It is right on Asia’s doorstep, but James Dunn finds that outside the big resource names there is surprisingly little Asia exposure in Australia’s stock market
Australia’s A$1.2trn (€970bn) stock market, the eighth-largest in the world, has something of a split personality. At 30% weighting to materials stocks (in the S&P/ASX 200), the index is heavily influenced by the big, diversified, global ‘bulk’ miners it hosts – notably BHP Billiton and Rio Tinto – whose shipments of iron ore and coal feed much of the Chinese economic growth story. That sizeable chunk of the Australian market is definitely of interest to global investors, as a way to ‘play’ the emerging Asian growth theme.
“Australia could be considered as a proxy for the emerging Asian markets, particularly China,” says Bob van Munster, head of equities at Sydney-based Tyndall Asset Management a subsidiary of Nikko Asset Management. “Approximately 60% of Australia’s exports are consumed by Asia.”
Four of Australia’s top five export markets are in Asia: China (which consumes 25% of Australia’s exports); Japan (17%); Korea (8%); and India (6%). But with 32% of its stock market accounted for by financials – mainly the ‘big four’ local banks, which boast metrics much healthier than most of their global peers – one could argue that the Australian index is really more of a domestic story.
Munster cautions against that assumption. “A number of Australian banks, insurance companies and investment banks are building a presence in the region,” he says, pointing out that the Commonwealth Bank of Australia is a part-owner of a Chinese bank, and that ANZ has a shareholding in two Chinese banks and aims to raise its Asian revenues, with 20% of earnings to come from Asia.
In healthcare, Asia is the fastest-growing market for the global leaders in plasma protein biotherapies and cochlea implants, CSL and Cochlear, even though the continent as a whole already accounts for the majority of their earnings.
“CSL has become the largest external supplier of albumin to China, following the closure of large sections of the Chinese plasma collection industry due to quality concerns,” says Munster. “For Cochlear, the Asia Pacific region accounts for about 14% of earnings but is expected to grow at around twice the rate of the developed world markets in coming years.”
Munster goes on to mention building materials firms like James Hardie, BlueScope and Boral, and big names in the gaming industry such as Crown (which owns 34% of Melco Crown Entertainment in Macau) and Aristocratic Leisure (which supplies about two-thirds of the gaming machines in the special administrative region). Most global investors have very little awareness of these opportunities.
“Unfortunately, I think it is all about the resources,” observes Simon Ibbetson, principal of asset consultancy 358 Australia. “If you look at international managers’ portfolios, they have two or three stocks from Australia in the portfolio – BHP, Rio Tinto and maybe one of the banks – and that is about it, really. Don’t forget, the Australian equity market is about 1% of the MSCI, it’s a rounding error.”
A decade ago, says Andrew Pease, global head of investment strategy at Russell Investments, global investors – particularly European funds – would look at the Australian market within an Asia-Pacific ex-Japan mandate, in which Australia got a 25–30% allocation.
“What we’re finding now is that a lot of pension funds are shifting more to global indices, in which Australia has a much smaller weighting – [and it’s] not only a smaller weighting proportionally of that index, but also a different focus,” he says. “Also, a lot of the mandates are shifting – within the multi-manager portfolios, now you’re giving managers a lot more latitude to choose the best companies, regardless of the regions they’re located in: they will ask themselves whether they like Westpac better than Standard Chartered Bank or another bank.”
While global fund managers wax and wane in their view on resources, the attractiveness of the Australian banks remains their high yields, with nominal dividend yields in the 6-7% range. Graham Harman, director of capital markets research at Russell Investments, says Australian bank stocks are starting to show up on global investors’ quant screens for yields, but adds that the yield picture does not convince everybody.
“I think a lot of global investors are very conscious of the fact that the loan-to-deposit ratios are very high in Australia by global standards, and the banks are heavily reliant on both overseas funding and house prices staying high,” says Harman. “There is still a perception that Australia has been the lucky country – it has been the only OECD country with 21 years of GDP growth – but that the luck is going to run out some day and, in particular, that house prices have to come off.”
William Davies, head of global equities at Threadneedle Investments, does not consider the Australian banks to be all that attractive in a global context because they serve a relatively mature market and have lower growth rates. “The size of the Australian financial sector is also small relative to the global sector and there are many more opportunities in the US, UK and in Asian financial centres such as Singapore and Hong Kong,” he says.
This is one of the main problems with the Australian market, says Harman – it does not host any global brand-name companies. “If international managers want to buy a bank stock, they can buy good-quality global names that they know a lot more about, much more cheaply, in Europe or North America. The same goes for most of the non-resources industries in Australia. That’s problem number one.”
Problem number two, he says, is that global investors understand that non-resource, non-bank exposures have been hit by the strong Australian dollar and weak consumer spending. “If you look at the media sector, the retail sector and the building-materials sector in Australia, there are plenty of areas where there has been a lot of pain, and where the stocks, to some extent, have almost dropped off the ‘investable’ radar on a global stage.”
Given all of this, it is no surprise that problem number three is that the market does not really have non-resources stocks that offer meaningful exposure to Asia – the firms listed by Munster are the exceptions.
“Global investors have already seen a lot of Australian companies over the years go out into Asia and America, and start playing with the big boys – coming out of a cosy, oligopolistic type of world – and get eaten for breakfast,” Harman observes. “I have actually seen investors in Asia asking for Australian industrial stocks that are expanding into Asia, with a view to shorting them.”
For global companies, distance is no barrier to trade or investment, so Australia’s proximity to Asia does not result in a competitive advantage in most industries, says Davies.
“Playing emerging market consumer growth through developed market stocks has been a theme in our global funds for some time,” he confirms. “But we generally find global companies such as Nestlé, Swatch or McDonalds are better positioned to take advantage of this growth than Australia-listed companies outside the resources sector.”
He adds that most ASX-listed industrial and consumer companies derive the majority of their earnings from Australia, so are not well-positioned to benefit directly from Asian growth.
“If you compare Australia to Japan, for example, Japan is a key supplier of industrial, consumer and technology equipment to Asia, and there are a large number of listed companies that derive significant proportions of their earnings from Asian markets,” he says. “In our Global Select fund we have preferred export-orientated Japanese companies such as Makita and Toyota, and companies which derive a significant proportion of earnings from outside Japan, such as Asahi.
“In contrast, Australian exports to Asia are mostly primary products such as materials, energy and agricultural products.”
That is not to say that there are no genuine industrial and consumer businesses in Australia worth considering for global investors, he says – but in specialist portfolios. “For example, our Global Equity Income fund has taken advantage of the relatively high yields available in Australia on industrial companies, and has invested in companies such as Suncorp, Telstra and Coca-Cola Amatil,” he says.
Australia might be on Asia’s doorstep, but it seems that, while its economy is just big enough to support a range of companies focused on domestic demand, it is not quite big enough to support a range of companies across sectors ready to take on the markets of its fast-growing neighbourhood.