The Middletons Securities Hi Five Investment Report 2014 suggests investors increase their international exposure based on the likelihood of offshore economies outperforming the Australian economy and further falls in the value of the Australian dollar this year. 

A more than likely rise in inflation gives way to alternative strategies for corporate bond investment, while in equities the potential scrapping of the carbon tax as a result of the recent change of government looks favourable to certain resources companies, according to the report. 

Increasing international exposure

Investing internationally gives an additional contributor to your return, namely movements in the value of the Australian dollar, Middeltons Securities principal David Middleton said, who added that investing locally limits the source of returns to the market.

“In the chart (below), the darker blue bars show the returns from international markets in US dollar terms and the lighter bars show the change in the value of the Australian dollar compared to the US dollar,” Mr Middleton said.

“The blue line shows the return from international markets for Australian investors,” he said.

“If the Aussie dollar continues to decline, which we think it will, although not at a rapid pace, then a lot of companies with international earnings could do quite well.”

Australian companies with international income

This is a recommendation that has been carried over from last year and is really an opportunity for a bit of earnings growth if the Australian economy is a bit slow in 2014, Mr Middleton said.

“A lot of companies like CSL and QBE were knocked about and punished when the dollar was rising and you would expect them to claw that back as the dollar retreats,” he said.

Below are four companies – Ansell Limited, CSL Limited, Sonic Healthcare and Computershare – that Mr Middleton suggests investors might consider.

Inflation-beating income

If you go back over the last 20 years and look at the level of inflation and real interest rate returns, then there is a negative correlation, Mr Middleton said.

“As inflation gets higher, then historically you have a lower real return from fixed interest investments,” he said.

“We are starting off at a low base anyway because interest rates are low and inflation is normal.

“What we are pointing out is there is indexed income available, and the cheapest is really on corporate bond markets.”

You can pick up an indexed bond at the moment that has a running yield of just under four per cent with indexation at the capital and at the income stream, said Mr Middleton.

“So you are locking in a return of 3.7 to 3.8 per cent, which is pretty terrific really,” he said.

“If interest rates do spike, and there is a higher probability of that happening than we have seen for some time, then you are going to be protected by it.”

In his report, Mr Middleton suggests a “more exciting idea” of owning an indexed bond and a long-term indexed annuity bond together and leveraging up the running yield, boosting the income potential to five per cent.

“With that, you are actually getting a higher running yield now with inflation protection,” he said.

“If inflation does kick up, you will probably get a bit of capital growth as well.”

Beneficiaries of the change of government

Ugly polluters are going to benefit from a change of government, according to Mr Middleton, who added that this is neither a good thing nor a bad thing. 

“It’s not a value judgement,” he said.

In his report, Mr Middleton highlights AGL Limited’s acquisition of the Loy Yang power station “for a song” when the carbon tax was introduced, a cheap asset that will generate “excellent profits into the future”.

“AGL’s EPS has been going up and down for some time, but is now starting to go up a bit,” Mr Middleton said.

“The current pricing actually looks quite cheap,” he said. “The abolition of the carbon tax is very favourable to their profitability, so that’s really the call there.”

Residential construction and tourism

Mr Middleton recently cautioned investors about overpriced building suppliers, citing Boral’s then share price at 24 times the anticipated earnings for this financial year.

The logical reaction to a lift in home building figures would be to start buying up the major building supply firms, like Boral and GWA Group, Mr Middleton said, but he prefers two alternatives: Wesfarmers and Lend Lease.

“Wesfarmers own Bunnings, which is the major hardware chain in Australia and a leading supplier to homebuilders,” he said.

“While Wesfarmers’ share price has run up quite a bit over the past year, it is still at reasonable levels. 

“Lend Lease are major builders of residential properties, commercial properties and infrastructure. 

“It remains busy throughout the business cycle but potentially gains significantly from growth in the housing sector, not just because they build apartments but because they also build the schools and shopping centres that are required to support them.”

For tourism activity, the best barometer is movement through airports, which is where investors may be able to pick up a benefit from this theme, the report stated.

Investors holding Sydney Airport stock will benefit directly from increases in passenger traffic as the airport charges a fee on every ticket, it said.

“They can also charge more rent to all the shops and bars at the airport because there are more passengers and they pick up extra from charges to all the services that pick up and drop off passengers at the airport,” Mr Middleton added.