When the COVID-19 pandemic first started to bite in Australia, we said the banking sector would hold up in relative terms, certainly better than it did during the Global Financial Crisis. I’m pleased to say, those projections are holding true.

Seven months on since the COVID-19 pandemic started impacting the global economy, Australian major banks have fared well despite weaker earnings, reflecting our early view that this recession would hurt income statements but not balance sheets.

Large fiscal stimulus and changes to the regulator’s forbearance, which are the requirements of banks classifying deferred loans as arrears and needing to hold additional capital for those assets, are the main reasons for the relatively good performance of the banks. The crucial test for the banks’ balance sheets will occur once fiscal stimulus eventually subsides, and regulators start unwinding current forbearance measures. Once the banks need to declare deferred loans as arrears, they will also need to hold more capital against these loans, which ultimately impacts their capital ratios and the banks’ asset growth prospects.

We believe that we should have greater clarity on the health of the banks’ loan portfolios by mid-2021. In the meantime, we continue to assess the banks’ deferred loans. A large portion of these loans have been taken out by customers that were unsure about the impact of COVID-19 on their personal income. We have run several sensitivity analyses assuming banks’ reduced pre-provision profits and assessed how the banks would be able to cope with the potential provisioning if we assumed 20% to 50% of the deferred loans at its peak would become impaired. Even under the worst-case scenario, we believe the Australian major banks should be able to cope with the impact over a two-year horizon.

However, since mid-2020 we have noticed that the balances and accounts of deferred loans have declined. We believe that even our previously most benign scenario is likely to prove overly cautious given borrowers have resumed repayments, allowing the banks to perform significantly better than anticipated. We remain cautious as the duration of the pandemic and regulatory forbearance time frame is likely to impact the viability of businesses, which in turn impact the major banks’ asset quality.

We believe COVID-19 will have a longer-lasting impact on the banks’ earnings profile as interest rates are likely to stay low for at least the next three years, hurting revenue generation even if credit growth were to pick up again. The Reserve Bank of Australia’s (RBA) Term Funding Facility (TFF) provides some cushion as the banks can refinance their upcoming wholesale funding maturities with this cheaper alternative. We believe that this facility is likely to stay in place unless the RBA starts raising interest rates, allowing banks to generate more attractive asset spreads on loans which would offset larger funding costs if the TFF was withdrawn.

In other words, we believe the RBA needs to be confident enough that marginally higher interest rates will not restrict credit growth – a time which is likely to coincide with the RBA gaining confidence in the timing of its next hiking cycle.

Hence, we believe major banks’ senior note supply may be disappointing. We estimate that the Australian major banks – which used to be penalised for being highly reliant on wholesale markets – may not need to issue new senior unsecured notes for at least the next 12 months. The risk is that unless the RBA is willing to see loan rates increase – most likely driven by an increase in the cash rate – the TFF is likely here to stay.

Any issuance will be opportunistic and may likely occur in the offshore markets so that the banks maintain their relevance in global markets. We foresee Australian major banks to remain active issuers in subordinated notes (Tier-2), in line with their regulatory capital requirements, but any other capital market funding will be minimal. In 2018, the Australian Prudential Regulator Authority introduced the total loss-absorbing capacity (TLAC) requirements to ensure banks had sufficient assets to absorb losses and recapitalise in the unlikely event off failure. The conditions allowed banks to meet these new capital requirements by increasing their Tier-2 capital. This led to a boost in Tier-2 issuance volumes which many considered to be significant, even scary to some.

In 2020, these estimates would be considered miniscule and any issuance is likely to be absorbed comfortably across several markets. Hence, we believe that the current pricing of outstanding Tier-2 notes are attractive even considering our expectation of weaker credit profiles over the next 12 months. In fact, even a prolonged recession and a slower recovery, which will impact banks’ credit strengths, should not have a meaningful impact on credit spread widening for Tier-2 as central banks are likely to remain supportive.

At AMP Capital, we have identified a number of these trends early and our credit funds hold a sizeable portion of these instruments which have positively contributed to the funds’ returns.

Author: Andrea Jaehne, Senior Credit Analyst – Global Fixed Income

Source: AMP Capital 16 Nov 2020

Reproduced with the permission of the AMP Capital. This article was originally published at AMP Capital

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

In a massive healthcare breakthrough in the race to save and protect lives from COVID-19, Pfizer has announced some highly promising vaccine trail results. All going to plan, this should save lives, and in time, help return our societies to some form of normality.

While it’s not yet a finished product, the vaccine shows great promise and is close to the mark, with large-scale testing that hasn’t shown side effects. Extrapolating this forward, we might be able to contain the COVID-19 virus more than the flu, even if it mutates.

Why markets are watching

Markets of course are also interested in reflecting this panacea, as it could mean increased mobility and reopening for society and all the spending that entails. A vaccine could also potentially be a contributing factor to the end for deflation. Both are powerful forces that can push equity profitability higher.

In our view, it won’t be a straight line upwards, but the surge of optimism (and short covering) on Tuesday, 11 October in Australia, could show the path forward as the world emerges from a tough year.

Sectors that led the vaccine rally Travel, Banks and Energy are coming off all-time lows of market cap share.

Source: AMP Capital, Bloomberg. Note travel stocks are a subset of both industrials and consumer discretionary sectors.

The winners so far

Sectors like travel, energy and banking that were at their lowest quarterly proportions of our ASX200 index at the beginning of this quarter are amongst the biggest gainers of the vaccine’s boost so far.

For background, since the pandemic hit, energy has lacked demand and had weak commodity prices across oil, gas and electricity. Banks have had low margins and credit growth, both of which have bottomed and are going higher in our market. Travel stocks of course have suffered with tourism being depleted.

These three poster child value sectors are now so cheap that they might offer high EPS (earnings per share) growth, as much lower valuations than you can get in the growth side of the market and that is why we believe they can make sustained gains as the virus is forced to retreat.

Could there be losers?

The losers from a vaccine on the market could perversely be those that have gained most this year:

• Tech disrupters which had been gaining not on profitability but on the promise of it down the line (assuming they are not disrupted by the next wave of technology by then) after a fast transition to a digital and contactless COVID-19 world;

• Some health care stocks which provided PPE equipment or ventilators for the outbreak; and

• Online shopping which had enjoyed a massive boom as people shopped from their homes.

With the shift of earnings growth back into real businesses, some of these growth valuations are hard to justify and may push valuation multiples lower as the rate of change of customer adoption turns negative. The run up in valuations in tech has been overdone and there are real risks to their stock prices here if revenue trends moderate.

Source: AMP Capital; Bloomberg

Then of course there is the challenged alternatives-to-equities in a low-rate world. Would you believe that there are currently US$17 trillion in bonds with negative yields in the world right now? That’s 12 times the size of our Aussie equity market, or about the same market cap as all stocks currently listed on the New York Stock Exchange. This is because of zero interest rates, risk aversion and a lack of safe assets.

Importantly too, should the vaccine inoculate inflation and boost growth, we should start to see a rotation of investments out of these bonds (which are a cost to hold) and into equities that are reasonably valued and broadly recapitalised.

As we get closer to a widespread vaccination plan, we will see these trends continue and it could be a great shot in the arm for equity returns in 2021.

Author: Dermot Ryan Co-Portfolio Manager, Sydney, Australia

Source: AMP Capital 18 Nov 2020

Reproduced with the permission of the AMP Capital. This article was originally published at AMP Capital

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

The tightly held office market in Australia, particularly in Sydney and Melbourne, has had a stellar run in recent years, with strong fundamentals and robust tenant demand resulting in record low levels of vacancy. The last six months, however, has seen COVID-19 containment measures resulting in a large portion of the workforce working from home rather than in a central office.

As restrictions ease and the full impacts of the pandemic come to light, businesses will need to reconsider their organisational structures, ways of working and the spaces they use to ensure a balance between the needs of individuals, teams and the business.

While it’s too soon to tell what the ‘future of office’ will be, and the impact remote working will have on office demand, the office will still play a fundamental role in how companies operate. And as the largest real estate sector, office exposure, particularly high quality and differentiated offerings, we believe will remain a key component of any diversified real estate portfolio.

Office market update

Australia’s office markets have been quick to respond to the economic slowdown resulting from COVID-19 containment measures. The combination of increased supply and a contraction in tenant demand resulted in a significant increase in vacancy levels from recent record lows, to over 10% in Australia’s two largest markets of Sydney and Melbourne at the end of the September quarter.

In line with the soft economic outlook, we expect office demand conditions to remain under pressure for the remainder of 2020 and to stabilise and improve from 2021 onwards. While the major office markets were well positioned heading into the downturn, it is our expectation that their vacancy levels will remain above historical average levels, before recovering from 2022 onwards. Secondary office markets with higher exposure to small business tenants are likely to experience the sharpest increases in vacancy, compared to the core prime markets which are anchored by more stable, corporate tenants and long lease terms.

Transaction activity has also experienced a sharp contraction since the start of the pandemic, particularly in comparison to the strong levels recorded last year. However, New South Wales and Victoria remain the most sought-after office markets in Australia and continue to attract investor interest. Whilst we saw valuers making adjustments to income assumptions early in the pandemic period, capitalisation rates have only just started to soften causing falls in value. However, we do not anticipate this to be to the same extent as during the 2008/2009 Global Financial Crisis, with real estate pricing being supported by the still attractive spread to low bond yields and investors still seeking exposure to income producing investments.

The greatest risk for office valuations going forward is in the assets facing significant vacancy and leasing risk, which is more likely to be in the secondary stock. As investors begin to price risk back in, the spread between prime and secondary asset pricing will increase and as such, we believe that prime real estate remains attractive in the context of broader investment markets.

A resilient sector

There are many factors at play which make it hard to quantify the impact a more agile workforce will have on demand for office space in the long term. What we do know however, is that between technological advances, the growing role of sustainability and wellbeing and the importance of flexibility, collaboration and community in attracting and retaining talent, the office as we once knew it is changing.

The office sector is a resilient asset class though, and as people start to get back into the office and make their choice where to work, the new post COVID-19 workplace landscape will start to take shape and the office market will inevitably evolve to meet these new requirements as it has done before.

In the meantime, whilst we are seeing tenants deferring the decision to relocate, renewing leases to secure their current space while assessing longer-term impacts on how and where their staff will work, there are also indications that the demand from global businesses for prime offices will continue.

Atlassian for example, have advised all their employees that they will be able to choose, 100% of the time into the foreseeable future, where they work. At the same time, they have recently announced they are designing and proposing a $1 billion+ state-of the-art, sustainable, hybrid timber, high-rise headquarters adjacent to Sydney’s Central station. Facebook, Amazon, Google, Apple and Twitter have made similar decisions on varying scales, citing the need to provide an attractive option of working in an office environment for their staff, as well as employee engagement and cultural reasons to maintain (and grow) their office presence.

While the office may look and feel different, it will still play a fundamental role in how companies operate. Opportunities remain for investors who are able to access quality assets that are actively managed with innovative and agile re-positioning to meet the changing needs of businesses and their workforce.

Finding quality assets and management

In times of change, investors have the opportunity to position themselves in portfolios that both minimise the short-term risks, but also position them for growth when it reappears. These portfolios will comprise assets that remain attractive to tenants throughout the market cycle. That of course, includes the office sector – the largest real estate sector and a key component of any diversified real estate portfolio.

For commercial real estate, a non-homogenous, relatively illiquid asset class, it means that bottom-up, on the ground expertise has re-established itself as a critical component of investment metrics.

Looking ahead, there is no doubt that workplace design and the way office space is used will continue to evolve and tenants will expect the support and guidance of experienced managers like AMP Capital to ensure the user experience, amenity and facilities of their accommodation continue to meet their needs as their requirements change, be it for COVID-19 related reasons or otherwise. The ability of an asset to meet these changing requirements will determine attractiveness of the building to tenants and therefore how secure the income stream is and how sustainable the asset’s investment performance will be.

Unpacking active management

Active management is the implementation of innovative and agile strategies that continue to evolve the asset to meet the needs of current and prospective tenant customers. As part of this, placemaking expertise, central to the evolution of retail assets, is becoming increasingly important in the office sector, ensuring assets remain relevant and attractive to tenants and enticing to their workforce.

Take customer experience as an example, which is a key factor for tenant customers’ decision on which office space to take up. More and more, the attraction of working in an office will be based on the user experience – businesses are looking for a sense of community, a building that reflects their brand, culture and purpose.

Amenity is high on the list of what attracts tenants to our buildings. This includes access to childcare, gyms, high quality ‘end of trip’ facilities (changerooms, bike storage and maintenance facilities), concierge services, cafes, and access to flexible working spaces to make the best use of valuable floor space.

Wellbeing and hygiene will also be front of mind for users of office assets as a result of COVID-19 and the role of technology will be significant in providing the level of comfort required for people to return to the office safely. AMP Capital is currently piloting a number of initiatives that will continue to support our tenants in their requirements, such as smart phone frictionless building access and sensors to manage occupancy and optimise operating costs.

Taking an active management approach ensures portfolios are resilient to short-term impacts of market movements and investors can continue to maximise investment returns, and minimise risks, at all stages of the market cycle.

Case Study: An example of a proactive management approach

Over the last two years, AMP Capital initiated an investment strategy to reposition Angel Place, an A Grade office asset located in the centre of Sydney’s CBD. The objective was to elevate Angel Place as one of Sydney CBD’s most iconic, tenant-centric office assets, ensuring it remains attractive to the changing needs of tenants.

The strategy included the refurbishment of the lobby to a premium standard, the introduction of market leading flexible workspaces and an enhanced user experience in the form of concierge services, improved building amenity and increased community engagement.

Completed in 2019, this asset repositioning shifted market perception of the building allowing us to take advantage of a strong leasing market and forward-solving vacancy risks in order to maximise leasing and renewal opportunities ahead of any anticipated market downturn. As a result, a high level of occupancy has been maintained and income returns maximised for investors into the future despite the current market conditions.

The fundamentals of commercial real estate remain

While it’s important for investors to consider how their short-term exposure will fair in an economic downturn, the fundamentals of investing in commercial real estate remain:

• Seek minimal vacancy exposure/risk through long weighted average lease expiry (WALE); and 

• Ensure assets are well located, well designed and well managed, to ensure they attract and retain high quality tenants throughout the market cycle.

Portfolios that exhibit these characteristics and continue to meet the ‘flight to quality criteria’, will be best placed to weather the short-term impacts of a market downturn while providing investors growth opportunities as markets start to recover.

Accessing prime commercial real estate is not just for institutional investors. Find out how you can access quality office assets by clicking here.

Author: Claire Talbot, Fund Manager – Real Estate Sydney, Australia

Source: AMP Capital 30 Oct 2020

Reproduced with the permission of the AMP Capital. This article was originally published at AMP Capital

Important note: Investors should consider the Product Disclosure Statement (PDS) available from AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) (AMP Capital) for the AMP Capital Core Property Fund (“Fund”) before making any decision regarding the Fund. The Trust Company (RE Services) Limited (ABN 45 003 278 831, AFSL 235150), a wholly owned subsidiary of The Trust Company Limited (ABN 59 004 027 749), is the responsible entity of the Fund and the issuer of units in the Fund. The PDS contains important information about investing in the Fund and it’s important investors read the PDS before making a decision about whether to acquire, continue to hold or dispose of units in the Fund. None of the responsible entity, AMP Capital or any other company in the AMP Group guarantees the repayment of capital or the performance of any product or any particular rate of return referred to in this video. Past performance is not a reliable indicator of future performance. While every care has been taken in the preparation of this video, AMP Capital makes no representation or warranty as to the accuracy or completeness of any statement in it including without limitation, any forecasts. This information has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. Investors should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This information is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.

Earlier in the year we wrote about our attraction to the mining services industry given a favourable macro backdrop, earnings growth and cheap valuations.

While the macro side was very shaky for a few months through the COVID-19 pandemic, we believe it has actually become even more positive given Chinese stimulus and record low interest rates, leading to even higher gold and iron ore prices. Despite some COVID-19 hiccups on the operating side, most mining services companies have sailed through in reasonable shape with the median earnings revision this year for the group down 7%, considerably less than the ~20% fall seen by the broader small cap market.

Past performance is not a reliable indicator of future performance. Stock names: Seven Group Holdings (SVW); Macmahon Holdings (MAH); Perenti Global (PRN); NRW Holdings (NWH); Emeco Holdings (EHL); IMDEX (IMD); Monadelphous Group (MND); MACA Limited (MLD) Source: AMP Capital, FactSet.

Set up for earnings growth

The COVID-19 pandemic has demonstrated the role of the mining sector in the Australian economy, with mines running largely at full capacity over the past nine months. Miners continued critical maintenance work and expansion projects, with the taps recently turned back on for exploration. Iron ore majors are pushing ahead with growth projects and need to complete them in order to offset other mine closures from depleted resources. We are also seeing a number of developers complete feasibility studies and look to finance new projects – particularly in the gold space.

The boom in capital raisings seen over the past six months on the ASX has extended to the junior mining space, with the chart below showing fresh equity raised is up almost 4x from the bottom of the cycle in 2015, and approaching the top of the market in early 2011. We believe this is a good sign for future exploration programs, and coupled with a high gold price (gold typically makes up around 50% of global exploration spend), should set up a good period for companies providing services to the exploration industry, including drillers, tool providers and assay labs.

Past performance is not a reliable indicator of future performance

In our view, medium-term earnings for the sector should be well supported provided commodity prices hold up. An increase in exploration spend should flow through to new deposits being discovered, which is expected to lead to new mines being developed in coming years. Development projects which were parked a few years ago due to low prices are now being restarted, which benefits earthmovers, construction companies, equipment providers and contract miners. Financing projects is becoming easier given lower interest rates and supportive equity markets, while the risks lie in potential cost inflation and labour constraints given border closures.

Coal worries

The coal market has been the main overhang on the sector, with factors such as lower power demand due to the COVID-19 outbreak and Chinese import restrictions leading to low prices across the coal complex. Longer term, the potential for an acceleration of the move away from coal and towards renewable fuel sources through ‘green stimulus’ programs could cause further structural change within the industry. This provides a challenging backdrop for service providers in the coal market. However, we believe that existing contracts will be honoured and provide enough time for providers to shift their business further towards other industries and commodities. Service providers exposed to production are also better positioned as ‘take or pay’ obligations with rail and port providers means it is often more economic for mine owners to operate at a small loss rather than mothball production and pay rail and port fees. Capital markets are also open to provide additional liquidity to operators, with Coronado Coal recently conducting a $250 million equity raising.

Valuation support

Despite the positivity of high commodity prices, increasing capex programs from miners, and earnings which have far exceeded the market average, this bucket of stocks has underperformed the index since the start of the COVID-19 pandemic by 16%, and is trading on an average P/E multiple of just 10x for FY21, compared to 20x for the index. We are under no illusions that this is a cyclical sector that goes through boom and bust periods and deserves to trade at a discount to the market due to this volatility and the capital-intensive nature of the business models. However, we believe the current discount is excessive, especially considering the growth outlook and positive free cashflow being generated by the sector. In our opinion, the market is ignoring the sector in favour of re-open trades, tech stocks and the miners themselves. Nonetheless, we believe that earnings drives share prices and continued delivery on this front will see investors take notice of the sector and see it outperform the market.

We are invested across the sector, and we believe that Seven Group and Macmahon are extremely well-run businesses with a good level of earnings predictability, NRW should benefit from public infrastructure and iron ore work while trading on a free cashflow yield of over 10%, and IMDEX offers leverage to the coming exploration boom in gold.

Author: Matt Griffin, Co-portfolio Manager, Small Caps Sydney, Australia

Source: AMP Capital 17 Nov 2020

Reproduced with the permission of the AMP Capital. This article was originally published at AMP Capital

Important notes: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.