Tax change could benefit Australia

Planned changes to the investment tax regime will not necessarily result in more New Zealand shares in a fund manager's balanced portfolio, says Arcus' chief investment officer Mark Brighouse.

When the changes come into effect next April, fund managers will no longer have to pay tax on capital gains from New Zealand and Australian equities, but will still have to on equities in other markets.

All else being equal that is an incentive to switch from offshore to local shares. Brighouse said investors needed to consider the trade-offs between after-tax returns, volatility and diversification.

Even with a "home country bias", the split between international and domestic shares within the equities portion of a balanced portfolio was typically about two-to-one in favour of international shares.

Modelling Arcus had done to take account of the changed tax rules suggested there would be only a limited degree of switching from international to domestic shares as a result of the tax changes, with the international equities slice shrinking from perhaps 40 to 36 per cent and domestic equities rising from 20 to 24 per cent.

"Of course under the new rules Australian listed shares are included under the domestic umbrella and this increase in domestic equity exposure could all go to Australia," Brighouse said.

"To the extent that local fund managers already have a heavy home bias in their portfolios they may be reluctant to increase that bias even further."

Arcus, which is part of the French-based Axa Group, has more than $4 billion in funds under management on behalf of clients including Spicers Wealth Management and the Bank of New Zealand.

Brighouse said it would not be in any hurry to lift its holding of domestic equities, in part because the tax factor ran counter to valuation considerations at the moment.

New Zealand shares looked relatively expensive on a price/earnings multiple basis compared with many overseas markets and the period of economic weakness the country was going through meant local equities were likely to underperform offshore ones.

For the first time since the late 1970s, monetary policy was being tightened simultaneously in the United States, Europe and Japan, reflecting uncommonly synchronised growth in all three economies.

Arcus' chief economist, Rozanna Wozniak, said with global interest rates rising while New Zealand short-term rates were set to fall, the yield gap which had kept the exchange rate high last year was narrowing.

And with the exchange rate falling, the flow of relatively cheap money from overseas, especially Japanese, investors which had funded fixed-rate mortgages would dwindle.

Even with a pick-up in net immigration, she expects retail sales and the housing market to continue to weaken. "We are overdue for a period of pretty much no growth in house prices lasting for some years."

Brighouse said many mortgage borrowers would not experience much relief when the Reserve Bank went in into easing mode.

The yield curve is inverted, with short-term rates higher than long-term ones, which are influenced more by global yields.

The curve would revert to a normal one as short-term rates fell while long-term ones rose, and the point at which it pivoted (and little change in rates would occur) was likely to be around two-year maturities.

That is also where a lot of fixed-rate mortgage debt sits. "I can't see borrowers getting a much better deal."