses fundamental industrial analysis to avoid value traps and identify the fair value of European equities. Are European stocks overvalued? Emma Wall 27/03/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello and welcome to Morningstar. I'm Emma Wall and I'm joined today by Isabel Levy, founder of Metropole Gestion to talk about value investing. Hello Isabel.
Isabel Levy: Hello.
Wall: So, I suppose I start with considering the rallies we've seen in Europe, in the UK and in the US. Are markets, overvalued at the moment?
Levy: Well, we don't think the European markets are overvalued, because if you look back, we had a rally of course at the end of last year and even this year. But the fact is that for the past four years and from 2011, we had so many fears in Europe about the destruction of the Eurozone, about the lack of growth comparing to the American market, or even comparing to emerging market, that basically we didn't recover the undervaluation we had comparing to the American market. So, it's only a start I would say.
Wall: Value is something that can be very personal and there are number of value metrics individuals use, investors use. How accurate do you think these metrics are?
Levy: I mean we have to look at, of course the markets. Some people in the markets are local to global metrics, PE, price to book, so we have to look at them obviously, and if you look in terms of PE, the PE of the European markets are much lower than the PE of the American market right now. So, I think in terms of undervaluation comparing to the American market is obviously, if we take a global measure. Then I would differ little bit and choosing different measures depend on the company and the sector we are talking about.
So, we have to take a global approach about the market, but also a specific approach companies by companies. So sometimes the PE for company which is very cyclical and it's at the bottom of the economic cycle without producing any earnings, obviously, the PE is very high, but it's very un-expensive but you are at the bottom of the economic cycle.
Wall: I suppose that it's a case of not being a slave to the data, because this in fact can leave to value traps which can catch out investors, and mean that they lose money.
Levy: Yes, they can lose money, but dependent on the horizon you have in front of you. When you are an equity investor, I'm afraid to say that, we have to look very long-term and some people are talking about three years, two years, what is long-term is all the definition about long-term. But if you look at the regulators, they oblige you to write on your prospectus that long-term is at least five years. So, being an equity investor, should mean that you have wanted for long time and that you can wait. So, this is very important to keep that in mind.
Wall: Isabel, thank you very much.
Levy: You are welcome.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2688 mailto: ?subject=Are European stocks overvalued?&body=http://www.morningstar.com.au/video/story/2688 Which funds are worth paying for?
23/03/2017 High active share funds--that is, those managers who take off-benchmark bets--outperform those which are low active share. So, ban closet trackers from your portfolio. Which funds are worth paying for? Emma Wall 23/03/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by professor Martijn Cremers to talk about active share.
Hello, Martijn.
Martijn Cremers: Hi. How are you?
Wall: So the first question I'd like to ask is, what is active share?
Cremers: Active share is a very basic measure of how different the holdings of a fund are relative to the holdings of a benchmark. So, benchmarks have zero active share. They are fully overlapping holdings, right, with themselves. A high active share fund means that the fund invests very differently, that the rates of the fund are very different than the rates of the benchmark. So very least you know you're going to get something very different.
Wall: Your studies have looked to the correlation between active share and performance. What is that correlation?
Cremers: It's hard to predict performance, right. It's a bit of a fool's game. At the same time, we find one really very strong result, and that is that the low active share funds, these are funds that have a lot of holdings that are the same as the holdings in the benchmark. They have substantial overlaps. That those funds with low active share, active shares below 60 per cent or so, that they substantially underperform.
On the upside, there is much weaker evidence; active managers have had hard 10, 15 years. But there is some evidence, depending how you look at it that the high active share managers even as a group have performed fine.
Wall: Does that mean as an investor, I should ignore passives entirely and just go for those high active share funds?
Cremers: I would say the opposite. If anything, most funds are not that high active share. So, unless you know that the fund is high active share, then I think passive is for many investors the right approach. At the same time, I like the core-satellite approach, where the core would be passive, but then for the satellites, you go wides and you diversify, well, and introduce high active share managers.
Within high active share, what I found is that a certain patient approach works best. So, I just wrote a new paper called Active Share and the Three Pillars of Active Management. The three pillars are skill, conviction, and opportunity.
Skill is hard to measure, but high active share means at very least that the manager has the courage of the manager's convictions and a lot of opportunity to actually be different. And so, in my view, having a high active share means at least having conviction and opportunity. In general, it takes a lot of skill to successfully run a high active share fund for a while. So whenever if you find that the patient high active share managers have done well, that's what I would suggest for the satellite.
Wall: It's really about eking out those closet trackers, those people you are paying for active management that are actually doing better than the benchmark and being left with pure passive and pure active management.
Cremers: That's right; especially because many of the low active share funds are not that cheap.
Wall: Martijn, thank you very much.
Cremers: Yeah. Thanks for having me.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2687 mailto: ?subject=Which funds are worth paying for?&body=http://www.morningstar.com.au/video/story/2687 Bond market wobbles no cause for panic
21/03/2017 Australian bonds see only a slight tremor in response to the Fed's rate rise, says John Likos, Morningstar's senior credit analyst, who also provides insights on the new, and anticipated, hybrids from Australian banks. Bond market wobbles no cause for panic Glenn Freeman 21/03/2017 http://video.morningstar.com/aus/video/170321_Likos_Bonds_Update_AUDIO.mp4
Glenn Freeman: I'm Glenn Freeman for Morningstar and I'm joined today by our senior credit analyst, John Likos.
John, thanks for joining us.
John Likos: Thanks for having me.
Freeman: Now, John, just firstly, at the start of this month we've seen the US Federal Reserve increase interest rates again. What does this mean for Australian fixed income investors?
Likos: Yeah. Look, I think, the Federal Reserve, when they recently upped their rates, they probably actually maybe still came under market expectations in terms of the potential level of increases during the course of the year. But nevertheless, what we did see was still a general widening in bond yields, particularly, the longer-term-dated notes and that was reflected in Australian bond yields as well. So, we saw our 10-year rate increase as well towards 3 per cent.
Now, what that effectively means is we are now going to require potentially more return when companies or governments got an issue at that longer tenure. So, there's been a little bit of a tremor in Australia. Look, it hasn't been overly significant.
We've seen some actions, potentially through the banks, et cetera, in raising some of their book prices on some of their investor loans, possibly just getting ahead of potential increases in funding costs which have been prompted by the reassessment of these longer-term yields.
Freeman: And what are the implications for some of the other global bond markets?
Likos: Yeah, we've seen sovereign yields come off their lows in the last three to six months effectively throughout Europe and the US possibly of a little bit of longer timeframe and even Australia.
So, we've come off from 1.8 per cent roughly in the 10-year to about 3 per cent. So, investors that have exposure to fixed coupon fixed income securities will experience the greatest potential capital losses of that – if they don't sell, there'll be paper losses.
But the fixed rate coupons will lose the most in an increasing interest rate environment. However, if we're talking floating rate notes, then they are buffered because they remove that interest rate risk as benchmark rates go up.
So, look, generally speaking, there's definitely been a bit of a wobble in global bond markets as the markets begin to reprice the curve upwards as opposed to what we've had for such a long time which has been a tailwind for a 20-year bull run in bond markets.
All of a sudden, we are getting a little bit of a turbulence, but that's by no means any reason to be afraid or think you've got to jump ship from the fixed income or credit asset class because as always it provides a critical function in any portfolio.
Freeman: Now, last time we spoke, we discussed the NAB subordinated notes and since then we've also put out some commentary on the ANZ and Challenger hybrids. Can you just talk us through what's happening there?
Likos: Yeah, sure. As you said, we wrote up a note on the NAB subordinated notes too and they actually list today. Probably as we speak they are coming on market. We think they will generate significant support in the marketplace. There are Tier 2 securities, so they are less risky than your AT1 hybrid securities and we're very – our recommendation was to subscribe. We'll see where the actually security price is and then we'll issue our initiation of coverage note on that.
We've also written up a note, as you say, on the Challenger hybrid securities. Now, they are not due to list for another few weeks; however, we recommended investors subscribe on the basis that they are high-risk investors.
So, we want to make that very clear. This is a high-risk investment. If your first hurdle isn't met on the basis of what is your risk-return profile, if you consider yourself medium-risk or below, then you can just put that aside.
But if you consider yourself high-risk or above, we think it offers compelling value at current prices. Now, the book build on that's closed; however, once it lists, it will be worth monitoring.
The other security, as you mentioned, that we've written something up about recently was the ANZPC. This is kind of an older security. It's a Basel II-type security. It was issued under the previous regime as opposed to the Basel III.
It doesn't have all the triggers that the new hybrids have. It doesn't have the capital trigger, for example, but it does have the non-viability trigger. Look, we've been a bit brave on this one. We've made the call that we believe ANZ might not actually call the security at its first call date; however, we think it makes sense for them not to do so.
So, we are by no means worried. If anything, we'd almost prefer to happen because it will be the result of a decision made on the basis of economic merit. If it's not called in September this year, which is the first of September, it will likely be called within the next two years.
And what will happen effectively is there will be a pickup in yield to eventual call date if they don't call at the first call date. So, our recommendation of hold remains under either circumstance. If they do decide to come back and replace with a new security, then we will examine the merits of that new security at that time.
Freeman: And John, what about some of the so-called bond proxies, the listed real estate, infrastructure and the utilities sectors?
Likos: Yeah, look, a lot of those securities have always been purchased on the basis of their dividend yield, for example. Now, all of a sudden, we're seeing benchmark rates increase. So, the dividend on those securities, the gap isn't as big anymore as what it was.
So, as the benchmark rates increase, well, all of a sudden, the premium decreases and people are starting to think to themselves perhaps the new premium isn't enough. And so, we're seeing a significant outflow from those securities, those bond proxies, as you'd say. So, again, in saying that it's been somewhat volatile. We've seen some of these REIT prices be particularly turbulent in the last three to six months. But again, that's probably a question best left for our Morningstar equity analysts.
Freeman: Now, just lastly, we've just over a week in March. What's your outlook for the month overall?
Likos: Yeah, look, I think, it's a relatively quiet week in terms of news flow this week. I don't think we'll see too much. I mean, the NAB note will get some maybe airplay in terms of listing today and we'll see how that goes. It will be a pretty quiet month, but we provide a summary of every month in our credit monthly. Investors can access that ordinarily in the first few days of every month and that's a good little snapshot via charts and a little bit of text in terms of what's happened during the month.
Freeman: Thanks very much for your time today, John.
Likos: Thank you.
Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.
21/03/2017 Want sustainable long-term returns? Morningstar UK reveals the essential components and the fund providers who are getting it right. ESG: Essential steps for successful long-term investing Emma Wall 21/03/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Mats Andersson from the Global Challenges Foundation to talk about ESG.
Hello, Mats.
Mats Andersson: Hello.
Wall: So, why should we care about ESG, about environmental, social and governance issues?
Andersson: I think it's absolutely vital for an investor to have this on the agenda because my belief is that you cannot long-term be successful unless you have this on the agenda. And I know that there's a misconception that there's a conflict between sustainability and good returns. I think we get more and more proof it's the other way around. If you do this in a smart way, you will actually lower the risk and enhance your returns. And that's exactly what asset management is all about.
Wall: And I think there is a misconception there. I think a lot of people have an idea of ethical or hippie investing is about actually screening out some negative stocks which could be high-growth and therefore, you're having to choose between a profitable portfolio or a sustainable portfolio. But actually, your studies have shown that that's not the case at all.
Andersson: It's not the case at all. I think that what the problem is and the challenge today is that 95 per cent of all pension capital and capital as a whole is evaluated on a yearly basis. We know that the mandate, we know that the savers will be there for 10, for 20 years and if you can prolong the time period where you evaluate this and actually give the mandate to the asset owners or the asset managers to really make sure that long-term you find the good companies, I'm sure they will understand this is the way to enhance returns because short-term it's an unknown factor, I agree. Long-term, it's absolutely essential that you have sustainability on your agenda.
Wall: What kind of time horizon are you talking about there, because you mentioned pension portfolios which can have multi-decade horizons?
Andersson: Yeah. And honestly, I mean, I was the CEO of AP4 and we had--by law we were supposed to invest on a 40-year horizon which could be a bit challenging. But I think that just by saying that, say, five to 10 years will make a huge difference to the way managers behave today and what they will in the future.
Wall: And are there any examples of best practice where you think, yes, those people are getting it right?
Andersson: I think there are many examples and I'm agnostic and I'm a believer in the let the 100 flowers bloom, find your own way to do it, but you have to understand that this is a mandate that I have and this is mandate that I will actually carry out. And once you do that, then there are so many good examples. You have the (AP) in Sweden; you have FRR in France; you have Hermes in US, you have (PJM); in Holland, you have APG; you have New York Retirement Pension Fund. So, there are so many good examples now compared to five years ago. So, let's carry on that route.
Wall: Mats, thank you very much.
Andersson: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2685 mailto: ?subject=ESG: Essential steps for successful long-term investing&body=http://www.morningstar.com.au/video/story/2685 Few values left in global stock market
20/03/2017 Morningstar's directors of equity research think investors need to be cautious in the market today and offer some of their best investment ideas. Few values left in global stock market Morningstar US 20/03/2017 http://video.morningstar.com/aus/video/
Jeremy Glaser: After an eight-year market rally it should come as no surprise that there are an increasing number of questions about if the market is overvalued and if there are any attractive pockets left.
Recently, Morningstar's global equity research directors came together in Chicago, and we had the opportunity to talk to each of them about where they see valuations today and what some of their best investment ideas are.
Michael Holt: Globally, if we aggregate the price/fair value estimates, from of all our analysts, we come up with median value of 1.04. Now this is a number that's easy to misinterpret, but the simple version is, there are far more names that are overvalued than we're seeing that are undervalued right now. So, as an investor, you have to be far more selective and make sure you're doing your homework on every name you look at.
Now this valuation is not spread equally across all the sectors. We see a couple, like basic materials and the energy sector, where it looks even more overvalued than the rest of the sector, so you have to be even more selective and do your due diligence in those areas.
Last, I'd just like to add, make sure you understand when a stock is fairly valued, what does that mean? It means that we don't see the margin of safety we'd like to have as an investor to capture that capital appreciation. However, we do expect a 3-star stock, which is fairly valued, to deliver a total return in line with the cost of equity, so there is an opportunity cost to holding cash. So, take a look at the quality of the business. See if they have economic moats and see if you're protected if, through the cyclical nature of the market. That's how you can make good investment decisions.
Elizabeth Collins: Looking at the companies and sectors that the North American equity research analysts cover, we do see a lot of companies and industries that are overvalued. In general, we think that the market is pricing in a lot of optimism and not taking into account a lot of things that could go wrong in the future. Some of the things that are being priced in are things like deficit spending, increased spending on military, infrastructure increases, higher interest rates due to higher inflation expectations and lower taxes. While all of these things would be undoubtedly good for equity valuations, there are things that would come with the cost, and these are things like gridlock in Washington, D.C. might mean that these things don't come to fruition.
Similarly, there could be increased competition. Infrastructure spending that raises commodity prices would ultimately be met with new supply that drives down commodity prices. Likewise, lower taxes that benefit companies' bottom lines should ultimately benefit consumers in the form of lower prices in the absence of strong and sustainable economic moats. Given that, we do think that the market tends to be, in general, fairly valued, though we do see some sectors that have weaker valuations. Those sectors are communication services, real estate, healthcare, and consumer cyclical.
I'd like to give you a couple of our best ideas within the undervalued sectors. First, I'd like to talk about Roche. It's a biopharmaceutical company and they also have a diagnostics business. A lot of healthcare companies are facing the threat of cost containment, but this is actually a threat that plays into the advantages of Roche. Because of their in-house diagnostic arm, they have advantages when it comes to personalized medicine, which should lower cost, all else equal. They also have competitive advantages because of their biologics and the inability of competitors to replicate those biological innovations.
Another best idea that I'd like to talk to you about is Williams-Sonoma. They do the namesake Williams-Sonoma stores, also Pottery Barn and West Elm. This is a category that isn't facing a lot of headwinds, and we do think that the company has a narrow moat thanks to the intangible asset of their brand, which helps consumers decide that their products have higher quality and are worth spending money on. And we do think that they are ahead of their competitors when it comes to things like supply chain management, consumer analytics, and e-commerce. All said, we think that the market is being overly pessimistic about both Roche and Williams-Sonoma and they're two of our top picks in undervalued sectors.
Alex Morozov: Looking across to European equities, if you just look at it from a relative perspective, compare it for example to the US stock market, you can perhaps sense that the European market is relatively undervalued relative to the US It's not necessarily how we look at things, but that from a multiple perspective, European stocks do look a little bit cheaper. There are a couple of reasons, perhaps, for that.
Well, one, probably the most important one is that the growth in Europe is weaker than the US You still have a lot of countries that perhaps are not pulling their weight. Southern Europe is still not out of the woods. There's still a lot of concern about the general growth environment in Europe, and most European companies do have a bit of an outsize exposure to Europe as a continent.
And then a second way of looking at it--perhaps this is more of a headline risk, if you will--there's still a lot of uncertainty over political environment in Europe. Last year, Brexit was a major shock to the system. A lot of UK stocks have really taken a beating, and we still have a number of major political events in Europe that could provide this additional shock.
What we try to do though, we look at the companies that can and will have this sustainable earnings power that could survive whatever shocks the system's is going to provide. So the companies with economic moats are critical. Even though the European market as a whole is probably fairly valued, stock-picking is critical for us as is the case with all the analysts at Morningstar, but in an environment where you see a lot of fairly valued, perhaps even overvalued stocks, we still have a few interesting ideas in this space.
When we look at some of the top picks that we have, it's not surprising those are the companies with economic moats. My favorite name right now--especially considering that this is in the consumer staples space and consumer staples have run quite a bit a lot of the valuations are quite stretched, so not too many ideas that we have in consumer staples--but one that we do have is actually a wide moat, InBev, the largest beer manufacturer in the world. This is the company that last year completed his acquisition of SABMiller and with that, it became by far the biggest beermaker in the world.
The company has a few issues. It's exposed to emerging markets and when you are exposed to emerging markets, you are benefiting from perhaps higher growth in those areas, but you're also much more susceptible to some of the shocks that you see with emerging markets, whether it's currency, whether it's growth volatility, etc., but ABI has a very powerful business model, both given its size, its ability to extract pricing concession from its suppliers. Right now, it's trading about a 10 per cent discount to intrinsic value. It represents a really unique opportunity to buy this wide-moat business that rarely goes on sale.
The other ideas from Europe I have are in the aviation industry. One of them is the plane manufacturer Airbus. The other one is the aviation parts manufacturing company called Safran. Airbus has a narrow economic moat. Safran has a wide economic moat. Both benefit from a transition to the narrow body planes that we're going to see over the next 10, 20 years. Both are also companies that have gone under significant transformation, their operating model. We see a lot of upside in both of those companies. We see significant potential for margin uplift, earnings growth. Most importantly, those are the companies that regardless of what happens in Europe in terms of the political turmoil, weaker than expected growth, those the companies that we're confident and comfortable with our forecast for the next 15-, 20-plus years. And that gives us confidence in our recommendation of those two wonderful businesses.
Adam Fleck: We view the Australian market as particularly overvalued right now, trading at about a 9 per cent premium to our amalgamated fair value estimates. There's really a couple of key reasons for that. In Australia, of course, the financial services industry and the materials market make up the bulk of the tradable assets. In particular, we see commodities as overvalued right now. BHP and Rio are two of the largest that we have 1- and 2-star ratings on. And really, what has happened there is we continue to expect significantly lower commodity prices, particularly those that are related to the steel industry, over the long run as China's economy slows and rebalances, leading to a sharp fall in the several years to come.
So, it's really no surprise that we see the Australian market as overvalued right now. However, we still think there are some pockets of opportunity, especially as you look outside the materials space. They're somewhat few and far in between, but I wanted to share a few with you. The first, when you really look for undervalued names, you start to see some names that perhaps are not of the highest quality. One such name might be Ten Network. This is a no-moat company that we think has poor stewardship and very high uncertainty, but nonetheless trades at a 44 per cent price/fair value ratio, a substantial discount to our fair value estimate.
This is one of three commercial TV networks in Australia. And it's come under pressure recently as the company expects negative EBITDA this year, given some of the increased competitive pressure and pressure from the advertising market more generally. However, we're supportive of management's investments in content in this business. It's already paid off with some rising market share, up to 24 per cent from 21 per cent a few years ago. We expect that to get up to about 25 per cent over the long run, and see EBITDA returning to a positive long single-digit rate, which drives our fair value estimate.
If you start to look at 4-star names, you can see some opportunities and some higher quality stocks. One would be Brambles. This is a wide-moat stock that trades at 4 stars. It is the largest, global provider of pallet and reusable plastic crate pooling services. And unlike Ten, we think Brambles has a wide economic moat, based on its global scale and cost competitiveness and cost advantage. This is a business that's been hit hard from increased competition recently. It's also seen some inventory destocking at the customer level, and e-commerce has had some negative impacts as well. However, we see the company re-investing in its pallet quality. It's done so in the past. That's typically taken 12-18 months or so, but as it does that and feels the benefit of that longer term, we don't see a threat to the company's wide economic moat. And with retail sales continuing to improve, particularly in the US where this company has a nice presence, we see the market undervaluing the name right now.
Lorraine Tan: Return of risk appetite in Asia has led to a narrowing of upside gains that we see in equities. Having said that, we still think there are a lot of buying opportunities in selective stocks. There are also areas, whereby on a midterm basis, that will still benefit from some of the key themes and developments that will continue on for the next few years.
Starting with China, we look at that. A lot of the buy calls that we had in the financials and real estate space have run up but we still like the Industrial and Commercial Bank of China. The bad news over the past few years on the potential NPLs are still probably there, but we're seeing a uptick in macro activity, particularly on the infrastructure side, that should sort of alleviate some of the pressures going on for some of the financial institutions. In this regard, we thing there's still upside potential for ICBC on a midterm basis.
The other area that we're quite keen on in terms of the China policy developments is essentially factors that involve the environmental aspect, whether it's on the clean energy side or whether it's in terms of the reform that's going on in terms of tariff pricing for a number of the utilities and activities there. The key names that we like, we have a couple of ideas here. These include one of our best ideas, which is Guangshen Railway. We think the government will need to increase tariffs to help alleviate the debt situation for the former Ministry of Railway, and that will help improve the returns that companies like Guangshen Railway will see. The company's in a nice net cash position as well, so we think that's a relatively safe bet to have in a portfolio.
Companies such as ENN Energy and Beijing Enterprises, the latter being another best idea, will also benefit from situations of continued encouragement in terms of the gas usage in China as they move away from coal. That means also more reforms in terms of gas pricing and continued growth in terms of fairly strong growth in this sector and these companies are all enjoying pretty high returns on investor capital at this stage.
Turning to Japan, Japan has had a good runup, mainly because of the yen factor. But we are actually seeing some situations of companies actually benefiting from longer term corporate restructurings that are going on. We like in particular the Mitsubishi UFJ financial group. This is a bank, the leading bank in Japan, and the reflating story will definitely benefit MUFJ, and the fact that it's also still trading below its book value means that there's still some upside potential. It's got a fairly diverse global flow of revenue and we think that will also give the bank some additional opportunities in terms of driving loan growth.
For the rest of the other Japanese stocks, we also like Murata Manufacturing. It's for a longer basis in terms of its passive components. It not only gets a benefit from what's going on in terms of what's going on in terms of the smartphone demand, which will continue to grow in terms of LTE and 5G activities, but we think its movement in terms of the more passive components for the auto industry will also drive future demand for its output./video/transcript/2684 mailto: ?subject=Few values left in global stock market&body=http://www.morningstar.com.au/video/story/2684 Why the time is right to invest in emerging markets
20/03/2017 Hilde Jenssen from Norwegian fund manager Skagen admits that emerging markets have disappointed investors over the past three years--but says valuations are attractive and reforms are boosting returns. Why the time is right to invest in emerging markets Emma Wall 20/03/2017 http://video.morningstar.com/aus/video/
Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall and I'm joined today by Hilde Jenssen from Skagen Funds to talk about emerging markets.
Hello, Hilde.
Hilde Jenssen: Hi. How are you?
Wall: I'm very well. Thank you. Unfortunately, emerging markets have not had a very good rap in recent years. They seem to be very out of favor and this is despite in the last 12 months having pretty healthy returns. Why do you think people are so against emerging markets?
Jenssen: Well, that's a great question. I think a lot of the unpopularity in emerging markets is because people have been disappointed over the years, especially the last five years. And people are disappointed because they keep waiting for corporate results to become stronger and companies to show better health, but it just hasn't happened at the speed that people were hoping. What we're seeing now that makes it interesting is a lot of changes in the various economies around the world that make this a particularly attractive market.
Wall: And it's a very attractive valuation point of view as well. Despite the fact that we have had a rally from the last 12 months, it's come from a very low base. So, this is a good time to get in?
Jenssen: I think so. Well, clearly, we are a value-based manager and we think long-term about business models and which companies that are able to thrive in various environments. So, with that, we look at the long-term path of earnings trajectories and take that into account when we make our investments. But what we do see is that corporate earnings are getting stronger, cash flows are improving as well which is really important and that's an important thing to look at long-term as well. But we see underpinnings and some of the tailwinds are actually coming from reforms in various markets that also touch on the way that businesses are being run around the world.
Wall: And I think that's a very important point because traditionally emerging markets were seen as higher-risk. I know they do come with a lot of volatility. People think emerging markets means no corporate governance, no shareholder rights and therefore, they are less attractive than investing perhaps in a developed market equity. But actually, that's increasingly not the case, isn't it?
Jenssen: Yeah, and I think that's really important when you look at a company as a potential investment is not to see necessarily where the company is at the current moment and how well it's being managed, but where could it potentially be in 5 to 10 years from now and that's where we are mentally when we are looking at potential investment opportunities.
Wall: Hilde, thank you very much.
Jenssen: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching./video/transcript/2683 mailto: ?subject=Why the time is right to invest in emerging markets&body=http://www.morningstar.com.au/video/story/2683 Johnson: Fed's path may not be smooth
16/03/2017 The Fed's plan for stair-step rate hikes in the coming years will likely be derailed by economic reality, says Morningstar's Bob Johnson. Johnson: Fed's path may not be smooth Jeremy Glaser 16/03/2017 http://video.morningstar.com/aus/video/
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. As expected, the Fed raised its benchmark rate by 25 basis points today, and we're here with Bob Johnson, he's our director of economic analysis, to see if we learned anything new from this release.
Bob, thanks for joining me.
Bob Johnson: Great to be here today.
Glaser: The Fed really almost went out of its way to get the market ready for this increase today. There really was no big surprise, at least on that front.
Johnson: Absolutely not. They had sent out a bunch of people, Fed governors, to go out and make speeches, and they've all indicated, "Gee, I thought rates would probably move higher," and we went from three weeks ago with a zero probability of a rate hike to almost 100% three weeks later. Lo and behold, we got the number.
Glaser: Beyond the rate hike, we are also looking at what they say in the statement of so-called dot plot, or economic projections. We look at everything else that happened, any surprises there? Is it still just business as usual?
Johnson: It's really business as usual. The economic forecast, which we always take a close look at, was unchanged, as was the unemployment rate, as was their inflation assumption, so there was no change from their December meeting. They're thinking relatively low GDP growth of about 1.9 per cent, about 2 per cent inflation, both core and headline equalling each other here in the very near future. It was a very boring, steady state. No recession in sight, no growth spurt in sight-type of forecast.
Glaser: They don't see anything fundamentally changing in the economy, they just think it's time for rates to move higher?
Johnson: I think that what they expressed that they wanted to give themselves some wiggle room. If some external shock hit the economy, that they've got some room to adjust, which, when you have rates terribly low, you really don't have much room to operate in, and that's part of what's going on. I certainly think that part of the inflation data, you want to be a little cautious. We can talk about the inflation data, but it has moved up, and it certainly had some impact on the consumer already.
Glaser: We're going to look at that dot plot a little bit more closely. It shows where governors think rates will be, both the short term and the longer term, and it looks like they're kind of ready for a stair-step up to get to that 3 per cent longer term rate. Is that realistic? Can we see two more increases this year?
Johnson: You know what? I think it either will have some type of spurt or stimulus or something happen with oil prices that will force their hand and make them work faster, or that we'll have a slowdown, which will make them move slower and then maybe start again. But in any case I think that we won't get the stair-step that they're predicting. They're basically saying every three or four months we're going to raise rates from now until the end of 2018, till we get to about a 3 per cent Fed funds rate, from the three quarters to 1 per cent that they moved the rate to today.
Glaser: What's next for the Fed, then? What do you think they'll be looking at closely? Is it, does the labour market hold up? Is it inflation? Is it a combination of things? What will predict if they actually are able to continue on this steady move?
Johnson: They really stress that they're still very data-dependent. Everybody tried to focus them on the dot plot and the nice stair-step and the move up, two more rate moves this year, but really it's all dependent on the data. They continued to stress that, well, if the economy's slowed, or if it's not as strong or as weak as people think, then we'll have to act differently, that this is not cast in stone, this is just kind of our road map. And if we start to vary a little bit on inflation or growth rates, well, then, we'll have to reconsider what we do with our interest rates.
Glaser: Overall, do you think the Fed is making the right moves here? Does their take on the economy agree with yours, Bob?
Johnson: I think that they made the right move right now. I think they had to give themselves some more wiggle room, in case we did hit unexpected turbulence, and they needed to stimulate the economy. They really didn't have much room to do that from where they are right now, so that gave them that extra room, and that's why I think they needed to do it. I think they also--inflation was starting to look a little higher, so I think they wanted to make sure that things didn't get out of hand there a little bit, so I think it was great from that standpoint. The market had already kind of priced at end of their expectation, so why not do it? Certainly, if something turned into a problem, they could always roll it back at another meeting. I think that it was the right move.
Longer term, I think that perhaps they're a little bit too optimistic on the economy. I think that certainly the data we've seen recently looks a little weak with the consumer, which is 70 per cent of the economy being affected by higher inflation. Not that much higher inflation, but higher inflation. At the same time, wage growth is about the same as it's been for the last two years, so that clearly puts the consumer in a little bit of a bind.
Glaser: Bob, thanks for your analysis today.
Johnson: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser, thanks for watching./video/transcript/2681 mailto: ?subject=Johnson: Fed's path may not be smooth&body=http://www.morningstar.com.au/video/story/2681 First-half 2017 earnings season insights
15/03/2017 Companies produced reasonably good results overall with only a few standouts, even as a cost-out theme dominated, says Peter Warnes, head of equities research, Morningstar. First-half 2017 earnings season insights Nicholas Grove 15/03/2017 http://video.morningstar.com/aus/video/170314_Warnes_Reporting_Season_AUDIO.mp4
Nicholas Grove: I'm Nick Grove for Morningstar and today I'm joined by Morningstar's Peter Warnes, who is here to give us a breakdown of the recently concluded half-year earnings season.
Peter, thanks for joining us today.
Peter Warnes: Great to be back, Nick.
Grove: Peter, you described this batch of earnings as being solid and generally better than expected, but what were the key drivers of this performance?
Warnes: Nick, I say solid and a little better than expected, that's probably in terms of a total number, in other words, the total profits of corporates. You saw in the December quarter that company profits were up 20.1 per cent in the national accounts. So, that's what I'm talking about. Individually, we did have some disappointments. But look, broadly speaking, the key driver was still cost out. It's very, very difficult in a below-trend economy for companies to get meaningful organic growth. And so, cost out was the driver of a lot of the bottom-line. And that's reflected in low wages growth and sluggish employment. So, it was really the labour part of the equation that was giving the bottom-line a bit of a boost.
Of the 174 companies that reported that we cover 66 we increased earnings per share estimates, forward estimates; 68 we reduced; and 40 remained unchanged. So, that gives you a broad brush of what we thought of the reporting season. Reasonably good. There were a few standouts, but pretty reasonable.
Grove: Peter, were there any companies whose earnings disappointed and which saw a negative market reaction but you think represent some compelling value at this point in time?
Warnes: Nick, of the bigger companies, those that disappointed and were punished were Brambles and it had been to the confessional beforehand, but still what came out and disappointed even with the result and the cancellation of our targets going forward. Telstra, Medibank Private, all missed their targets. Ramsay Health Care was significantly negative on the reaction to the announcement but the results were good. But the CEO succession muddied the water and what have you.
Now, in terms of those four companies, we do see undervaluation, if you like, in Brambles. We think long term it looks attractive, but I don't think there's any need to chase it. I think you've got time on your side. There's going to be a little bit of time before they work out those problems in the US. Telstra similarly--I mean, the whole telecommunications space is very, very competitive. The NBN is unsettling. And so, again, I don't think any rush to being there--all those companies are ex-dividend as well. So, there's no need to go and say I want to buy those because the dividend is there. Medibank Private, look, NIB shot the lights out. Medibank Private is struggling. Again, a lot of churn there and missing targets, but again cost out--it's a cost-out story.
The one that we do like is Ramsay. They've got deep management, a deep management team. They will find the right person to take over from Christopher and this is an opportunity to buy that stock I believe.
The other stock that has no moat and didn't get belted but we like in the media space, which is unusual, because the media space was disappointing generally, is Nine Entertainment. We think it should be looked at. But again, this is a no moat and high uncertainty. So, you got to be a bit careful there. You can't put all in. But it's attractive on a fundamental basis.
Grove: Conversely, Peter, which stocks and which sectors in the market do you think are looking a little bit frothy at the moment?
Warnes: Nick, I mean, we'd obviously continue to say resources and the related mining services sector, because we have got a long-term quite negative view on commodity prices, iron ore, coke and coal, copper. They are the drivers of those big resources companies. And so, our valuations are significantly below the market. And as I say, they are long-term valuations. So, we believe that they are frothy. And mining services obviously have been rubbing shoulders with it and getting a bit of tailwind from what's happening there. The expectation is that the resources companies have got significant free cash flow and they are going to start reinvesting. We are a little bit more sanguine than that and we suspect that there's quite a bit of froth there.
Strange enough, in the engineering and construction space, that's CIMIC, Downer and Lendlease, they will perform pretty well and they were all rewarded with pretty good--their results were well-rewarded by the market. Again, that's kind of more infrastructure and government spending and what have you rather than direct mining investment.
Grove: Finally, Peter, with the world as it is being in unchartered waters politically and with all the market uncertainty, should investors actually listen to some of the day-to-day noise or should they actually just focus on company fundamentals? And do you think it's probably a good idea to let a bit of cash build?
Warnes: $64 question, Nick, isn't it? Look, there's a lot of noise out there. And strangely enough, despite the noise, and we know where a lot of the noise is coming from, a "Trumpet," the thing is that you must continue to watch the fundamentals and look at the future fundamentals, not the past fundamentals. You always invest in the future. And we continue to say you've got to be investing in moat companies and a lower uncertainty around the fair value, the better.
But having said that, with this noise and also with volatility so low, personally, I think you are allowed to take some insurance and take some insurance by letting cash build. I suspect we're going to have a correction in the market in the not-too-distant future. We in Australia might see the banks hold up don't forget three of the big banks which have got March balances, balance dates, are full of dividend--ANZ, NAB and Westpac--and there could be some buying to get that dividend and of course, that's 20 per cent of the market, isn't it? So, personally, yeah, I think let cash build, be a little cautious. These markets are highly valued.
Grove: Peter, thanks very much for your time today.
Warnes: Pleasure, Nick./video/transcript/2680 mailto: ?subject=First-half 2017 earnings season insights&body=http://www.morningstar.com.au/video/story/2680 The growing appeal of LICs
06/03/2017 The popularity of listed investment companies is on the rise once again, but there are several things investors need to be aware of before buying in, explains Michael Malseed, Morningstar senior analyst, manager research. The growing appeal of LICs Glenn Freeman 06/03/2017 http://video.morningstar.com/aus/video/170303_Malseed_LICS_Audio.mp4
Michael Malseed: Like all investments these things are cyclicals. So, what we've seen in the last sort of three to four years is renewed liquidity in the capital markets and renewed interest in investment as a whole.
So, the listed investment market has taken advantage of that and we've seen a lot of IPOs come to market and a lot of capital raising among existing listed investment companies. So, in total, around $3 billion has been raised since 2013.
The popularity from the investors' side has come mainly from the ease of access to these investments. So, they can be traded through an online broking account or through a traditional stock broker. So, this has appeal to individual investors and also self-managed superannuation funds which are obviously a growing part of the market.
So, a listed investment company is a professionally-managed fund by an investment manager listed on the ASX. The other alternative for a professional manager of money could be to have a unit trust. They go down the listed company path because they can raise a significant amount of capital in one go through an IPO.
So, they could raise $100 million, $200 million in one go as opposed to raising money slowly through a unit trust. So, when investors have demand for this type of product it's quite appealing for investment managers to use, tap into this capital and raise that money quickly. So, that's one of the reasons why we've seen a lot coming to market because it's tapping into that investor demand.
As with any professional investment manager, the quality of the manager and their ability to generate adequate returns or superior returns for you is first and foremost important. So, that's the same as with the unit trusts or any other type of investment.
Uniquely to a listed investment company is how they trade on the ASX. Shares in a listed investment company trade on the ASX and it's the meeting of willing buyers and willing sellers to trade at a price.
Ideally, it should trade at the net tangible assets of the fund or the value of the investments in the fund. But often due to a lack of liquidity in the market the price traded on the ASX can be quite different. And that's when we talk about a share price being at a discount or a premium to NTA.
We've looked historically at the data. Typically, larger and more liquid LICs that are more established would trade closer to NTA.
Some listed investment companies can trade at a big premium if there's a lot of new investor demand into the fund and existing shareholders aren't willing to sell at a price. So, popular LICs can trade at a premium.
Investors should be aware they are paying over the net tangible assets of the fund, so there's a risk that if that premium unwinds at any time then they could bear losses associated with that or that could eat into any gains that the fund makes in NTA.
Often LICs below a market cap of $300 million with limited liquidity can trade at quite sizable discounts and those discounts can widen over time, particularly during periods of market stress.
So, that's an important consideration for investors. That information is available on Morningstar's website. We produce a monthly report. The listed investment companies publish their net tangible assets at the end of every month and we provide a report showing the share price relative to their NTA, so you can see how far out of the market some of these LICs are trading at.
27/02/2017 As the curtains close on the 1H17 reporting season, BHP books earnings that are slightly softer than expected, while Woolies takes market share at the expense of margins. Earnings season wrap: BHP exercises good cost control Nicholas Grove/Glenn Freeman 27/02/2017 http://video.morningstar.com/aus/video/170227_Earnings_BHP_Audio.mp4
Matthew Hodge: The result itself was little bit softer than forecast, but no doubt a significant improvement on the previous year. And really that's a function of couple of things but really mainly higher commodity prices as everyone knows. They have also done a pretty good job of controlling costs and pull quite a significant amount of costs out of the business. There's probably less of that to go in future. That's kind of the way BHP is now and with prices where they are at obviously making pretty good money. There are questions around the sustainability of that and EBITDA margins interestingly were as high as they have been since the peak of the China boom.
Fortescue, their result was pretty much as expected. They've done a really good job of pulling costs out and the iron ore price has been just phenomenal for them. So, it's really helping them pay down debts. So, their balance sheet was really a sore point two or three years ago, and it's becoming on a sound footing, but the sustainability of this level of earnings particularly when they are exposed to iron ore, is the real question. You've got the iron ore prices trading well above the support from the cost curve at the moment, and we don't think that's going to continue.
Johannes Faul: So, Woolworths reported its interim results on Wednesday. Key points to take note of in our view were around the supermarket business, which accounts for over 65 per cent of group EBIT in the half. The big surprise to the market was the strength and momentum of sales growth that outgrew the market and in particularly outgrew Coles. That strong sales growth was very well received by the market and the stock was up significantly on the day.
The other interesting data point however in our view was that EBIT margins for the supermarket business declined from 5.2 per cent to 4.3 per cent half on half. In our view, long-term EBIT margins for the group sit around 4 per cent. So, only 30 basis points lower from where Woolworths currently sits and this is due to our view on the competitive environment. We'll see a response from Coles in terms of price cuts, which means Coles will try to regain market share it has lost. Also, a second competitor called Aldi is expected to continue aggressively rolling out its stores over the near term, over the next four or five years and capture market share.
So, given the competitive pressures on the top line, and likely price cuts from Coles which might also lead to further price cutting from Woolworths, we've been taking a cautious stance on the supermarket industry in Australia./video/transcript/2678 mailto: ?subject=Earnings season wrap: BHP exercises good cost control&body=http://www.morningstar.com.au/video/story/2678