The new reality for Australian equities
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    The new reality for Australian equities

    27 July 2020
    Having previously relied on mortgage growth for their burgeoning profits, Australian banks now have tough challenges as home loan lending slows but costs continue to rise.
    Earlier this month KPMG issued a report, The new reality for bank profitability, which highlighted the serious profitability and growth challenges Australian banks are facing in the aftermath of COVID-19. As a result of the record low rates and pressure on net interest margins (NIMs) banks face pressure to manage costs and increase productivity. With the RBA unlikely to raise rates in the short term, banks will continue to face ongoing structural headwinds.

    Since Australia’s “recession we had to have” in 1994, Australian banks have benefited from a growing economy in which home loan lending and credit growth thrived. This growth drove the banks’ profits to record levels.

    Australia's 'big 4' net operating profit after tax (NPAT)
    Source: Bloomberg, Financial reports

    Median of the major's net interest margins (NIMs)
    Source: Bloomberg, Financial Reports, sourced 20 July 2020.

    As you can see, banks were already facing headwinds in 2019, as the RBA loosened monetary policy, and we expect profits to fall further in 2020. Banks’ profits are sensitive to the mortgage market, according to KPMG’s report, it is estimated that every 5 basis points reduction in mortgage net interest margin (NIM) results in a 1 to 2 percent reduction in cash earnings for the major banks. NIMs remain under pressure.

    Having previously relied on mortgage growth for their burgeoning profits, Australian banks now have tough challenges as home loan lending slows but costs continue to rise.

    Housing loan commitments (excludes refinancing)

    Source: Australian Bureau of Statistics

    Average total operating expenditure growth

    Rebased to 100, Source: Bloomberg, Financial Reports, KPMG sourced 20 July 2020

    These headwinds are highly problematic for bank shares and for the many Australian investors whose portfolios have significant exposure to the big four banks. They don’t bode well for sustaining current dividend payout ratios. The four pillars (CBA, Westpac, ANZ and NAB) represent a quarter of the S&P/ASX 200. In other words, if you hold a blue chip portfolio or are invested in an active or passively managed Australian equity fund that tracks or benchmarks to the S&P/ASX 200, $1 out of every $4 is likely to be invested in banks and therefore vulnerable to the risks they face.

    Conversely, taking an ‘equal weight’ approach to the S&P/ASX 200 can provide true diversification across securities and market sectors, reducing concentration risk to the banks. We’ve written a lot about the importance and benefits of taking an ‘equal weight’ approach, where the same weight, or importance, is given to each stock, reducing concentration risk.

    As an example, the VanEck Vectors Australian Equal Weight ETF (ASX code: MVW) invests in over 80 of the largest and most liquid ASX-listed companies using an equal weight approach. MVW’s exposure to the big four banks is less than 5%. This dramatically reduces investors’ exposure to the big four, reducing concentration risk and reducing the impact of dividend declines. MVW is close to 2 ½ times more diversified than the S&P/ASX 200, as measured by the Herfindahl Index*.

    Find out more about MVW.

    *Learn about the Herfindahl Index.

    This information is issued by VanEck Investments Limited ABN 22 146 596 116 AFSL 416755 (‘VanEck’) as responsible entity and issuer of the VanEck Vectors Australian Equal Weight ETF (‘Fund’). Nothing in this content is a solicitation to buy or an offer to sell shares of any investment in any jurisdiction including where the offer or solicitation would be unlawful under the securities laws of such jurisdiction. This information contains general advice only about financial products and is not personal advice. It does not take into account any person’s individual objectives, financial situation or needs. Before making an investment decision in relation to the fund, you should read the PDS and with the assistance of a financial adviser consider if it is appropriate for your circumstances. The PDS is available at or by calling 1300 68 38 37. The Fund is subject to investment risk, including possible loss of capital invested. The PDS details the key risks. Past performance is not a reliable indicator of future performance. No member of the VanEck group of companies gives any guarantee or assurance as to the repayment of capital, the payment of income, the performance, or any particular rate of return from the Fund.