Thursday, August 31 2006
Over the 5 years to the end of June 2006 International shares investments have been poor. Really, really poor. They have returned around -2% a year for the past 5 years.
As investors, how should we react to this poor performance? At A Clear Direction Financial Planning we expect that over the long term all growth asset classes will return around 10% to investors. About 7% above the inflation rate of 3%. There are three growth asset classes that we invest in: Australian Shares, international shares and listed property trusts. By investing in three asset classes with similar average returns we don't change the expected returns from growth asset classes, still around 10%, however we reduce the volatility of the portfolio - because being exposed to three asset classes with the same expected return will smooth the ups and downs of the portfolio.
Here's the kicker. The same average return, with less volatility, results in a greater compounding effect in your portfolio - meaning a higher ending portfolio value. So, regardless of poor returns over 5 years, we are more focused on the fact that international shares are an asset classes that historically has produced good long run returns, and there is no reason that they will not in the future. They are an important part of our portfolios, and play an important role in providing diversification.
Another underlying reality is this. No-one knows what investment markets will do tomorrow, this year, next year and going forward. If we were to decide to have no international share exposure just because it has performed badly in the last 5 year period then we would be trying to guess which market to be in at which time. And history has shown that this simply does not work!
One very last comment. The accepted financial planning wisdom is that a 5 year investment in any asset class is 'long term enough' to ride out the ups and downs due to market volatility. A five year investment in a fund like the BT international fund has returned -4.08% annually for the five years to the 30th of June 2006. A 5 year investment timeframe in a growth asset class simply does not guarantee a successful investment experience, and there is the proof!
Saturday, August 26 2006
At its highest Telstra traded at well over $9.00. Today I read a columnist who suggested the final sale price of the $8 billion of Telstra to be sold in November could be as low as $3.15.
So what should prospective investors do or be thinking about right now? The answer is not much - there will be plenty of time to gather more information about Telstra between now and the time when you have to put forward your money.
Telstra remains a huge producer of cash flow for investors. Indeed, the dividend payments to investors are often regarded as the one thing that keeps the share price from falling even further. The government are going to use 'installment receipts' to sell the Telstra shares. This means that for each share about $2.00 will have to be paid up front and the rest, say $1.20, will have to be paid 18 months later. One tactic used to support the sale will be the fact that there will be a 28 cent dividend over the first 12 months. 28 cents on a $2.00 first installment will be enthusiastically described as a '14% yield'. How could you go wrong when the average sharemarket dividend yield is 4%?
The number one way that you can go wrong will be if they cut the dividend. Management can and do cut dividends that are paid to shareholders. This is not likely to happen over the first year or two, however can happen after that. The second way that you can go wrong is that you don't take the time to understand the company and its prospects. You need to form an opinion about the ability of the company to grow its future earnings. I think that it is almost as simple as this: If you think Telstra is capable of growth of 5% a year in the future, buy the company. If you don't think it is, don't buy the company. There is a lot of information that we will need before we can make that judgement.
If you want an example of dividends being used to prop up a float you need go no further than Australian Magnesium Corporation. This was a start up company that many people were 'suckered' into investing in because the Government had underwritted 'pretend' dividends - that is dividends that had not come from earnings. While Telstra is different from this, it is a massive company with a long corporate history, it is a company under pressure from regulators and competitors within the industry.
What are we most looking for over the next 3 months? An understanding of how the regulators (the Government) and Telstra are going to be able to work together in the future. If they can settle their differences, and form a reasonable relationship that will allow Telstra to benefit from its capital expenditure programs, the the upcoming sale of Telstra at less than $3.50 a share is worth a look.
Friday, August 25 2006
An interesting piece of research was presented on today's ABC lunchtime news show. Dr Karl was talking about some recent research that showed that companies that listed on the stock exchange performed better if they had a simple and easy to remember name. It was presented as light hearted research, however it provides a reminder as to some of the folly of 'active management', that is spending time and money to try and identify which companies are going to perform better than any other.
It reminds me of some research that said companies that start with the letter 'W' had outperformed over a period. In fact, I would think that over the last 10 years this might still hold true - there are not that many companies that start with the letter W the biggest such as Woolworths (25.7% a year average for last 10 years), Wesfamers (23.2% a year average for last 10 years), Westfield (had a merger about 3 years ago so there are no combined results), Westpac (19% a year average for last 10 years) and Woodside (23.1% a year average for last 10 years) are all strong performers over this time. All these companies beat the average sharemarket return be some margin.
So the moral of the story is that we should invest in shares that start with 'W' or have easy to remember names. Or, for a lay down winner, easy to remember shares that start with the letter W. No rational person would be, or should be, comfortable with either of these strategies as a basis for a long term investment strategy. Therein lies the problem with 'active management', trying to pick and choose which shares are going to outperform. There is so much information already priced into each share that it is really difficult to pick any that will outperform. And, when patterns or outperformance are identified, who says that it is just not luck driving the higher returns - such as the letter 'W'.
At the end of the day the market does a good job of rewarding long term investors who focus on a long term, well diversified, buy and hold approach to investment.
Wednesday, August 23 2006
Investment Markets have been a little bit up and down lately. And a lot of the commentary in the media has been whether it was time to get out of investment markets for a while, have they now bottomed, and it is the right time to buy back in.
In the long term sharemarkets - both Australian and International - have provided returns of around 11-14% a year on average. They are respectable returns, so why add extra pressure and expenses assocated with trying to buy and sell investments.
The 'Miracle of Compound Interest' refers to the way that, over time, investment earnings increases as there are investment earnings on investment earnings. For example, let us assume that I have $1,000 in a bank account earning 10% interest (a little bit unreasonable give current cash earning rates, however it makes the maths easier). In the first year the $1,000 earns $100 interest. However, if this $100 is not spend the 10% interest on $1,100 in the second year is $110. And so on. The key is not to be impatient. The benefits of compound interest will take some time to show through. Set up an investment portfolio. Invest regularly into in. In time, the investment earnings on investment earnings (compound interest) will help push you towards your financial goals.
Wednesday, August 16 2006
Financial services is a funny industry. It is an industry where the participants somehow decide that they are smarter than the great thinkers - the Nobel prize winners - in financial economics.
Merton Miller (Nobel prize winner) explained why the expected return of an investment has to be linked to risk; why there are no free lunches. And yet many people in the industry still promote low risk ways of earning a high return. They simply don't exist, people are too selfish to give away a return higher than they need to - so the return will always be related to the risk.
William (Bill) Sharpe (Nobel prize winner) explained that they best way to earn a return above the cash rate was to expose some percentage of your portfolio to the sharemarket, in a broad and diversified way. The sharemarket provided a 'market risk premium', that is a higher rate of return over the long term for people who invested in it.
Markowitz (Nobel prize winner - do you notice any pattern?) said that an investor should use diversification to minimise the amount of volatility (ups and downs) in their portfolio, to try and get a smoother return over time.
So there you have it. The fundamentals of investment success from some of the great thinkers:
- If you want a higher return than a cash investment, expose some of your wealth to higher risk, higher return sharemarket investments.
- Don't look for shortcuts - risk and return are related, so high return must mean high risk.
- Diversification is an investors friend - use it to minimise the ups and downs of your portfolio.
Saturday, August 12 2006
David Tweed does not seem to be a very nice person. As the man behind Australian Share Purchasing Company he obtains the list of all shareholders in a company and then writes to them offering to buy their shares at below market value. Invariably some less financially literate people fall for the offer and David Tweed ends up buying their shares at a discount to their true value. A practice that seems to me to be nothing more than an intolerable disgusting rip-off of good people.
Earlier this week David Tweed launched a fairly pathetic defensive of his practices in a letter he wrote to the Australian Financial Review. People will, however, defend his right to such activity on the basis that it is a 'free market'.
One of the theoretical inputs that a free market needs to work property is 'perfect information'. The lack of information is what David Tweed is exploiting in his 'venture'. (It is hardly a venture - something that destroys value for all customers is more akin to robbery than any proper business venture). That is, people are not aware of how they can sell their shares to realise a higher price that David Tweed is offering, or else they would do that. While ASIC has tried to limit David Tweed's attempts at robbery, including forcing David to put the current market price of the shares on any offer to purchase them, is seems people still get caught by his offers.
Australian Share Purchasing Company seems to be so ironically named. After all, ripping off good hark working people who just don't have all the information at hand is simply un-Australian!
Monday, August 07 2006
Over the past three months I have been writing a second book with Scott Keefer. Scott has commerce and post graduate financial planning degrees and is joining the firm. The book is called 'Its Time You New the Truth - Building Investment Portfolios that Work!'
The book looks at the key aspects of building an investment portfolio. These are:
- Focus on asset allocation as the long term driver of portfolio returns.
- Minimise trading and tax costs
- Be well diversified
- Stick to your portfolio over time
It is worth considering what people who started investing 4 or 5 months ago are now thinking. The Australian share investments are probably down up to 10%. Now would be the worse time to sell. It is important to focus on the fact that volatility is part of the investment experience. In the long term higher volatility asset classes like Australian shares produce higher expected returns.
Sunday, August 06 2006
I had the somewhat saddening experience of being an exhibitor at the Investment Expo on the weekend. The part that made me sad was the number of people selling trading programs promising returns of over 100% a year. This just won't happen. How do I know?
Let's assume for a minute that I have just been granted the gift of trading that lets me earn a 100% return a year on the stockmarket. What am I going to do with it? Probably the first thing I would do is borrow $300,000 and trade this myself. The interest costs on $300,000 are $25,000. That is a tidy profit for me of $275,000 a year. I could live on half of this and then use the remaining $140,000 to add to the $300,000 starting balance and made $440,000 in the next year. And so on.
Or I might start a managed fund that charged a fee of 4% and 40% of the profits in excess of the average sharemarket return. With an ability to return 100% a year I would very soon have $1 billion in funds under management. The 4% fee would equate to $4 million a year. The outperformance over the average sharemarket return would be, on average, 88% a year. Being entitled to 40% of this equals a $350 million annual bonus. That is $354 million of income - and growing over time!
What I would not do with this ability is sell it as a 'share trading' program. Why? Because as other people are buying when I am buying, and selling when I am selling, it will reduce the returns from my trades. I will be selling away my secret. I am far better off trading the secrets myself, or profiting by starting a managed fund. No rational person will be selling share trading programs that really work!! And they certainly would not have to use the high pressure sales pitches that underlie such sales.
Friday, August 04 2006
Rivercity is the latest in a string of new sharemarket floats that has been disappointing. With an issue price of 50 cents, the stock closed 10% down on this after the first two days trade. We tend to hear about floats that do really well, however fail to be told that many floats end up 'under water'. Recent poor performers such as Sydney Roads and Emeco have highlighted that not all is 'blue sky' in the land of floats.
There is a effect known as the 'losers curse' when talking about investment floats. It means that if small investors are offered stock in a float, there is a chance this is because none of the big investors, such as institutions, want it. For example, high profile floats like Babcock and Brown, Tattarsals and Wotif are hard to get access to for the retail investor. However speculative biotech stocks are more likely to be available.
Wednesday, August 02 2006
My latest Eureka report article considered the big issue of how well have the biggest fund managers performed over the past 5 years? I looked at only Australian share fund and found that, on average, the Australian share funds of companies like Macquarie, BT, Colonial and AMP had failed to beat the average market return. In fact, they failed to the tune of 1.7% a year.
This is an interesting warning. If the biggest and best financial services industry can't beat the index return through 'active management', then who can?
Another interesting aspect of the article is that an index fund, which simply matches the average return with little buying and selling of investments, was very tax effective. The Vanguard Australian share fund had a pre tax return over the 5 years to the 30th of June of 11.6%, beating the vast majority of the active funds, and an excellent after tax return of 11.33% for someone in the 30% tax bracket. The active funds, which by their very nature will be trading a lot, would have lost much more than this in tax.