Being a millionaire may not be enough for a comfortable retirement

Source: Delta Research & Advisory Pty Ltd The above chart shows the probability of running out of funds in retirement for someone who retires with $1,000,000 in today’s dollar and draws $55,080 each year (ASFA Retirement Standard for a comfortable retirement for a couple), growing at 3% inflation. It is assumed the funds are invested …

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Australian Government Bond Yields…continue record lows

Source: RBA In less than 2 weeks the Australian Government Bond yield curve has dropped another 20bps plus and since August last year, the yield curve has dropped around 160bps on average…which means for bond fund owners double digit returns over the previous 12 months continue. Obviously the main reason for this drop in yield …

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A Slideshow on the European Crisis

Paul Krugman, Nobel Prize-winning Princeton Economics Professor, has placed an upcoming presentation on the European Crisis on his website…please click here. It is such a simple story as to how badly Europe is going, why it erred, and why to continues to err. Some of the fascinating points in his slideshow include… British GDP has performed worse …

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A Few Investment-Related Budget Outcomes

As expected the Federal Budget focused on a surplus and to the government’s credit is looking to distribute some of their mining profits to the not so wealthy. Whilst the opposition is suggesting that some of the cash payments will be going straight to retailers instead of their intended purpose, that’s not necessarily a bad …

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World’s 10 Strongest Banks (by Nation)

I thought this list would have contained at least a couple of Australian banks given their high credit ratings, profitability, and belonging to one of the stronger developed economies of the world. Anyway, the top 10 strongest banks can be found by clicking on the following link… Bloomberg’s List of World’s Strongest Banks. or World’s …

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Being a millionaire may not be enough for a comfortable retirementAustralian Government Bond Yields…continue record lowsA Slideshow on the European CrisisA Few Investment-Related Budget OutcomesWorld’s 10 Strongest Banks (by Nation)

Mar 06

Australian Bond Yields…still edging up

Categories:

Economy, Europe, Fixed Interest, General Investment, Government Bonds, Interest Rates, Investment Strategy, Yield Curve

by michael

Source: RBA

I know the above chart is a couple of days old but there’s not much change since last Thursday. At its simplest what it shows is that the bond market is still expecting the Reserve Bank to decrease interest rates some time during the year…with 1 year bond yields at less than 4%, the market still expects at least one and may be two interest rate decreases some time this year.Despite that, results of a survey of 24 economists overnight showed that every one of them believes that rates will stay on hold today.given the stabilisation of many economic factors both here and overseas I have to agree.

The big issue, of course, is still Europe and the Greek default (or whatever you want to call it), won’t occur until later this month and that could very well create some market volatility. I say that because whilst we already know what is most likely to happen there is uncertainty in terms of what will happen with Credit Default Swaps (or default insurance) that many hold on Greek debt…will they be triggered or not and if so, what will be the financial consequences in the shadow banking system….the last week of March may be interesting.

Anyway, back to the chart, given bond yields bottom at 3 years and 10 year yields are still fairly low, still suggests that the Australian economy is unlikely to shoot the lights out and inflation is well contained for the moment. The creeping up of the yield curve is a reflection of a quiet month of economic news…no news is good news.

Moving forward I believe the most important local economic indicator will be unemployment. Obviously Europe will have the biggest short term impact on sharemarkets, but if our unemployment level increases significantly this may flow into weaker confidence, even lower house prices, and therefore lower GDP growth. Given all of the cutbacks announced I’d be very surprised if unemployment doesn’t go up but its the sharpness of that increase that will be critical.

In terms of investment its still  very difficult environment. Bond yields are very low ad sharemarkets still have numerous macro risks hanging around and a low growth economic environment and high Australian dollar may limit A-REIT’s upside so its a very tough call (of course term deposis continue to pa attractive margins over bonds). My pick at the moment is volatility…I’m very confident it will increase from these curent low levels so if I could easily invest in volatility (which I can’t) then I would.

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Mar 04

Portfolio vs Asset Allocation…potential pitfalls

Categories:

Financial Planning, General Investment, Investment Strategy, Portfolio Construction

by michael

Many financial planners recommend their clients follow a particular Strategic Asset Allocation that may be based on the output of the combination of a risk profile as well as matching the client’s needs. For example, a popular strategic asset allocation for a “balanced” portfolio may be along the lines of…

  • Australian Shares 35%
  • Global Shares 25%
  • Property 10%
  • Bonds 20%
  • Cash 10%

or in simple terms, the “balanced” portfolio contains 70% ‘growth’ assets and 30% ‘defensive’ assets (i.e. cash plus bonds). Whilst this overall asset allocation appears simple enough, unfortunately when the underlying investments are chosen, inadvertently, they often increase the portfolio risk beyond that of the Strategic Asset Allocation’s risk. This is because the overall risk of the Strategic Asset Allocation is based on broad-based indices but our investmen portfolio may significantly deviate from them…for our “balanced” asset allocation the indices may be…

  • S&P/ASX 200 Accumulation index
  • MSCI World Index (Unhedged)
  • S&P/ASX 200 A-REIT Accumulation Index
  • UBS Composite All Maturities
  • UBS Bank Bill

…but our portfolio may contain Australian shares outside the top 200, or may have high exposure to Emerging Markets or exposure to Growth Shares. Also, perhaps the property allocation contains global REITs, and the fixed interest has a high proportion of credit. There may be other risks in the portfolio from hedge funds, long/short funds, commodities, or perhaps a very high proportion of mezzanine finance. If an investment portfolio contains these exposures then whilst they may add up to the stated proportions of the Strategic Asset Allocation, compared to the above-mentioned indices the final portfolio will undoubtedly carry significantly more risk…and also more cost from higher than index fees.

So if risks are embraced over and above the Strategic Asset Allocation’s, then it may require an increase in allocation to the more defensive allocation of cash and bonds. If credit is added to the portfolio, reduce some equities or property; if there is a large small cap allocation in Australian Shares, perhaps the overall Australian shares allocation needs to be reduced.

So please keep in mind that a recommended Strategic Asset Allocation is based on cheap simple index funds and if your portfolio has different risks to these traditional indices then it may have more risk than you realise…more return potential sure, but more loss potential too.

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Mar 01

A Letter from Zilch Capital…

Categories:

Hedge Funds

by michael

This link from The Economist was passed onto me today and is a hilariously written letter from a fictitional hedge fund manager to its investors. I have reproduced the full letter below (I hope The Economist doesn’t mind) …

Dear investor,

In line with the rest of our industry we are making some changes to the language we use in our marketing and communications. We are writing this letter so we can explain these changes properly. Most importantly, Zilch Capital used to refer to itself as a “hedge fund” but 2008 made it embarrassingly clear we didn’t know how to hedge. At all. So like many others, we have embraced the title of “alternative asset manager”. It’s clunky but ambiguous enough to shield us from criticism next time around.

We know we used to promise “absolute returns” (ie, that you would make money regardless of market conditions) but this pledge has proved impossible to honour. Instead we’re going to give you “risk-adjusted” returns or, failing that, “relative” returns. In years like 2011, when we delivered much less than the S&P 500, you may find that we don’t talk about returns at all.

It is also time to move on from the concept of delivering “alpha”, the skill you’ve paid us such fat fees for. Upon reflection, we have decided that we’re actually much better at giving you “smart beta”. This term is already being touted at industry conferences and we hope shortly to be able to explain what it means. Like our peers we have also started talking a lot about how we are “multi-strategy” and “capital-structure agnostic”, and boasting about the benefits of our “unconstrained” investment approach. This is better than saying we don’t really understand what’s going on.

Some parts of the lexicon will not see style drift. We are still trying to keep alive “two and twenty”, the industry’s shorthand for 2% management fees and 20% performance fees. It is, we’re sure you’ll agree, important to keep up some traditions. Thank you for your continued partnership.

Zilch Capital LLC

Source: The Economist

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Feb 26

Jeremy Grantham’s latest Must-Read

Categories:

General Investment, Investment Strategy

by michael

Jeremy Grantham’s latest quarterly newsletter is on the GMO website and as usual it is an educational, pragmatic and brilliant read. There is so much to take away from this one. There are three parts to his ‘longest quarterly letter ever’…

1. Investment advice from your Uncle Polonius

…which contains 10 absolute must read points. One of my many favourite bits …

To be at all effective investing as an individual, it is utterly imperative that you know your limitations as well as your strengths and weaknesses. If you can be patient and ignore the crowd, you will likely win. But to imagine you can, and to then adopt a flawed approach that allows you to be seduced or intimidated by the crowd into jumping in late or getting out early is to guarantee a pure disaster. You must know your pain and patience thresholds accurately and not play over your head. If you cannot resist temptation, you absolutely MUST NOT manage your own money.

2. Your Grandchildren have no value

part of his conclusion in this different perspective is…

Capitalism, by ignoring the finite nature of resources and by neglecting the long-term well-being of the planet and its potentially crucial biodiversity, threatens our existence. Fifty and one-hundred-year horizons are important despite the “tyranny of the discount rate,” and grandchildren do have value.

3. Investment Observations of the New Year

He provides his market outlook for short, medium and long-term and I won’t spoil what his specific calls are other than he is bullish, bearish and fair value…but not in the same order…sorry about that

Jeremy Grantham is undoubtedly one of the deepest thinkers in the investment world and his quarterly letter is a must read for anyone who wants to better understand the potential impacts of the major issues of our world on investment markets. I know its a long read, although at 15 pages its not really long as you’ll get more out of this than virtually any book you’re likely to find on investing.

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Feb 24

I always like a good interest rate or yield

Categories:

Europe, Government Bonds, Interest Rates, Macroeconomics

by michael

Unfortunately whilst the yield on Greek 1 year bonds is high at 730% (yes there’s no decimal point), it can hardly be described as good. When you have a 730% interest rate on your 1 year loan, its pretty safe to say that your chances of paying it back are zero. I understand why Greece is being bailed out (essentially to avoid a Lehman’s type contagion on banks and markets) but default is inevitable.

The fiscal austerity that is being imposed on Greece will reduce government expenses but will do absolutely nothing to increase government revenue…this is a requirement for Greece to recover. So the Greek situation will just get worse as revenues continue to fall due to continued vicious cycle of higher unemployment and lower consumer expenditure and for government that means lower tax revenues and higher debt requirements and therefore continued higher interest rates.

I originally put this chart up because I found it somewhat of a joke, but its not a joke at all, its actually a nightmare for many innocent people.

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Feb 20

Excellent long term performance from bonds…but there’s a lot more to it

Categories:

Equities, Fixed Interest, General Investment, Government Bonds, Interest Rates, Investment Strategy, Managed Funds, Portfolio Construction, Superannuation

by michael

A look at the average returns of bonds over the last 30 years does not suggest that equity returns have really been worth the risk. Table 1 shows the returns on Australian Bonds (Aust Comm Bank All Series/All Maturities) versus the accumulated return of the Australian sharemarket (S&P/ASX 200 TR) and whilst equities have the better performance over 30 years its hard to imagine the additional 1.53%pa return has been worth the additional risk.

Table 1

Source: iRate van Eyk Research

Looking ahead many investors will see these returns and conclude that bonds are a better investment than shares, but unfortunately they won’t be looking at the full picture.

The below chart shows exactly what has happened to long term interest rates over the last 30 years and the trend is pretty obvious…its significantly down. So 30 years ago, an Australian 10 year government bond was yielding around 16.5% and now it yields below 4% which is a significant drop. This means that over this time there has been a strong capital gain by holding bonds (when interest rates drop, bond prices go up) so the question is, will this trend continue?

Whilst it is absolutely possible that longer term interest rates (or yields) continue to drop, evidenced by Japan, US, UK and Germany whose 10 year bonds are 2%pa at most, over the longer term you would have to expect that return potential favours equities.

As I mentioned in an earlier post, the forward expectation of returns over the next 5 year for a bond fund is approximately the 5Year bond yield plus around 0.5% of credit risk, which equates to somewhere between 4% & 4.5%.I’m pretty confident that for the market as a whole that is not a particularly attractive return so the ongoing attractiveness of bonds may be challenged.

Whilst I do believe, that the macro economic risks should keep the prudent investor underweight risky assets for the moment, I am failing to see a compelling story in favour of boring old bonds. Term deposits are offering a very nice margin for the retail investor and corporate credit (for non-banks) appears attractive given cashed-up corporate balance sheets, but traditional asset allocation models are looking a little challenging.

The one issue that is in the back of my mind in favour of bonds, despite the macro risks, are potential structural changes in the Australian superannuation system. MySuper may result in far more conservative default funds as trustees realise the balanced fund is completely inappropriate, and the transfer out of the old default funds could be sped up by the introduction of superstream as well as the mass retirement of the baby boomer segment. Either way, the average Australian super fund carries a little more risk than it possibly should so I expect it to change over the years to come.

Back to my main point…equities look frightening, bonds look expensive, and cash is on the way down…its time to start looking at some non-traditional (sub) asset classes to diversify into.

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Feb 18

RSS Feed not currently working

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Uncategorized

by michael

Since I changed the look and feel of Fureyous, it appears the RSS Feed has ceased to work so my apologies for those of you who receive notification of posts via RSS.

I am currently working on fixing it and will advise by updating thispost once it is working again.

I made an attempt a little earlier but it brought the whol site down so I need a better solution than the first.

Stay tuned!

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Feb 16

Platinum Asset Management…they’re good but also a tad greedy

Categories:

Managed Funds

by michael

Platinum Asset Management is undoubtedly the most successful International shares manager in Australia. Their long term performance is way above global benchmarks and thanks to this, their support has been unwavering and they have grown and grown to be one of Australia’s largest fund managers with over $18 billion in FUM.

Unfortunately like most companies their primary focus isn’t necessarily their customers. The Chairman’s address at their AGM a few months ago said,

The Board’s highest priority has been to ensure the focus of the investment management team continues to be on client’s returns

…its a pity they didn’t attribute that priority to whoever sets their fund’s pricing.

Sure their performance is pretty good as the performance of the Platinum Internation Fund demostrates below. But when you earn Profit before tax of $213m on Revenues of $264m (or a gross profit margin of 81%!!!), something tells me they may be a little greedy. so overall I’m really struggling to believe that their fund investors are a high priority.

Source: van Eyk Research

Whilst profit margins are 81% for shareholders, despite their benchmark relative strong performance…their investor clients can’t claim profit margins anything like it…and never will. Given the staff also own a lot of Platinum stock I’m fairly confident failure to perform in the future shouldn’t worry them too much financially and the stickiness of the funds in Platinum is likely that profitability will never be threatened. Which is not necessarily a bad thing, but surely there comes a point when its time to give back to those who have supported you for so long.

So…I know this is a big call as many advisers and their clients are very very loyal to Platinum, but perhaps there are some other global fund managers out there that may be a little hungrier and fairer to their client investors. Perhaps its time to change.

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Feb 11

Performance Reviews…and I don’t mean investment performance

Categories:

Uncategorized

by michael

I know this is a finance-related blog but I’m compelled to vent about something that has bugged me my whole career…the dreaded annual performance review…anyway…

I was just readng Felix Salmon’s latest post, and found a sentence that I always believed in but thought I was the only one (mainly because it was just personal observation as opposed to owning any actual evidence)…

There is absolutely zero evidence that frequent, rigorous performance reviews ever do any good, and quite a lot of reason to believe that they actually do harm.

The link in Salmon’s sentence takes you to an outstanding articulate logical explanation of the failure of the annual performance review…music to my ears.

Key points…

  • Two people, two mindsets…the employee is thinking career progression, job progression and salary increases whilst the boss is picking holes in performance that could be improved
  • Performance doesn’t determine pay…although I do believe it might determine size of bonus but I found out last year even that isn’t always true (I’m still pi**ed about that)
  • Objectivity is subjective…let’s face it, two different bosses more often than not would conclude differently on one’s performance (often its a personality contest)
  • One size does not fit all…unfortunately the performance review is focused on a pre-determined checklist that may sometimes have little correlation to the true performance
  • Personal development is impeded…thanks to the performance review the boss is often the last person one goes to when they need help…wrong behaviour
  • Disruption to teamwork…the performance review has the tendency to undermine the teamwork aspect between boss and employee
  • Immorality of justifying corporate improvement…I think we all know that the performance review actually adds nothing to the bottom line of corporate performance.

The proposed solution is a “two-sided, recriprocally accountable, performance preview”…this implies that the performance of the employee is accountable to the boss, whose job it is to help, guide, and coach not the one-way, employee acountable method that dominates today.  This provides an environment where the focus is “about problem solving and not problem creating”…read the article for better justification than I can provide in a few words.

Personally, I couldn’t care less, and never have, about my performance review…I know how I’m going and always have and I’ve just wanted to get on with my job and do the best I can. The performance review has always been an annoying distraction to my day. If things aren’t going well, then the performance review is way too late, and my boss would or should have been communicating this to me way before.

Now if I can only convince my employer to ditch the performance review…mmmm…or perhaps I need to be the employer. ;)

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Feb 10

Don’t forget the E in PE

Categories:

Equities

by michael

Source: RBA

The above left chart, Forward PE Ratio, shows that the Australian sharemarket is potentially relatively cheap at the moment. The forward PE ratio, which is the ‘current price’ of the Australian sharemarket divided by forward estimates of earnings, has only been lower during the GFC and the 1990-91 recession ‘we had to have’. So on that basis alone, it appears that Australian shares may be worth buying.

However, the concerning part of that equation comes from the chart on the right, where the black line labelled 11/12 is trending sharply down. So whilst we may believe the “price” is low based on the PE ratio, the reality may be that it is “forecast earnings” are high. As forecast earnings decrease, the Forward PE Ratio will increase independent of price, and eventually may not look so attractive any more. Over the last 12 months analysts have consistenty decreased their forecast earnings for the Australian sharemarket and the current trend does look a tad worrisome.

So before you consider that a sharemarket is cheap (or hear it from a fund manager!) because the Forward PE Ratio is low, please consider whether forecast earnings are too high and likely to decrease….which is easier said than done…as the PE Ratio is a dangerous measure to be used alone.

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