Australia’s property market prompts top fund to cut debt

Bloomberg

Australia’s overheated property
market has spurred one of the nation’s top-performing fixed income money managers to cut some of its real estate debt investments to the lowest level since the 2007 financial crisis.
Vivek Prabhu, the Sydney-based head of fixed income at Perpetual Ltd., is making the move as he braces for potential blow-ups in the nation’s A$7.6 trillion property market. He has whittled down the debt holdings of Australian real estate investment trusts within the A$926.4 million ($692.7 million) Perpetual Wholesale Diversified Income Fund to 2.9 percent from a peak of 14.8 percent in 2014.
“Looking at the property cycle — both the residential and commercial — we’re probably closer to the top than to the bottom,” Prabhu said in an interview. “The risks are increasing but the compensation for that risk, or the credit spread, hasn’t really moved out.”
Australia’s house values rose at the fastest pace in seven years in 2016, fueled by record-low interest rates that emboldened buyers to pile on more debt. The nation’s residential property has attracted billions of dollars
from investors including those from China despite warnings heady price increases in recent years may be unsustainable.
Prices are expected to continue climbing in 2017, driving up household debt levels and worsening the financial risk of borrowers in the event of an interest rate hike, Fitch Ratings said in a report dated Jan. 15. Loan delinquencies have also been on the rise in mining-focused states such as Queensland and Western Australia following a slowdown in the commodities sector, according to data from Genworth Mortgage Insurance Australia Ltd.
“In a rising rate environment where all asset classes were inflated by falling rates, the property sector is one that comes to mind as being exposed,” Prabhu said. The Wholesale Diversified Income Fund returned 4.28 percent in the one-year period to November, more than double the Bloomberg AusBond Bank Bill Index’s 2.12 percent in the same period.
Perpetual, which Morningstar Inc. ranked the top-performing fund manager for Australian fixed income during the year to October, invests just over A$5 billion of its A$6.1 billion debt portfolio in company and financial bonds and asset-backed securities. Prabhu ramped up the diversified income fund’s investments in financials and corporates last year, and he said that has helped.
The fund holds notes issued in various currencies by Australia’s big-
four banks, Citigroup Inc., HSBC Holdings Plc, Sydney Airport Ltd. and
supermarket owner Woolworths
Ltd., among others. Debt issued by Australia’s largest bank by market value, Commonwealth Bank of Australia, contributed some of the biggest gains for the fund last year, according to Prabhu.
The fund’s investments in bank and financial paper have almost tripled to 37.3 percent in January from 12.9 percent in July 2006, he said. “The economy and more confidence in stronger growth is a positive for banks as well as in terms of reducing non-performing loans,” he said. “It paid off well in 2016, but spreads have tightened and we have been trimming specific names and replacing them with others where we see better relative value.”