Shorts Outgunned in Australia as Retirees Drive Stock Market

When David Hurwitz started shorting Commonwealth Bank of Australia in 2012, the valuation on Australia’s largest bank was twice as high as global peers, a signal to him the stock would fall.

Instead, the shares have rallied about 40 percent.

Bets against large Australian companies by hedge fund managers including SC Fundamental LLC’s Hurwitz are coinciding with an increase in investments from local pensioners with A$557 billion ($494 billion) in self-managed funds. The retirees, who often overlook traditional measures of valuation in favor of big dividends and familiar names, pumped more than A$8 billion into the stock market in the year to June 30, 2013, about 65 percent more than in 2010, according to Credit Suisse Group AG.

“They are the army,” said Hasan Tevfik, director of Australian equities research at the Zurich-based bank. “They are the dominant force in the equity markets now. Investors don’t understand who’s actually driving share prices.”

Professional investors should avoid shorting the stocks the retirees favor, including Australia’s four largest banks and former state phone company Telstra Corp., according to Tevfik. Short sellers bet that a stock will decline, borrowing shares to sell with the expectation of buying them back later at a lower price.

Dissatisfied with the fees charged by professional managers, Australian retirement savers have boosted the assets held in so-called self-managed superannuation funds fourfold since 2004. SMSFs are unique among pensions in developed nations in that they choose their investments, are responsible for custody arrangements and for keeping records. They can invest in assets including stocks, bonds, cash deposits, property, artwork and even wine.

Loading Up

Such funds are expected to oversee A$2.2 trillion by 2033, according to a Deloitte Touche Tohmatsu Ltd. report last year. Australia’s entire stock market is worth $1.3 trillion.

“The self-managed super funds just load up and load up” on shares in Australia’s big four banks, John Hempton, chief investment officer of Sydney-based hedge fund Bronte Capital Management Pty., said by phone. “This market is insanely expensive.”

Shares in Commonwealth Bank rose 1.7 percent at 3:06 p.m. in Sydney, while Australia & New Zealand Banking Group Ltd. gained 1.8 percent, both the most in eight months. Westpac Banking Corp. gained 2.3 percent, the most in almost 10 months, and National Australia Bank Ltd. rose 1.4 percent after reporting full-year cash profit fell as much as 14 percent.

Market Rally

The four banks, which contributed the most to a five-year rally in the nation’s stocks, trade at an average of 2 times the value of their net assets, according to data compiled by Bloomberg. That compares with a median multiple of 1.2 on the Bloomberg World Banks Index.

Hurwitz, a partner at New York-based hedge fund SC Fundamental, said Commonwealth Bank’s recent decline -- the lender posted a 6.9 percent drop last quarter, the most in three years -- is “just noise”.

“It certainly hasn’t been a great short thus far, but the shares are trading well in excess of double what we consider current fair value,” he said by e-mail Oct. 7. “It is certainly possible fair value could fall significantly.”

For Olivia Engel, State Street Corp.’s Sydney-based head of Asia-Pacific active quantitative equity, the valuations are a reason not to buy. Engel said the four lenders, which make up about 30 percent of the benchmark S&P/ASX 200 Index, represent only about 7 percent of State Street’s Managed Volatility Alpha Fund.

Historic Measures

She’s confident they will eventually come down to earth.

“Over the years I’ve witnessed a few periods in history where people have questioned whether historic measures of valuation apply, because valuations they’re seeing defy gravity,” she said by phone Sept. 23. That logic has always turned out to be misplaced, she said, citing the tech bubble as an example.

For retirees dividends take precedence over valuation, said Boris Pogos, 59, who manages his own pension fund.

“Dividend yield is really important in my stock selection,” said Pogos, a Melbourne-based independent investment analyst who’s been running a self-managed pension fund for 16 years and has 80 percent of his portfolio in equities. “For people who want to live off the income rather than the capital, the high-dividend yield reduces the need to sell stocks.”

Dividend Yield

Among global stocks boasting at least $10 billion in market value, Australian firms tie with Macau for the highest average forward dividend yield after the Netherlands at 4.4 percent, according to data compiled by Bloomberg. The big four lenders and Telstra, the former monopoly phone company, offer an average yield of 5.6 percent, the data show.

That compares with a yield of 3.36 percent on benchmark 10-year Australian government bonds.

Fund managers need to take into account changes in the composition and behavior of fellow investors, said Aswath Damodaran, who focuses on equity valuation as a professor of finance at New York University’s Stern School of Business.

“These retirement funds have longer time horizons and preferences for larger dividend paying stocks than the rest of the market,” he said in an e-mailed response to questions. “The old metrics, applied lazily and as rules of thumb, will yield the conclusion that these stocks are over-priced. If you believe that the fund flows have changed, you have to find a way to bring it into your analysis.”

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