Nicholas Grove: QBE Insurance is coming up on the halfway mark of its financial year and Morningstar's David Ellis believes there are a number of external factors that bode well for the company. He joins me today to discuss these developments.

David, welcome.

David Ellis: It's pleasure, Nick.

Grove: First of all, David, you recently said you expected QBE's earnings to be boosted quicker than expected, should these external factors continue to be an influence. What are these developments that you're referring to?

Ellis: Sure. Well, QBE, as we know, is an Australian-based global insurer, has major operations in the US and in Europe and in the UK, as well as Australia. So what we're seeing with QBE's US operations - they had a terrible 2011 and a terrible 2012 as far as earnings are concerned - but in 2013, so far we've seen a low number of large catastrophe events, so natural peril events and natural disasters.

We have seen some signs of the US economy picking up. So there is some tentative improvement there. We've seen the US dollar recovering, so the Australian dollar is falling, so it's fallen about 10 per cent in the last month or so. The expectation is that the Australian dollar could fall further against the US dollar. So that's boosting earnings.

Not the least, there are some indications that the long-term US interest rates are starting to increase. The yields are starting to recover. QBE has a large proportion of its $30 billion plus of its investment portfolio that are in government bonds, sovereign bonds from various sovereigns around the world, and a reasonable proportion that is in US Treasury notes and US corporate debt, or quality corporate debt. So higher interest rates, longer-term interest rates in the US is a plus for investment earnings for QBE.

So, the combination of those four factors, as external factors, suggest to us that on top of what QBE is doing internally that these factors are going to - are a positive and will continue to be a positive to the earnings recovery.

Grove: David, should these developments continue, can investors expect a significant improvement in dividends?

Ellis: No is the short answer. QBE recently announced a change to the dividend payout ratio policy. So, they reduced the payout from 70 per cent to 50 per cent. So, this 2013 financial year, we expect - irrespective of the profit recovery - we expect dividends roundabout $0.50 per share, in line with 2012. We expect - going forward - we expect dividends to grow in line with earnings per share growth, but still at that 50 per cent payout. So, we do expect high dividends starting in 2014, but growing at earnings per share growth based on a 50 per cent payout ratio.

Grove: David, when discussing QBE, you often refer to the combined operating ratio or COR. Can you elaborate on this measurement? And why is it important for investors to know about it?

Ellis: Sure. Another way to describe the combined operating ratio is the combined operating expense ratio. So, it's the total. It's a combination of the three components to running the insurance business. So, the first one is - the largest component - is the claims expense. So, we're forecasting it, based on company guidance, a combined claims expense of around about 60 per cent of earned premium.

And that 60 per cent is split between 10 per cent, which relates to or is projected to cover catastrophe events and 50 per cent of earned premium just on run-of-the-mill everyday type of claims. So, that's 60 per cent for claims of earned premium and then the two other components are commission expense, so that's commissions that QBE pays to insurance brokers and the like, around about 15 per cent of net earned premium. And then finally, administration expenses, so administration expenses of roughly around 15 per cent of net earned premiums.

So, you've got administration expenses, you've got commission expenses, and then you've got claims expense. So the combination of those three is - for QBE - varies between 90 per cent, and in 2012, it was 97 per cent of earned premium. But we are forecasting that to be around about 92 per cent of earned premium in 2013, and it's a reflection of a well-run insurer when that combined operating expense ratio is less than 100 per cent of earned premium.

If it's more than 100 per cent of earned premium, that insurance company in that example loses money - incurs a loss on its insurance underwriting. QBE has not delivered an insurance underwriting loss since 2001, so it's had 11 years of consistent insurance underwriting profitability. So, its combined operating ratio, its COR, has been below 100 per cent each year for the last 11 years.

Grove: David, thanks very much for your time today.

Ellis: It's a pleasure, Nick.

Nicholas Grove: I'm Nick Grove for Morningstar.com.au and I am here at the 2013 Morningstar SMSF Strategy Day at the historic Sydney Cricket Ground, and I am currently joined by Ibbotson Head of Fixed Income and Currency Brad Bugg. Brad, welcome. First off Brad, what are the key local and international macro themes that you think investors should be focusing on in the 2014 financial year?

Brad Bugg: Sure. I think investors have had a very good run 2013 year to date and over the last 12 months. But I think they can't expect those sort of returns to be replicated going forward. There's a number of stresses and challenges in the market which are likely to come to the fore in the short to medium term.

First of those is everyone's watching what the central banks around the world are doing at the moment, and I think that's going to be key to the short-term performance of markets. Just the end of last week, we saw Ben Bernanke talking about easing some of that stimulus or tapering some of that stimulus in the months to come and that caused a negative reaction in the market.

Another thing I think we need to keep an eye on is the trajectory of macro indicators. In the US, we're obviously seeing some sort of improvement in terms of unemployment and housing. But there are a lot of stresses to do and negotiate in terms of the deficit there. And with all the political wrangling that's going on, investors need to be mindful of that as well.

Also, in Europe, we're by no means out of the woods there. They still have a lot of economic pressures which they have to deal with. There's still a lot of debt in that economy which needs to come down. So, all that I think is going to make for a tougher environment going forward.

Grove: Brad, when you say investors should adopt a more defensive stance in their portfolios and stick to cash, how much of a weighting towards cash do you think is appropriate?

Bugg: Well, I think it would differ for every investor. But I think investors should generally look to hold higher levels of cash than what they might normally in their portfolios. We think the reward for risk isn't very attractive at the moment, and investors should be patient and wait for more attractive opportunities to deploy that cash, because we think cash plays two roles in a portfolio at the moment.

First of all, it's the only asset class which we think will give you a certainty of capital preservation, because with traditional assets like bonds, there's a real risk that you could lose a bit of money and they're not going to perform the same way that they have in the past. And second is that option value. It allows investors to redeploy that cash into more attractive opportunities when they do come along. So, we think cash is playing two roles at the moment, and therefore, investors should hold higher levels than they might normally.

Grove: In your opinion, Brad, what are going to be some of the catalysts that will signal to investors that it's time to start re-weighting their portfolios into more risky assets?

Bugg: Well, I think, first of all, we probably need to see a reasonably sizable correction in equity markets. Equity markets have come a long way over the last 12 to 18 months on an apparent sort of understanding that central banks will stand behind markets and do "whatever it takes" basically. We think that breeds a level of conservatism and complacency, which is dangerous and leaves the markets vulnerable to shocks whether they come from the US, from Europe or even here in Australia. So, we would look for a sizable correction in equity markets to start redeploying some of that cash. But again, investors need to be selective and look at the opportunities it presents.

Grove: Finally, Brad, where do you think the best income opportunities will come from for Australian investors in the 2014 financial year?

Bugg: Sure. I think Australian investors remain relatively lucky in terms of they are able to generate a real return for cash. That's not the story in most markets around the world. In Europe, the US and the UK, a lot of those investors are actually seeing a negative real return on their cash. So, I think cash remains an attractive asset. For investors looking to tie their money up for shorter periods of time, they can get a little bit extra. But I think people need to be wary that opportunities come and go quite quickly. So, that reduces the optionality of any cash that you might hold.

I think also corporate bonds are another avenue where investors can potentially get some attractive yields. But they are certainly not as attractive as they have been over the last couple of years and there are a few things going on in corporate credit which we would caution investors to be wary about.

Grove: Brad, thanks very much for your time today.

Bugg: Thank you.

Nicholas Grove: I'm Nick Grove for Morningstar.com.au, and I'm here at the historic Sydney Cricket Ground for the 2013 Morningstar SMSF Strategy Day. And I'm joined today by Morningstar head of equities research Peter Warnes. Peter, thanks very much for your time today.

Peter Warnes: Thanks very much, Nick, great to be here.

Grove: Peter, are high-yielding, sustainable equities going to be the order of the day for the 2014 financial year and for the foreseeable future?

Warnes: Nick, I think there is a good chance that trustees will continue to look for sustainable income in the equities part of their portfolio. I can't see any reason that's going to change. Mind you, those stocks have had a very, very big run post-2009, and so the low-hanging fruit has been harvested. But having said that, I think you can get a fair return that would yield, whether they are grossed up or not for franking, that would please the trustees. I think that's still going to be the flavour of the month and possibly the year.

Grove: Peter, should investors only be focused on dividend sustainability? And how much room should they leave in their portfolios for a little bit of "speculative fun?"

Warnes: Nick, we look for balance in our portfolios everywhere. I mean, yes, you can have a bias towards income, and income bias has been preferable over the last three or four years. Sustainability is all about sustainability of the cash flow, then the earnings, and then the dividends that come from that. And it's very, very important to make sure that these companies that are chosen have competitive advantages, if you like. Our economic moat classification - that really does indicate that there is sustainability behind the value. So, I would think that those stocks are still going to be looked for. Now, whether or not people should have a speculative part in their portfolio, look, when all is said and done, it's okay to have a little bit of fun. But be aware that the risk is much, much higher, and therefore limit that risk exposure to a maximum of 5 per cent, I would have thought, in the equity part of your portfolio.

Grove: Peter, like Woodside Petroleum did recently, do you think we're going to see a greater number of Australian companies make significant changes to their dividend policies going forward?

Warnes: Nick, I think what's happening is that income investors perhaps are in the driver's seat now, and boards are reacting to their desires. But they've also got to be conscious that they have a business to run and can't leave themselves capital-short, if you like. So the market will reward those companies who do pay special dividends. You've got to be absolutely sure that those dividends are sustainable. Look, the special dividends are a one-off and are not going to be repeated. It's all about what the company can continue to pay right through the cycle, and sustainability is all about continuing to earn significant profits, earn excess rates of return on their invested capital in excess of their weighted average cost of capital. Then, yes, there will be hiccups, but over time that sustainability will come through.

Grove: Peter, what signs should investors look for to differentiate between those companies that are truly able to pay solid dividends from those companies that are just jumping on the income stock bandwagon?

Warnes: Well, again, Nick, we have to come back to the Morningstar moat rating. Beware of the wolf in sheep's clothing - beware of that high yield, because it will have high risk. It is all about investing in those companies who can, because of their competitive advantage, continue to earn sustainable cash flow, earnings and dividends, and really that's where the focus of a portfolio should be.

Grove: Peter, thanks so much for your time today.

Warnes: Pleasure, Nick.

Christine St Anne: We are at the Morningstar Investment Conference, and today I am joined by one of the speakers, Fidelity’s Paul Taylor, to give us his insights into finding growth in the Australian market. Paul, welcome.

Paul Taylor: Thank you. Good to see you.

St Anne: One of the themes that have come out in today’s conference is growth in global markets. As an Australian equity manager, are you finding some sort of opportunities in Australian companies that are poised to capitalize on this growth?

Taylor: I think we've got a range of good global companies based here in Australia as well. I mean, we've got a – the market is very broad and deep, and I think we’ve got a lot of very high quality companies in the market. I guess, I would probably – that’s what I'm generally more looking for. I think I am specifically looking for companies that have just overseas earnings, but I think good quality companies, whether they are in Australia or sales around the world, I think it will position the sort of market.

But if – from the global perspective, obviously the miners are very globally oriented. You've got Brambles that’s well positioned in the US. You've got some interesting smaller companies like Treasury Wine that’s had a tough time due to the currency. That’s obviously in a much better position as the Australian dollar comes down as well. So I think there is a range of really good quality Aussie companies.

St Anne: Paul, on that point of BHP, how are you seeing the big miners placed for growth given the fact that commodity prices are continuing to cool?

Taylor: I mean, within the mining sector, I think the big guys are BHP and we are probably better positioned than most of the other ones, mainly because they are the low cost providers typically within the commodity. So BHP and Rio typically own what I would call the Tier 1 assets, which are the long life, low cost assets. So, if I just talk about iron ore as an example, BHP and Rio are mining iron ore at a cost of about $30 to $40 a ton.

Iron ore at the moment is still way over $100, but even if it comes back to, say, $80, which is very bearish scenario – you know when you're pulling it out of ground at $30 or $40 a ton, you're still making a lot of money and there's still a huge incentive about BHP and Rio to expand production. So, yes, as commodity prices come back and that's been the environment that we've been in. That's not good for any miner.

But I think the actual, the bigger guys at BHP and Rio are much better positioned, because they are the low cost long life mine owners, and I think in this environment that's what you got to – the focus has moved away from commodity prices, how much is iron ore going to go up to, to now being much more about costs, who is the low cost provider, who has the quality assets, who has the Tier 1 assets.

St Anne: Paul, the Australian market seems to be all about yield. Are you finding that this is the only opportunity available in Australian market?

Taylor: I think you do have to, obviously, be selective in yield and I think you can just – just because something is on a high yield, just go ahead and buy it, but I think yield continues to be important. I think it's probably important to set the scene and set the framework here, because it's – there's a lot of different macro issues happening around the world. We've been through a subprime crisis, global financial crisis, sovereign debt crisis, and I think we're trying to work our way out of that globally.

I have a fairly positive outlook, but I still think that because of all of those issues, we're going to be in the sort of lower growth world at least for a time. Now, if we're in this lower growth world, you got to look that's the sort of framework that we're working within. So what are going to be the rare assets in that environment, and in that environment what – I think if you can deliver growth in a low growth world – so companies that deliver growth, they are rare assets.

I think they're going to get bid up by the market, but also if you can deliver sustainable yield that's also a rare asset in a low growth world, and I think they're going to get bid up by the market and that's what we have seen. We’ve seen that yields compression. Even better still, if you've got a sustainable yield and you’ve got growth, that really is the sweet spot I think in this sort of – in the world we have at the moment.

St Anne: Paul, finally, we're finding some companies moved to pay higher dividends. Does this mean that they don't have much of a growth profile?

Taylor: It's an interesting – I think it's a really important question. I think it's an interesting question. It's because you would naturally think if a company that has a high dividend payout ratio should be low growth, because they have got less capital to reinvest back into the business and grow their business.

What we've actually found – what actually range of academic studies have found is actually that high dividend payout ratio companies grow faster than low dividend payout ratio companies, which is a real – which are very interesting finding and it basically comes back to not the payout ratio, but really the discipline that that payout ratio brings.

So a high dividend payout ratio actually brings a lot of capital discipline on the Company. So if you are paying an 80 per cent of your dividends – 80 per cent of your earnings in dividends, it means you've got less money to reinvest in the business. But for those companies they are really careful – because they have got less capital, they are really careful that they – and they are making sure that they get their 15 per cent return on invested capital from that new capital entering the business.

Whereas, low dividend payout ratio companies typically the money is burning a hole in their pocket. They’ve got this money. They have got to invest in it. So what the studies have found is that they – the low dividend payout ratio companies typically overpay for acquisitions, spend too much on CapEx and really blow the money. The money is burning a hole in their pocket. So it's a big counterintuitive, but actually the discipline that a high dividend payout ratio brings has actually met higher growth for those companies. I think it's an important lesson, especially in this sort of market.

St Anne: Paul, thanks for joining us. Nice to see you again.

Taylor: You're welcome. Good to see you.

Christine St Anne: We're at the Morningstar Investment Conference in Sydney, and I've just attended a session with our equity analysts. Today I'm joined by one of them, Mathew Hodge, who is with us to discuss how he approaches quality companies. Mathew, welcome.

Mathew Hodge: Pleased to be here.

St Anne: Mathew, firstly, what sort of investment approaches do you use to identify a company that is a buy?

Hodge: Well, I guess, we don’t really focus on making a stock a buy so much. We're really focused on getting the fair value right, what do we think this business can earn long term, what will its long-term earnings be, can the business generate returns above its cost of capital. All of those things will feed into the fair value estimate, and then it just depends on what the share price is. If the share price is sufficiently low, if there is a large enough discount to fair value, then it will be a buy.

St Anne: We are no doubt in a very challenging investment market. Does that alter your investment processes?

Hodge: Not at all. We really focus on getting the fair value right. We focus on trying to identify companies which can earn attractive returns in the long term sustainably, so moats. And then we try to focus on what is the uncertainty around that valuation. Then whatever the share price is, we’ll drive what the recommendation is. It’s just, we want to take advantage of when the market is moving, we want to buy when the stocks are cheap, and we want to be more inclined to sell when the stocks are more expensive.

St Anne: Mathew, as you know, income stocks have rallied pretty hard. Is there any value to be still found in this market?

Hodge: Well, the best place to go is to look straight at their income portfolio, because they are our best ideas in that space. We still have 15 stocks in there, so we still have stocks. We still can find stocks. They tend to be at close to fair value, so you won't expect the kind of returns that we've had, 15 per cent, 20 per cent a year. What you would expect is sort of low single digit returns from here. You're not going to get excellent returns, and that's fine. Other opportunities will come up. These stocks will fall out of favor at some point in time, and you’ll be able to invest more at that point and get a better return then. We just aim to have the best relative value of what's available for that strategy.

St Anne: Finally, Mathew, how does Morningstar distinguish itself from other research houses?

Hodge: Well, we have a structured process, I guess, if you like. The thinking around the moats is very structured. We've categorized how a company can have a moat. That has to go to a moat committee, so there is oversight and consistency globally. There is consistency with our cost of equity assumptions. It's something the analyst doesn't just tweak because they want to. So there is multiple levels of oversight and there is a lot of structure in how an analyst goes about doing things, which is good, because you put things in the right buckets and you make the universe comparable, which is very important.

St Anne: Mathew, thank you for your insights.

Hodge: No problem. Thank you.

Christine St Anne: A decision by the Reserve Bank of Australia to cut rates will have implications for investor's portfolios. Today I am joined by PIMCO's John Valtwies to talk about what the rate cut means specifically for fixed income.John, welcome.

John Valtwies: Thanks, Christine. It’s good to be here.

St Anne: John, firstly, so what does the rate cut mean for fixed income investors?

Valtwies: Well, for fixed income investors, it makes little difference. Fixed income will continue to play that role of the anchoring portfolios, providing that steady income stream, given the contractual obligations around coupons and income payments.

Speaking more broadly, I guess it makes it a little more difficult for investors who rely on income given the shrinking universe of income options available. And by that, I mean with the RBA cutting interest rates, we know the banks are quite swift in cutting their own deposit rates. So, for investors who've already observed shrinking deposit rates for the last 12 to 18 months or so, there is a shrinking universe available for income investments.

So, they now have to reconsider or rethink their defense when it comes to preserving capital or strategies that preserve capital. But more important how are they going to achieve that income especially for retirees. And that’s one aspect about fixed income that doesn’t change regardless of what’s happening in terms of interest rates as that income will continue to be paid.

St Anne: John, on that point of shrinking income opportunities. What high yielding opportunities, if any, are you seeing in the fixed income market?

Valtwies: So the fixed income market really opens up a playing field. So, depending on what fixed income market you're talking about, it enhances overall flexibility when it comes to achieving levels of income. So, let's consider, Australia, for instance. The Australian bond market is less than 2 per cent of the global bond market. So, what that means is almost 99 per cent of the yield opportunities are being foregone, if you’re focusing on purely Australian sources of yield, let's say.

Opening up the global bond market gives you access to $100 trillion investment universe. So from an income standpoint, it means you have an enormous amount of flexibility to achieve levels of income that will meet your investment needs.

Now obviously there is some factors that investors should be mindful of and that include risks within the global bond market. Now, that's why it's also important to be active and to be aware of those risks and to be able to move from those locations that will place your capital at risk and invest in locations that will preserve capital, but also preserve those income levels.

So, when it comes to sourcing income, you can actually focus on areas of high-quality securities that are backed by robust fundamentals. And although the state of the global economy is quite fickle at the moment, let’s say, growth is low and inflation is low and therefore, we can see low income levels around the globe. There are still locations with the global bond market where you can access steady and attractive sources of income, but it's all about focusing on those locations that are backed by improving or growing fundamentals that won’t place capital at risk.

St Anne: John, what about corporate bonds? Are you seeing any value there?

Valtwies: So when it comes to corporates, like many markets around the globe over the last 12 to 18 months, there has been an insatiable desire or hunger for income. And that's been reflected in many income-producing sectors of the bond market as well as income-producing sectors of many other markets. And so, when it comes to value, it's an interesting question, because valuation is a critical part of any investment process. So, investors must be mindful of valuation.

So, certainly with the demand for income, value is becoming increasingly important when it comes to investing in corporate bonds. Corporate bonds, from a valuation standpoint, have – their spreads have compressed significantly over the last 12 months and that's off the back of that global hunt for income or hunt for yield.

So, investors need to be mindful of that and they need to be mindful of what they are looking at when it comes to making investment. Are those investments being made off the back of a strong underlying fundamentals or is it being made off the back of attractive income levels? So, credit quality must be a big focus for people looking for income.

St Anne: Finally, John, the Australian Securities Exchange or the ASX has moved to list bonds. Would that change an investor's approach to fixed income?

Valtwies: Providing investors with more tools to make their investment objectives is always a good thing, and clearly providing access to fixed income instruments is important given Australians typically have a significant under investment to fixed income instruments. So, raising the awareness about an asset class that can help preserve capital, but as well as provide that steady income stream is a valuable tool for all investors.

St Anne: John, thanks so much for your time today.

Valtwies: Thanks for your time, Christine.

Christine St Anne: We're at the Australian Shareholders' Association's annual event in Sydney. Today, I'm joined by the ASX's Elmer Funke Kupper to talk about the market outlook and initiatives by the ASX. Elmer, welcome.

Elmer Funke Kupper: Thank you.

St Anne: Elmer, you recently reported an uplift in revenue and it comes at a time when market seems to be gathering strength. Do you expect that momentum to continue?

Funke Kupper: I think it's been particularly strong in February, March, April. So, at the half year results we said it’s still little fragile, retail investors are sitting on the sidelines. I think some of it has come back in the last two months. So, yeah, we've had much healthier trading volumes in the equity market, and combined with strong trading volumes in our other markets, we had quite a strong third quarter, yes.

St Anne: Elmer, on that point of investors sitting on the sidelines, there have, of course, been a lot of discussions about investors remaining in cash and term deposits. Do you think that they are going to start moving more into the listed equities markets?

Funke Kupper: I think investors make their own choice. I think during the GFC, we saw a drop-off in equities and a significant increase in bank deposits. While that doesn't help my company, it probably helped the economy, as of course banks rely on those deposits. So I think it was quite healthy that that happened. What we're now starting to see with interest rates coming down and yields coming up, and we're seeing the bank results recently paying very healthy yields, people are starting to go back into the marketplace. It seems to be somewhat of a hunt for yield and returns that many corporations seem to be responding to. They make up their own minds, investors make up their own minds, but if you put the two together, you can see that happening.

St Anne: Elmer, you've had fixed income ETFs, and now the ASX is looking to list bonds. Will that change the role of fixed income in an investor's portfolio?

Funke Kupper: Well, in some ways they already have fixed income investments through deposits in banks. I think that is effectively fixed income investment. We know that when we benchmark our market to other markets around the world, that we don't have a large or liquid corporate bond market. And we know from overseas markets, like Europe, that a healthy corporate bond market is something that investors value. So we've been looking at ways to start that process and create such a market for investors. An important first step is the quoting of Australian government bonds on the exchange, because that creates effectively a benchmark price for the corporate securities, because it's the lowest risk form of investing, and corporate securities then sit above it.

There's a number of other steps that we would need to take. We would quite like to see a longer-dated government bonds, so you can create a proper price curve for longer-dated securities. We need to simplify the documentation requirements and change their director liabilities for the corporate bond market. All that work is underway. So I'm hopeful that if you add all of that up, then in next 12 months we will start to see the corporate bond market slowly develop in Australia.

St Anne: Elmer, now with listed fixed income securities, and of course, we've had listed equities, how does that compare with the traditional funds management industry? Do you think investors are going to increase their allocation more to direct investing?

Funke Kupper: Well, fixed income ETF is a fund, of course, that's listed on the exchange in which you can buy units. I don’t see a big shift, and I think part of that is driven by what I call the weight of money. So if you look at the superannuation guarantee that keeps going up. We do know that the superannuation sector and the funds management sector will continue to grow. At the same time, we see self-managed super grow and personal investment grow. So where that ends up, I don't know. I'd like all of them to grow, of course, because that's part of what we do.

But I don't think we should underestimate the forces that make superannuation grow, like the increase in the guaranteed continue to grow there. We've got some very large superannuation funds already, and they will only get larger, and that sort of – that's where most of the money, I think, will go because it's this guaranteed inflow of money. And then private investors will make their own trade-offs between fixed income, securities, and deposits.

St Anne: Elmer, in your presentation, you mentioned dark pools and high frequency trading, and of course the role of ASIC. What about the role of the ASX? What role do you play in securing investor confidence when it comes to these sorts of trading tools?

Funke Kupper: We think retail investor confidence is everything. I think we've taken a different approach than some other exchanges, such as exchange in the United States and Europe. We have taken, if you will, a high ground here, because we think it's in the long-term interest of our market, and therefore in the long-term interest of the ASX that this is well managed. So, we raised a number of issues in the last two years on this issue, on high frequency trading and dark pools. I think ASIC has been listening to us. They've been listening to other market participants, and more importantly, they have been listening to investors, and I think they've come up with a measured approach and a series of steps that will control both dark pools and high frequency trading. But, of course, you have to recognize that we can never get rid of it. I mean, its effect of life, technology is effect of life, innovation is effect of life, and in many cases it's a good thing. So, we are trying to do is allow innovation, but manage the unhelpful side effects, and I think relative to other exchanges and other markets, I think ASX and ASIC have done that very well in Australia. In fact, we're seen as the poster boy of financial market regulation these days.

St Anne: Finally, Elmer, our company Morningstar has the opinion that the ASX has strong competitive advantages. How are you going to maintain that with the new entrants in the markets, like Chi-X?

Funke Kupper: Well, I think competition is  here to stay, isn't it. So, Chi-X has been growing. We believe Chi-X will grow and will compete. So, that's the world we live in today, and that will continue to be the case. So, our job is to make sure that we continuously improve the services for investors with our own trading products. We've built a new data center that allows us to generate a new form of incoming technical services, and all of that has gone relatively well. So, we've been competing I think well. But, of course, when your market share starts at 100 per cent, it can really only go one way, and I think our market share over time will decline as Chi-X grows. Our job is to make sure that we compete well and that we deliver great services to our clients, and of course, that our shareholders continue to benefit from a growing company, and that's the balance that we’re trying to find. I think so far so good.

St Anne:  Elmer, thank you so much for your time today.

Funke Kupper: You're welcome.

Christine St Anne: With June coming up, it's time to look at some inter-financially strategies. Today I'm joined by Westpac's David Simon to give us his take on some super-specific strategies. David, welcome.

David Simon: Thanks, Christine.

St Anne: David, there has been quite a few changes in superannuation. Is it still tax effective?

Simon: Yeah, sure. Look, I mean, superannuation is just a tax structure, and even though there is a lot of changes or a lot of suggestions and proposed changes around superannuation, it still remains the most tax effective structure in the Australian tax system. So a modular tax rate has a tax rate up to $0.465 in the dollar, which once you include Medicare, a company has a flat rate of tax of 30 per cent. But indeed superannuation whilst in accumulation phase has a tax rate of only 15 per cent, and indeed if you go to pension phase, it still remains at zero tax rate. So it's still a very applicable structure for investors.

St Anne: David, well, let's look at the current system. What sort of contributions could people make before the end of the financial year?

Simon: Superannuation is just one tax entity. So it's important that people have diversification, not just of asset classes, but indeed of tax entities. So there are so many changes around superannuation and they will continue to occur. As indeed, changes around individual's tax rates and what else. So it's really important that people are diversified around their tax structures to make sure they protect themselves somewhat around legislation.

But importantly, superannuation still, as I mentioned, does remain a very, very tax efficient vehicle for people to save for their retirement. Now, there are two different ways you can actually contribute to super. There is one way which is before tax and another way which is after-tax. Some of the examples of before tax contributions are going to be quite familiar. So that’s – it starts with the statutory employer contribution, so that’s about to go up. It's still currently 9 per cent, but that's about to go up and progressively up to 12 per cent over the next few years, and that's effectively your employer making contributions on your behalf into super.

You can also, as an employee, elect a salary sacrifice, and that's effectively to withhold some of the cash you receive from your employer and have your employer contribute that money in superannuation on your behalf before it's taxed at your marginal tax rate. Ideally, that would offer a more concessional tax rate for most Australians than otherwise.

The other form would be if you're self-employed. If you're self-employed, you are actually able to make a personal deduction, but indeed claim a tax deduction on that contribution right up to the cap of $25,000. So they are more the common before tax contributions.

The after-tax contributions include something called a non-concessional contribution, and that indeed has its own cap. So you can contribute – if you're aged 65 or below, you can actually contribute up to $150,000 per year as an after-tax contribution, or indeed you can bring forward three years’ worth of contributions and make a one-off one contribution of $450,000. Effectively that goes into the super fund tax free, and ideally it can come out tax free as well. So it's a really smart way to boost your retirement savings and transfer your assets from a taxable environment, your marginal tax rate, into a low-outbound tax rate through super.

You can make that contribution through cash, but indeed you can also make that contribution by using other investment security, such as listed shares. So you can effectively in specie transfer some shares into superannuation as after-tax contribution. That will cause a capital trigger event, which may or may not include tax. But eventually once it goes into the environment, it's certainly efficient from that point of view.

Other types of contributions include – that are after-tax include a co-contribution, where the government will provide an additional contribution on behalf of the superannuant, if they are a low income earner. So there are a variety of different methods people can boost their retirement savings.

St Anne: What about tax deductions? Can people look at that perhaps in the context of, say, capital gains?

Simon: Yeah indeed. So for an investor that – there are things that – some assets and I’ll use direct shares as an example. So, let’s say, an investor has direct shares in their own name, and then decides to have – make an after-tax contribution into superannuation whilst holding those shares and retaining those equities, that could create a capital gain event.

If that does create a capital gain event, they could – if they are self-employed or if they are an unsupported person, they could actually declare some of that transfer as what we call a concessional contribution or a personal deductible contribution. In turn, offset some of that capital gain, or if not all of it, by declaring some of that transfer as a tax deductible contribution.

St Anne: Finally, David, what about spouses? Do they have a role to play in some tax effective strategies?

Simon: I mean, look, there is two things around spouses. If you’re in a situation where you’ve got a primary income earner and a lower income earner being a spouse member, as long as they are earning a very low income – at up to $13,800, the primary income earner can actually contribute up to $3,000 as an after-tax contribution into their lower income earner spouse, and then actually declare or receive a $540 rebate in their tax return, which is effectively 18 per cent of the spouse contribution.

Another method of using the spouse is, if there is a one member that’s materially close to the age of 60, then the younger one can actually share their contributions or split their contributions to the older one. The benefit of that is that they are closer to 60, meaning that they can access their superannuation earlier than the younger spouse, but also access it tax free as well.

Christine St Anne: David, thanks so much for your super insights today.

David Simon: My pleasure. Thank you.

Christine St Anne: Gearing strategies certainly came under pressure following the global financial crisis. However, if sensibly implemented, these strategies can boost a person’s retirement savings. To talk about some of the sensible approaches, I am joined by BT's Cathy Kovacs. Cathy, welcome.

Cathy Kovacs: Thank you.

St Anne: Cathy, what makes a sensible gearing strategy?

Kovacs: Well, really depends on the individual, and it’s a pretty broad based word or term, gearing strategy. But, generally speaking, I think a strategy that allows somebody a comfortable level of borrowing. When I mean comfortable, it’s commensurate with their risk appetite, commensurate with their ability to repay their debt, if you are thinking about the loan component. The other side of that is, what are you borrowing to invest? So, aligning your gearing strategy with your long-term investing needs, diversified portfolio that helps you make – rates your retirement savings.

St Anne: On the point of a diversified portfolio, can some of these gearing strategies apply to more speculative stocks?

Kovacs: Yes, it can. But again, I think if you take the gearing away from the investment, we all know that we don’t put all our eggs in one basket. So what you could do is, alongside a diversified investment strategy, you could add a degree of risk through a more speculative stock. But keep in mind that when you are adding leverage, you’re already adding a degree of risk. The other thing about some speculative stocks is that, they don’t offer any dividends potentially, and so if people are looking at dividend income, they need to be aware that they won’t get that from a more speculative stock.

St Anne: In terms of dividend income, is it best for investors to reinvest their dividends when it comes to gearing strategies. What is the best approach?

Kovacs: It depends on the individual and where people are in their lifestyle. So a pre-retiree or retiree, in fact, might want the dividend income as part of their lifestyle needs. Someone else may be in the earlier stages of their investing career and might elect to reinvest those dividends to get the compounding benefits. Either way, whether you’re reinvesting the dividends or you’re taking them, if the stock pays a franking credit, you’re still getting the benefit of the franking credits. But I would add to that that people shouldn’t be relying on the dividends to make their interest payments, because in the event that the stock’s stops paying a dividend, you still need to be able to pay the interest on your loan.

St Anne: Cathy, what about installment warrants? Are they still popular with investors?

Kovacs: So to answer that question you really have to think about what is the custom value proposition of an installment warrant. So installment warrants are method of borrowing to invest or gearing inside a superannuation fund. So if you think about the growth in self-managed superannuation and the amount of equities that people are holding inside the self-managed super, the amount of cash that they are holding, the fact that people are going to be underfunded in retirement, all of those things say to me that a degree of borrowing in super is going to help people get to their retirement needs, and an installment warrant is just a way of doing that.

St Anne: How do installment warrants compare with other gearing strategies, such as margin loans?

Kovacs: In installment warrant, if you like, is a packaged solution. So it is more definitive. We tell you which stocks we will offer installment warrant over, so it's not a broad universe. The other thing is that, by definition, an installment warrant is a limited recourse loan. So in the case of a margin loan, you could have a margin call event. So if the value for your equity folds, you need to top up your capital,. You don't have that in the limited recourse loan. So in the even that your value of investment folds, you just don't have to make the second payment on installment warrant, or you could sell that installment warrant on the ASX at any time. So it's very liquid.

The other thing is, which I like to think about when I am thinking about gearing in super, is that installment warrants are really easy way to get exposure and geared exposure inside your superannuation fund. So if I decided that I would like to get geared exposure to the ASX 200 tomorrow, I can do that by calling my stock broker or going to the online broker with the ASX code that allowed me buy an installment warrant over an ASX 200 ETF, for example. So it's a really simple way to get geared exposure in your side of super fund.

St Anne: Cathy, thanks so much for your time today.

Kovacs: Thank you.

Nicholas Grove: The big two miners, BHP Billiton and Rio Tinto, released their quarterly production numbers earlier this week. And here to give investors an idea of which company put in their best performance, I'm joined again by Morningstar's Mark Taylor. Mark, thanks very much for your time today.

Mark Taylor: Thanks, Nick.

Grove: Mark, firstly to BHP, which commodities were the key drivers of its numbers and did those numbers contain any surprises?

Taylor: Well, the key drivers of earnings are unchanged. It's iron ore, copper and oil and gas prices, and then weren't any major surprises in prices or production numbers. If anything, that was marginally ahead of expectations despite the fact that volumes were off quite sharply due to cyclones and weather events.

Grove: Mark, how did Rio's numbers stack up and were there any surprises there?

Taylor: Very similar actually. And for Rio, iron ore is pretty much everything at the moment. Its numbers were marginally below expectations, but not meaningfully so, and in fact both Rio and BHP said that their full-year earnings projections were intact. So, while there might have been swings in the quarter itself, they will be making those up over the balance of their fiscal years.

Grove: Mark, in your opinion which company delivered the most pleasing set of figures?

Taylor: Well, I don't think there was any one area or one company that stood out, particularly in the quarter, as being more pleasing than the other, but just as a general statement, BHP's figures, I think, are more pleasing because they're just not quite so focused on one area. It's not all iron ore. Oil and gas is important for them and that did reasonably well, especially the shale gas in the States is starting to come to the fore, so that's quite pleasing.

Grove: Finally Mark, was there anything in BHP's third-quarter numbers or Rio's first-quarter numbers that are going to alter your full-year earnings forecasts, or is it all steady as she goes at this stage?

Taylor: It's pretty much steady as she goes. The one thing that did happen was the pit fall failure at Bingham Canyon in the States for Rio, but that was announced pre-quarter, so it was already factored in, but that is going to result in lower copper production for them and some added costs and lower revenue. So that has hit their earnings a little, round about 5 per cent or so, but by the time the quarterly came out, that wasn't news.

Grove: Mark, thanks very much for your time today.

Taylor: Thanks, Nick.

Christine St Anne: While the Australian markets have experienced the ups and downs, Wilson Asset Management has managed to outperform the market since the GFC. To give us an insight into how the portfolios work, I’m joined by Geoff Wilson.Geoff, welcome.

Geoff Wilson: Thank you very much.

St Anne: Geoff, first thing; how wide is the investible universe for Wilson Asset Management?

Wilson: We look at every listed company. So, we had maximum flexibility. I really believe in investing. It's incredibly important to have maximum flexibility. We tend to focus on mid- and small-cap industrials because that's where we believe we can have a real competitor advantage, and what that is, is our ability to find companies that are undervalued. We spend a lot of time meeting with management. We would have over a 1,000 company visits a year and probably see over 800 to 850 odd companies.

St Anne: On that point about industrials, what sort of value are you finding in that sector?

Wilson: The small industrials has had a good run like the large – like the overall market, but we are still seeing value in that sector. Some companies we have been buying recently are the likes of Cash Converters, Hills Industries, Brickworks, those types of businesses.

St Anne: Geoff, you're also invested in financials, but not the major banks. So, what sort of companies do you have investments in?

Wilson: In financials, our exposure tends to be in two parts. One is we buy because we are a listed investment company and we have three listed investment companies. The large one is WAM Capital, then its WAM Research and then WAM Active. I spent a lot of time analysing the sector, and what we do is buy other listed investment companies, when they try to get sizeable discounts and our larger holdings are Century, Ironbark, Emerging Leaders, and in all those three companies there are some interesting dynamics at the moment.

Also, we look at the smaller financials, where we have had exposure there. Magellan has been a very good performer for us. We bought them at the $2 llevel. We have been selling them recently. Another one is Clime Investment Management. To me, that's a little Magellan. At the moment, they are really excited to get some good fund flows run by John Abernethy. Those types of companies make out the rest of that.

St Anne: You already mentioned a number of stocks. Are there particular companies that you're bullish on?

Wilson: Brickworks – I mean, companies would be very happy talking about that where are the holders or buyers, would be the likes of Brickworks, also Automotive Holdings. We think there would definitely be a merger with AP Eagers over the next six months, and it could be a big fully franked dividend liberated there. Another company we are buying discount assets, we bought some more today is Keybridge. They are the type of companies.

St Anne: Geoff, finally, how is the merger with Premium playing out for your business?

Wilson: It's been really good for WAM Capital. WAM Capital merged with Premium. We had about $220 million odd of assets, Premium had about $85 million of assets. In the end, about 65 per cent of Premium shareholders decided to become WAM Capital shareholders. The merger went through on the 31st of December 2012. We had a Board meeting on the 2nd of January. There the Board decided to liquidate all the premium investments, which we did, and now that money has been managed as we manage the rest of our money.

What WAM Capital shareholders have picked up is the ability to utilise $46 million of tax losses and also franking credits to allow about 40 million fully franked dividend to be paid out. So, it's been a very good merger from WAM Capital’s perspective.

St Anne: Geoff, thank you so much for your time today.

Wilson: Thanks very much.

Nicholas Grove: This week saw Woolworths release its sales and revenue results for the third quarter, while Woolies' archrival Coles, owned by the Wesfarmers conglomerate, will release its results next week. Here to give investors an idea of how these two companies are faring as we head towards the end of the fiscal 2013 year, I'm joined by Morningstar's Tim Montague-Jones. Tim, thanks very much for your time today.

Tim Montague-Jones: You're welcome.

Grove: First of all, Tim, how did Woolies' third-quarter sales shape up in your opinion, and were there any surprises in the figures, either positive or negative?

Montague-Jones: It was a strong quarterly result, but we had expected that. The comparable sales number was up about 5.3 per cent, which is a strong number for group sales. The number the last quarter over the December half year was strong, because what happened over Christmas was we've had lower interest rates, rising equity values, and favourable weather as well, which has encouraged retailers to sell more products. So, retail conditions across the board have risen, and Woolworths as well as Wesfarmers are doing reasonably well at the moment, and that was apparent in this result.

Grove: What kind of performance are you expecting when Wesfarmers reports its retail sales next week?

Montague-Jones: Well, they're both doing very extremely well. The bigger are getting stronger, and the weaker are getting weaker. Both Woolworths and Wesfarmers have significant market power, and they're taking market share away from the smaller independents. So, we expect Wesfarmers also to report - or the Coles part of the Wesfarmers Group - to report strong revenue growth as well. If you look at the actual statistics of retail sales for the month of February, they've increased quite strongly since January. So the tide is coming up and it's lifting the returns of all the major groups.

Grove: Tim, what are you expecting in terms of dividends from both Woolies and Wesfarmers for the full year?

Montague-Jones: Woolworths has a payout ratio of 70 per cent, meaning about 70 per cent of its earnings are paid out in the form of fully franked dividends, and we calculate that to be about $1.30 for the full year. For Wesfarmers, its payout ratio is higher, at about 90 per cent, and on our calculation we look at a full-year dividend payment of $2 per share.

Grove: Finally, Tim, what are going to be the major themes confronting these companies in the 2014 financial year that investors should keep in mind?

Montague-Jones: That's an interesting question. Both groups are going to be, I believe, under a lot of pressure from the ACCC (the Australian Competition and Consumer Commission), because their market power is significant and they're getting stronger. There's a threat to smaller groups who want to kind of kick up a bit of political pressure for some action to be taken. So, I think that will be a concern for both groups. If we look at specifically Woolworths, for them next year a big component of the earnings growth is going to be Masters, which is a home improvement store portfolio, which is increasing, and that will be a key focus to see the performance of that group next year. For Wesfarmers, obviously, it's Target, which has not been performing that well and they've recently appointed a new managing director to the group. It would be interesting to see what their turnaround strategy is going to be and how successful it will be.

Grove: Tim, thanks very much for your time today.

Montague-Jones: You're welcome, Nick.

Christine St Anne: MFS Investment Management recently won the Morningstar's Fund Manager of the Year Award in global equities. It's also an investment firm that has performed during flat markets. To give us a little insight into the investment processes, I’m joined by Marian Poirier. Marian, welcome.

Marian Poirier: Thank you.

St Anne: Marian, what sort of companies does MFS like to invest in?

Poirier: The focus MFS has really is investing in quality companies, companies that quite often have been around for a long time, and we aim to make sure that they are around for quite a few years going forward, companies like a lot of leading global brands. Some of the luxury goods names like LVMH Louis Vuitton, just choosing them as an example. They are the sort of the company doesn't have to discount the prices. One of the other things with LVMH that's key is they are now starting to derive quite a significant portion of their revenue from the emerging markets. So, thinking about their product positioning going forward.

One of the other companies which was one of our large contributors last year to our significant outperformance was Heineken, another global brand and another company that’s deriving quite a bit of the revenue from emerging brands.

But it's got to be companies that are able to grow their earnings sustainably going forward and so that’s really the sort of companies that look forward to invest in.

St Anne: Our recent research report had noted that you tend to sing during benign market, can you give us some little insight into the investment processes that allow you to do that?

Poirier: Rest assured, I’m not going to start singing. We've done a lot of research actually in terms of different types of markets and how we perform accordingly. And we've done some research recently in terms of looking at the history of our global equity capabilities. So going back as far as 1992 and looking at – dividing it up into quarters, looking at periods where the market has outperformed by more than 5 per cent and markets where the time periods – apologies when the market has underperformed by more than 5 per cent and then in between, and in all quarters, all performance types of period, we outperformed. Probably the portion in the middle so between minus 5 and plus 5 is where we outperformed the most regularly.

So we delivered the most quarters of outperformance, but the magnitude of that outperformance tends to be more in the markets that you referred to, Christine, sort of the words falling quite a bit. And I think that that is really dying to our focus on quality.

Talking to a lot of our analysts internally, one of the things that they say a lot is when – and I have seen this happen. When they are pitching ideas to the investment team, the focus in that discussion is not about the potential upside and how much more this company can deliver and how that will translate into performance, 95 per cent of the discussion is on the buying side.

How can this go wrong? How can your thesis fall apart? What happens if currencies fluctuate? What happens if commodity prices fluctuate? There is no predicting where they are going to go. There is a lot of stress testing. So, we invest in those quality companies that I mentioned that are going to outperform, no matter what the market environment is like, and again it's coming back to quality. If you are investing in a quality company, quite often they will outperform in both periods.

St Anne: Marian, also, your portfolio managers have a personal stake in the business. How important is that to ensuring performance?

Poirier: I think its key. You know, if you are in charge of managing so much of the money for clients, you need to – I know the expression overused as it is, having skin in the game – having your own personal money invested alongside that of your clients, I think its key to delivering performance.

St Anne: David Mannheim is a very well-respected portfolio manager, and of course, one of your co-lead managers, what about key person risk? How do you overcome that?

Poirier: Even going back before that, I actually think one of the ways we overcome key person risk, is we hire the right people to begin with. And I will give you a couple of examples of the way it works. There is a very long and lengthy process, number of interviews that people go through before they get hired by the firm, but right from the onset it is all about being part of a team. There are no stars, and I know that you mentioned Dave Mannheim, and he is co-PM with Roger Morley. But you would never hear either of them talk about portfolio without talking about the platform and the team of people behind them. One of our co-head of Asian Equity Research, Simon Gresham, who is based here in Sydney, and he has, sort of, coined the phrase or he has used it to me quite a few times. He said that every one’s voice is heard at this firm and he likes that.

An another example is Roger Morley, when he was interviewing, he gave me few insights and he said quite often it's 30, 40 interviews before he joined the firm, and he said that one day after having met with maybe 10, 15 people from the investment team, senior management, what he loved and one of the reasons that he ended up accepting the role was because he couldn’t work out who was important, and that I think says volumes for the way that we manage the firm.

St Anne: Marian, that’s a positive note to end up on. Thank you so much for your time.

Poirier: It's nice to chat.

Christine St Anne: Morningstar recently released its global equities wrap-up, and found a number of managers that outperformed. To give us a little insight, I’m joined by Morningstar’s Kathryn Young. Kathryn, welcome.

Kathryn Young: Thanks so much for having me, Christine.

St Anne: Kathryn, so who were the top performing managers and what sort of attributes did they have?

Young: Well, we noticed a few trends that really drove performance over 2012 in global equities, and I think investors were familiar with a lot of those. So, one of those is that growth outperformed value on average. So, strategies we cover with a growth bias tended to do better than a value bias. And one of the big reasons for that is that many of those, sort of, ‘expensive defensives’ that people have heard a lot about, and these are the firms with large consumer brands, global consumer brands that people recognize. Those tended to do very well.

And a lot of people, lot of investors say that it’s because the market was putting a premium on safety and a little bit of yield in this environment. So, the managers that we cover that tend to have a quality growth strategy did very well. And among those are MFS Global Equity, Magellan Global, and Platinum International brands.

But that's not the only thing that drove performance. Another big driver was that financials was the best performing sector over the year and that really came on the back of the ECB’s comments that they would do whatever it takes to save the European Union. So, financials did really well and those strategies that were heavily invested in financials also did well. So, some of those are PM Capital Absolute Performance, that was the best performer by far, and also Templeton Global Trust that had quite a bit of financials and did as well.

St Anne: So what are the implications for investors from all of these?

Young: Well, it's really interesting to talk about these things. All right. It’s interesting to talk about what drove performance and who were the top performers, but I think the most important thing for investors to get out of that is what it reminds you about investing in general and investing in managed funds, in general. And that is that investors should remain focused on the long term. So, these things that I just talked about expensive defensives, growth outperforming value, those are short-term things. Right that happened over one year.

But we really think that that's not – what happened last year is no guarantee or even real indicator about what’s going to happen over the coming year or the coming five years. And one good way to explain that is that growth and value have really exchanged leadership a lot.

So, over the past 10 years, they've gone back and forth. Value actually outperformed growth from the early 2000s through about 2008. And so they have exchanged leadership, but they have ended up roughly about the same place in terms of cumulative returns over that period.

So what's important to remember is stay focused on the long term, maintain adequate diversification across tiles, and you should be fine.

St Anne: The Australian market has been very popular in terms of income. Do global equities offer that same level of income?

Young: Well, it's a good question. Obviously, income is very important to a lot of investors right now. In Australia, we looked at that for our global sector wrap up, and we found that really Australian strategies, Australian-focused equity strategies, do offer more income than their global counterparts, and that probably makes sense to a lot of Australian investors.

Telstra, the big banks, they offer consistent and relatively high dividends. So, it's a problem because those investors, retirees or other investors who were very dependent on the income generated by their portfolio, they still need to maintain adequate asset class diversification, even though they have a focus on income.

So, it gets to be a little bit tricky, and we think that people who are focused on income they do have a good reason to have more of a bias towards Australian equities in their portfolio. But part of the good news is that product providers, fund managers are realizing that there is this void in the market, and so there have been some products coming out. But still early days for those, so it’s a little bit tough to say how well they can really meet investor needs and we are keeping eye on that.

St Anne: Kathryn, thank you so much for your time.

Young: Absolutely happy to help.

Christine St. Anne: The focus for many retirees is income and yet many of these retirees remain focused in a conservative portfolio. Today, I'm joined by Legg Mason's Reece Birtles to talk about rethinking your income solutions. Reece, welcome. Reece Birtles: Thank you.

St. Anne: Reece, one of the findings from your survey is that many investors expect an 8 per cent return. Is that a realistic objective?

Birtles: Yeah, it's going to be very difficult for investors to achieve 8 per cent returns going forward. When you look at fixed interest markets with the strength in the government bond yield at about 3.4 per cent, if you look at term deposits with best rates around 4.2 per cent now, and even equity income portfolios with a benefit of franking credits for retirees achieving around 7.5 per cent return. It's going to be very hard to go to blended portfolio with an 8 per cent return.

St. Anne: Another key finding is that investors are concerned about inflation, but remain focused on income. What about the role of growth in a portfolio?

Birtles: Inflation is very important to retirees. With a 20 year life expectancy, 2.5 per cent inflation is going to have a significant impact on purchasing power over time. So to achieve growth in an income stream, greater than the inflation rate requires investing in either real assets like infrastructure, utilities, or property or in equity income type strategies, which have the benefit of profits growing over time and growing the dividend streams.

St. Anne: Reece, term deposits remained very popular with many retirees. What about the effectiveness of a conservative portfolio to addressing their income concerns?

Birtles: When you look at the needs in retirement, it's about a stable and growing income. The interesting thing about term deposits is whilst that capital might be stable the income is actually quite variable with the interest rate cycle. So, for example term deposits have gone from yielding 6.2 per cent to about 4.2 per cent today over the last two years, which actually represents a 30 per cent decline in retirement income if you are invested in term deposits.

St. Anne: With the need to increase growth assets what sort of companies should investors look for in order to achieve their income goals?

Birtles: We think equity income strategy is very different in terms of how they should be designed than your typical funds that you've seen to-date. Being benchmark away it doesn't make any sense in retirement. You don't want significant concentrations in one company because if something was to occur to it, it could have a significant impact on your retirement income.

We also think you should be invested in high-quality companies that have less variable earnings. So high-quality companies are going to be less susceptible to shocks from competitors or the changes in technology. We think you need to look quite broadly, it's not just about the top 20 companies, you need to get strong diversification in the income stream from dividends.

St. Anne: Reece, thanks so much for your insights today.

Birtles: Thank you.

Christine St Anne: Perennial Investment Partners recently won the Morningstar Fund Manager of the Year in the fixed income category. Today I'm joined by Noel Murphy to talk about the opportunities in the fixed income market. Noel, welcome.

Noel Murphy: Thank you.

St Anne: Noel, we're now in a low yield environment. Is there still value to be found in fixed income?

Murphy: Well, I think they can to a limited extent, but we have to be realistic. Bond yields are lot lower now than they were, say, 10 or 20 years ago. So, I think, our view is that largely the bond market has been in a long-term structural rally that's largely come to an end. So I see good value in fixed interest as a defensive investment if we were heading into recession, but that's not our expectation at this stage.

St Anne: Within the context of asset allocation, what sort of approach should investors take when it comes to managing their fixed income portfolio?

Murphy: Well, I think they've got two choices, and it's a philosophical question. Investors need to decide whether they are going to take a strategic long-term sit and forget approach, where they don't try and time the market in fixed interest and just have a permanent strategic asset allocation, or they take a more tactical approach. I think it's the second approach that we would advocate for the time being. Given how low long-term interest rates are, we believe that a tactical approach to fixed interest is more appropriate in the current environment.

St Anne: Noel, as a bond manager, what sort of value are you finding in the market?

Murphy: Well, we're not particularly keen on Commonwealth Government bonds, but by contrast we like State Government bonds. We like floating rate investment grade credit, specially the banks. We think that's a good story. We also have like listed property – the bonds issued by listed property trusts and some infrastructure investments. There is an area where we are quite concerned, and that's US high yield. We think that's probably fully priced, and if anything, may surprise people in delivering poorer returns going forward.

St Anne: Hybrid securities have also been quite popular among investors. Noel, did they have a role to play in a fixed income or defensive portfolio?

Murphy: Well, I think they have a very limited role. For the time being we think they are offering good value. So I think as a yield enhancement they are fine, but they should never be a significant part of any defensive portfolio, in our view.

St Anne: Finally, Noel, there's been a lot of discussion about interest rate cuts. What sort of impact would that have on fixed income?

Murphy: Well, ironically, I don't think further falls in the RBA cash rate will have much influence on bond yields. I think we're probably seeing the low in bond yields in Australia. So, despite the fact that the Reserve Bank may cut another 25 basis points, I don't think it's going to be a big influence on bond yields or bond returns going forward.

St Anne: Noel, thanks so much for your insights today.

Murphy: Thank you very much.