Ten things you must do in 2015

Here’s your investing guide for the year ahead.

Summary: If you wish to borrow in the year ahead, do it sooner rather than later, as it will become more difficult to get borrowing approval. The Australian dollar is set to keep falling, while the oil price is likely to stay low and residential property will remain compelling. Consider investing outside super in case of changes to the tax regime.

Key take out: It’s a stock picker’s market, so avoid index funds in Australia and investigate LICs and newly buoyant agricultural stocks. The hunt for yield will also remain a dominant theme.

Key beneficiaries: General Investors. Category: Strategy.

Looking ahead to 2015 one of the key factors for any investor to digest is that calendar 2014 – particularly the second half of 2014 – did not turn out as expected. In other words interest rates have stayed where they are, inflation has barely budged and indeed our local share market is set to finish the market flat – or so little changed it barely makes a difference.

Put simply, it looks just now like Australia will be among the weaker spots in a broadly recovering global market in the year ahead: That is by no means a negative scenario for investors, but it does make for a more challenging landscape than anyone might reasonably have suggested a year ago.

At Eureka Report we have been concentrating on some larger themes in recent times: Pushing investors to consider overseas markets, pointing to the rewards of stock picking and continually assisting in the “hunt for yield”. Most investors who follow Eureka Report closely will be well armoured when it comes to making money in the markets but it also pays to stand back and consider the wider horizon with a new year unfolding. Here’s my 10 key items to consider over the summer break.

Ride the dollar all the way down

One of the enduring themes in recent times has been the descent of the Australian dollar and the parallel ascent of the US dollar. It’s interesting to note that when I did this list exactly 12 months ago (see The 10 things you must do in 2014) the RBA was publicly intimating it wanted to see the $A below US90c. 

More recently on December 11 this year the RBA Governor Glenn Stevens said he would now like to see the $A at US75c. As we go to publication the $A is roughly US81c and Commonwealth Bank has revised down its forecast which now expects the dollar to be worth just US73c in June 2015.

Moreover, as we know very well, currencies – like markets themselves – can overshoot. There is every reason to suspect the “drop” in the Australian dollar might also witness an overshoot.

From an investor’s perspective the widely anticipated further decline of our dollar against major currencies, especially the US, means a silver lining for the wider business of lifting allocation to offshore investments.

Borrowing: Do it sooner rather than later

For those with the fortitude we have just had several years where conditions for borrowing to boost your investments (also known as leverage) have been pretty close to perfect. Now those conditions are about to change. It’s not actually a question of interest rates, which may even drop lower. It’s the issue of actually getting borrowing approval.

Lending growth in the “system” is pretty nearly back to normal at around 9%. This means the banks’ loan books were underdone until very recently and are now back at normalised levels. But more ominously a trio of moves which loom large at the end of 2014 will pinch bank lending conditions in the coming months. First the Murray Inquiry has recommended that gearing in DIY super funds be scrapped entirely. Second ASIC has said it will examine interest-only loan activity. And most pertinently, APRA has warned banks they will have to lift their capital levels if they allow the interest-only portion of their books to grow at more than 10% a year. As we close 2014 a staggering 42% of new loans are going to investors. Be aware that number is set to shrink.

Avoid general index funds and ETFs in Australia

In markets where you may be out of your depth, such as European stocks or American sub-indices, there are logical reasons you might put your money in a “basket style” grouping of investments that seeks to mirror an index. But on the Australian market such an approach has too many weaknesses at this time.

Looking back over 2013 and 2014 we can start to see a historic recovery from the dreadful days of 2009 when the market hit bottom. In the year ahead there is very little reason to expect an extended broad recovery in Australian corporate earnings or indeed any real strength in GDP or related macro statistics. Remember resources make up a substantial slice of the ASX and with miners in a deep cyclical downturn we can’t expect overall numbers to be strong.

As a result we find ourselves in a classic stock picker’s market. This is not where index huggers or ETFs do well because they are carrying stocks which their own managers would knowingly avoid if their mandates allowed them to do so. One point: General index funds which follow the entire Australian market may not be promising but there will always be opportunities in niche ASX-focussed index funds that seek to follow one category in the market rather than the entire index.

Position your portfolio with regard to oil

The single biggest economic surprise of the last year was the 50% drop in the oil price – it is fair to say almost nobody saw it coming, including oil companies such as Santos which found itself with a very public financing problem and a smashed share price in December.

Intriguingly our more staid oil stocks such as Woodside held up well during the plunge and remarkably Woodside now finds itself paying a dividend yield of 6%. As our resources correspondent Tim Treadgold has explained to shareholders in the big oil and gas companies the best thing to do is sit tight. There is no reason to panic sell (see A falling dollar can be your friend, December 22).

But looking at the issue more widely, a lower oil price is a game changer. Note the doubling of value in Qantas, the renewed interest in transport companies or even the falling freight charges for bulk carriers managed by Rio Tinto and BHP Billiton. At $US59 a barrel (Brent) there is a new energy paradigm in the markets – we have cheaper fuel despite tensions in the Middle East and in the face of combined efforts within OPEC to work things out. The consensus is that oil prices will stay low for at least the next 12 months.

Stick with residential property

First let’s look at the numbers – RP Data CoreLogic says average house prices rose roughly 8.5% over the course of 2014 while gross rental yields would have averaged a little more than 4%, giving a return close to 13% for the year. That’s a better return than cash or the share market (even assuming accumulated dividends). 

For investors the issue in 2015 may not be whether prices will keep going up (it is widely expected they will rise in low single digits, maybe 4%) or whether yields will fall (they are expected to remain at gross 4.25% or so). Rather, it is the mixed prospect of getting finance. Without doubt the combination of regulators intensifying their activity around interest-only loans and the Murray inquiry’s recommendation that gearing in DIY super be scrapped will hit the provision of finance.

Nonetheless, taking even a conservative estimate of 4% growth in prices and 4% rental return there is a return at hand of 8% which looks better than almost any other investment class. One point: Yields are getting very low in high value properties, typically under 3% gross. Investing on the basis of these numbers you would have to get a strong return in price each year to justify the commitment.

Investigate peer-to-peer lending

The outstanding aspect of this new technology which allows internet-enabled matching between lenders and borrowers is that investors can become lenders in the purest sense. In the last 12 months a string of new peer-to-peer operators have opened their doors in Australia, the most interesting being SocietyOne, which is backed by James Packer’s Consolidated Press Holdings and News Corp (owner of Eureka Report), and Ratesetter, a subsidiary of a $1 billion operation in the UK.

Overseas experience at companies such as Lending Club in the US suggests that borrowers and lenders both get better deals under these arrangements. Ratesetter Australia suggests investors should get something close to 7% per annum while borrowers may be something close to 5% less than standard commercial bank rates. (To read more, see Peer-to-peer lending: Is it for you?, December 17.)

The fear of course is that this new “banking” model has not been tested in tough times and moreover that regulators have not yet fully understood the model. Nonetheless, assuming an investor goes into the business with eyes wide open, understanding there may be unsecured loans and crucially accepting that funds here are not guaranteed as they are in the banking system (you could lose the lot), peer-to-peer should be examined by any serious investor, especially those looking for new income streams.

Agricultural stocks: Check your bias

It would be entirely reasonable for any long-term investor in the Australian share market to be dismissive of the listed agricultural sector which has disappointed so many so often. But then again one of the outstanding lessons offered by billionaire investor extraordinaire Kerr Neilson of Platinum Asset Management has been to check your biases – circumstances change and so should your attitude to stocks. 

From the entrails of stock market duds such as PrimeAg, or perennial failures such as beef producer Australian Agricultural Company, this last year saw a stunning turnaround in the fortunes of listed agricultural stocks. The bonanza had commenced with the takeover battle for Warrnambool Cheese and Butter by Canada’s Saputo group and fed through to rising stock prices for a string of selected stocks such as feedstock supplier Ridley and nut producer Webster. Even the long-struggling AAC managed to perform well over the year, rising from around $1.15 to $1.43.

In the year ahead we will most likely see further demand running through our local agricultural sector as offshore interests, especially from China, seek to buy more farms and farm produce. For investors perhaps the greatest frustration is the narrow range of listed investments in this sector. United Dairy Farms, a newly listed small cap in the sector which offered an IPO at 20c in October, was trading higher at 27c prior to the Christmas break.

Don’t put all your eggs in the DIY basket

A wise investor explained to me his reason for keeping a substantial slice of his investment funds outside of superannuation: “It’s like a lobster pot,” he opined, “once the money is in there you can’t take it out… but the government can change the way they tax it.”

Already in early 2014 we found out how governments can change their minds when in the dying days of the Gillard administration they introduced the high income earner super surcharge. Maybe few were surprised when the Abbott administration never felt the need to rescind that legislation despite a wide agenda of reversing Labor government policy.

In the year ahead there are deeper fears for the current tax regime around superannuation for the simple reason the budget deficit is bigger than anyone estimated. Now as Scott Francis has pointed out in Eureka Report (see It's time to look beyond super savings, December 22), a simple 1% tax slice off the existing total value of superannuation assets in this country would be worth a staggering $18.5 billion. It is almost inconceivable any Treasurer could leave such a honey pot alone when facing a budget blow… you have been warned.

Look at LICs

For some reason listed investment companies (LICs) became slightly unfashionable in recent times, associated perhaps with the more conservative and cautious members of the financial services brigade. However, in recent months we have seen a string of new LICs of all shapes and sizes enter the market, refreshing a sector long associated with established brands such as AFIC and Argo. Indeed Perpetual managed to list its new $250 million LIC, Perpetual Equity Investment Company, on December 19.

In a market where returns may be suppressed, fees can be high and there is constant volatility, the concept of investing in a “basket” of equities is always attractive. Index funds offer low fees but they also carry all the worst companies in the market as they simply use computer programs to reflect the market. Active fund managers may offer better than benchmark returns but they will carry higher fees.

At their best LICs offer lower fees and “active management” and in a stock picker’s market that might just be the right formula for many investors in the year ahead.

Extend your hunt for yield

The RBA has left interest rates unchanged an unprecedented fifteen times in a row at 2.5%. Moreover, the consensus is moving towards an expectation of further rate cuts rather than extended stability. Indeed Deutsche Bank, Goldman Sachs, NAB and Westpac are now among the institutions that expect one or more rate cuts in 2015.

On this basis the amount you will receive in bank accounts or term deposits will be worse than ever. With inflation around 3% and retail deposit rates around 3%, money on deposit is in store, it is not invested.

All the more reason to recognise that the hunt for yield remains a dominant theme for all investors. Among the best options is the stock market, particularly dependable, high-yield stocks. This would include the banks, insurers and selected blue chips such as Telstra. A niche product that remains attractive in the index fund or ETF category is the best of the locally listed “high yield” funds that capture the best dividend payers in a single basket of stocks.