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Old model key player in a new game

Investment income is eclipsing capital gains as a contributor to total returns, writes John Collett.

Investment income is eclipsing capital gains as a contributor to total returns, writes John Collett.

The easy capital gains enjoyed by investors on shares and property until fairly recently are likely to continue to recede into memory. Much of those capital gains of the past 20 years were driven by the fall in interest rates and increasing use of leverage to turbo-charge capital gains. For investors the game had changed, market economists say.

"The leverage boom is now over and that was the primary driver of above-trend economic growth globally," the head of investment market research at Perpetual, Matthew Sherwood, says.

Income from investing is now going to be a bigger contributor to total investment returns - capital gains and income - than in the past, he says. During the sharemarket and property price boom, investors were mostly after capital gains.

"That attitude is changing," the chief economist at AMP Capital Investors, Shane Oliver, says. "Income is the key to generating a decent return."

An ageing population will help drive the trend as retirees and older investors focus on capital protection and the generation of income to meet their living expenses, Oliver says. Those investors wanting higher capital growth may have to seek out opportunities in the fastest-growing parts of the emerging world, such as Asia, but that comes with more volatility, he says.

House prices

Most of the factors that helped to make Australians the richest on Earth (See box: World's wealthiest) will stay unchanged. The mining boom has played the biggest part in recent years and likely into the future. Australia's favourable tax treatment of interest on borrowings used to invest, negative gearing, could only be removed at the government's peril.

But it is rising house prices that are "probably the key underpinning the huge surge in Australians' wealth over the past 15 years or so", Oliver says.

The Credit Suisse Global Wealth Report 2011 says the level of real estate assets held by Australians is now the second-highest in the world, after Norway.

Real estate assets make up 65 per cent of total household assets.

In Britain, real estate makes up about 50 per cent and in the US about 30 per cent.

If there was to be any sustained fall in house prices, it would have a big impact on Australians' wealth levels.

But despite the doomsayers predicting a collapse in prices, they have so far been proven wrong.

"House prices have come off a bit lately but we are talking about 3 or 4 per cent," Oliver says. "Whereas US house prices are 30 per cent lower and in some areas a lot weaker and 15 to 20 per cent lower in the UK," he says.

The chief economist at CommSec, Craig James, says for house prices to collapse there would need to be a big rise in unemployment or interest rates would have to go through the roof and neither of those things look as if they are going to happen.

However, Oliver says it would be unwise to think that just because we have seen strong gains in wealth driven largely by housing that that is going to continue.

"I think the more likely scenario is that we do go through an extended period where house prices are pretty soft," he says.

Australian shares

Australian shares are still trading at levels well off their to-date highs of early November 2007 as concerns remain of the European debt crisis, the strength of the US economic recovery and whether China will have a hard landing as it seeks to contain inflation.

James says foreign investors in Australian shares tend to be "fair weather friends".

When there are concerns about the global economy, foreign investors are going to be less inclined to buy Australian shares.

The high Australian dollar is also working against our market, he says, as it makes Australian shares more expensive for foreign buyers.

But the fundamentals of the Australian sharemarket remain sound. Australian companies are in good shape.

"Gearing is low, profit levels are reasonably high and dividend yields are high," Oliver says.

Sherwood says Australia is in a good position with low government debt and growing trade exposure to Asia.

Australian shares are on a cash yield of just under 5 per cent and with franking credits, almost 7 per cent. Bank deposit rates are coming down as the banks are not competing as hard for deposits as they were.

The bet is that the Reserve Bank will cut the cash rate on Tuesday, Melbourne Cup day and, if not, then probably in December, which could bring bank deposit rates to less than 5 per cent.

Oliver says there could be another cut in interest rates early next year.

"There is just too much weak economic data in Australia and globally at the moment to justify keeping rates at this level and the inflation picture is looking more benign," he says.


For those worried about their retirement there was more bad news in the latest super returns. Funds posted their worst three-month return since the December 2008 quarter. Researcher, Chant West, says the typical "growth fund" - where most people have their money - lost 5.1 per cent during the three months to the end of September.

A co-founder of Chant West, Warren Chant, says in the middle of this year, the typical growth fund required about 6 per cent to return to its pre-GFC high of October 2007.

"That shortfall has blown out to 11 per cent," Chant says. "Even if funds were to meet their typical performance objective of about 7 per cent per annum, it would still take between one and two years to mark that up."

But anyone tempted to move to switch to cash should think again, Sherwood says. The temptation to go to cash is understandable given the decline in account balances. "We have to keep in mind that Australian equities are exposed to the growth centre of the world and our economy is sound," he says.

"At the moment our economy is going through a bit of a mid-cycle slowdown but it is expected that economic growth will accelerate during the next 12 months. And we know there is a good connection between a growing economy and higher corporate earnings, which drives-up share prices."

World's wealthiest

Despite the doom and gloom, there are reasons to be cheerful. As measured by median wealth levels, Australians are the wealthiest people in the world, says the Credit Suisse Global Wealth Report 2011, which measured the wealth of the world's 4.5 billion adults.

It found Australia's median wealth, the mid-point between the wealthiest adult and poorest, was $US222,000 ($213,800), the highest in the world.

Average wealth was $US397,000, the world's second-highest after Switzerland with $US540,000.

It is the median figure that is more meaningful because it says more about how a country's middle class is doing.

Wealth in Australia is more evenly distributed than in other countries, particularly compared to the US, which has median wealth of about $US53,000.

As Credit Suisse measured wealth in US dollars, the strength of the Aussie dollar has helped push Australia up the rankings.

But even after removing the currency affects, Australia's performance has been robust, particularly since 2000, the report says. The report also says Australian wealth is highly skewed towards real estate assets.

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