- On April 19, 2017
Despite a backdrop of socioeconomic uncertainty and increased financial market volatility, growth in the personal savings of Australians remains strong. As of 30 June 2016, total personal investments stood at $2.3 trillion, representing an even larger pool of savings than the superannuation system.
However, Australian households are increasingly exposed to significant concentration risk from their holdings of term deposits, bank shares and investment property. Rice Warner’s recently released Personal Investments Market Projections Report 2016 reflects the substantial commonality of risks involved in investment properties and typical equity portfolios.
Australians have, over the past decade, held much of their assets in cash, equity and investment property. Graph 1 reflects that this trend has continued into 2016 with changing views on the interest rate environment driving consolidation into these traditional asset classes. In general, these assets are largely underpinned by Australia’s large banks who are market leaders in providing term deposits and extending loans for property investment.
Graph 1 shows that investment properties are the second largest sector for investments outside super, closely following cash and term deposits.
Graph 1. Personal Investments asset allocation as at 30 June 2016
Escalating Interest Rate Risk and stretched property prices
Australia is experiencing its lowest interest rates ever, with the Reserve Bank Cash Rate currently sitting at 1.5% and competitive variable mortgage rates between 3% and 4%.
Despite the macroeconomic benefits of this environment, rates are widely expected to rise over the next few years following the recovery of the American economy and rate hikes in the US. As Australian investors are predominantly tied to variable rate loans, any increase in rates would quickly feed into the cost of servicing mortgages, especially for investors who are using negative gearing and hence dependent on income other than their rent to service the mortgages.
Further, and in addition to this interest rate risk, Australians who hold investment property assets face a myriad of other structural risks in coming years, these include:
- Changes in tax treatment as housing affordability moves up the political agenda.
- Restrictions on movement of capital by international investors, especially those based in China.
- Property-specific risks such as repair bills and loss of rent.
- Difficulties with property investments at the same time as difficulties with other investments that have similar economic drivers.
“Diversification” with Banking Equities
In terms of their equity holdings, historically Australians have been heavily invested in the domestic banking sector due to its high visibility, perceived strong track record (despite the GFC) and size relative to the rest of the Australian market. However, institutions in this sector are, by nature, highly interlinked through mutual lending and similar profit drivers such as margins – net of funding costs and defaults – on mortgage lending.
The effect of this is that the conventional wisdom of spreading investment funds across several shares will do little to reduce risk if individuals hold too many bank shares and Term Deposits. This is demonstrated by Graph 2, which shows the cumulative movement of equities directly held by households against the ASX200 Banking Index¹ over the 2015/16 financial year. Overall, the figure reflects strong co-movement between the value of household investments in direct equities and the performance of the banking sector, together highlighting the number of eggs that have found their way into the same basket.
Graph 2. Cumulative movement of Direct Household Equity against the ASX200 Banking Index
Future Developments and Trends to Watch
Given this concentration of risk, it becomes apparent that structural change in these sectors should be implemented with caution and on a holistic basis.
Rice Warner’s recent insights blog² touches on one possible change with the potential to cause a further escalation of risks, specifically allowing superannuation to be accessed to fund housing purchase. The combination of dilution of retirement savings and further upward pressure on property prices means such a measure would at best be counter-productive for those whom it is intended to help, and at worst would further increase the risk of the property booms in Sydney and Melbourne ending in tears.
¹ Ticker code AXBAJ on the ASX trading platform.