Australia managed to navigate its way through the global financial crisis years without entering into a recession. This is largely thanks to a China-driven resource boom and local fiscal policy initiatives by the Australian government at the time. Fast forward to 2016, and things are not looking as stellar for the Australian economy. Three key catalysts may have a negative effect on the Australian economy.
China Economic Slowdown
Although China’s economy is continuing to grow, it is doing so at a much slower pace, which is stifling Australia's export growth, in particular mining and commodity exporters. As of 2015, China was Australia's largest trading partner. This highlights the importance of Australia transitioning its economy away from being mining-driven to focusing on services. Economic activity is likely to remain slow during this process.
Looming Credit Crisis
Prominent Australian economist Steve Keen believes Australia is in the onset of a debt crisis. He suggests the country is at risk of recession if the debt level held by the nonfinancial private sector is greater than 175% of gross domestic product (GDP), and if debt to GDP rises more than 10% over the last year. As of 2016, Australia has fulfilled both, with private nonfinancial debt at 205% and debt to GDP at 13% over the last 12 months. Keen believes when these conditions are met, credit growth is likely to stall as servicing debt exhausts funds available to finance it, likely causing a recession.
Many economists and hedge fund managers believe Australia is experiencing a property market bubble, displaying similarities to the U.S. market before the global financial crisis. A growing number of interest-only loans expose borrowers to variable interest rates. These loans have grown by approximately 80% since 2012 and put borrowers at a greater risk of default if interest rates rise. As of June 2016, the average price-to-income ratio in Australia is 5.6 times; however, the ratio is a staggering 12.2 times in Sydney, Australia’s most populous city. The exodus of capital flowing out of China has likely added to Australia’s overheated property market. Expensive housing is a key reason behind Australia’s excessive household debt levels. It may therefore be prudent to avoid the following three Australian mutual funds in 2016.
Vanguard Index Australian Shares Fund
The Vanguard Index Australian Shares Fund (“VAN0010AU”) was launched in October 1998. The fund provides investors a cost-effective way to gain exposure to Australian companies and property trusts listed on the Australian Securities Exchange (ASX). It attempts to provide long-term capital growth and dividend income. The top holding is the Commonwealth Bank of Australia (OTC: CMWAY), accounting for 9% of the fund’s portfolio.
As of April 30, 2016, the fund has AUD$470.7 million, or $347.2 million USD, in assets under management (AUM) and a maximum management fee of 0.75%. It requires a minimum initial investment of AUD$5,000, or $3,689. The fund has returned 5.48% over five years and 4.22% over three years. It has returned negative 5.38% over one year. The fund is likely to underperform, especially with its strong exposure to property trusts and banking stocks, if an Australian housing market meltdown occurs.
All Star IAM Australian Share Fund
The All Star IAM Australian Share Fund (“VEN0006AU”) is an Australian equity large blend fund. It attempts to provide, before expenses and taxes, returns of 3% higher than the S&P/ASX 200 Index, the fund’s benchmark. The fund primarily invests in local stocks and unit trusts. It was established in July 2007, and its top holding is mining company Rio Tinto Ltd. (NYSE: RIO) with an allocation of 6.07%.
The fund has a maximum management fee of 0.99% and AUD$36.14 million, or $26.66 million, in AUM. It has a high minimum investment requirement of AUD$20,000, or $14,758. As of April 30, 2016, the fund had a five-year and three-year annualized return of negative 6.43% and negative 2.22%, respectively. It has had a disappointing return of negative 11.71% over the last year. This fund is likely to underperform as Australia transitions away from a mining-focused economy.
Vanguard High Yield Australian Shares Fund
The Vanguard High Yield Australian Shares Fund (“VAN0017AU”) was created in June 2000. It attempts to replicate the FTSE ASFA Australia High Dividend Yield Index before fees. The fund has ample diversification by restricting investment in any specific industry to 40%. Its top holding is Wesfarmers Ltd. (OTC: WFAFY) with a 10.95% weighting.
The fund has AUD$902.8 million, or $666.03 million, in AUM with a AUD$5,000, or $3,689, minimum investment requirement. It has a maximum management fee of 0.9%. As of April 30, 2016, the fund has returned 7.79% over five years and 2.02% over three years. It has returned negative 9.40% over the last year. In the event of the Australian economy taking a downturn, dividends are likely to remain steady or decrease.