Newsletter Christmas 2009
December 23, 2009
Government Regulation
Much has been written in the newspaper recently about the standard of financial advice in New Zealand, and the imminent Government regulation of the advice industry. I expressed my views in the August newsletter, and feel it is worthwhile touching on the subject again. It’s an issue investors should keep abreast of because it has the potential to change the way investment advice is delivered and paid for.
There have been more calls for the banning of commission payments to financial advisers recently. The Sunday Star Times ran an article explaining how the Capital Markets Development Taskforce is poised to recommend law changes preventing financial advisers from taking commissions. The U.K has already committed to banning commissions, and Australia is considering similar moves. As I said in the August newsletter I believe banning commissions is short-sighted, and feel investors should be able to choose for themselves how their adviser is remunerated. Disclosure is paramount however, and investors need to be able to assess if there is a potential conflict of interest in the advice they are receiving. There are different rates paid by the various companies, and arguably there is the potential for advisers to let self-interest override the needs of their clients. The Capital Markets Development Taskforce has said the new law will impose a clear fiduciary duty requiring advisers to act in the best interests of their clients. Call me old fashioned but I wouldn’t have thought we need a law to stipulate that. I plan to own this business for the next 15-20 years and the only way I’m going to make money from it is to put investors’ interests ahead of my own each and every day.
The negativity around commissions has arisen from the managed funds industry and the meltdown of the finance company sector. For a number of years inexperienced advisers (largely insurance salesmen) have been selling their “ABC Super-Dooper International Growth Fund” or their “ABC Diversified Income Fund” and receiving ongoing commissions for as long as the money remains invested. More often than not these funds have performed poorly, however the adviser continues to benefit regardless. More recently the finance company failures have highlighted some ugly practices, with advisers clearly funnelling investors’ funds into an area that generates the greatest return for the adviser. Removing commissions isn’t going to solve these problems – there will always be dishonest and incompetent advisers and there will always be poor investment products. We also receive commissions from new issues of shares and bonds, yet this doesn’t seem to generate any negative publicity whatsoever. Maybe it’s because the companies involved (Rabobank, ANZ, Contact Energy, BNZ, Fonterra, Auckland Airport etc) have a much higher standing in the investment community than the finance companies. Nevertheless the method is identical – “sell this product to your clients and we will pay you a commission.” My job is to assess the merits of all these types of offerings (shares, bonds, finance company debentures, Government bonds, KiwiSaver, etc) and determine whether or not they fit the needs of our clients. To me the commission issue is irrelevant – first and foremost I want products that benefit my clients – if I do that on a consistent basis, I stay in business.
What are the alternatives? The most common method of remuneration in the financial planning industry is based on “funds under management.” Investors pay their adviser a fee based on the value of their investment portfolio. This is fine as long as the adviser is providing you with “value.” They should be actively managing your portfolio for you if you are paying them an ongoing fee. What tends to happen, however, is that as advisers build their business they cull out the clients with less money to focus on those that can generate the most return. Advisers would be reluctant to take on clients with small sums of money – possibly the very people that need financial advice the most. A second alternative that seems to be gaining traction is simply charging for the time spent advising a client, much the same as a lawyer or an accountant does. My concern with this is the amount of time I spend on things other than directly dealing with clients. Much of my day is spent reading and researching, and that time would need to be charged accordingly. I might take a call, for example, for advice on whether or not to take up the PGG Wrightsons’ rights offer. That call might last five minutes, but what about the hour I have spent reading the prospectus and monitoring the prices of the rights and the underlying shares? In my opinion this method of charging would restrict many people from seeking financial advice – again the very people that need advice the most.
I prefer the transaction-based model where investors pay brokerage (or we receive a commission) based on each transaction entered into. I feel it offers the best value for investors. Whatever method is used there will always be one group that subsidises others. Wealthy investors would prefer to be charged an hourly rate; investors with small sums would prefer the transactional model. What I need to do is ensure I am offering investors value, whilst at the same time earning a fair income – I’m not doing it for nothing! I would be interested in your views on how best to pay for financial advice – please let me know.
Expensive Shares?
I often hear people suggest they couldn’t possibly buy a share valued at, for example, $50, because it is too expensive. Their rationale is that you don’t get as many shares for your money when buying higher priced shares; or a 10cent share has a far greater chance of doubling in value than a $50 share. This is a commonly held view, however is completely irrational. The important factors that determine share price are the number of shares on issue, company earnings, dividends paid, and the future prospects of the company. If we look at two different shares as an example we can draw some comparisons.
Price Dividend Paid P/E Ratio
Fisher & Paykel Healthcare $3.33 17.71 cents 23.90
Westpac Bank $28.95 145.94 cents 18.10
Let’s assume we have $20,000 to invest. We would receive 6006 shares in Fisher & Paykel Healthcare, or 690 shares in Westpac. If Fisher & Paykel Healthcare continues to pay a dividend of 17.71 cents we would receive income of $1,063 – a yield of 5.32%. If Westpac continues to pay a dividend of 145.94 cents we would receive income of $1,006 – a yield of 5.03%. As you can see there isn’t much between the two companies in relation to their ability to generate income; even though their share prices are so far apart. Warren Buffett’s “Berkshire Hathaway” shares are currently trading on the New York Stock Exchange for $1,000 each! “Apple” shares were trading at $70 in 2006, and peaked at $195 in December 2007.
Office Hours
We will be closing over the Christmas and New Year Period. The office will close on December 23rd at 12.30 and will reopen on January 11th. I will be in the office briefly each morning to clear mail so please don’t hesitate to ring if you need something done. Leave a message on the answer phone if necessary – I will clear these each day. Also don’t hesitate to ring me at home or on my mobile phone at any time.
I sincerely hope you all have an enjoyable break over the Christmas and New Year period. I plan to relax at home with family, and will be working desperately to stay ahead of my boys in the back-yard cricket standings.
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Newsletter December 2009
December 1, 2009
Government Guarantee
The Government recently announced changes to the deposit guarantee scheme, none of which will affect investments that are currently protected by the guarantee. Institutions that are currently participating in the Retail Deposit Guarantee Scheme have until December 4th to accept the revised deed, which will come into effect on January 1st. If an institution declines to accept the changes to the scheme, any deposits taken after January 1st will not be guaranteed. Deposits already covered by the scheme will not be affected. These changes are separate from the extension to the scheme announced in August. The main change is that participating institutions will be able to offer guaranteed and non-guaranteed deposits. Presumably the extra rate offered for a non-guaranteed deposit will equal the fee that does not have to be paid to the Government, plus a margin for the extra risk.
Offering both guaranteed and non-guaranteed investments is an essential step in removing the guarantee altogether. At some stage the Non-Bank Deposit-Takers have to be able to stand on their merits, without the behaviour-altering backstop of the Government Guarantee. The new laws that impose stricter requirements on the non-bank sector should help restore confidence, however I think it will be years before that confidence is completely restored. I would liken the finance company collapse to the sharemarket crash in 1987. There are investors who will never own a share again after 1987, and I’m sure there will be investors who will never again consider a finance company, regardless of its strength in the future. Having the word “finance” in a company name now only seems to invoke negative sentiment.
Depositors will need to think very carefully about investing in non-guaranteed deposits in the early stages of the withdrawal of the Government Guarantee. There is a huge amount of money due to flow out of the finance companies in October next year, and we need proof that companies have the strength and investor support to cope with that. The obligations the Government is now imposing on the non-bank sector should go some way to toward helping investors (and advisers) analyse the merits of continuing to support these companies.
Asset Allocation and Model Portfolios
Last month I looked at some model portfolios, and suggested the percentage of an investor’s funds that might be allocated to each asset class.
Individual Investments
How far you diversify your portfolio is something that can be debated infinitely. Most people would recognise the need to spread their investments to reduce risk; however you can take that theory to the extreme, and diversify your portfolio into mediocrity. The administration can also become quite a burden if you have a large number of individual investments. With the exception of Government Guaranteed investments, bank deposits, and highly-rated fixed interest investments I suggest you don’t have more than 5% of your portfolio invested in a single security.
Bank Deposits
I recommend splitting your bank deposits between at least two banks. I have no reservations about the main trading banks, so your choice will be based on the rates offered, together with your historic relationship with the bank. Aim to split your bank deposits into different sums with varying maturities, so that you have money falling due at different times throughout the year. Always keep some cash at call – the online or phone accounts offered by the likes of Rabobank, Kiwibank and UDC are good for this purpose.
Fixed Interest
As with bank deposits, aim to divide your bond portfolio into varying maturities. Try to avoid having all your bonds maturing at the same time so you are not exposed to reinvesting all your funds at the bottom of the interest rate cycle.
Shares
The choice of shares to include in a portfolio will be based on your objectives, (growth versus income) and your tolerance to risk. We usually look overseas for growth and here in New Zealand for income. New Zealand companies historically pay more of their profits in dividends than overseas companies. Although I advocate buying and holding shares (rather than actively trading) you should always be prepared to regularly review your holdings and make changes if necessary. Far too many people refuse to sell a poor-performing share simply because it is trading at less than they paid for it.
Fixed Interest
Goodman Property Trust
We still have a small amount of the Goodman Property Trust bond available.
- 5-year term (June 19, 2015)
- Senior ranking and secured against $1.14 billion of property assets
- Minimum interest rate of 7.75%
Trustpower
Trustpower is issuing $125 million of five-year and seven-year fixed-rate bonds, with the provision to accept oversubscriptions of up to $50 million.
The main features of the offer:
- Two maturity dates (December 15, 2014 and December 15, 2016)
- Interest rates are 7.60% for the 2014 bonds and 8.00% for the 2016 bonds
- Interest will be paid quarterly
- Minimum Investment of $5,000 – thereafter in multiples of $1,000
- Closing date – December 18th
PLEASE CONTACT THE OFFICE AS SOON AS POSSIBLE IF YOU WOULD LIKE TO RESERVE AN ALLOCATION OF THESE BONDS
Commissions
Debate is raging about commission payments to financial advisers, and the potential for conflicts of interest. I have touched briefly on this topic in the August newsletter, and will revisit the subject next month. We are paid commissions by the finance companies and the various bond and share offerors (for example Goodman will pay 1.50% commission on their bond, of which we receive half). In the past the finance companies have paid advisers a commission on a maturing debenture that is reinvested with their company. It appears now, however, they will only pay that commission if it bears our stamp. If you are renewing a debenture with South Canterbury Finance, UDC, Marac, or Equitable, and you believe we should be paid a commission (perhaps we have advised on the merits for or against, or have raised an issue in the newsletter), please bring the application into our office to process.
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